Survival of the fittest
The recently published 2003 Annual Financial Benchmarking Survey from Deloitte and the Winemakers' Federation of Australia has further underlined the problems facing Australian wineries. But the message behind the report seems fundamentally optimistic: many of the difficulties are cyclical and for wineries that learn from the mistakes that have been made, the future looks good. Ben Cooper reports.
The Australian wine industry has undoubtedly enjoyed some good times during the past 15 years or so but the recently published 2003 Annual Financial Benchmarking Survey from Deloitte and the Winemakers' Federation of Australia (WFA), has further underlined what has been clear for some while. Times have changed and a challenging and evolving business environment is squeezing the profitability of Australia's wine producers.
In spite of recent changes to the Wine Equalisation Tax (WET), which will help to ease the financial and administrative pressure for some wineries, the survey predicted further consolidation, particularly among those with sales in the A$1m to A$5m bracket. Wineries in this group experienced tough trading conditions and intense competition, contributing to an average loss of 7.9% before tax.
Of wineries generating up to $1m, some 40% recorded a loss for the 2003 financial year, as a result primarily of fierce competition, the excess supply of bulk red wine and greater consolidation within the retail sector.
Wineries with sales ranging from A$5m to $10m also performed poorly with a significant fall in average gross margin. Many wineries have been forced to reduce prices to remain competitive. They recorded stock write-downs of 3.8% of revenue.
The survey also showed that A$10m-$20m wineries experienced difficult times including reported losses on bulk wine sales of 4.8% of revenue. The gross margin in this category is the lowest of all categories at less than 30%.
However, the performance of wineries with sales of A$20m and above improved from last year, with profitability returning to levels reported in the 2001 study. The report concluded that this was particularly positive given that these wineries most closely with the five major Australian wine companies.
To what degree the current problems are cyclical, part of a natural plateauing following a period of intense growth or the result of mistakes is a knotty question. But Stephen Strachan, chief executive of the WFA believes that the industry is undoubtedly experiencing "growing pains".
"There is no question in my mind that the industry grew too quickly in the late- 1990s," Strachan told just-drinks. "The consequences of that growth are the growing pains we are currently experiencing. Firstly, the rate of vineyard plantings to red varieties in 1997, 1998 and 1999 was unsustainable and secondly, the new winery entrants to the industry - about 200 per year - was too high."
Stephen Harvey, head of the Deloitte Wine Industry Group, also stressed that the affects of the current problems varied significantly, depending on the region and the variety concerned. "Things are still pretty tough," he said. "We are still in a production exceeding demand cycle and this is currently expected to last at a macro level for a couple of years. It does however vary dramatically by region and by variety."
But there is some better news on the horizon regarding the over-capacity, as vineyard plantings slowed considerably after 1999. "This means we will have only modest production increases in coming years seasonal factors permitting," said Strachan, "making the growth targets a whole lot more achievable."
But while such structural factors have a huge bearing on performance and profitability, it is clear that the WFA believes there is much that can be done at an operational level by wineries to alleviate current problems. "First and foremost, wineries need to focus on their marketing, "says Strachan. "They need to establish and promote the point of difference for their brands and work hard on their distribution."
Harvey concurs. "Smaller wineries need to have a focus on their niche strategy, chase a Parker rating for US exports, develop excellent mail order cellar door businesses, maintain focus on quality and regional differentiation and have a very close look at distribution," he told just-drinks. "Consistency of quality and distribution are the keys to success. The key for the Australian industry is to maintain its level of innovation, both from a wine style, packaging and marketing perspective. The production cycle will fix itself, but we must maintain our relevance to the export customer."
Strachan also stressed the cyclical nature of the business and is clearly reluctant to be too hard on wineries that had made mistakes made during the boom times. "The wine business is cyclical - which is not surprising when you consider the very long lead times in production. In reality, it's difficult enough to determine what customers will want in six or seven years time. Add to that the need to understand what your competitors are doing and predicting the marketplace is fraught with difficulty. We all saw a market opportunity and backed ourselves. The problem was, nobody foresaw the dramatic production growth in Australia, or in California, Chile or Southern France."
The overriding theme is that it is the combination of cyclical factors and strategic mistakes which has cost individual wineries and the industry as a whole during the current difficulties. But without excusing mistakes that have been made, the authors of the report are clearly stressing that errors are almost bound to be made when new frontiers are being crossed during a period of rapid expansion. "There is no doubt our wineries are making some mistakes but we have had an increase in the number of small wineries from low hundreds to over 1,600 over the last 19 years," said Harvey. "Many are still finding their way. Growth can and will continue and it is about discovering the how to manage distribution networks in each country."
Strachan too remains sanguine regarding the current situation for Australian wineries. "Despite press to the contrary, I think the industry in Australia is in pretty good shape," he said. "The robust supply position of the last few years and the discounting that has accompanied it has forced companies to focus on their costs along the supply chain and to re-examine their relationships with suppliers, particularly grapegrowers. The wine companies have used this period to drive grapegrowers to meet much more stringent criteria for the delivery of grapes to winery specification. The upshot of this is a step up in quality and a major improvement in overall consistency. I think our wineries will emerge from this period leaner, but able to deliver better quality and consistency in their wine."
But while some wineries have developed and toughened up during the bad times, others will simply not survive, Strachan warns. "I don't think all of Australia's wineries will share in the opportunities this decade," he said. "Those with strong brands and a good business model will flourish. Unfortunately, many will not. For many of our small and medium wineries, particularly those that have come on the scene in the last seven or eight years, it will be a tough battle."
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