Demand apparently is so good for Beam's (NYSE:BEAM) Maker's Mark brand of bourbon that it's decided to lower the alcohol content by three percentage points, from 45% alcohol by volume (90 proof) to 42% (84 proof), in order to meet its customers' thirst for the product. Those who like their drinks strong are no doubt appalled by the company's decision. Shareholders, on the other hand, could be in for a windfall. What are the financial ramifications of this decision? Let's have a look.
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Why the Decision?
Maker's Mark is one of Beam's seven power brands. With the exception of Pinnacle vodka, Maker's Mark had the best comparable net sales growth in 2012 of its top brands. Last year, it raised prices on both its Maker's Mark and Jim Beam brands of bourbon. Like the age-old trick by chip companies and so many others in the consumer packaged goods industry, where they shrink the size of the bag while leaving prices the same, Beam has concluded that it can't raise prices any further, so it's doing the next best thing and watering down its product. In a letter to its best customers, Rob Samuels, chief operating officer, had this to say about the move:
"... demand for our bourbon is exceeding our ability to make it, which means we are running very low on supply ... after looking at all possible solutions, we've worked carefully to reduce the alcohol by volume (ABV) by just 3%. This will enable us to maintain the same taste profile and increase our limited supply so there is enough Maker's Mark to go around, while we continue to expand the distillery to increase our production capacity."
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Clearly, Beam wants to spin this as an effort to meet customer demand and not one of margin expansion. However, if it were really committed to meeting customers' needs, a reduction in the size of the bottle from 750 to 700 milliliters (the standard in Britain) would possibly achieve the same result.
Most people don't realize that whiskey is distilled at levels of alcohol much higher than the proof it's ultimately sold at in order to deliver consistency across various batches. For example, one batch of Maker's Mark might come out of its distillation process at 70% alcohol by volume and then 75% the next. To achieve 45% alcohol by volume (soon to be 42%) each and every time, it adds water to the bottle. So, now that the company has decided to lower the alcohol content by three percentage points, it's effectively reducing the alcohol content prior to bottling by anywhere from 35 to 44 percentage points. Therefore, the cost to reduce the alcohol content is the extra water required for thinning; it's minimal at worst.
Unless consumers boycott the new "Maker's Mark," which is hard to imagine, given that plenty of bourbons are sold at 40% alcohol by volume, the cost to the company will be negligible. In fact, using a quick home distilling calculator, I've determined that a 750 ml bottle of Maker's Mark under the new alcohol content will require an additional 12.75 ml of water and 12.75 ml less ethyl alcohol. Working backward, the reduction in alcohol would generate an additional 416,398 bottles, or 46,266 cases, and approximately $2.4 million in additional revenue.
The more interesting question is what would happen if the company kept the ABV the same but shrank the bottle by 50 milliliters, as suggested earlier. A quick calculation yields an additional 80,000 cases (8,400 ml vs. 9,000 ml) by going this route and approximately $9.6 million in revenue. While neither figure is insignificant, it's a drop in the bucket for a company whose 2012 revenue was $2.5 billion.
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The Bottom Line
I must admit that I'm completely perplexed by Beam's decision, given the economics of it. There's not much to gain in terms of increased case production by using either method. This is nothing other than a move to generate greater profits from each bottle of Maker's Mark sold in the future. If I'm Diageo (NYSE:DEO) or Brown-Forman (NYSE:BF.B), this probably comes as no surprise. If you're a shareholder, the good from this move probably will outweigh the bad.
At the time of writing, Will Ashworth did not own any shares in any company mentioned in this article.