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The announcement that none of the potential pivate equity bids for TWE has come to fruition does not entirely surprise, although the purported attitude of some shareholders toward the price previously offered is curious. The nature of the due diligence and bidding process instituted by the TWE Board appears to have been designed to get just this result. The reports from TWE that both bidders supported the company’s strategy rather supports the hypothesis that this backing was a prerequisite for bid support, notwithstanding the fact that it likely reduced the value of the bids (unless both KKR/Rhone Capital and TPG really were clueless, which I doubt although without knowing who has advised them I can’t help but feel their wine industry nous is open to question). What remains to be seen is whether the agreement KKR and TPG will have signed up for in order to gain entry to due diligence now precludes them from returning with a new or revised unfriendly (i.e. unrecommended) bid. If so, this transaction appears to have been cynically managed to preserve the status quo, potentially contrary to the interests of TWE shareholders.

There have been many comments in recent weeks regarding the implications of private equity bidding for TWE. I do not believe that comparisons with Accolade are helpful. Accolade is a much simpler business and, as a consequence, its private equity owner CHAMP has been able to institute a much simpler strategy to add value.

By contrast, if I were a private equity buyer for TWE I would definitely be aiming to gear up as high as possible for the simple reason that I would be planning to sell assets quickly to reduce debt with a view to ending up with enhanced equity in the assets that remain after debt has been repaid from proceeds. The value adding process would not be a vainglorious attempt to grow earnings of the whole but rather an attempt to get the business back to a state of simplicity and focus. These are the hallmarks of the most profitable wine businesses worldwide, which TWE is not. Paradoxically, I also believe that the current wine conglomerate incarnation of TWE requires more capital and working capital investment than a smartly run smaller business cherry picked put of the balance of relatively unloved or undersupported brands.

Some media and industry commentators would have us believe that break up of TWE would be some sort of disaster for the Australian wine industry. I suggest this couldn’t be further from the truth, although part of that is a spectator’s desire to see how some of TWE’s famous brands could perform if actually set free and properly loved. Another paradox: it could be better for the Australian wine industry AND consumers AND investors. That would be a rare combination, but none are possible under the present configuration.

 

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The ongoing takeover saga concerning what is now Treasury Wine Estates goes back to the misguided strategies of previous owners, made worse during the era of Fosters ownership.

Nevertheless, it appears that there may be some perspectives missing from the public discussion around the actions taken by Treasury, the manoeuvrings of the parties involved and the implications of change. In particular it always astounds how little the wine media understands the philosophies and the tactics of private equity (let alone the position of investors in public companies as Treasury presently is). By the same token, the financial industry and media often seem to display extraordinary naiveté concerning the business models and drivers of wine businesses. In this respect the fact that wine businesses are so markedly different to beer or spirits brands in terms of capital intensity, working capital seasonality, competitive pressures, brand and portfolio requirements and elasticity of demand are commonly misunderstood or ignored.

This was a problem for the now Treasury businesses during the Fosters era and long before that. Some would argue that the rot set in even before the Southcorp and Rosemount merger in 2001, when the two different business models collided in a catastrophic case study of what can happen when the new managers completely misunderstand both the drivers and the key relationships then underlying the business. The weakened Southcorp fell into the Fosters fold in 2005 and the process of value destruction continued for similar reasons.

Part of the problem is the nature of the key Treasury businesses. Penfolds virtually invented the icon-halo effect business model, centred on the image of desirability that spreads from Grange to the Bin series wines and then down to the mass market labels. This was a model that Rosemount had tried (with its Balmoral Syrah and Roxburgh Chardonnay) but never mastered. Its success had been driven by producing large volumes (especially of chardonnay) to a set formula using low price Riverlands fruit. Other brands within the portfolio had similar top labels, but these never achieved the same relationship perceived in the case of Penfolds (whether or not the so-called halo effect ever produced an economic benefit, which is open to argument).

This misunderstanding has been perpetuated through the Fosters and then Treasury corporate structure and hiring practices. For a long time Fosters wine divisional structure was based upon the end markets, which probably works well for beer but only created a gulf of separation from the production side of the business. Subsequently the structure has moved slowly back towards the production side as the imbalances between production and sales have become exaggerated. Even so, the company has still been caught doing what all of the other international drinks brand companies have done building up stock levels in China in anticipation of a boom, only to have found that the market was not as predictable as expected. For all the good ideas they may bring, both Fosters and Treasury hired consumer brand managers to run the business, not wine people with a deeper understanding of the industry (with consumer branding experts under rather than over them), and this has been a telling factor. It is a mistake that it is quite plausible private equity owners will also make if they have misunderstood the business.

