The economics of Scotch whisky

I was interested to see that the Grant family of Dufftown, Banffshire, in Scotland are collaborating on an MBA with Strathclyde University. The Grants are more familiar as the owners of Glenfiddich, the world’s best selling single malt whisky. And I did their distillery tour only this weekend.

Whisky is not only a global industry with a product of great appeal (to me at least). I now realise it’s a great example of: i) the power of marketing; and ii) the importance of time in business.

The marketing is critical to differentiating hundreds of types of whisky that all originate in three ingredients: water, barley and yeast. Much is made by Glenfiddich (and others) of their wonderful spring water, used to make the whisky in the town of Dufftown, the self-styled whisky capital of the world. But there are dozens of distilleries using water from nearly identical sources. And most of them (including even Glennfiddich) use distilled water to reduce the whisky strength from the 55-57% cask strength down to 40% normal bottle strength, which they do in or around Glasgow, much more efficient for distribution of the finished bottles.

Meanwhile everyone cheerfully tells you that two thirds of the taste comes from the time the whisky spends in the cask (barrel). Most is matured in US bourbon casks which can only legally be used once so become surplus to be sold to a grateful Scotch industry. Some goes into sherry casks which are much more expensive and rare, as the sherry industry is contracting.

Curiously, whereas American bourbon must use brand new oak casks (flamed inside to create charcoal), Scotch virtually never uses new casks because they lack flavour. One theory was that American coopers (makers of casks) secured this legal requirement to protect their employment but I haven’t been able to confirm that.

So each whisky’s taste depends on the combination of casks used, far more than the barley, water or yeast. After a little practice you can certainly tell the difference between Scotch aged in bourbon versus sherry casks, the latter being more sweet and fruity. But sometimes the manufacturers switch between casks so you get a more complex and rounded taste. Since most customers can’t tell the individual differences, the industry brands unusual combinations and sells them at a great premium.

There isn’t even a guarantee that older Scotch is better. After some point the alcohol falls to a point where it’s not strong enough to be sold legally as whisky. And the taste can decline after initially improving. Older Scotch is smoother but you can’t guarantee it tastes better.

Finally it’s a curious business financially. You must age whisky for at least three years before you can sell it as Scotch. So a new distillery is cash negative for at least three years. And the best selling stuff is typically 10 or 12 years old. So changes in demand now cannot be met by doing anything other than waiting. You have a vast inventory so I imagine there is a hefty working capital required. And how would you evaluate the decision to invest in new capacity? It would be a very long and rather speculative discounted cash flow model.

But Grant’s don’t disclose much information, since secrecy and mystery are important to the marketing message. Cheers.

2 Responses to The economics of Scotch whisky

  1. I have had the chance to visit the cellar of the largest Armenian cognac (which is as far as I know the only company outside of France to be legally allowed to use the label cognac) producer Yerevan Brandy Company,currently owned by Pernod Ricard. Just like whiskey, the brandy production has its technology which seems to be a bit more complicated. The high volume alcohol is distributed in few sorts of pure oak barrels where it is stored from 5 years (a minimum) to 70 years (maximum). Crystal clear water flowing from mountains located ~2500-2800 meters above the sea level is used. The oldest alcohol in the production recipe of the 20 year aged brandy is 70 years.
    The final product has a great smooth taste and contains all of the few proceeding flavors brandy has.
    Nairi (the most popular 20 year aged brandy) is made from 18-20 different blends.

  2. P.S.
    The syndicate of insurance companies which underwrote the Brandy Company’s policy faced in 1998s an extremely difficult task of estimating the monetary value of the various sorts of alcohols in the barrels kept in the cellars because they were all of different age and grape harvest year.
    It seems like you can’t really derive this valuation from the cost of a bottle of the final product because the volumes of mixture and sorts is not disclosed.
    Unfortunately I don’t know how they sorted the problem in the end, but it would be extremely interesting to learn about the valuation model.

Leave a reply

This site uses Akismet to reduce spam. Learn how your comment data is processed.

We are using cookies on our website

Are you happy to accept our analytics cookies, which help us learn about our website visitors and their use of this site? Learn how to disable all cookies.