For three decades, Dilmah was the poster boy for Ceylon Tea. Today, the company faces a litany of problems, from declining retailermargins, threats from commodity brands and a looming possibility of blended Ceylon tea in the market. The question is, what is Dilmah going to do?

NESTLED ON THE SIDE OF AN ARCHED hallway is a barely visible, upscale tea house in a refurbished colonial building fronting Chatham Street. The atmosphere inside the t-Lounge by Dilmah has all the requisites of a café-esque experience: from the cozy sofas, dim lights and wooden floors, to the ambient music that bounces off the rugged brick wall. The signature of the store is the multicolored mosaic of metal tea boxes cloistered together on a wooden shelf against the wall. These boxes contain Dilmah’s collection of what it calls the ‘t-series’.

Most of the tea belonging to the t-series is sourced from Sri Lankan plantations, while the rest have their origins in Oolong, Darjeeling and Assam in China and India. Look closely, and there is an important detail missing on the boxes containing Sri Lankan tea: the coveted sword-bearing lion symbol, the singular identifier of ‘Pure Ceylon Tea’ that adorns every single origin product produced in Sri Lanka.

“We don’t rely on Ceylon tea anymore,” says Dilhan Fernando, the second son of the founder of Dilmah and a director of the company Merrill J. Fernando. His words are perplexing. For years, Dilmah has been singlehandedly campaigning to safeguard the Ceylon tea brand by voicing its concern against blending teas produced elsewhere in the world with Sri Lankan tea – because the ‘Blended in Sri Lanka’ label may confuse customers looking for Pure Ceylon Tea.

Fernando’s statement is a hint of a prelude on how the company views itself today, which begs the question, has Dilmah become a bigger brand than Ceylon tea?

Early this year, the company opened its seventh international outlet of the t-Lounge at a luxury shopping complex in Dubai, partnering former Pakistan cricket captain and international commentator Rameez Raja. Unsurprisingly, guests at the launch included many Pakistani cricket stars from Mohammad Hafeez to Wasim Akram, and even West Indian legend Sir Viv Richards. The glitzy launch at the choice locate in one of Dubai’s most exclusive shopping malls was not for a stake in the vanity scale. Dilmah’s underlying intention is prescient: Make tea drinking an experience.

“Ask somebody in any of those tea houses what the ‘terroir’ of a tea is and they’ll give you a blank look”

Over the next few months in 2017, Dilmah intends to open four t-Lounges in Iran alone. By April 2018, the company is setting up for an exponential expansion, growing its global footprint as a tea house chain to 25 outlets in 15 countries. Dilmah’s first t-Lounge at Chatham Street was forecasted to breakeven in two to three years, but surprised everyone when this was achieved in a mere eight months. “In Kuwait, right in front of our t-Lounge is a very old English tea house called East India Company, and for every 20 customers we have, they have one,” he boasts.

The person most responsible for this initiative is 49-yearold Dilhan Fernando. Fernando extrudes a youthful flair and genuine enthusiasm in contrast to the country’s weary and archaic tea sector executives. For half of the year, Fernando plays the role of a missionary priest travelling the world spreading the message of tea. In the first six months of this year alone, he has already visited 14 countries in six continents, conducting tea workshops, meeting retailers and hoteliers, and holding press conferences and doing interviews, all as his messianic duty for tea.

The t-Lounge is his latest medium in addressing a case for the reverence of tea. But, sophisticated tea house chains are not a revolutionary idea. In North America and Europe, franchised tea houses are a phenomenon.

One of the significant developments in the tea world five years ago was when Starbucks, the multi-billion-dollar global coffee giant, made one of its largest acquisition, Teavana, an American retail tea brand for $620 million. Chief of Starbucks Howard Schultz described tea as a $90 billion global opportunity, and claimed it as a market bigger than coffee. Teavana was its break-in vehicle into tea, and in the ensuing years, Starbucks tried to do what it does best, open cafés, but this time it was a chain of stores dedicated to tea.

Many anticipated it to grow in the same speed as its predecessor, and the company expected to have 1,000 Teavana tea bars by 2023. But, the Starbucks-Teavana tea bar experiment was short-lived. By January 2016, Starbucks was retreating and closing stores.

Fernando boils down Teavana’s tea bar failure to deficiencies in two areas: authenticity and expertise. “Ask somebody in any of those tea houses what the ‘terroir’ of a tea is and they’ll give you a blank look,” he says while sipping a Ceylon green tea with ginger and lychee. His argument is that new age consumers succumbing to fancy marketing isn’t enduring. Instead, they seek an intimate relationship with the products they consume. “The consumer knows a lot about the product, from wellness to its antioxidant properties,” he says. “Millennials want to hear about the history, provenance and event to know how the mist affects the tea. This is no bullshit generation,” says Fernando in a momentary departure from his pious composure.