Part of the problem is that Penfolds (and several but definitely not all of the other Treasury brands) is really an oversized boutique wine business. Its drivers aren’t entirely in common even with other mass market wine businesses. In its efforts to boost short-term profitability (partly based on the China blue sky myth) Treasury has been through a phase of aggressively lifting prices of Penfolds products and creating a range of new luxury Penfolds wines – possibly trying to emulate some of the value add strategies of spirits producers in recent years. The unsurprising consequence is that not all customers are happy with the perception that their loyalty is taken for granted. Even Penfolds Grange has lived in denial of certain realities: it is a multi-region blend at a time that the Australian wine industry is turning back to industry marketing based on provenance, while at the same time production levels are massively higher than they used to be so that Grange is far from being the rare luxury it once was. Once a mainstay of the independent wine trade it is now readily available (at a price) in supermarkets across Australia and New Zealand.

As a consequence many of the actions taken by Treasury in recent times have been misunderstood by both the financial and the wine press, albeit for different reasons. To many the changes in the Penfolds release calendar and the recent initiative to sell discounted wine fridges to boost wine sales have been perceived as attempts to boost short-term profitability in order to save the business from predators. This completely misunderstands the relationship between short-term profitability and economic value, especially since the most obvious consequence of both initiatives is largely to shift the timing of profits rather than the quantum. It was no surprise when a new bid emerged after all.

To state the obvious, the price at which KKR made its original approach to Treasury will not have been its best price. It was, nevertheless, rejected by the board. Few of the changes made by the company since, whether on costs, process improvements, marketing changes or sales initiatives, will have materially increased the value of the overall business. Nor are any of them things that a private equity buyer could not also do if it chose.

Moreover, it is clear that private equity buyers will have some options available to them that the present board either is unwilling to do or considers unpalatable. That means that private equity buyers may have the ability to enhance the value of the business in ways that the company cannot do.

The sum of the parts?

The simplest way of all is to recognise that the value of the parts of Treasury today is likely to still be greater than that of the whole (notwithstanding the fact that some of Treasury’s historically valuable brands have been neglected to the point they are already as good as worthless). This factor is most likely the reason why the takeover competition has developed the way it has. The fact there are two competing bids at the same price indicates that for TPG a matching price was really about having a seat at the table. This implies that the process may devolve into a behind the scenes auction of some of the parts to be followed by a formal offer being made (and recommended by the board) for the balance of the company. It is worth noting that while often competing, TPG and KKR have a long history of partnering on investments as well.

Treasury (and Fosters before it) has been a problem for Australian wine, but not always in the ways perceived in the media. It has simultaneous promoted the virtues of Australian wine but also unconsciously undermined the global market for Australian wine as well as for many of its own brands.

In a world of brands, brand hoarders often destroy value. The value of a brand is heavily dependent on both use and potential, but the lack of one of these can undermine the other. It can simply be impossible to maintain the level of marketing prioritisation required to maximise the potential of each of a portfolio of brands once a certain level of brand hoarding has occurred. Inevitably some good brands will be utterly devalued. By way of contrast LVMH is an example of a company owning a large collection of luxury brands that has developed clear strategies for what it adds to its portfolio and how it will seek to promote and add value to each brand.

Paradoxically, one of the most value additive strategies open to Treasury, or to a future owner, may be to sell Penfolds – the clear jewel in the crown. The problem with Penfolds is that its influence over the Treasury portfolio has continued to grow, and to assume increased internal prioritisation, so that it has become a dead weight on top of the rest of the business. The emphasis on marketing and selling Penfolds products has come at an enormous cost to sales of other brands. It is not inconceivable that the US stock glut, a consequence of poor market information, planning and inventory controls, was accentuated by the internal marketing priorities (whether of Penfolds or other US brands) suppressing demand for many competing products.

Treasury’s Australian wine portfolio alone includes more than 30 brands, a mix of famous old names and newish names somewhat obviously invented by marketers. Some of these brands, once household names in Australia, now either languish as homes for cheap supermarket bargains or are rarely seen. Even those brands receiving a little more love from the marketing department are still often competing against sibling brands or worse, have been formally de-prioritised in some markets. One of the difficulties with a demerger of the brands will be the extent to which previous management has closed down many smaller regional wineries, originally attached to individual brand companies, in the pursuit of a phantom holy grail of scale and lower costs.

The roll call of brands that once held significant (often quality-driven) positions in the domestic Australian and export markets, but which have now been relegated to bit rolls as multi-regional blends or price point gap fillers, is extensive. Some of these brands could recuperate and flourish with some love and investment. For others that could no longer be said, even for names with significant historic resonance.

Treasury Australian brand Roll Call (not comprehensive): Annie’s Lane, Bailey’s of Glenrowan, Coldstream Hills, Devil’s Lair, Great Western, Heemskerk, Ingoldby, Jamieson’s Run, Leo Buring, Lindemans, Maglieri, Metala, Mildara, Penfolds, Pepperjack, Robertson’s Well, Rosemount, Rothbury Estate, Rouge Homme, Saltram, Seaview, Seppelt, St Hubert’s, T’Gallant, Tollana, Wolf Blass, Wynns, Yarra Ridge, Yellowglen.

Even so, the parts are still worth more than the whole because the way the whole company works stifles the real potential of too many brands. New owners of parts might change that.

