First published in the Financial Times on 20th May 2014.
It is easier to make money from people that have psychochemical dependency on a product
For the cynical entrepreneur, the perfect business is one that sells a legal, high-margin, addictive product. To my knowledge there are only three such industries: coffee, alcohol and tobacco. Each offers challenges, opportunities and moral dilemmas.
Coffee is certainly the least harmful of the three. It contains caffeine, which is mostly a beneficial drug – although the recent book Caffeinated: How Our Daily Habit Helps, Hurts, and Hooks Us by Murray Carpenter, points out some of the downsides. The industry is relentlessly consolidating, with newly merged groups such as Jacobs Douwe Egberts threatening Nestlé, the global market leader in the $81bn a year industry that commands a share of about 22 per cent.
All the big players, from Starbucks to Nestlé, seem to make juicy operating margins, stretching from 18 per cent to 30 per cent on categories such as Nespresso capsules. These are much higher returns than typical for food and beverage companies. The industry has been transformed in countries such as the UK and the US, where customers are migrating to more expensive espresso coffee. As a participant in the retail segment, I’m astonished at how demand for higher quality coffee continues to rise.
Alcohol is a much larger and more controversial trade. It is estimated to be worth $1tn a year globally. It gives considerable pleasure to hundreds of millions, but also causes a lot of damage. The Lancet, a medical journal, reckons it contributes significantly to one in 25 deaths, and the social costs amount to more than 1 per cent of gross domestic product in western nations. However, in Europe, which has the world’s highest consumption of alcohol per person, alcoholic drinks overall are in sharp decline. In Britain, for example, consumption has fallen 18 per cent in the past 10 years. I believe these behavioural changes are more to do with fashion, taste and new habits – including drinking better coffee and more beer and less spirits – than government intervention.
I have been a licensed victualler for 30 years, and inevitably have mixed views on the issue. It provides relaxation and employment, and alcoholic drinks have been part of our culture for many hundreds of years. In moderation, some argue it is beneficial to health. But it can wreck lives and cause substantial collateral injury. Unfortunately, a small minority of drinkers consume a large proportion of the total alcohol drunk, and thereby suffer disproportionately: they are the alcoholics. Moreover, governments are hooked too: for example, receipts from alcohol duties in the UK are about £11bn a year.
There has been considerable merger activity in the alcoholic beverage business in recent years. Big companies such as Anheuser-Busch InBev, SABMiller and Diageo now dominate the market. Distilling is certainly lucrative: Diageo makes operating margins of more than 30 per cent. Brewing beer and producing wine are less profitable.
Tobacco is the greatest villain of the trio. I have consciously avoided having anything to do with the cigarette business in my career. Smoking has essentially no redeeming features, and is the most addictive and deadly of all the legal activities described here. It is believed to kill almost twice as many people a year as alcohol, or 6m. Three companies have more than 60 per cent of the global cigarette market – China National Tobacco, Altria and British American Tobacco. The total business is worth about £500bn. All enjoy huge margins: for example, in 2013 Altria’s operating income was 33 per cent of sales. Of course, the western companies are also engaged in a related activity: defending against litigation. They are constantly battling lawsuits and, like the alcohol businesses, face steadily declining markets in developed nations but growing ones in emerging economies.
Two facts are clear from the three principal industries selling addictive consumables: margins are high, and global consolidation is very advanced. Regulatory and ethical issues probably only enhance profitability for the incumbents. It is easier to make money from customers who have psychochemical dependency on your product than from those who possess discretion about their purchases. But entrepreneurs and investors selling such non-medical drugs still have to deal with their consciences.