The Canadian Distillery Industry

Domestic Market

The domestic market for the distilled spirits industry grew slowly during the 1996 to 2005 period. The value of the Canadian market (defined as shipments of own manufacture minus exports plus imports) stood at $935.5 million in 2005, which represents a value increase of 78.6% from 1996. (See statistical page at the end of the profile). Population growth and shifts in consumer taste for new products brought about a modest increase in per capita consumption of spirits by Canadians over the age of 15 (from 5.07 litres per capita per person in 1996 to 7.02 litres per capita per person in 2006).

Sales of spirits in 2005 measured by volume totalled 141.5 million litres, up 3.6% from the previous year. Canadian products represented almost 64% of these sales. Whisky products such as, Canadian, Scotch and Bourbon accounted for almost 30% of all spirits sales in Canada in 2005 and almost 80% of these sales were Canadian whisky. Value of sales of spirits grew in all regions of Canada except Newfoundland and Labrador.Footnote [Note 2]

Higher prices, due in large part to high taxes, coupled with lifestyle trends with preferences for beverages with lighter alcohol content as a result of health consciousness and social concerns about drinking and driving contributed to flat domestic sales of spirits between 1992 and 1997. Since then, total spirit sales have shown a moderate increase growing at a steady rate of 4% annually from 1997 to 2005. Footnote [Note 3]

In 2006 sales of vodka surpassed the sales of Canadian whisky for the first time, making vodka Canada's favourite spirit Footnote [Note 4]. This indicates a shift in consumer taste as young Canadians are choosing cocktails more frequently. Vodka provides the most neutral base for mixed drinks and is particularly good to mix with the new flavoured liqueurs on the market.

The domestic beverage industry is also experiencing increased pressure from imports for which Canadian consumers have been developing a taste. Imports, which in 1996 were 43.2% of the domestic distilled beverage market, increased to 58% by 2005, from $226.3 million in 1996 to $598.5 million in 2006. At the same time, the sales volume of imported products in the spirits markets grew at an annual average rate of 5.7%, compared to 4.1% for domestic brands.Footnote [Note 5]

Overall in the six major spirit categories (whiskey, rum gin, vodka, brandy and liqueurs) imports displayed a healthy 5 year gain of 4.2% compared to only 0.8% for domestic brands according to Beverage Marketing Corporation.

The largest increases in imports came from bourbon, fruit brandy, Irish whisky and rum. Products such as grappa and limonjela have become important examples of specialty products.

Recently, there have been indications that the decline in retail sales has been halted. According to Spirits Canada (formerly the Association of Canadian Distillers), domestic market retail sales registered modest gains during the 1998-2005 period. In 2005, sales in Ontario grew 3.7% on the previous year.

Figure 2: Distillery Shipments of Own Manufacturing Canada, 1996-2005.

In 2003, the number of establishments had increased slightly to 22 from 20 in year 2000; however manufacturing shipments decreased to $905.9 million from $946.8 million during the same period.

The distillery industry has traditionally been an export-oriented sector but its performance in the market has lagged in recent years. In 1996, the industry exported 64.8% of its production, compared to only 49.7% in 2005.

Figure 3: Trade Performance, 1996-2006

Despite the value of exports decreasing from $548.5 million in 1996 to $384.9 million in 2006, there has been an increase in the export volume. In 1996 the total volume exported was slightly over 75.4 million litres, while in 2006, 83.6 million litres were exported.Footnote [Note 6]

Although the industry faced problems in the domestic market, performance in the export market was positive throughout the 1990s, aided by a lower valued Canadian dollar and improved access to the US market. As a result of the NAFTA Agreement exports performed well during this period.

Recently, because of a higher valued Canadian currency, Canadian goods have become more expensive in US markets. To compensate for this problem the industry has maintained volume at historical levels.

Export performance for the industry is driven by demand for its products in its largest market--the US --particularly for Canadian whisky. The industry's heavy dependence on demand for a single product is reflected in the fact that Canadian whisky represents almost 90% of the total value of distilled product exported globally for most of the 15 years prior to 2006. Exports began to lag in the US market as distillery products as a whole began to fall from favour in the eyes of US consumers. In recent years, the US market for distilled spirits has improved somewhat but much of this improved demand has been for non-whiskey products such as vodka and rum.