The recent decline in per capita domestic wine consumption in New Zealand (not to mention other countries where this has occurred) raises the obvious question: is the reduction across the board or variety specific? As one retail commentator recently mused, are we in New Zealand becoming slightly “sauvignoned out”? It is logical given our viticultural emphasis on the variety that the retail market share of sauvignon blanc might well be higher than in most of the countries we sell sauvignon blanc to (where there will be a larger overall selection of wines since the overall percentage of other imports will typically be much higher than it is here). I am not ignoring the fact that the percentage of sauvignon blanc we export from New Zealand is much higher than the proportion of any other varieties (or to express this in the reverse, we drink a much smaller proportion of the sauvignon blanc we produce than we do of any other variety). The issue is firstly whether the domestic market for sauvignon is close to saturation and, if so, whether future market trends will provide a useful lead indicator of the impact of changing preferences globally (whether or not sauvignon blanc’s local market share has actually diminished lately, given that I opened from the standpoint of a purely anecdotal remark and it is not necessarily proven to be the case).

The launching point for this discussion is the historic reality that wine sales globally have tended to be highly fashion or trend driven, for a wide variety of reasons. Styles and varietal preferences come and go over periods of time – often 1-2 decades. Even when a variety undergoes a recovery after a period of market neglect it is usually stylistically different to how it was previously. There may be an argument that generational change is a factor, for example. Climate change may also be an influence (as seasonal climate differences have long been proven to be an influence on many beverage markets).

Nevertheless, it is probably safe ground to suggest that at some point in the foreseeable the continuing global market demand (and therefore market share) of sauvignon blanc will stop and then start to decline. Unless global demand for wine continues to grow, diminishing market share will mean diminishing actual demand for sauvignon blanc. The rate at which these trends will affect New Zealand will be affected by global competition from other sauvignon blanc producers (which, in the immediate future most likely means our main international export market competitors France, Chile and South Africa).

Will demand for sauvignon blanc subside dramatically? Probably not. The nature of the demand that drives sauvignon blanc sales globally is that it seems to be adopted as a favourite variety of a certain proportion of drinkers in each market. This means that even if global fashion changes there will probably be a solid core of demand that will remain fairly constant for a prolonged period of time. This will then deplete slowly through natural “taste attrition”. The rate at which these drinkers switch to other varieties will depend on the rate at which newly fashionable varieties or styles shift from the low but important market shares driven by early adopters to the point of mass adoption. Most fashionable varieties never make the shift to mass adoption and so it is trite to try forecasting what it will be, but the likelihood of this process happening is inevitable.

The process can also be producer/marketer-driven to a certain extent. It is quite plausible that the current wide popularity of sauvignon blanc has been accentuated by the marketing efforts of New Zealand and other producers of the variety that have helped to increase its exposure to large numbers of drinkers. This is itself poses a risk and an opportunity, because once any style or variety reaches saturation in the market of its time, the marketers of that variety or style typically have two choices: diversify choices within those styles as a means of maintaining market share (something that has already started to happen with sauvignon blanc, or to shift marketing effort to the active promotion of replacements in order to be at the “ground floor” for future opportunities. The latter happens only very rarely in practice (in most other markets as well as in wine) because most producers only realise that the market has changed too late.

When the market changes, New Zealand will likely continue to make and sell far more sauvignon blanc than anything else for a considerable period of time. The first damage will be to the marginal growers – to those who planted in anticipation of ongoing growth – or to those existing producers who will lose out to the latecomers, possibly because of disadvantageous locations. In either case there will be growing overproduction and falling prices at the grape, bulk and bottled wine levels (except, most likely, at the very top end).

One of the factors that will influence this cycle will be the fact that not every producer will experience it in the same way. Even when overall market share is flattening or falling there will always be some market participants, large and small, who are still experiencing growth. Some of these may be so focused on their own success and need for product security that they are ignorant of the degree of change in the rest of the market and are continuing to plant vineyards that will not be in full production for several more years.

The process will then become one of adjustment and there are a number of reasons why this process could be unnecessarily painful. Market adjustment is always an unequal process. Some are affected more than others. Some react much earlier than others who do not. In a wine world where growers have the choice of pulling out vines or taking short cut and grafting onto existing plants, the key to adjustment is to have the options determined and in place before the need arises.

Diversification is an obvious solution, but it is problematic and much riskier if it has not been an ongoing process. This is one of New Zealand’s great problems. New Zealand nurseries have imported a growing number of increasingly high quality varietal plant materials. There is room for more yet, but it is a start. The problem is that, with a handful of exceptions, most of the work with new varieties is being done by small wineries and growers. The significance of this has been accentuated by the changes in ownership and marketing priorities of most of the larger wine companies that dominate production today.

While 25-30 years ago the likes of Montana (now Pernod Ricard), Corbans (now Lion), Matua Valley (now Treasury) and Nobilo (now Constellation) were active importers and triallers of new varieties, this emphasis has almost completely gone. The large wine companies primarily want sauvignon blanc, pinot gris and pinot noir for export markets. The corporate philosophy of most large producers eschews significant experimentation. Paradoxically these companies, which have the most at risk should the tide turn, should be the ones most advanced in trialling both the growing and winemaking development of new varieties. They are the ones doing a disservice to their shareholders because the time taken to catch up to any new trend can be as long as a decade (once the time is allowed for access to adequate quantities of buds, replanting or grafting over, getting new vines into production, learning the viticultural requirements for new varieties in different regions, sub-climates and soils, learning the individual winemaking process requirements and developing styles, not to mention trialling styles with the market).

