Sipping pretty: Tequila’s global ambitions

May 21, 2015, 12:30 PM UTC
Fortaleza Tequila
Photographs by Frédéric Lagrange for Fortune

The liquor’s popularity in the U.S. has soared as high-end makers emphasize artisanal, pure versions. Now it’s trying to become a worldwide phenomenon. Can a Mexican export win over the Chinese?

In early November locals in the village of Bushmills, in the upper reaches of Northern Ireland, got a surprise. The British liquor giant Diageo, owner of the venerable Old Bushmills whiskey distillery on the outskirts of town, announced it had decided to trade it for—of all things—a tequila maker. In exchange for Bushmills, Casa Cuervo, the Mexican company behind Jose Cuervo, gave Diageo its super-premium Don Julio brand, along with $408 million.

To whiskey fans, the deal made no sense. At 272 years, Old Bushmills is widely considered the longest continuously operating distillery on the planet. Irish whiskey is one of the fastest-growing spirits categories worldwide. And Diageo had already bought two major tequila brands—DeLeón and Peligroso—earlier in the year.

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But Diageo was onto something. While the media have focused on the surge in consumption of vodka and, more recently, whiskey—both of which far outsell tequila—the agave-based spirit has been quietly outpacing their growth rates in the U.S. market. Almost all the action is at the top end, with brands like Don Julio, whose sales have been spiking by 25% annually in recent years. “It’s a bet on value, not on volumes,” says Spiros Malandrakis, a senior alcoholic-drinks analyst for Euromonitor.

The calculation is simple. Liquor sales are increasing at a healthy 5% clip, and hard alcohol is stealing market share from beer and wine. And as in other parts of the food business, the past decade has seen a tectonic shift among consumers away from inexpensive mass brands toward artisanal, high-end products. It’s what people in the industry call premiumization. And there is no liquor riding the premiumization wave as high as tequila.

“There’s a much greater recognition that tequila can be a sipper, not just a shooter or dropped in a margarita,” says Bill Norris, the beverage director for the Alamo Drafthouse Cinema chain, whose venues feature dozens of premium tequilas. “People see it alongside single-malt Scotch.”

This isn’t your college frat’s tequila. Two decades ago almost all tequila sold in the U.S. was mixto, or blended, from a combination of just over half agave mash and the rest sugar and flavoring chemicals, the sort of additives that give tequila its nasty reputation for leaving you with a mind-piercing headache after you down a few (or more than a few) margaritas. Tequilas like Don Julio, by contrast, are made exclusively from a single species, Weber blue agave—more expensive, but a world of difference in flavor. And though too much of any drink will leave you reeling in the morning, fans swear that 100%-agave tequilas provide a “cleaner” buzz and leave them fresh the next morning. Last year, for the first time, Americans drank more 100%-agave tequila than mixto.

Fermentation vats at Patrón’s distillery (left); inspecting the finished product.
Photos: Frederic Lagrange for Fortune

The numbers tell it all. According to data from the Distilled Spirits Council of the U.S., between 2004 and 2014 total U.S. tequila sales grew 63%, decent if not blockbuster growth. But consider the super-premium level, where bottles start at around $30. In 2004, Americans bought just 513,000 cases; a decade later they purchased 2.39 million, a 365% increase. By comparison, vodka grew 51.8% overall and 143% at the super-premium level, while bourbon, the industry darling, grew just 40% overall and 282% for super-premium.

For Diageo, numbers like that made dumping Bushmills for Don Julio a no-brainer. “Tequila is one of the most exciting categories in spirits,” says Alex Tomlin, senior vice president of marketing for tequila and other drinks at Diageo North America. “It has broken out of the shots ghetto.”

Tequila still has a lot to prove. For every newcomer or convert, there’s a consumer whose queasy memories of past hangovers keep him away. And unlike vodka and whiskey, which are popular around the world, tequila is mostly sold in the U.S.  For the category to really hit big, it’s going to have to find a way to win over even more consumers. That may mean not just breaking out of the shots ghetto, but also making inroads in a new market with huge potential: China.