Japan is the second major importer, averaging just over 3% of Canadian export volume from 1996-2006. Sales to Japan were hampered due to economic difficulties in the Japanese economy in the late 1990s and more recently by an ageing of the population.

The pattern in Western Europe has been similar where sales have remained relatively flat. With disappointing results in developed countries, the industry is now turning to emerging markets. Companies have been turning their attention to markets, such as India and to Eastern Europe where over the past few years progress has been made in improving market access as a means to regain sales.

Bulk shipments to Japan and the US accounted for most of the increase in exports in the mid-to late 1990s as moving product in bulk rather than fully packaged or bottled was more economical. Bottled shipments decreased during that period, indicating a trend away from the sale of branded products. An additional reason for increased bulk shipments has been sales to companies that bottle and market products under their own labels. For example, one of the best selling Canadian whiskies in the US had been shipped in bulk from Canada and then bottled and distributed in the US by the US brand owner.

While the decline in bottled shipments was partially due to lower consumption levels in the US, US companies bottling bulk Canadian whisky often sell it for a retail price significantly below the price of premium bottled brands imported from Canada. Canadian manufacturing firms are thereby in the position of supplying a bulk market that can undercut the market share of their own branded bottled products.

Spirits Canada maintains there is evidence that the movement of bulk shipments is declining, particularly with premium products where there has been some new product development activity and where there has been a return to cased and bottled export sales in the 1999-2006 period.

Employment

The distilling industry has come through an extended period of restructuring. Through the late 1980s and into the 1990s, a number of establishments closed while others experienced excess capacity as demand in the domestic market lagged for spirits. The industry's slow sales contributed to production declines and losses in employment. In 2005, approximately 1946 people were employed in the distillery industry. (Due to changes in Statistics Canada's survey methodology the employment data is not directly comparable to previous years. See Changes Affecting Historical Comparability of Data (external PDF).

Investment

Statistics Canada's data indicate a static market for distillery products, while the average annual growth of investment in capital construction in new buildings declined in the latter half of the 1990s. Investment in updating and replacing machinery and equipment continued to average around $26.7 million annually throughout the decade.

The distilling industry investment strategy has focused on re-sizing and re-positioning to serve a changing market. During this time, firms have upgraded production technologies, partially in bottling processes, where glass has been replaced by polyethylene terepthalate (PET plastic) for some lines. There has been investment activity in new product line extensions, which have included new premium and super-premium products in some cases.

Structural Factors

Canadian distillery operations have traditionally had a solid worldwide reputation for quality, particularly Canadian whisky. Despite industry rationalization, the domestic distilling industry is still considered large by world standards. Traditionally, Canadian beverage alcohol plants have had sufficient size which gave them better access to competitively priced inputs, including corn, rye, distillers malts, and packaging to enable them to be internationally competitive on production costs.

Canadian distillers purchase approximately 10.5 million bushels of corn annually in the production of distilled spirits, representing 2.2% of total Canadian corn production; the majority of which is sourced from Ontario although some is imported. Distillers traditionally have had a ready access to adequate supplies of competitively-priced grain ingredients. The base alcohol for distilled spirits is derived primarily from corn Footnote [Note 7]. This base is then flavoured in different ways to create a variety of spirits products. For example, distilled rye is used as the main flavouring component of Canadian whisky. The industry also buys small amounts of malted barley for whisky production.

Distillery company profits may fluctuate somewhat with changing grain prices, but these costs are not considered a major issue compared to sectors such as the animal feed industry which are much larger grain users. The distillery industry uses only one percent of the North American corn crop.

The increase in demand caused by a rapidly growing ethanol industry generated dramatic increases in corn prices across North America in 2006. These price increases are of concern to food and beverage makers including distillers.

Because the industry exports nearly half of its production, the higher value of the Canadian currency has negatively impacted the profitability of the distillery industry.

Brand recognition, international reputation and consumer loyalty are very important to the distilling industry. As a result, the ability to advertise is very important. Until recently, restrictions on advertising of alcoholic beverages made it difficult to introduce new products to increase market share and to compete against other beverages. These restrictions have now been lifted.

It should be noted that distribution and product availability are restricted because distilled spirits for home consumption are sold only through provincial liquor board outlets.