Doing all of this from scratch after the market has changed is simply dumb strategy. (So is the arrogance of thinking you can just buy the expertise).

I do not ignore the fact that if larger producers were actively pursuing diversification experiments it could have mixed consequences for existing smaller experimenters. The positives could include increased access to more diverse sources of quality plant materials, the benefit of accelerated viticultural learning and the market exposure advantages when several producers are marketing a new variety rather than one producer doing it on their own. The negatives include the greater risk of geographical or stylistic cul de sacs being taken by small producers; or losing the uniqueness or marketing point of distinction that can be essential for small producers.

The strategy of diversification is multi-faceted. In the first instance it is about risk management but, if managed intelligently, it is also about ensuring or creating future growth options. In this respect it is an essential component of a value enhancement process. For this reason it is curious that shareholders and financiers alike fail to demand diversification programmes of some form or other from medium to large sized wine producers for whom the programmes would be a small part of existing asset and budget allocations.

A number of recent articles touting future trends or next big things that I have read in recent weeks have highlighted factors that I believe warrant some serious questioning indeed.  I am convinced that a great many wine professionals are influenced heavily by personal tastes sometimes to the detriment of judgement, and moreover that this influence causes many professionals to have blinkers on when it comes to what it is that actually motivates the choices of the buyers of most wine (other than, of course, price).

How much or how little do we know about the mass public that buys by far the large part of our industry’s product?  How much do we rely on consumer research – and therefore on its process of selecting the subjects and on the questions that are asked?

The following discussion touches on a few such canards that I believe we should sometimes step back and question.

Why not Riesling?

Could it be that two of the riesling grape’s strengths are also its weaknesses – handicaps against ever truly competing against the likes of sauvignon blanc or pinot gris?

Versatility.  Yes riesling is one of those few grapes that can produce excellent wines in every style from very dry to unctuously sweet.  Most often it is made in styles ranging between just off-dry to medium sweetness.  The problem is that most potential drinkers only have a limited preference range and find riesling’s range of styles confusing and unsettling. Notwithstanding attempts to introduce standardised guides to sweetness, unfortunately still too complex for most drinkers however well intentioned, most drinkers are scared to try a new riesling fearing it may be something they will not enjoy, unlike the “reliability” of pinot gris or sauvignon blanc.

In fact one of riesling’s problems has always been that it has been an “introduction to wine” sort of a drink.  An awful lot of wine drinkers, completely unaware of the pinnacles of riesling, think of riesling as being relatively sweet and view it as a past phase that they are unlikely to ever want to return to.

Flavours.  To put it quite simply, I think a lot of people (perhaps that should be most people) don’t actually like the taste of riesling: not when it is super tart and austere as some young rieslings are, and especially not when it is aged and starts developing the famous kerosene characters.  I believe that flavour characteristic turns off a great many riesling drinkers who simply don’t care that it is a classic varietal trait.

So why has riesling been enjoying something of a revival in the US?  And why has German Riesling been enjoying something of a revival in a number of markets?

The use of the word “something” is particularly indicative, and in both cases the nature of the revival is stoked by both the strong press given to the variety, and by past memories.  However, the reasons for each are very different.

The wine that has experienced strong recent growth in the US is very much “commercial riesling”, a wine made in a fruit forward style that riesling is perfectly capable of handling, but not too structured or demanding of the taster.  The lift in popularity of riesling in the US probably says more about the continuing growth in the number of wine drinkers in that country than about its participation in a riesling renaissance.

German riesling, by contrast, is now largely drunk relatively young when its spectacular acid freshness highlights its youthful fruit characters.  Most drinkers of German Riesling today wouldn’t recognise an Auslese from the 1990s as having anything in common with the style they enjoy, let alone a beautifully aged classic from 1971 or 1976.  One possible supposition that might be interesting to consider is that the last heyday of German riesling in the 1970s and 1980s coincided with the beginning of the love affair of the baby boomers with wine.  It was the “introduction to wine” beverage of a whole generation.  That may in fact have been its problem ever since.

Disclosure of interest: The writer is a fan of good riesling.  Unfortunately, however, I can’t make my mind up whether I would prefer riesling to be the eternal beloved niche wine or a true mass success.  I do fear that the latter, some form of popular reflection of approval for my personal taste, would inevitably lead to yet another period of decline that riesling seems destined to.

Minerality & Texture/Structure

I have recently read articles discussing future candidates for revived popularity (a subject that usually revolves around former favourites and rarely new ones) the idea being expressed that minerality and either structure or texture would be among the reasons for popular success.

