• by Karlene Lukovitz  @KLmarketdaily, June 1, 2010

Pinched by declining sales in their traditional categories, retailer pricing pressure and other factors, beverage makers are increasingly looking to acquire or partner with companies outside their core product segments as a growth strategy, according to a new Rabobank report, "Convergence in the Beverage Sector."

This "convergence" strategy of expanding into new beverage sectors is expected to become even more common among both non-alcoholic and alcoholic beverage companies going forward, reports Rabobank, the leading banker to the global food and agriculture industries.

"Beverage companies are at a watershed moment," observes Stephen Rannekleiv, food and agribusiness research and advisory executive director for the bank. "With an unprecedented level of margin pressure and changes in consumer preferences, beverage companies must develop new strategies to improve profitability."

Properly managed, mergers and acquisitions, joint ventures or distribution agreements can be used to grow revenue, increase operating efficiencies and improve the strategic positioning of a company's brand portfolio without cannibalizing existing brands, Rannekleiv says.

Changing consumer beverage preferences have been one driver of convergence. In the mature U.S. and European markets, consumer health concerns, combined with greater interest in new products, continue to cause carbonated soft drink (CSD) sales to lose share to bottled water, ready-to-drink teas and other noncarbonated beverages. In the U.S., CSDs' share of non-alcoholic RTD beverages dropped from 85% in 1998 to 64% in 2008, while bottled water's share grew from 4% to 20% and other noncarbonated beverages' share grew from 11% to 17%, according to the report.

As a result, U.S. bottlers have seen steady margin erosion. For instance, Coca-Cola Consolidated, the second-largest C-C bottler in the U.S., saw margins deteriorate from 47.5% to just under 43% between 2002 and 2009, and its noncarbonated beverage sales grew from 10% to 17% of its portfolio during that time frame, Rabobank reports.

Since the recession, consumer price sensitivity/trading down have also become an important factor. In the non-alcoholic sector, for example, Coca-Cola's Vitaminwater and other Glaceau brands saw double-digit declines in the U.S. last year, after seeing 102% growth in 2008, the analysts point out. Coca-Cola responded by acquiring the small but rapidly growing Energy Brands company.

Within the alcoholic sector, a shift toward new drink choices is also ongoing, and price resistance began eroding EBIT margins as of 2008. During 2009, four of the five largest spirits companies reported declines in these margins ranging from 0.17 to 2.28 percentage points.

Beverage acquisitions/partnerships are sometimes driven by more attractive margins in the target segment, notes Rabobank. For instance, Constellation Brands, whose core business is wine, formed the joint venture Crown Imports with Grupo Modelo to participate in the higher margins offered by beer. (In 2009, Constellation's return on assets for Crown Imports exceeded 21%, versus 6% for its wine/spirits division, per the report.)

Going forward, however, the existing level of consolidation with the industry -- combined with growing antitrust obstacles -- mean that the inability to expand within a company's core segment is likely to be a dominant factor in M&As and partnerships. In the U.S., the top two non-alcoholic RTD suppliers now own a combined 65% of the market, and the top three rum suppliers and top two beer suppliers now own 75% and 78% of their markets, respectively, the report points out.

Ongoing consolidation of retailers in the U.S. -- and consequent increased pricing and alternate delivery pressures from retailers -- are also driving beverage company convergence strategies. (The top five U.S. retailers increased their share of market from 39.6% in 2001 to 62.3% in 2008, while smaller retailers' share shrunk from 18% to 5.6%, Rabobank reports.) To improve the balance of power and realize competitive advantage, beverage suppliers are increasingly growing their portfolios with "critical" brands, the analysts note.

In addition, the operational cost reductions/efficiency improvements, infrastructure/distribution expansion and cash flow balancing benefits that are often possible by combining operations across beverage segments/companies are spurs to convergence.

Potential pitfalls in these strategies include "converging into lower margins" (major spirits companies have been exiting the wine business for this reason) and overpaying for an acquisition.

Areas of convergence opportunities within the beverage sector, according to Rabobank, include M&As/joint ventures between global soft drinks and beer companies (example: the new purchasing partnership between PepsiCo and ABI); large soft drink companies investing in growing juice and dairy segments (especially products with health/wellness positioning); global spirits companies and breweries merging or collaborating to add revenue, improve efficiencies and avoid U.S. antitrust obstacles (Diageo, as well as Constellation, now has a significant beer portfolio); and U.S. wineries and microbreweries joining forces to take advantage of the lowering barriers between the traditional distribution systems for the two beverages.

In addition, emerging markets may offer value-enhancing opportunities for a number of types of cross-segment initiatives, including soft drinks/dairy/juice and soft drinks/beer collaborations or M&As, Rabobank concludes.