It’s hard to pinpoint the first rumbling of the tequila boom, but you could do worse than go back to the day in 1991 when Martin Crowley and John Paul DeJoria, the founders of Patrón, hired Burt Stewart as their first employee. At the time almost all tequila was consumed in cocktails and shots, the better to hide its impurities. Even in Mexico, mixto was the rule; middle-class Mexicans drank brandy and whiskey. But in the mid-1980s plugged-in Americans who traveled to Mexico started to notice a creeping number of small-batch, 100%-blue-agave sipping tequilas in bars and restaurants. Those brave enough to try them were impressed, and they came home to spread the word.

High-quality tequilas began dribbling into the U.S. But the drink didn’t get a big-money rollout until 1989, when Crowley and DeJoria, the founder of the Paul Mitchell line of hair-care products, debuted Patrón. They found a traditional distillery in Mexico to produce it, and they came up with great packaging.

They were met with a deafening silence. So they approached Stewart, a sales expert, for help. He began flying around the country, hauling cases of Patrón in the back of his rental car in search of new clients. “It was one door at a time, one customer, one account at a time,” recalls Stewart, who recently retired from the company (he says he will still do some consulting). “They said, ‘Burt, we love you, but we have Cuervo.’ ”

It took several years, but by the late 1990s Patrón was growing at a steady clip in the U.S.  Part of it was packaging. Cheap mixtos tended to be sold in bottles with decidedly down-market label designs. Crowley and DeJoria presented Patrón in a distinctive decanter with a fat cork on top, the sort of thing not out of place alongside an assortment of XO cognacs in a luxury-hotel bar.

It helped that a new generation of drinkers was emerging, particularly in Texas and Southern California, where Hispanic culture was driving rapid changes in the food scene. By the turn of the millennium, “fancy Mexican” was no longer an oxymoron, and it only made sense that “high-end tequila” would follow fast behind. “The Mexicanization of American culture put tequila in the pole position,” says Tomlin of Diageo.

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Such consumers cared about authenticity and exclusivity, two qualities that define 100%-agave tequila, with its import-only status and long artisanal tradition. “People want to understand who’s making their spirits, to understand the human hands involved,” says Clare Kanter, vice president for white spirits at Pernod Ricard USA, which last year bought a reported $100 million majority stake in Avión, a super-premium brand created by Ken Austin, the founder of Marquis Jets.

By the late 2000s the number of high-end brands had exploded, with new entrants like Avión and Casa Dragones. Established names like Herradura and Sauza were snapped up by big American spirits companies (Brown-Forman and Beam Suntory, respectively). In 1999 the rock singer Sammy Hagar introduced Cabo Wabo, a brand he developed at his eponymous bar in Mexico, and within a few years it was tied with Don Julio as the second-best-selling premium brand in the country, behind Patrón. (Hagar later sold the brand to Gruppo Campari for $91 million.)

The biggest story is still Patrón, which today controls 70% of the super-premium market. The company generates more than $1 billion in annual revenue. “It was just an evolution,” says Stewart, looking back on his days schlepping liquor in his trunk. “People were looking for something different. People drink tequila for a good time. When you go to the tequila section in the liquor store, you’re going for a party. But it’s an elegant way to drink.”

Tequila, like whiskey, is very versatile. “It has a flavor profile that makes it a good mixer,” says David Ozgo, the chief economist at the Distilled Spirits Council. “At the same time, with the high-end brands it can stand easily on its own. You see it sipped in a brandy snifter like it’s a cognac.”

If anything, tequila is in a better position than Scotch, bourbon, or vodka for sustained growth. Like whiskeys—whose ingredients and production are heavily regulated, whether in Scotland or the U.S.—it has an innate authenticity. Tequila can be made only in the Mexican state of Jalisco, according to strict rules, something that appeals to craft-conscious millennial consumers.