Trade-Related Factors

The Canadian market is more open to imports as global trade expands. Under the North American Free Trade Agreement (NAFTA), whisky and rum tariffs were eliminated between the US and Canada, and other tariffs have been phased out since January 1, 1998. Relevant excise levies on imports, equivalent to those applied to domestic products, remain in both countries.

NAFTA has eliminated both tariff and non-tariff barriers, which in the past had limited access to the Mexican market. Similarly, the industry gained improved access into Japan in the mid-1990s, when a World Trade Organization (WTO) panel ruled against discriminatory taxes that favoured domestic spirits. While these developments provided an opportunity to increase Canadian exports into Japanese and Mexican markets, the industry has not been able to turn these improved access opportunities into increased sales over the longer run.

The trade balance in 1996 with all countries was $322.3 million and increased to $344.8 million in 1999. However, it then declined steadily to reach a trade deficit of $213.7 million in 2006. The deteriorating trade balance highlights the industry's vulnerability due to its heavy dependence on a single product, i.e., Canadian whisky. In North American markets Canadian whisky has lost some of its popularity relative to other spirit products and to other alcoholic beverages such as wines.

In the case of trade with the US, the rate of growth of imports has also been stronger than exports but the balance of trade remains in Canada's favour.

The industry has traditionally concentrated on the US as its priority market, but there is recognition with trade liberalization that there are opportunities improving in both South America and Latin America, including Mexico. Such opportunities are of strategic importance to growth of the Canadian distillery industry given the unrestricted access to the Canadian market other countries now enjoy.

Non-tariff barriers have a significant influence on world trade in distilled spirits. An important element is whether a spirit is recognized as a geographical indication or distinctive product in the legislation of the importing country. Such recognition protects the product from being blended with any other product, protects its prestige and enhances marketing efforts. Canada, for example, recognizes spirit drink names such as Scotch and Irish whiskies, bourbon, tequila, cognac and armagnac.

In Canada, distillers can import bulk spirits only for blending with domestic spirits. The Canadian distillery industry does not bottle products such as Scotch or Irish whisky, or cognac.

Although Canadian whisky must be produced in Canada, it is not necessarily shipped from Canada directly to foreign markets around the world. Some companies ship to central warehouses abroad and then distribute product to other countries. This means it can be difficult to determine the ultimate destination of products shipped from Canada. In some instances products are exported in bulk and bottled locally, thus reducing the freight cost.

One reason imports have captured close to one-half of the Canadian market is a consumer preference for variety, partially driven by a growing multicultural population. In addition, liquor boards are becoming much more market-oriented. Liquor boards increasingly monitor changing tastes in their respective domestic jurisdictions and as international purchasers, they stock what sells, regardless of origin.

As well, since the negotiation of the Canada-US Free Trade Agreement in 1987, Canada has granted US products national treatment (equivalent to treatment for domestic products) for listings, distribution and price mark-ups. A similar bilateral agreement on liquor board practices was reached with the European Community in 1988 and extended to all imported products on a multilateral basis under the General Agreement on Tariffs and Trade (GATT).

As a result, government policies and practices are required to treat domestic and imported products equally. It should be noted that prior to this, national treatment practices were already largely in effect for distilled products, compared to other alcohol beverages such as wine. Further, Canadian subsidiaries of multinationals act as import distribution arms for their corporations' foreign brands. These firms distribute and market foreign products along with domestic products.

Regulatory Factors

Distilleries face extensive federal and provincial regulation. Much of the provincial regulatory framework stems from a federal statute, the Importation of Intoxicating Liquors Act. This federal legislation requires that all imported liquor into Canada enter through the resident liquor board within each province or territory (see list at the end of the document). The provincial and territorial governments are also responsible for the blending of alcoholic beverages, as well as regulating and controlling traffic in intoxicating liquor for sale and consumption within the province.

These liquor boards collect federal and provincial taxes on alcohol products and then add their own mark-up prior to sale of the product.

The federal excise tax system for alcoholic beverages presently in effect in Canada, imposes taxes on spirits produced in Canada at the point of production, and it is payable at the time spirits are packaged, unless they are immediately entered into an excise warehouse. The federal excise tax on imported spirits is calculated from the point where spirits are imported and received into liquor board bonded warehouses, but does not become due until the product is shipped to the point of retail sale.

