#125 The Hangover (Pt. 4) – Diageo in India
In 2012, media such as Forbes reported on a landmark deal between the world’s largest maker of spirits, British company Diageo, and India’s “King of Good Times”, Vijay Mallya. For over $3 billion (and a few other incentives including sponsorships for Mr. Mallya’s formula one racing team), Diageo acquired a 55% stake in Mallya’s United Spirits Ltd. (UCL), which had more than 50% of market share in India. It seemed to be a match made in heaven, and certainly a dream come true for Diageo, which had launched an unsuccessful wine business in India in 2006 that it shut down again after only three years, and that had also formed an earlier, failed joint venture with the country’s second-biggest liquor firm, which found its end in 2011. And it was a dream come true for Mr. Mallya, too. The glitzy entrepreneur’s ornate conglomerate at whose heart is Kingfisher Airlines, had run into financial difficulties and desperately needed the cash infusion. Not only had he personally slipped 24 notches in the Forbes Asia rankings of wealthiest people – from No.49 in 2011 to No.74 in 2012 – but he also struggled to keep his businesses afloat. When the deal closed in 2013, things still looked peachy nonetheless, at least for Diageo. The deal provided them with access to a market with an increasing thirst for alcohol, but also with sourcing, bottling, and distribution infrastructure as well as network relationships. The deal made India the second-largest market for Diageo’s brands, which include Johnnie Walker whisky and Smirnoff vodka. But soon thereafter, things deteriorated.
Although Diageo had been aware of their new partner’s financial challenges – which were the drivers behind the deal in the first place – the company was in for some surprises. Or, at least, they say so. Diageo discovered that companies within Mallya’s empire were “intricately, and confusingly intertwined” (as the Wall Street Journal has put it). Funds in the millions had been diverted from some companies to others – mainly to Kingfisher to cover rising fuel costs and deal with mounting debt – with little record or prospect to be repaid. Initially, Diageo claimed not to have known of any of this, and only learned of the irregularities after forensic audits by PwC and Ernst & Young. But as it surfaced recently, even the then COO of Diageo (and later CEO), Ivan Menezes, had knowledge very early in the beginning, as the Indian Economic Times reported. In addition, there seem to have been several cases of bribes paid to Indian politicians in various regions in order to provide UCL with favorable treatment, all recorded in a handwritten ledger that Mr. Mallya shared with Diageo executives, as the Business Standard writes. Meanwhile, Diageo cut ties with Mr. Mallya in 2016 who left India for London amid criminal investigations of unpaid debts, possible money laundering and tax evasion. A parting gift of a $75 million severance package must have sweetened Mr. Mallya’s departure. Investigations continue in India and in Britain, and extradition proceedings are under way.
Asking the “Why” question has become very popular in recent years. I can’t help but asking “why” in this case, too. Why was Mr. Mallya behaving the way he did? Was it just the immediate pressure of mounting debt, or was there more in the external environment that may even be typical for doing business in India? Especially considering that other Western companies face similar challenges in India. British Petroleum (BP) was fined $1.55 billion in connection with a gas-drilling joint venture in India. Vodafone received a $2.2 billion tax bill when India changed its tax laws in 2012 – after the company had acquired India’s largest telecommunications company for $16.4 billion. Daichi Sankyo saw its acquisition of a majority position in Indian Ranbaxy Laboratories at stake when the latter agreed to pay a hefty fine of $500 million in the United States – shortly after the deal had closed, of course. And why did Diageo choose to ignore what they seem to have known from the beginning, but then take Mr. Mallya to court much later? Lots of material to think about and to discuss here.
July 30, 2017 @ 6:45 pm
Vijay Mallya, the king of good times failed to prove his business acumen when charged with title of “willful defaulter” by the banks, that he chooses to live in exile and forced himself to escape from India leaving behind a huge debt burden. He was once celebrated in India for his flamboyant lifestyle and was the sweetheart of corporate giants and politicians. Mr. Mallya was a born businessman who went on to build the India’s largest brewing industry and Worlds largest in its volume. The huge empire of Mallya was not built in one night, it took him years to plan a business strategy to enter in to the brewing industry which was looked down in the traditional Indian values and still some states prohibit the sale of alcohols in India.
Mallya’s commitment to the breweries led to the tremendous growth of his United Spirits Limited empire which was formed out of Mc Dowell& co, Herbertsons Ltd, Triumph distillers, Vintners Pvt Ltd, Baramati grape Ltd, Shaw Wallace distilleries and four other companies. This marked the conglomerate of huge acquisition of one such kind in India in brewing industry. Kingfisher beer introduced by Mallya is still one of the leading brand in India. Apart from brewing industry, Mallya’s interest was also in sports and aviation.
Mallya owned the force one group in formula race, the first Indian to own a team and owned Royal Challengers Bangalore in Indian Premier League. All was good in history of Mallya until he took a decision to enter in to aviation field which was in its nascent stage in India. Sustaining in Aviation sector was not an icing on cake in India. In the times of 2000’s, as India was moving towards jobless growth by 2005, most of the manufacturing sectors started to lag in production due to surge in prices of raw materials, lack of huge investments, rapid mechanization throwing out the demand for labor market, technological growth leading to service sector growth which catered to 65 % GDP providing 35% job market. The Agriculture sector corresponds to 50 percent of GDP but was left unnoticed and abandoned by the government leading to less production and money flow thereby pricking the growth rate of Indian Economy with surging prices of food, fuel, real estate, and growing population that couldn’t meet with nominal salary standards. This was the time Mallya plunged into aviation sector with Kingfisher airlines, “Kingfisher does not adopt low cost, no frills model but chart the middle course” – Alex Wilcox, CEO, Kingfisher , but soon the airlines started to wither away from its motto when it acquired a low cost Air Deccan in 2007 with the desire to handle international operations . This was the worst mistake that led to the downfall of the king of good times.
