The NZ Wine Industry in 2010

Two years ago the New Zealand wine industry was drunk on its own success, so the NZ Herald’s “The Hangover” caption  (Weekend Herald 3 April 2010, http://www.nzherald.co.nz/business/news/article.cfm?c_id=3&objectid=10636005  and associated articles) is quite apt.  Nevertheless, hangovers, however uncomfortable, are merely a part of a recovery process.  The industry has been going through such a hangover ever since 2008.  Coming at the same time as the wider NZ economy is cautiously creeping out of its bunker, there should be more cause for optimism than for dread.

It is clear, however, that there are still severe structural flaws in the industry that have been highlighted by the market behaviour of many companies over the last year.  These structural flaws, and some of the market failures in the wider economy (especially with respect to financing capabilities), will affect where the industry heads over the next period.

Right now the companies in trouble are those that have been struggling to keep their heads above the water for the last two years – not those that are suddenly in trouble.  Who survives and who doesn’t will be down to the same combination of factors, such as management and marketing on the one hand, and uncontrollable events such as the dollar and the economic strength of export markets on the other.

As a consequence I believe there were a number of statements made or ideas floated in the articles that warrant questioning.

What is actually happening?

Yes, at the big picture level, there is a fundamental issue of supply exceeding demand.  As usual this hides a lot of detail at the “ground level”.  There are, of course, many companies in dire straights and others going great guns.  Some do not have enough wine to sell to meet the opportunities in front of them.  Should they really be cutting production because someone else has too much wine?

Anyone who has wandered down a supermarket wine aisle over the last year will know that there is a lot of discounting happening.  It begs the questions, though, as to who is discounting and why?  It does not take more than a cursory glance to figure that the companies leading the domestic discounting are several of the very largest companies in the industry.  This should hardly be surprising because many have been publicly at the forefront of cutting grape purchase contracts and stating the need to cut high inventory levels clogging their warehouses.

Logically these companies will have experienced much higher overall market shares as a consequence of discounting.  However, also logically (since discounting is not exactly a good thing for consumer loyalty), the retail market share of these companies will probably drop sharply in the foreseeable future.  Once stock levels are down there will be no reason to discount in the same way any longer.

However, what the big company discounting has done is squeeze the sales of everyone else in the market, and this is what has flowed through to affect other companies.

At the other end of the food chain many growers are seeking to sell up and leave the industry.  The number of wineries selling up, as opposed to vineyards, still seems surprisingly small, although more will likely follow.  However, the question of who will buy the assets now on the market warrants serious consideration. 

Is there really a group of big overseas-owned corporates hovering and waiting for the chance to buy up the industry for a song?  This doesn’t exactly seem plausible.  The existing big companies are the ones that have been selling discounted wine furiously to try and get their balance sheets back in order.  The overseas parents have been selling assets for the last couple of years, not buying.  The idea of these companies suddenly going on a New Zealand spending spree does not seem likely.  There will be overseas investors moving in, such as the Foley group that recently acquired local assets, but these are the exceptions rather than the rule.  Groups like that may cherry pick some assets in future, but this is not a trend in the making.

The most logical buyers of most assets will either be existing financially strong grape growers looking to expand and gain efficiencies, or second tier wine companies with growing market strength that need to support their growth.  Of course the fundamental problem faced by New Zealand-owned companies as buyers is whether they have adequate access to capital.  Falling vineyard prices will not help the already difficult ability to access bank funding.

Export Success

Philip Gregan’s very pertinent observation that selling 30% more sauvignon blanc in the last year “is good news” seems to have been lost in the current of the story.  The truth is that 30% increase in volumes sold is a phenomenal outcome.  Indeed, the situation would be truly dire if we had merely held on to market share.

One issue affecting producers today is how to price into the UK market given the rise of our dollar against the pound.  However, it is interesting to note that most other countries are asking the same question – it is the weakness of the pound that has created this situation rather than the strength of the NZ dollar.