The more I have thought on this, the more convinced I am that strongly mineral-influenced wines will only ever be a particular favourite of wine-educated niche markets.  In fact, I would go so far as to say that the wider public do not and would not recognise minerality, almost certainly might find the idea somewhat distasteful, and might actually be inclined only to think of minerality as a sort of off flavour distracting from fruitiness.  In short, I don’t think that the wider wine-drinking public particularly likes minerality at all.  Indeed, why are we (those of us who do enjoy mineral influences) deluding ourselves into thinking that many people do like these characters?

Structure and texture.  Structure has many aspects – body, roundness, acid, sweetness, etc. All influence the structure and texture of a wine on the palate.  The mass market consumer does not think about structure and never will.  Individual aspects of a wine’s structure do matter, but certainly not in an analytical way: only for how much they are perceived to make a wine taste pleasant, drinkable, or not.  The additional problem is, of course, that even in the mass market different consumers have different degrees of tolerance for different structural characteristics of wine.

In general, however, I believe that the characteristics that wine aficionados relish as texture are anathema to the wider market.

Surely we all know that success in the mass market does often rely on sugar, which has a very particular taste and mouthfeel.  That is what the phenomenal success of Yellow Tail and its copycats are built upon.  Indeed why not use sugar dosing: sweetness hides a multitude of off flavours that might damage consumers’ enjoyment.  How many inexpensive Australian shiraz (and not always inexpensive, for that matter), and increasingly some New Zealand red wines as well, does one have to taste to be able to say that they just taste sweet.  Not “fruit sweetness” but residual or added sugar sweetness. And yet they still pick up medals and awards, as attested to by the stickers on the supermarket shelves.

If ever there was a component of wine that needed the epithet “not too little and not too much” it is acid.  Too much and a wine can taste sharp, sour, austere, angular and even abrasive on the palate.  Too little and wines will taste flabby and loose, and will rarely cellar well.

Yet we need to remind ourselves that the right level of natural acidity conveys the sense of freshness to a wine.  This is the ingredient that carries New Zealand’s sauvignon blanc – without its steak of refreshing acidity the fruit flavours would completely lack the vibrancy that tells you where they came from.  It is the singular reason hotter countries struggle to replicate the Marlborough formula.

Most wine drinkers don’t think about acid in wine – it might even be a turn-off for many.  They just know that the most popular white wines the world over right now have refreshing qualities that highlight the fruit and the drinkability of the wines.  Structure?  Who cares – more of the same please.

What Faults?

One of the ironies of promoting medal winning wines in supermarkets is that identification of faults is such a significant part of the wine scoring system, and yet consumers for the most part don’t care at all about technical faults and are far more concerned about flavour and easy drinkability.  It is highly questionable whether the objectives of the two are at all aligned other than that the sticker on a bottle may make it easier to sell against other bottles on the same shelf at the same price point.

Indeed many faults that cause winemakers sabres to rattle have far less effect on consumers.

Take trichloroanisole or TCA (the cause of corked wines).  We readily lose sight of the fact that most drinkers have no idea what a corked wine really is, and a great many have quite low sensitivity to TCA.  Most of those who are sensitive to TCA would be most likely inclined just to think something’s wrong with the wine and never buy it again.

Reduction.  Very similar – who actually knows how many screw-capped wines suffer from reductive characters?  There is probably something to the theory that we have become accustomed to some of these characters instead.

High Alcohol’s High Wire Act

Why do high alcohol wines still sell?  Supposedly the world wants lower alcohol wines.  Indeed hot wines are supposed to be defective, are they not?  Yet the evidence from some wine competitions suggests that some judges are either not especially sensitive (or could it be that they are de-sensitised after tasting a lot of wines?) to alcoholic heat, and that this is a reason why it does not get marked down as often as it should – or how else can one explain regular encounters with high medal-winning wines with searing back palate heat.

Maybe it’s just that many current or former spirits drinkers also enjoy heat or are de-sensitised to the much lower apparent heat of wine?  That certainly might explain the tolerance of high wine alcohol levels in some countries, for example.

So we have the dichotomy of a world that, we are told, is wanting lower alcohol wines (but still with flavour, personality, balance etc), and at the same time defending our high alcohol wines.  How many times does one read reviews stating that although a particular wine has an alcohol level of 14 or 15% “it’s no problem because it is balanced”.

To be frank, I have tasted a number of wines that have received such reviews and I am perplexed. Why can it be that palates who I unhesitatingly believe to be far superior to mine can’t spot the elephant trumpeting in the back of their throats?  These wines had unmistakeably hot finishes. Sometimes you could even smell spirity characters.  Quite honestly I really believe that the number of truly “balanced” 14.5% alcohol wines is actually very small indeed, far rarer than the reviews.  I also suspect that many reviewers write about the wine being balanced for no other reason than that they like it, are seduced by its flavours and concentration, and want to give it a good score even though it really isn’t balanced.

The statement has become little more than a defence mechanism against the risk of criticism for reviewing or scoring such wines despite their glaring faults.