George Clooney and his partner Rande Gerber hustle their brand.Photo: Denise Truscello—Wireimage/Getty
Photo: Denise Truscello—Wireimage/Getty

It’s also a favorite of the velvet-rope set, where celebrity tie-ins—George Clooney, Justin Timberlake, and Sean Combs have all recently invested in tequila brands—have made brands like Avión and Clooney’s Casamigos regular items on pricey bottle-service lists.

For many consumers, tequila hits a sweet spot between the robust flavor of a whiskey and the fresh lightness of a vodka. “People really appreciate the taste and smoothness,” says Rande Gerber, one of Clooney’s partners in Casamigos. “My wife”—that would be Cindy Crawford, the supermodel—“and her friends appreciate how you can drink it and wake up and not have a hangover.”

The tequila industry isn’t just about celebrities and multinationals, even though their products dominate the sales rankings. It’s also about people like Guillermo Erickson Sauza. The name may be familiar; Sauza is one of the most storied brands in tequila. But his grandfather sold the company in 1976—“the whole family was stunned,” Sauza says—and it’s now owned by Beam Suntory.

A traditional tahona wheel crushes agave piñas at the Fortaleza distillery (left); Guillermo Erickson Sauza at the distillery he renovated in Tequila, Mexico.
Photos by Frederic Lagrange for Fortune

With the growth in demand for 100%-agave tequila in the 1990s, Sauza, who worked around the distillery as a teenager, decided to reclaim his birthright. He couldn’t get the brand name back, but he could restart the old family business. After a few years of renovating an old distillery, he began selling in 2005, and since then his flagship brand, Fortaleza, located in the tiny town that gave tequila its name, has become one of the category’s leading independent brands.

Fortaleza is a world away from U.S.-based brands like Casa Dragones and Casamigos, which are typically sourced from third-party distillers and are heavily dependent on marketing. Many corporate brands rely on modern industrial technology like autoclaves and diffusers, which use steam and chemicals to strip the sugars from agave. Sauza keeps things pretty much the way his ancestors had it. The hearts, or piñas, of the agave plants are roasted for 36 hours in a walk-in oven, which turns the plants’ starches into sugar. The piñas are then crushed with a two-ton stone wheel, called a tahona, which separates the plants’ fibers from the sugar. The distillers pitch in a proprietary yeast, converting the sugar to alcohol, and the mash is then distilled through century-old copper-pot stills.

Sauza spends almost no money on advertising, focusing instead on the American consumer’s demand for authenticity and craft. “There’s a segment of consumers that wants the small-brand experience,” he says. His company does 70% of its business “on premises”—in bars and restaurants—and regularly flies bartenders and owners to the distillery, the better to impress upon them the differences between Fortaleza and a corporate operation like, well, the other Sauza distillery, located less than a mile away in Tequila.

Tequila: An Intoxicating Rise

The quest by drinkers for the purest, most “authentic” spirits is a double-edged sword, however. Yes, it has fueled demand for high-end tequilas. But it’s also enticing some fans to try something perceived as even more pure and authentic: mescal. Some of the most committed imbibers say the rush of multinational interest has imposed technology and monoculture onto agave cultivation and production, smoothing down its interesting edges. “These plants are so cloned and cloned, they’re not very healthy,” contends Phil Ward, the owner of Mayahuel, a bar in Manhattan’s East Village. “The quality is just going down.”

Mescal is a broader category than tequila, embracing a wider geographic region and a larger number of agave species. It connotes a more artisanal, handcrafted approach to distilling agave. Mescal is often harvested from the wild rather than grown on farms; plants are roasted in pit ovens instead of steamed in autoclaves. Distillers use natural fermentation instead of adding yeasts. The result is a broader variety of flavors, making it a favorite for trendsetting bartenders.