Fernando’s postmortem analysis of Teavana tea bar is a deliberate insinuation of Dilmah’s strengths. Dilmah, unlike Teavana or most tea house chains in the world, has the rare claim as a producer who markets under its own brand. Taking this to its advantage, the company strives to blend an artisanal and family heritage narrative around its product. This is abundantly depicted in Dilmah’s television campaigns. Most often, Merrill J. Fernando and both his sons Dilhan and Malik star in the company commercials, presenting the portrayal of a father passing on the skill and knowledge of his craftsmanship to his children. “As a family business we want to show our family integrity and family passion,” says Fernando. “That passion is the difference.”

As much as Fernando strives to convert people to tea, the numbers are less reflective of his efforts. For two consecutive years, Dilmah reported declining revenue growth. Profits from its tea bag segment, which contributes to 86% of its revenue, remains stagnant and has declined since it peaked in 2014. Plagued with high prices and competition from low-cost brands, the company has experienced weak supermarket sales, its primary distribution channel, ever since.

Along supermarket aisles, the dark green, rectangular Dilmah boxes sit on the shelves amid the musty gold-coloured Twinning and bright yellow Lipton tea packs. Imprinted on its side is a picture of a smiling silver-haired Merrill J Fernando clad in a light-coloured buttoned downed shirt. The presence of Dilmah in supermarkets is under threat. How Dilmah will remain a competitive force under the aura of mass market brands will be a crucial play for the company.

“Retail margins are pathetic,” says an agitated Fernando. Dilmah has openly spoken about its lackluster record in recent years. Early this year, speaking to an Australian newspaper, Fernando said the revenue contribution from Australia, a key market for the company, has significantly reduced from 25% to 20% over the last three years.

For three decades, Dilmah’s binding relationship with retailers was an inextricable factor for its success. From the first time in 1988, since it established its partnership with Australian supermarket giant Coles and its subsequent entry into Woolworths, ensued a firm base as a fledgling retail brand. But today, the tables have turned, making retail Dilmah’s Achilles heel.

Modern day retail success is an exercise of constant price reductions to increase consumer footfall to stores. Aggressive schemes of discounts and promotions are demanded by retailers. For pricier brands like Dilmah, these are challenging circumstances affecting their bottom lines. “Retailers are hitting us. They make 30%, while we are lucky to get 10%” he says. Recently, in a bold move, the company pulled out of Sainsbury, the UK’s second-largest supermarket chain, refusing to tolerate the hostile environment in retail. “They were clamouring for discounts,” says Fernando. “When we exited, the buyer was shocked because no producer had ever deleted products off the shelves by themselves.”

Lipton and Twinning, Dilmah’s largest competitors in the international market, are owned by multinational food giants Unilever and Associated British Foods, respectively. These brands are relatively low priced, and offer generous discounts and promotions to consumers. They dominate sales volumes in the tea category and have the ability to sustain business through low margins. “We are fighting against commoditization,” says Fernando.

This scenario offers the company two options: to reduce the price and compete with the rest of the mass-market brands, or to influence consumers’ purchasing behaviour towards premium tea. Fernando believes consumers are increasingly shifting towards more sophisticated products and are more inconspicuous towards smaller local brands rather than mass market ones. There is validity in Fernando’s argument. The artisanal movement today has expanded into a plethora of products from wine, beer and coffee to spirits, and is one of the fastest growing sectors in the world.

This scenario offers the company two options: to reduce the price and compete with the rest of the mass-market brands, or to influence consumers’ purchasing behaviour towards premium tea

But, retailers are not buying Fernando’s premonition. “Today, if you go to a retail buyer and talk to him about quality, they start laughing saying ‘tea has had its day’.”

This is Dilmah’s predicament today. “Consumers are giving us a message that they want quality, and the retailer is asking for a reduced price,” he says. “We decided to go with the consumer.”

Moving away from the retailer isn’t without consequences for a company wholly dependent on supermarkets to get its products to the consumer. Dilmah does not intend to completely wither its retail presence, but its healthy relationship with retailers has suffered since 2010. He explains this shift as a result of the old generation of buyers replaced with the new. The only problem is that the replacements do not have the same appreciation for tea. “Today, 90% of tea buyers in the world in big retail don’t drink tea,” he says. “So, it’s impossible to talk to them.”

“In this space, it looks like an indulgence right now, but we are setting the scene for a time when consumers’ migration towards quality is acknowledged by the retailer, which we expect to happen in around two years.”

In the domestic front, Dilmah is facing a battle that it has been waging for ages. The perennial issue of blending. The three-decade-long debate is controversial and the industry is polarised: purists and blenders. Dilmah, who leads the minority purist camp, believes in single-origin tea and is vehemently opposed to further relaxation of imports for the purpose of blending. In October 2016, to bring a final solution to the matter, the government appointed a special committee to study the impact of blending on the tea industry. But, even after eight months of deliberation, the committee could not arrive at a unanimous agreement.

The question of blending arises because of the high cost to produce Ceylon tea. The labour cost alone accounts for 70% of the cost of production and is the highest among tea-producing nations. To circumvent this problem, an idea was proposed to blend Ceylon tea with cheaper imports from countries like Kenya, Vietnam and India.