The Language We Use

If the wine industry, and indeed the wine press as well, is keen to distance wine as a beverage from its potential abuse as an intoxicating agent for immoderate drinkers, then why is there the continued use of language that equates squarely with the use of wine as such a beverage?  Examples?  Much of the press seems incapable of using the word “wine” in a headline when words such as “drop” or “tipple” could be used instead.  So, what is wrong with using such words?  Maybe to wine professionals they might seem innocent enough, but from a wider public perspective, words such as these have origins or messages with quite clear implicit meanings. “Drop”, for example, has implications of “down the hatch” and of language equated with heavy drinking.  “Tipple”, by contrast, has connotations of slightly illicit “guilty secret” drinking behaviour, and is the likely origin of the word “tipsy”.

Neither has any relationship to drinking with food, one of the strongest potential defences wine has (and rarely seems to try and use) against the onslaught of the neo-temperance movement. There are indeed other widely used expressions that almost certainly have similar, detrimental connotations.

Even if one disagrees with my interpretation, the fact is that if even a small part of the wider public recognises these words in a similar context (and I believe it is actually more than that), then the words have done a disservice at best, and damage at worst.  At the risk of seeming a killjoy, they are words we should be able to do happily without and should actively seek to stamp out.

New Zealand Winegrowers has made two public statements regarding excise in recent times.  In the first it advocated shifting the accounting for excise to the retail end of the chain.  In the second it advocated that the Government give the annual excise increase due on 1 July next year a miss owing to the significant impact it would have on the wine industry.

There is an unfortunate irony in that I suspect New Zealand Winegrowers is hamstrung by the technicalities (in particular that the true cost is not simply excise) in respect of its public pronouncements.

The fact is that excise on alcoholic beverages is a multi-layered beast.  Demonstrating this may go some way to show why shifting excise to the retail end of the chain is both economically and ethically more desirable, and yet unlikely to happen.

Moreover, in pulling its punches New Zealand Winegrowers has refrained from pointing out the double up in the excise increase attributable to this year’s increase in the rate of GST.  In short, the 5% forecast level of CPI inflation by next year includes the 2.2% annual effect of the increase in the rate of GST from 12.5% to 15%, which increase has already been factored into the excise impost (if not in theory, very much so in practice).

Allow me to illustrate this.  The following table shows the impact on either the winery or the consumer (or, as often than not, both) in the event of a 5% excise hike next year.

Case Bottle
Current Excise 23.42 1.95
GST on Excise 3.51 0.29
Total Excise Impost 26.93 2.24
Add retail margin (e.g. 35%)
Excise portion of markup 8.20 0.68
GST on markup 1.23 0.10
Total Excise Impost incl margin 36.36 3.03
Adding a 5% excise increase
Resulting Excise 24.59 2.05
GST on Excise 3.69 0.31
Total Excise Impost 28.28 2.36
Add retail margin (e.g. 35%)
Exise portion of markup 8.61 0.72
GST on markup 1.29 0.11
Total Excise Impost incl margin 38.18 3.18
Resulting Increases
Ex-winery excise 1.17 0.10
Consumer excise (ex winery) 1.35 0.11
Consumer excise (retail all inclusive) 1.82 0.15

While the 35% retail markup is an approximation (as some distribution and retail combined mark ups will be less, and others more, depending on the channels supplied), the true impact at the consumer level will be greater when restaurant margins and other costs are added in.

Note also that the Government collects income taxes on the proportion of the margin on excise that may be retained as profits by the retailer.

Of course this is not the whole story.  The 2010 GST increase had the following impact on the ex winery (GST inclusive) excise impost:

Current Excise (ex winery) 23.42 1.95
2010 GST increase on Excise (ex winery) 0.59 0.05
Pre increase Total Ex-Winery 26.35 2.20

What this means is that when you add the double slab of 2010 GST and 2011 increase, including GST on the increase, you get:

Total GST (ex winery) 4.27 0.36
Total Excise Impost (2010 & 2011) 28.86 2.41
Total Increase from 1 Jul 2010 1.93 0.16
% Increase on 1 Jul 2010 7.3 7.3

So how might excise have risen over 7.3% in 12 months? It is the proverbial anomaly when you have a tax on a tax.

Of course, it is one thing to have a double up – where the increase in a tax causes the increase in excise and, therefore, in the tax on that excise.  The other question is the extent to which that reaches the consumer.  If the retailer refuses to pay a higher price or compromise on its margins, the economic cost to the winery for continuing to supply that retailer is not the level of excise it must absorb, but the level of excise including the GST on the cost that is not able to be passed on.

Based on the assumption that at present a little under 40% of New Zealand wine is drunk domestically (and therefore subject to excise), and that about two thirds of this is tied to “immoveable” price point structures, accordingly about 66% of the total increase in excise, plus GST, is worn by the industry, and a mere 1/3 (representing about 13% of total NZ wine production) will be passed on to consumers or borne in some proportion by retailers.