Mallya never wanted to accept the fact that his dream aviation Kingfisher airlines was not flying high, so he started to deviate the funds from brewing industry to airlines to invest more in nothing good which crippled the ledgers of the united Spirits Limited, Meanwhile Mallya was seeking to sell some of his shares in USL to compensate for losses. This is when Diageo comes into scene, which already has lost to find grounds in India but still in hunt to establish its empire in India. The desire of Diageo to enter the growing young market of India made it unstoppable to decline the deal with Mallya though it was aware of the ledger discrepancies.
Diageo was determined to buy shares of USL and the buying of shares started from 27 May 2013 and by end of 2014, Diageo became the major shareholder of USL after which Diageo started to dig out the ledger fallacies and when Mallya was issued arrest warrant owing to willful defaulter tag, Diageo offered a $75 million deal of non-interference with company activities for 5 years and Mallya resigned with immediate effect in Feb. 2016.
Is it the mounting pressure of debts or the external environment to be blamed? In this case of Kingfisher Airlines, the external environment for huge investments in aviation sector in jobless growth economy of India is threatening and highly risk taking. The global economy with surging prices of crude oil in India became a devil in disguise for Kingfisher Airlines. The acquisition of Air Deccan, which was collapsing further led to loss and within a year the debt started to grow and in Nov 2010 it reached 6000 Crore subsequently leading to the closure of Air Deccan in Sept 2011. Though Mallya was Member of Parliament, it was too late that the government introduced FDI in aviation as Kingfisher was already dead in its fleet.
All the other cases stated in the blogs are entirely different from that of Diageo, which plunged into an entirely broke down business in a big market like India without any systematic verifications i.e., Mallya was trying to adopt a diversification in his business strategy, where there is no link between the brewing industry and aviation industry. The lack of knowledge of aviation section, high risks, huge investments led to high operating costs, mishandling of accounts, managerial inefficiency thereby closure of the airlines. Despite all this, Diageo choose to ignore the fact of discrepancies in ledgers as it was determined to enter the Indian market which is the largest for the alcohol industry. Diageo was interested only in the shares of USL and started to acquire as much shares as it can in short period of two years to become the major shareholder to bring situations in favor of the company. The Corporate readiness and Target Market selection of Diageo proved to be important to increase its hold on USL and its profits. Diageo’s step is a systematic international market entry with right approach towards buying of maximum shares in USL to come to win the favor of decision making power and control managerial activities by making Mallya a non-active founder Emeritus of USL group. Whereas Mallya failed in assigning the global strategy for kingfisher with crippling Air Deccan at the wrong time of market and took huge risk without any knowledge and lack of managerial control in airlines due to frequent internal changes in management led to downfall of king of good times.
The Organizational design and structure was neatly sketched for USL group by Mallya as he had rich knowledge of the industry with systematic mergers and acquisition and introduction of product varieties. It was like managing eggs in one basket and watching it like hawk with diligence, commitment, and hard work but when it came to Kingfisher airlines it was like splitting all eggs baskets leading to huge diversification with lack of managerial competency, funds, knowledge, and strategy.
The alcohol industry in India falls under the category of regular demand (i.e., the demand for the product prevails throughout the year) catering to big market which promotes a huge sales volume year around. The profits earned are huge to overcome all the overheads cost and to launch new varieties as the market is active all year around. USL, being the biggest seller in India sweeps the Indian market with its various brands among which the noteworthy are the Kingfisher beer and whisky which has an increase in sale volume year after year. These criteria would have been convincing for Diageo to ignore the diversion of funds from USL to Kingfisher airlines in the initial stages of buying the shares.
The product diversification of Mallya was not the right choice when he aims to plunge into international airline routes he made a choice of acquiring low cost airline which cant compensate the royalty that the Kingfisher provided for its passenger and by branding the Air Deccan as Kingfisher Red Mallya further lost the brand identity and reputation with poor services and soon passengers opted out of choosing Kingfisher which further worsened the scenario with non payments to staff of Kingfisher airlines followed by continuous strikes and walk off mounting the debt pressure higher and higher . Though the target market of middle class was right choice for kingfisher airlines it played a fool around by acquiring failed business of low cost Air Deccan and renamed it as Kingfisher Red and gave a second-hand treatment, this worsened the brand image to the core. The massive marketing strategy and campaign proved worthless when the brand reputation was spoiled incurring more losses.
The Branding plays a vital role in promoting the sales volume. Creation of brand and sustaining the brand value is equally important. USL has one of leading brands like Kingfisher beer, Pinky Vodka, Black dog 18 YO, 4 Seasons of Barrique Reserve, Whisky etc., that led to the strong hold of customer base and hence Diageo didn’t want to lose a huge customer base. Though Diageo was aware of fallacies in accounting practices to some extent it was ready to pay the price for the brand image and the profit that was reaped in every case unit sales. The target market selection of India with world’s youngest population, who are attracted towards the westernization and party culture made Diageo to bid for the deal with Mallya. Diageo was keen in acquiring the business of same industry, which it has immense knowledge, experience in business analysis and framing market strategies.
The strategy followed by Diageo was keen in marking its ground in India and to expand its business in India which holds a huge customer base. Moreover, becoming a major shareholder in well established brands will bring down the marketing cost and will earn the reputation for its array of products as it comes under one banner. The product life cycle need not concentrate much in introduction phase as the brand is well sought among the customers. Basically, both the companies don’t think about the future of this business deal, for Mallya, it was a source of fund and for Diageo, it was a very important market entry to India.
February 27, 2019 @ 2:42 pm
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