This would elevate the competitiveness of tea produced and packed here, and drive demand from large tea brands like Lipton and Twinning that use blended tea as its chief source.

The Tea Exporters Association, who controls 80% of tea exports, views this favourably to move beyond the practice of trading tea in bulk form. International blending centers in Dubai, London, Rotterdam and Hamburg import tea in bulk form, then blend, package and re-export it to the rest of the world.

For Fernando, the tea hub concept is a pleasing but misguided strategy. Plagued with declining productivity levels and a shrinking labour force, coupled with depleted soil and high energy costs, Ceylon tea will always be the more expensive option against competitors. If blending ensues, Sri Lanka’s tea production will drop drastically, endangering the livelihood of thousands of estate workers, he warns. “For every kilogram you import from any place in the world, there is going to be one kilogram less of Ceylon tea sold.”

Fernando is pessimistic over the claim that Sri Lanka becoming a tea hub would be a one-stop solution to boost the flailing industry. “Just because we start blending here, there’s nothing to say Unilever or any other company will buy from Sri Lanka,” he says. To prove his point, Fernando explains that Ceylon tea was once one of the key exporters to Pakistan. When African teas, which are twice the price of Ceylon teas, entered Pakistan, the market share for Sri Lankan tea gradually declined. But, to imagine that Ceylon tea blended with Kenyan tea would enable Sri Lankan tea exports to recapture that lost share is wishful thinking, believes Fernando.

“Today, if you go to a retail buyer and talk to him about quality, they start laughing saying ‘tea has had its day”

The only incentive for tea marketing companies to open in Sri Lanka would be to piggy-back on the Ceylon tea brand. “They will do it for the short term for one reason: to capitalise on the image of Ceylon tea,” he says. “Then they would say, we are Ceylon tea because we are packed in Sri Lanka.”

Blended tea packs are legally authorised to carry the inscription of the source countries, communicating its origins to the consumer. But, most often, this is abused, as brands strive to highlight certain tea origins like Ceylon or Darjeeling tea to associate their premium with the product. One of its competitors, Tetley’s, owned by Tata Global Beverages is a culprit. “Through associates, I obtained some trade samples, and on the packet it says in big letters ‘Ceylon Tea’, and on the side it shows blended Ceylon, Indian and African teas,” says Fernando. This is what keeps Dilhan Fernando To put it simply, the Dilmah brand today transcends across a variety of teas, establishing itself as a premium tea brand, not only Ceylon tea awake at night. For years, consumers have associated Ceylon tea with its premium quality.

But, with blended Ceylon tea brands stacking up side by side with Dilmah’s single-origin Ceylon tea in supermarkets, would consumers be diligent enough to separate the two? Currently, a Dilmah tea packet in Australia is priced at $5, while blended teas range around $3. “It will only take consumers a couple of years to realise that Ceylon tea is no longer like it used to be,” says Fernando. If price-conscious consumers opt for the cheaper blended Ceylon tea brands, this would result in a credibility crisis for Dilmah to justify charging a premium price on its tea.

For three decades, Dilmah has been building its brand under the halo of Ceylon tea. Fernando acknowledges that consumer recognition for Ceylon tea has gradually diminished over the years. During this period, Dilmah too has strived to venture beyond the confines of Ceylon tea. As a result, the company has started to market single-origin foreign teas like Chinese Oolong, Darjeeling and Assam teas under the Dilmah brand. To put it simply, the Dilmah brand today transcends across a variety of teas, establishing itself as a premium tea brand, not only Ceylon tea. “If blending is adopted, we will benefit the most,” says Fernando. “Because if we put 50% of Vietnamese tea to our product, people are still going to buy it because it’s Dilmah. This will double our profit overnight.”

As much as it would be a lucrative option for Dilmah, as claimed by Fernando, it also means the company would have to compete on price. This could have been possible if it was a game where the winner is determined by the lowest price. This, he believes, is not a game Sri Lanka can play. “You are going into a bottomless pit,” says Fernando. “There’s always going to be someone who is going to do it cheaper.”

Fernando’s eyes light up when speaking about the burgeoning consumer interest in tea. This is not just a mere fantasy in his head. The tea category is expected to grow at 5.9% up to 2020. This is a huge shift for a beverage that is the second-largest after water, resulting in a slew of new consumers entering the market as first-time tea drinkers.

For Dilmah, the challenge lies in its ability to communicate the merits of tea to consumers. To do this, Dilmah has already launched tea schools, a workshop for chefs and hoteliers on tea-based cuisine and beverages around the world; tea radio, an internationally broadcasted show exclusively on tea; and the Dilmah Real High Tea Challenge, a culinary competition. These initiatives may be trivial on the surface, but Fernando foresees far-reaching impacts.

Fernando too is unfazed at a time when most have written off Sri Lanka’s tea industry. “It’s the most challenging time we’ve ever faced,” he says. “But we will survive.”