It is curious then that the Law Commission and other advocates for higher levels of excise as a consumer behaviour influencer have not wholeheartedly supported NZ Winegrowers on its stance regarding shifting excise payment to the retail end of the chain.  The fact that excise may be paid, by the winery, months or years before a bottle is sold is conveniently overlooked.  More importantly, the whole situation goes to show how impotent and irrelevant the present system is from the perspective of using excise as a tool to fight alcohol abuse.

Two reasons, both morally questionable and conveniently overlooked from a revenue perspective, why an excise shift won’t happen:

  • The tax on tax factor – Government would lose both the GST and income tax on the profit margin earned by downstream distributors and retailers on the excise charged as part of the price to them.
  • The breakages and losses factor – a certain amount of wine will always be damaged or stolen after it has left the winery.  The Government still collects excise on these losses.  There is no provision for reversal, since the people who handle wine after it has left bonded warehouses (usually the winery or storage facility) are not accountable to NZ Customs.

On closer inspection, however, are either of these actually material or true?

The breakages and losses factor is difficult to quantify without adequate data.  Assuming 2% as a breakages and losses factor (and I do not know if that is low or high) would mean a revenue loss of approximately $13 million on current excise estimates (including beer, spirits and other beverages also).

As regards the “tax on a tax” factor, if retail prices do not change from present levels, this need not be the case at all.  There will be a range of costs and savings shifted between the upstream and downstream sectors.  Retailers would be able to justify higher margins on the basis of taking on administrative costs (although in the age of GST compliance these should be not be onerous).

Let me illustrate. Under the present system, using a 35% indicative mark up rate, the general pricing economics look as follows:

Case Bottle Industry ($mil)
Case ex-winery 100.00 8.33 708.61
Excise 23.42 1.95 165.95
Total ex-winery price 123.42 10.28 874.56
Add retail margin (35%) 166.62 13.88 1180.66
Retail Price incl GST 191.61 15.97 1357.75
Effective total excise (incl GST) 26.93 2.24 190.84
Total value of GST 24.99 2.08 177.10

However, if the excise collection is shifted downstream, the same formulae would produce a different result:

Case Bottle Industry ($mil)
Case 100.00 8.33 708.61
Add retail margin (35%) 135.00 11.25 956.63
Excise 23.42 1.95 165.95
Retail Value (excl GST) 158.42 13.20 1122.57
Retail Price incl GST 182.18 15.18 1290.96
Effective total excise (incl GST) 26.93 2.24 190.84
Total value of GST 23.76 1.98 168.39

The level of total GST revenue lost is just $8.7 million under this scenario.

If, instead, prices are maintained at the same levels as originally, and we then work back to obtain the retailer margin:

Case Bottle Industry ($mil)
If price unchanged: 191.61 15.97 1357.75
Less GST 24.99 2.08 177.10
Price excl GST 166.62 13.88 1180.66
Less ex-Winery price 100.00 8.33 708.61
Less Excise 23.42 1.95 165.95
Retail Margin 43.20 3.60 306.10
Retail Margin (%) 43.20 43.20 43.20

While the percentage margin is expanded, the actual value remains the same so that, aside from shifts in compliance and funding costs, the net taxpayer position remains the same.

The biggest single added cost would be the transitional cost of establishing bonded storage areas and the downstream compliance regime – although this is no different to what a winery with a cellar door or restaurant operation already has to manage, and would continue to have to do so.

Overall, however, from a wine industry perspective the small reduction in compliance costs (since all would need to continue as bonded areas) is less important than the balance sheet impact.  Based on the (occasionally substantial but usually a matter of months) gap between incurring excise liabilities and receiving payment for most wine sales, the estimated working capital requirement incurred by the industry averages approximately $40 million and may well peak at closer to $50 million, not only incurring debt costs but also tying up valuable working capital that is not able to be utilised elsewhere.

At the present time, that release of overdraft working capital could mean the difference between survival and failure of many businesses under pressure from their banks.

I was interviewed this morning for TVNZ’s NZI Business programme on the Breakfast show regarding the state of the “industry in crisis”.
I felt that for those with the time to read it might be helpful to add to and amplify my comments (which for the time being may be found at http://tvnz.co.nz/business-news/nzi-business-wine-industry-in-crisis-4-15-video-3855494).

When the going stays tough
The focal point for much of the industry media commentary has been on the growing number of receiverships and mortgagee sales of wine and grape businesses.

It is easy to understand why people focus on these as the sharp evidence of industry problems. However, the truth is always a little more complicated. I would argue that many (maybe half or more) of the wine industry receiverships of the last three years could be traced back to reasons that were not strictly the fault of the industry downturn (e.g. property developers with vineyard interests, personal problems etc). In other cases the nature of the problems has sometimes been “atypical” – such as the failure or default of offshore importers, loss of contracts etc. Sometimes optimistic mistakes or flaws in business models have been highlighted.

What can not necessarily be said is that all these collapses occurred because people were bad at business. One of the most important things now is that some very skilled and knowledgeable people, who may have lost much of their wealth and savings but who still have enormous value still to contribute, are not lost to the industry.

Another thing to recognise is that receiverships, liquidations and mortgagee sales typically peak after the bottom of the cycle. Businesses have held on, scrambling to pay creditors and the bank, waiting for an improvement until the position gets stretched beyond their ability to manage and they run out of options.

