Peter Jones: The headlines may be bad, but Diageo has got it right

IF YOU want to understand the long-term plans of Diageo, a giant drinks company that this week announced it was cutting 900 jobs in Scotland, then I recommend a visit to the Morayshire coast.

Looking behind the dreadful headlines, there are lessons there worth learning for any business. And at Roseisle, not far from RAF Lossiemouth, you will see something rearing up out of the flat farmland that looks like a supertanker beached up against a petrochemical works. Actually it is a distillery, a vast distillery, and economies of size are what these announcements are all about.

The new Roseisle distillery, built for about £80 million, will produce about ten million litres of pure alcohol a year, or about 7 per cent of total annual whisky production. This mega-distillery is far removed from traditional ideas of a granite-walled distillery with its funny little pagoda-hatted roofs. And when it is up and fermenting, it will employ only about 25 people.

Compare that with the 900 people who are going to lose their jobs in about a year's time with the closure of the Diageo Johnnie Walker packaging plant in Kilmarnock and the Port Dundas grain distillery in Glasgow, and you begin to see the strategic logic.

The pattern becomes even more obvious when you look at the good news in the announcement – that 400 jobs are to be created with further expansion of the Cameronbridge distillery at Leven in Fife and its associated packaging plant. This is already the biggest grain distillery in Europe and now it is about to get even bigger.

Roseisle was conceived when the global sales volume of whisky appeared to be ever-increasing. And of course, between the initial production of the alcohol for whisky and its bottling for sale, is a period of several years.

This is a long-term business: if you want to increase sales in five years' time, you need to start expanding production facilities now. The time delay is even longer if it is malt whisky sales that you want to expand.

So it would be reasonable to presume that Roseisle's output was intended to become saleable at a point when global demand for whisky had risen to such a point that it was easily able to soak up an extra ten million litres of whisky. Even more reasonable when you consider that last year, demand for malt whisky exceeded supply and Diageo, among other companies, was rationing supplies into some markets.

And it would also be reasonable to presume that the recession is reducing demand, as recent indications from the Scotch Whisky Association seem to imply. Therefore, the recession might be blamed as a motivating factor for this week's job-cutting announcement.

But only up to a point. Diageo has long been engaged on a strategy where distilling and all the associated bottling and packaging activities are being concentrated into a smaller number of mega-sites.

An important aspect of the announcement about Kilmarnock was that the site was not capable of expansion. This week's announcement, I suspect, would have been made anyway at some point over the next few years. The recession merely brought it forward.

The net loss of some 500 jobs, plus the reduction in the number of production sites, will be a big saving for Diageo. This, plus the savings that are being made on production reorganisation in Ireland and some other cost reductions, are expected to save it about £120m a year by June 2010 and a further £40m a year by mid-2012.

It is at this point that accusations of corporate greed usually appear, especially when you note that Diageo recorded a post-tax profit of £1.5 billion in 2008. But this is a tough and competitive world, and any management that does not keep a focus on reducing costs will soon find itself driven out of the door by unhappy shareholders.

From a business perspective, the story behind the nasty headlines that have surrounded Diageo this week is of a management with a long-term, profit-growing strategy, flexible enough to be changed because of changing circumstances.

And that is a model that any management ought to have.

Unfortunately, many don't, a point underlined by a PricewaterhouseCoopers survey published last month of people engaged in trying to turn round businesses from trouble into health.

The big message from this survey of 150 turnaround specialists is that they are being called in too late. As a result, they reckon half of the companies they are called in to rescue from distress will fail. That is because they when they do arrive, they find companies struggling with debt, which is by far the biggest problem, closely followed by inexperienced management working on bad strategies and poor business models.

These are very basic business problems being cruelly exposed by the recession. Diageo has shown how to avoid them.

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