It is also no secret that a certain volume of New Zealand wine has been leaving our shores in bulk shipping containers.  It is therefore also no secret – in fact it has been recorded in the published statistics – that the average export price for New Zealand wine has fallen – as it must do since the lower productions costs in the absence of packaging and labelling mean that any seller would be expecting a lower price, regardless of whether the wine is qualitatively inferior or not.

Of course given the lower cost of production of bulk wine shipped in plastic bladders, let alone the fact that such wine is not carrying branding or other value added components, it is logical to expect a decline in value per litre of exports – but then again this is hardly comparing apples with apples against past prices for exports of bottled wine.

However, on looking more closely at the data, the fact that the decline has not been greater actually suggests that overall pricing has held up far better than expected.

  1. Over a long period the average price has been maintained as high as it has given the overall level of growth; and
  2. Even in the short-term analysis, the rate of decline of the average export price/litre has been far less than might have been expected given the anecdotal evidence of the volume of wine exported in plastic bladders.

Now 2010 is supposed to be the vintage when voluntary yield cuts pulled production levels down, closer to balance with demand.  So what has happened to render fruit discounting still necessary?

The data tells some of the story:

Year to 30 June 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
Total Production (mil litres) 60.2 53.3 89.0 55.0 119.2 102.0 133.2 147.6 205.2 205.2
Domestic Sales of NZ Wine (mil litres) 41.3 36.2 32.6 35.3 35.5 45.0 50.0 51.0 46.5 59.7
Export Volume (mil litres) 19.2 19.2 23.0 27.1 31.1 51.4 57.8 76.0 88.6 112.6
Total Sales Volume (mil litres) 60.5 55.4 55.6 62.4 66.6 96.4 107.8 127.0 135.1 172.3
Domestic % 68.3% 65.3% 58.6% 56.6% 53.3% 46.7% 46.4% 40.2% 34.4% 34.6%
Export % 31.7% 34.7% 41.4% 43.4% 46.7% 53.3% 53.6% 59.8% 65.6% 65.4%
Sales/Production ratio 1.005 1.039 0.625 1.135 0.559 0.945 0.809 0.860 0.658 0.840
Sales/Production prior vintage   0.920 1.043 0.701 1.211 0.809 1.057 0.953 0.915 0.840
Aggregate incremental stocks over 1999 levels (mil litres)* -0.3 -2.4 31 23.6 76.2 81.8 107.2 127.8 197.9 230.8
Incremental stocks/Export volume 0.0 -0.1 1.3 0.9 2.5 1.6 1.9 1.7 2.2 2.0

*does not take account of volumes lost/ullage/dumped/samples etc)

This table shows the history of production and sales for the last 10 years according to statistics published by NZ Winegrowers.  It is interesting that the ratio of sales to production has been far worse earlier in the decade than in the last 2-3 years, although obviously that was not in a global market quite like that of the present. (I have presented the ratio both in terms of same year sales and also year ahead sales – when, of course, much of a given year’s wine will actually be sold, and especially so for sauvignon blanc).

Interestingly, while there were prominent sceptics several years ago regarding how difficult it would be to sell the excess stock levels early in the decade (2003/2004), those levels pale in comparison to current levels -especially when the proportion of bulk sales is built into the equation.

Year to 30 June 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
Export Value (millions of NZ$ FOB) 168.6 198.1 246.4 281.9 302.6 434.9 512.4 698.3 797.8 991.7
Export Value/litre NZ$ 8.78 10.32 10.71 10.40 9.73 8.46 8.87 9.19 9.00 8.81
in US dollars 4.42 4.38 4.62 5.43 6.11 5.89 5.93 6.31 6.92 5.34
in UK pounds 2.78 3.02 3.20 3.42 3.51 3.17 3.34 3.26 3.45 3.31
Increase/decrease % NZ dollars   17.5% 3.8% -2.9% -6.5% -13.0% 4.8% 3.6% -2.0% -2.2%
in US dollars   -0.9% 5.4% 17.5% 12.7% -3.7% 0.7% 6.4% 9.7% -22.8%
in UK pounds   8.8% 6.0% 6.8% 2.8% -9.8% 5.3% -2.3% 6.0% -4.1%

 

Despite the not insignificant volumes of bulk wine sales before June 2009, it must be acknowledged that the proportionate rate has increased and so average pricing fallen in the period since.

