China’s crackdown on the “erotic sector” as part of an official anti-extravagance drive is posing a serious threat to the cognac industry, as Beijing closes karaoke and hostess bars where European drinks companies make a large chunk of their mainland profits.
Drinks analysts say the Chinese government’s crackdown on prostitution, betting and drugs – launched in February in the southern city of Dongguan – has already had a major impact on sales of high-end imported spirits.
China Market Research Group in Shanghai estimates that as much as 30 per cent of cognac sales overall in China are made to karaoke clubs, bath houses, hostess bars and other erotic sector venues. The researchers say those sales may have taken a hit of as much as 50 per cent since the launch of the latest anti-prostitution campaign.
Pernod, which derives around 12 per cent of its €8.6bn annual net sales from China, says about one-fifth of this China business goes through karaoke bars, wh – and sales through these venues, known as KTVs, are in “double-digit decline” in the year to date.
Cognac is popular with China’s rich private sector businessmen, who often entertain at venues where female companionship is also available. More than 2,400 such venues have been closed in the latest campaign, according to figures from the Chinese public security ministry.
“This latest clampdown is significant for the cognac sector because . . . it started in southern China where cognac consumption is highest,” say drinks analysts Trevor Stirling and Nicole Thain in a recent Bernstein Research note. “It is focused on private consumption and business entertainment, which is much more oriented towards western-style spirits and especially high-end cognac.” They estimate that the so-called “yellow” sector is “the most profitable channel for the cognac houses” in China.
Cognac sales in China totalled more than 27m litres in 2012, according to Euromonitor, more than double the level of 2007 and well above the 21m litres of whisky sales. Ninety-five per cent of this market is split between LVMH, Pernod Ricard and Rémy Cointreau.
Pernod Ricard, in a recent analyst presentation in Asia, highlighted the increasing impact of China’s anti-corruption campaigns – including what it called “recent action” on KTVs. “We’re in the process of expanding our activities with new offerings and geographic footprints,” it said.
It was a similar story at Rémy Cointreau, which makes $2,000-per-bottle Louis XIII cognac and controls 20 per cent of the cognac market in China, according to Euromonitor. The French distiller’s Chinese sales fell by a third year-on-year in its most recent quarter.
Previous government crackdowns have hit drinks consumption hard, slashing sales of high-end Chinese white liquor or “baijiu” – the preferred tipple of government officials. The impact has been so severe that it has forced the baijiu industry to go downmarket to target new consumers.
“This austerity policy is not going to decline,” says Luca Marotta, chief financial officer at Rémy Cointreau. “On the contrary, the government is stepping up its actions this year.”
China’s growing wealth and population means it remains a prominent market for premium drinks groups. Rémy Cointreau already derives 60 per cent of its cognac revenues from Asia and the rest of the world.
“Market growth will not come from one product or another,” says Mr Marotta. “It will come from demographic developments in China.”
But the heady days for $2,000 bottles of liquor in China could be over, says Ian Shackleton, an analyst at Nomura.
The spirits market will continue to grow in the medium term, he says, but “we feel that the ultra premium is not coming back in the same way. If you are Remy and focusing on the top end of the market, you will struggle.”
Huang Wei, Shenzhen-based food and beverage analyst with Citic Securities, says the impact will depend on how long the crackdown lasts. It is affecting other high-end liquors such as whisky, he adds. “People who go to those kinds of places prefer cocktails, and baijiu is not good for mixing in cocktails,” he notes.
“It is possible that many of these bars will ultimately reopen and/or that business shifts to other bars that are not tainted by the ‘yellow’ sector,” say the Bernstein authors.
But Mr Huang thinks the end result could be a more broadly based cognac industry in China that works to develop demand among the middle class as well as big spenders.