Foster’s new direction

Following the resignation of Foster’s CEO in June, the board’s decision in July to appoint one of its directors, Ian Johnston as acting CEO says two things. One is that the board is now firmly in control of the day-to-day management of the group and the other is that it is not going to rush the search for a permanent CEO.

Commentators have argued that it would have been easy for the board to have left retiring CEO Trevor O’Hoy in place while waiting for the new CEO to be found and for the results of the strategic review to be tabled.

With O’Hoy’s authority undermined by his voluntary resignation and the results of both the executive search and the review potentially not available until well into next year, there was a significant risk that a business already under pressure would lose more ground.

Apparently, Ian Johnston, a former managing director of Cadbury’s global confectionary business who joined the board last year, looks like a safe and capable pair of hands to provide leadership at a time when Foster’s faces several challenges.

Johnston joined the Foster’s board last September, two months before David Crawford became chairman. Mr Crawford went ahead with a boardroom renewal by adding former Diageo North America CEO Paul Clinton and National Australia Bank deputy chief executive, Michael Ullmer as non executive directors.

The number of new faces in the boardroom means that there is a significant constituency for change – the newer directors won’t feel defensive about the big wine acquisitions, particularly the AUD 3.2 billion acquisition of Southcorp, that now weigh so heavily on Foster’s performance.

The sense of urgency that Crawford has injected into the boardroom was reflected in the decision to conduct the strategic review and to bring forward O’Hoy’s departure. Importantly, the review is being driven by the board – not management – and is one where there are no preconceptions or ideas that are "off limits".

There are great expectations within the financial market that the review will produce radical change, with some expectation that it will lead to the demerging of Foster’s and its exit from wine. That’s possible, but not necessarily probable.

The big challenge facing Foster’s is not its management of its wine businesses, although that could and indeed has to be improved, but its exposure to currency movements and the volatility and unpredictability of grape production.

As Foster’s has pointed out, relatively modest movements in currency relativities have leveraged impacts on its earnings – in the last half-year presentation Foster’s said a 1 cent change in the Australian-US exchange rate would affect second-half pre-tax profits by AUD 2.1 million and a 1 pence movement in the Australian-UK exchange rate would affect earnings by AUD 4.2 million.

Since Foster’s bought Southcorp in 2005 the Australian dollar has strengthened from USD 76 cents to almost parity and from about GBP 42 pence to almost 49 pence, it was pointed out. That’s a fundamental change to the business environment for Foster’s that has undermined the economics of the diversification into wine.

It has been argued that one of the key issues for the current review of Foster’s wine business is whether an Australian-dominated wine production platform can ever produce acceptable returns from its exports.

Coca-Cola Amatil’s CEO Terry Davis, who was Managing Director of Foster’s wine business when it bought Wolf Blass wines in 2000, told a business luncheon in Adelaide on 23 June that wine companies are best run by families, not corporations. Citing Foster’s woes since attempting to absorb Southcorp in 2005, he said Australian businesses lacked the scale and product and packaging differentiation to succeed for an international corporate owner.

Whether Foster’s board will heed Mr Davis’ advice is open to doubt.

While Foster’s has positioned itself as a global leader in premium wine, a lot of the wine it sells isn’t premium, which makes it vulnerable to grape production gluts, currency shifts and all the other factors that make it difficult to produce consistent returns from the sector. One option would be to rationalise the Foster’s portfolio to focus purely on the higher margin brands with some pricing power.

That would also help make sense of a portfolio that is large and cumbersome. With hindsight, Foster’s should probably have sold at least one of its core brands after acquiring Southcorp – perhaps Lindemans – to create a more focused and manageable portfolio.

Certainly the size and complexity of the overall beverage portfolio has been a factor in the difficulty of implementing the multi-beverage distribution strategy in the domestic market, where the back office and supply chain gains offset by the customer confusion and resistance to the complexity of the Foster’s offer and the ‘one size fits all’ approach initially adopted in dealing with quite different customer groups.

While there are those in the market who see the failings of the multi-beverage strategy as evidence that Foster’s should structurally separate beer and wine and perhaps sell one or both businesses, it is more likely that Foster’s will remodel the customer interface and reintroduce some specialisation within its sales and distribution channels, rather than throw away the gains it has made through the strategy.

There is no certainty about the options the review will bring to the board. The board has asked for options but not recommendations, which underscores the reality that the board, not management, will take responsibility for the new strategy.

It is improbable, however, that the group, having painfully carved out a global position in wine, will abandon it at this point without making a final effort to prove that there is a model for a global wine business from which acceptable returns can be generated. There is, apparently, significant institutional shareholder support for that effort to be made rather than baling out of wine at a low point in the sector’s fortunes.

The appointment of Mr Johnston as acting CEO and the probable appointment of an outsider should for the first bring someone to the top of Foster’s who does not have a brewers’ background. The implicit accusation that brewers have run Foster’s into trouble is still grossly unfair since it has been the beer business that has funded Foster’s expansion into wine in the first place.

In any case, the results of a review that involves teams of external experts and the experience of confronting a strong Australian dollar and (once again) an over-supply of grapes could lead to a very different strategy for the wine business.