A quick glance at the December export data confirms that the rate of annual volume growth is approaching 30% over June 2009 levels, although total export values are only up 10% in NZ$ terms.

However, taking a step back and assuming for the sake of analysis that the anecdotally reported amount of bulk wine is 25% of total sales volumes, then if it is assumed that bulk wine sells for the equivalent of US$2/litre (as reported for some volume sales in Asia) it implies that the per litre value of bottled wine has actually risen over 10% in NZ$ terms, but fallen slightly (9%) in US$.  Switching this analysis the other way around, if NZ bottled wine leaves the shores at the same price as it did 12 months before it means that 25% bulk wine is averaging prices closer to US$3.70/litre or NZ$6.15.

Is this too good to be true? Or are the assumptions wrong?

I suspect that the answer is a combination of three factors: (1) the prices of NZ bottled wine have held up relatively well, assisted by an improved quality mix (including more pinot noir and higher value red wine, for example); (2) some of the bulk container product has actually been higher quality product being shipped for bottling and labelling elsewhere to reduce carbon footprint; so that (3) the actual “bulk” wine exports are smaller than reported.

This is not as bad an outcome as might be otherwise interpreted simply on the face of the data, and I am not ignoring the fact that the backward looking stats will get worse before they get better – such is the “lag” built into rolling period numbers.

In fact, if current sales volumes are maintained, New Zealand will sell more wine (approx 206 mil litres) than it produces in the year to June 2010 (estimating total production between 180 to 200 mil litres), the first time since 2003; the level of stocks as a ratio to export volumes will also drop to its lowest level since 2003. 

This raises the question whether bulk sales should actually be a more permanent feature of the marketplace.  All of the other major wine producing nations export bulk wine.  There has long been an active market for surplus wine between wineries within New Zealand.

Of course it will be argued, with some justification, that New Zealand is a small wine producer and cannot achieve the economies of scale that many other countries possess.  While this is true of most NZ wine production, there are grounds to argue otherwise with regards to sauvignon blanc.  Our production is larger than so called efficient competitors such as Chile and South Africa (and our yields have often been higher), our vineyard management costs much closer (partly owing to much higher mechanisation, offsetting cheaper labour) to the supposedly cheap competitors, and our processing costs not so much greater as to completely overwhelm the other factors.

The real question is whether we want to compete, even if it means marketing our bulk wine as being a cut above other countries’ bulk wine.

Since getting true supply/demand balance “right” is next to impossible, maybe New Zealand should consider that there is a place for developing markets for bulk wine into areas where the product is not carrying the NZ Brand message (with risk of consequent damage).  This at least may help keep our industry-wide production scale more competitive and help to cushion the risk of margin squeeze on bottled wine exports in future.

The Varietal Exposure

New Zealand does far less than Australia to explore alternative varieties and to try and find out if there are new varieties that we could find a starring role for.  We seem happy to define our strengths as being those things we have done before, not what could be done in future.

Is sauvignon blanc just a fashion story that could fall over tomorrow and leave us even more exposed?  The answer is probably a bit yes and a bit no.  Whenever sales of a particular style of wine take off dramatically over a short period of time, it would be foolish not to assume that fashion is a big factor.  There are, however, other trends going on.

One of the issues New Zealand faces is the fact that the vast majority of our total wine sales are to English-speaking countries and cultures.  There is a sameness about consumers in these markets that stands at odds with consumers in different parts of Europe, for example.