Federal Budget 2006 increased federal excise duties to off-set the impact of the 1% reduction in the Goods and Services Tax (GST). An excise duty rate increase of 6% was imposed on domestic and imported products on July 1, 2006. Distillers have some concerns about these duty increases, particularly since wine and brewery sectors obtained excise duty concession in the Budget of 2006.

The Canada Customs and Revenue Agency, in conjunction with the Department of Finance, undertook a complete review of the Excise Act. The principal objectives of this exercise were to safeguard the tax revenue generated by alcohol and to provide a fair and modern tax structure that minimizes the impact of government policies on the industry. Streamlined procedures should offer cost benefits to distillers in complying with requirements. The new Excise Act came into force in July 2003, replacing the provisions of the current Excise Act that relate to spirits, denatured and specially denatured alcohol and tobacco. However Parliament has since agreed that certain provisions relating to the issuance of age and origin certificates for the export of Canadian whisky under the original Excise Act are to remain in effect until July 1, 2009.

The Canadian Food Inspection Agency (CFIA) and the provincial liquor boards work together to ensure that alcoholic beverages, including spirits, conform to Canadian safety standards (for alcohol content, toxins, etc.) under the Food and Drugs Act before being approved for sale in Canada. In addition, both domestic and imported alcoholic beverages must comply with compositional labelling, net quantity and standardized container size requirements under the Food and Drugs, and Consumer Packaging and Labelling Acts.

On February 10, 2000, the Food and Drug Regulations were amended in order to modify the compositional standard for Canadian whisky as a result of a cooperative effort between Spirits Canada and Health Canada. The amendment appeared in Part II of the Canada Gazette on March 1, 2000.

Specifically, Spirits Canada had requested that appropriate compositional standards for Canadian whisky be published in Part I of the Canada Gazette providing, at a minimum, that Canadian whisky:  a) be distilled in Canada; b) is aged for at least three years in Canada in wooden barrels; and c) contains 40% alcohol by volume.

These domestic changes paved the way for establishing formal geographical indications for Canadian whisky which protects the product against inferior whiskies in the key global markets of our trading partners, such as the European Union, which had refused to recognize Canadian whisky because the Canadian government did not recognize it in the past.

The Spirit Drinks Trade Act, Bill S-38 came into force on June 1, 2006 in order to complete the implementation of the Canada-EC Agreement on Trade in Wines and Spirit Drinks as well as to fulfill Canada's obligation under NAFTA to protect certain American and Mexican spirit drink names. This Act protects the identity of a number of foreign spirit names such as Grappa from Italy, Bourbon from the United States, and Tequila from Mexico.

Technology Factors

The distilling industry in Canada, as in all countries, uses traditional, mature technology. The Canadian distilling industry is as technologically sophisticated as its major competitors. In general, Canadian distilleries have rationalized operations and upgraded production and distribution technologies which compare favourably with US operations, although some US distillers have larger economies of scale. The technological upgrading has been largely in bottling and packaging processes. The industry has reduced the weight of its glass bottles as an environmental measure. Additionally, a current focus is experimentation with new package formats such as PET plastics in place of glass bottles for some lines.

With a mature market, new product development is of critical importance. There is considerable effort devoted to the creation of new products to diversify traditional product lines with new items that will stimulate consumer interest at home and abroad.

While the production of fuel and potable alcohol have some technical similarities, distillers are unlikely to convert closed potable alcohol plants which have made branded spirits into fuel ethanol plants due to their small size. A modern North American commercial or fuel ethanol plant can be an extremely large complex. A major beverage distillery could have an annual production of approximately 32 million litres of alcohol per year, but a state-of-the-art fuel ethanol plant output capacity is 10 times greater.

As a result, a turnkey state-of-the-art fuel ethanol or industrial alcohol plant with North American competitive production costs represents a significant investment.

Issues and Challenges

Even though distillers realize they face a mature market for their products, the high degree of regulation makes it difficult for distillers to directly intervene in the marketplace to implement marketing practices or pricing schemes of their own that might generate consumer interest in their products.

Liquor boards, rather than the distillers, largely determine the marketing practices and price-setting policies and, ultimately, the profitability of the industry. Distribution and sales procedures are determined by the responsible provincial agency and are, in most instances, primarily through agency-controlled outlets. (Alberta is an exception with privatization of alcoholic beverage sales outlets).

Pricing structures are generally put in place by the liquor boards and these reflect federal and provincial taxation. As well, provincial governments apply varying mark-up to products depending upon marketing costs in their respective jurisdiction.