The mescal market is minuscule compared with tequila’s, and its flavors may be too robust and unusual for most drinkers. But the challenge it presents is not to be taken lightly. Several big brands are already reacting: Patrón recently released Roca Patrón, made using a tahona wheel, while Herradura, owned by Brown-Forman, and others have sworn off diffusers. “We are a little wary as consumers; we tend to think the more flash and more sizzle a brand has, the less substance it has,” says Lee Applbaum, chief marketing officer of Patrón. “We’ve been focusing our efforts to say, ‘Yes, we want to be this aspirational brand and product, but never lose sight of the fact that it’s made in this traditional, artisanal way.’ ”

Even as Big Tequila catches flak from purists, it continues to face a challenge in winning over more mainstream drinkers. “There’s still a stigma associated with tequila that needs to be overcome,” Applbaum says. That means working with bartenders and retailers to push consumers to rethink their tequila stereotypes. It also means finding new consumers. And since almost all tequila is consumed in the U.S. and Mexico, the future of tequila may well lie overseas.

Europe is the obvious choice, and most of the big brands—especially those owned by European companies like Diageo, Campari, and Pernod Ricard—are already well-established in the trendier bars of London, Paris, and Moscow. “You’ll see young Russian men drinking tequila instead of vodka because vodka is what their fathers drink,” Austin says.

Patrón and several other brands have recently set their sights on an even bigger target: China. Not only does the country offer hundreds of millions of potential drinkers, but the Middle Kingdom has traditionally been a white-spirits society. Baijiu, an unaged, grain-based distilled spirit, is the national drink. And 100%-agave tequila only recently became available there. Thanks to a quirk in Chinese food-safety laws, it had been banned until President Xi Jinping lifted the restrictions as part of a 2013 trade deal with Mexican President Enrique Peña Nieto. (The Mexican government and the tequila trade association recently launched a marketing campaign called “Tequila, Mexico’s Gift for China,” with a logo featuring a Chinese dragon and a Mexican Quetzalcóatl.) It is too early for solid sales figures, but brands like Patrón and Don Julio have been popping up at fashionable bars in Shanghai, Beijing, and Hong Kong.

Presidents Xi Jinping of China and Enrique Peña ­Nieto of Mexico in 2013 celebrating the deal that opened China to tequila (left); promoting Patrón in Shanghai.Photos, from left: Eduardo Verdugo—AP; Courtesy of Patrón
Photos, from left: Eduardo Verdugo—AP; Courtesy of Patrón

China offers a blank page for an often maligned drink. “There’s also an opportunity to create a new premium consumption behavior, like sipping,” says James Sykes, the vice president of marketing for the Asia-Pacific and South America at Beam Suntory. “With a new market we can enter with a clean slate, whereas the U.S. has a heavier association between tequila and shots or margaritas.”

Others are more skeptical. “The change in the Chinese law creates immediately a massive gambling opportunity,” says Euromonitor’s Malandrakis. “But it’s not going to be an immediate process, and at the moment China is not going through its best time. It will be a bumpy ride.”

But most consider it a solid bet. By 2018, says the Tequila Regulatory Council, one of the industry’s main trade groups, China will be the second-largest tequila market in the world, behind only the U.S. and surpassing even Mexico, with consumption shooting to $100 million, from just $5 million in 2013.

Even without China in the picture, the industry is feeling bullish. Tequila is already growing rapidly, and perceptions change fast—just look at how bourbon, a fusty drink 20 years ago, rapidly displaced vodka as the coolest pour at the bar. “To me, the end isn’t in sight,” says Austin. “There’s a massive wave of tequila consumers coming.”

Correction: An earlier version of this article incorrectly stated that the Sauza brand was sold by the father of Guillermo Erickson Sauza. In fact, it was sold by his grandfather.

An earlier version of this article misidentified the Casa Dragones bottle of tequila. The correct name and price are now reflected above.

This story is from the June 1, 2015 issue of Fortune magazine.