One of these factors is that white wine makes up very roughly a little over half of all wine sold in these countries and that three grape varieties completely dominate consumption of varietal labelled white wine: chardonnay, sauvignon blanc and pinot gris.  Riesling and other varieties are typically a long way back.  There is an increasing trend for broader market consumer fans of one of the three to express dislike of the other two, resulting in a sort of three way polarisation of taste.  In the English-speaking world a large number of consumers identify themselves as chardonnay or sauvignon blanc or pinot gris/grigio drinkers and the degree of interchangeability is falling.

This probably means that if New Zealand can produce and market all three varieties in the face of competition from other producers, there should be a reasonable expectation of holding our own in all volume terms. 

This does not mean that we should not continue to explore alternatives.  The current big three whites haven’t always been so, and will not always be either.

Regulation

“Be careful what you wish for, as you may well receive it” (Anon., proverb)

The last time any industry should consider regulation is as a corrective measure after that industry has experienced problems.  It is like another well known proverb, that regarding the subject of “closing the stable door”.  Were regulation desirable, it might have had an effect if it were enacted three years ago, but not now.

The very fact that producers in overseas countries with strong wine industry regulation make no secret of the fact that they envy our lack of similar regulation, and the freedoms and flexibility that go with not being regulated, ought to be the single most conclusive reason for not doing the same thing.

However, experience with regulatory impacts on industries in general, and on the wine industry internationally in particular, suggests other reasons for extreme caution.  Regulation acts as a form of safety blanket, but has a number of important consequences.  Regulation most often serves to protect the interests of the biggest existing players.  It makes it harder for others to join them.  In general it results in a reduction of competitive pressures and so would rarely be regarded as a good thing for consumers.  It tends instead to make life easier for regulated producers, reducing their risks and tending to result in lazy and inefficient businesses.

These are, of course, generalisations and would never apply to all producers.  However, they can be defended based on the experience of comparable wine producers such as those of Europe.   

There are also some significant practical issues raised by the suggestion of regulation.  What would actually be regulated, and how, are both serious concerns.  Yield limits in other countries are often a joke, or else produce the wrong outcomes – a quality producer with well balanced vines could be forced to drop large volumes of grapes one year, while the sloppy next door neighbour comes in just under the limit and sell its entire production of under-ripe, rot infected, lower quality wine.  Even within Marlborough, different vineyards or sub-districts have historically been cropped at different yields for different price points.  Access to water makes a substantial difference alone.

Then again, should the same yield limits be promulgated for different varieties?  Some varieties will never produce a quality wine at crop levels even close to the cut down yields of sauvignon blanc this year.  Then again, different varieties will crop at different levels given the different soil types and climates of different regions.  It’s not just that one size won’t fit all nationally, but one size won’t fit all even for a single variety in a single region.  In Europe the individual regions tend to make the key decisions for their own members – so the idea that a Hawke’s Bay or Central Otago representative body would make decisions governing all production within their respective regions should give hints as to the nature of the disputes (or open civil war) that could result from competition between different interest groups.

The more serious issue is the loss of future flexibility, such that if New Zealand is exposed to the risk sauvignon blanc is a global fashion that might wear off, the Muller Thurgau of the 21st century, regulation will result in our being less able to change.  Regulation severely handicaps adaptability – it is anathema to industry evolution.  It is ironic that in parts of France, and especially in Italy, it is the regulations that have needed to be changed to adapt to the fact that quality producers have repeatedly considered themselves forced to opt out of the protections that go with regulatory compliance.

Of course, the very fact that total production is down this year, despite as much as 2000 additional hectares coming into production, suggests that despite the disaster that was 2008, when greed was the defining factor in over-production of often poor quality sauvignon blanc wine (triggering a domino effect onto other sections of the industry), self-regulation has not exactly been a failure since.

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