The level of taxation by both provincial and federal governments and provincial mark-ups are key issues for the industry. The industry has argued that increased taxes have been a major factor in consumption decline, which has triggered the general industry decline and has subsequently hurt the profitability of the Canadian spirits sector.

The strengthening Canadian dollar has had a serious impact on Canadian export competitiveness which in turn could result in a reassessment by the industry's multinationals of continued manufacturing in Canada. A weaker US dollar adds to the potential of increased competition from imports in the future.

Smuggling has also been an industry concern. There is no consensus on the size of the alcohol contraband market. Generally, a lower consumer price for spirits in the US makes smuggling a profitable activity. Approximately 80% of smuggled product is thought to enter via Ontario and Quebec, but BC is also rising in importance, particularly given Vancouver's close proximity to the US border.

Another challenge which the industry had faced was a long-term ban on the advertising of spirits on television by the Canadian Radio and Television Commission (CRTC). The industry launched a court case in 1995 to challenge this ban and won the right to advertise. Since that time, Spirits Canada has advertised regarding the equivalency of alcoholic beverages and, more recently, private firms have begun to initiate some advertising. Similarly, a ban on advertising campaigns for branded beverage alcohol products in the US has also been removed.

Distillers are aware of the public's perception of biotechnology and genetically modified organisms (GMOs). There is concern that the industry could be affected if their products are negatively associated with these issues.

Opportunities

The development of a global economy has not affected the distilling industry in the same way that it has affected other segments of the food and beverage processing industry. This is largely because the industry is dominated by large multinationals which, for some time, have had a globally competitive perspective and maintained marketing/sales/distribution offices and manufacturing facilities for alcoholic beverages in most of the world's major countries. These facilities are either owned by a multinational firm, or operate as joint ventures with companies that were already established in that market.

A key to the continuing competitiveness of the Canadian industry in a global economy is the "appellation protected" status of Canadian whisky and the industry's adherence to quality. The US and Canada have granted reciprocal recognition of bourbon and Canadian whisky as distinctive products. This offers protection from competition and from adulterated or misrepresented products.

The whisky standard ensures that as long as there is a market for Canadian whisky, it will be manufactured in Canada. However, achieving a "distinctive" status for Canadian whisky worldwide would further protect this manufacturing base as it would also increase the prestige of the product internationally.

Product development and marketing are a strong focus for brand companies in the development of new markets. These operations are often controlled by multinational parent companies, as opposed to manufacturing establishments, and are not necessarily based in Canada. Branch companies rely heavily on consumer research and intelligence from distribution firms in individual markets when developing new product lines and targeting marketing campaigns to specific consumer groups within a particular country.

Further, although Canadian companies currently manufacture many types of distilled products, it should be noted that multinationals will shift manufacturing mandates between different production facilities (on an international basis, but particularly within North America) on products other than Canadian whisky as efficiencies demand.

Domestically and throughout North America, the distilling industry has targeted strong marketing efforts at revising interest in spirits beverages and attracting new generations of consumers. Part of this strategy has been the development of new products such as flavoured spirits and low alcohol content spirits beverages such as "coolers". In addition, the industry has been working on upscale line extensions (premium products) in their traditional products, many of which have been designed for export markets.

Also, younger alcohol beverage consumers are developing a more mature taste profile which typically includes spirits, as well as wine and beer. Further, there has been a noticeable trend back to "cocktail" consumption, especially with the introduction of "Martini" cocktail bars. In addition, dark goods such as whisky, brandy and cognac are beginning to enjoy a resurgence of interest.

The Canadian industry advocates education on equivalency and the responsible use of spirits. All these efforts are having the effect of bolstering spirit sales in what has previously been a declining alcoholic beverages market.

Canadian distillers' focus on the marketing and distribution of global brands and strong export orientation are key factors in maintaining the industry's competitive position internationally. The lifestyle trends away from the consumption of spirits in some markets have impinged on the profits of many distilling companies, not just those in Canada. However, the large multinationals which dominate the Canadian industry have significant resources to develop and market new brands, alter production capacities, shift product mandates to different geographical locations and attract investment as efficiencies demand. The industry forecast into the next few years is "cautiously optimistic".

Table: NAICS 31214 distilleries, 1996-2006