Indeed one of the most interesting statistics to me is that of how few receiverships and mortgagee sales there have actually been. The reason is not hard to fathom. Most vineyard owners owe at least a little (and sometimes a lot) to their bank. With low grape and wine prices the industry is, overall, wallowing in red ink. The last thing that any rational banker wants to see is vast swathes of vineyard land and millions of litres of wine stocks being sold off into an already depressed marketplace. This would, simply, turn a bad situation worse. Most of the banks have simply no option but to nurse the industry through the worst. However, this does not mean that there will be no more businesses falling into the receivers’ hands.

Turning the Corner?
At the bottom of any economic or industry cycle, there are always mixed messages. There are always positive statistics and good news stories to go with the gloomier indicators.

I consider that we are now at that point in the cycle where enough things have turned that the positive indicators outweigh the negatives. It has taken a long time to get this far! Evidence has taken the form of overseas export markets holding up (not many countries today can claim this), reduced levels of discounting (bit domestic and offshore) compared with a year or even six months ago, bulk wine supplies tightening and prices improving, plus more positive press about the industry’s key initiatives.

However, New Zealand is not out of the woods just yet, and one critical reason is that for all we are close to a supply demand balance at our latest production levels, we still suffer from a “structural” imbalance. This takes two forms: (1) we are still not selling enough of our wine in the secure branded form that gives us the control over price and quality that is the hallmark of stability; and (2) we still have the vineyards planted that could in a generous year, and without yield discipline (as was the case in 2008), produce more than 100,000 tonnes more grapes than we did in 2010.
Until that structural surplus is whittled back, whether through increased sales, more explicit yield controls, or the removal or “re-assignment” of excess vineyards, we run the risk that we will continue to shoot ourselves in the foot through periodic overproduction, followed by the inevitable practices that follow. Our inability to sell excess bulk wine to new markets rather than to our best markets, has caused long-term brand damage.

In the meantime the biggest worry is the obvious one: wine is an agricultural product and New Zealand has a marginal, maritime climate. The double hit of a big crop and a wet, poor quality vintage is the type of nightmare scenario that could set the entire industry back three years or more.

The bigger issue is time.
If you have been fighting hard to hold onto your vineyards or your company for the last three long, hard years, how would you feel if someone turned around and said “good news, we are past the bottom, only it is going to take many years to get prices and markets back to the point you can make a living again”? A lot of very sane people might ask the question “well, what’s the point of carrying on?”

It is too easy to hide behind the truism that grapes and wine are long-term industries. Yes, they are, but not in the sense implied by saying that industry recovery may be a long, slow process.

There is a choice, however. One can choose to either work hard over the long haul, hoping that neither unscrupulous people, changing fashions, nor the weather will upset the recovery process, and hope for the rewards at the end; or else seek to participate in collaborative initiatives to speed up the process.

Collaboration is a two pronged concept. On the one side it recognises that while the industry may comprise a large number of small businesses, working together can allow wineries to gain some of the economies of scale of much larger operators. On the other side collaboration, in its many guises, allows us to reflect on the fact that each of us or our businesses may lack certain skills, attributes, assets or other resources that someone else may have. There may be a price to pay for accessing those skills, attributes or resources, but bear in mind that the potential partners are also paying a price.

This is not simply a pitch for formally merging a lot of businesses, although that might be an option that makes sense for some – especially if the merger creates a business that is secure and worth much more than the sum of its parts.

Other forms of collaboration or partnership might be as simple as co-ordinating vineyard operations or administration, joint marketing initiatives (such as the Family of 12, Specialist Winegrowers, and MANA Natural Winegrowers groups of like-minded people), or new ways of sharing other resources.

The options for any given vineyard or winery, will probably be intrinsic to that business. The hard part is actually admitting the value to be found in looking, and in entertaining the possibilities in a serious way.
The fact is that without collaboration, the chances of speeding up the recovery process are, frankly, remote.

Shuffling the deckchairs (sorry for the Titanic analogy)
The emergence of some high profile wine industry deals at this time is almost certainly coincidental in the main.
The Delegat’s bid for the shares it doesn’t already own in Oyster Bay Marlborough Vineyards (a company that owns vineyards contributing roughly 25% of the grapes for the Oyster Bay brand, but doesn’t own the brand) appears to have been brewing for a few months now following the deal with Peter Yealands at the end of June, while the deal for Pernod Ricard to sell certain key assets and brands to Lion Nathan and Indevin appears to have taken place more quickly.

Both deals have a considerable amount of background “history”, including takeover battles and very public disputes. Both deals aim to resolve situations that had become increasingly uncomfortable, for differing reasons.
The more important facet of these transactions is that they are being done by companies that possess or are able to access capital resources in the first place, as lack of capital is the industry’s Achilles heel right now. The industry’s recovery would be significantly sped up and strengthened if capital were readily available.

The Future
Long slow haul, or fast track to the future? On one level, that of the bystander looking on and trying to make an assessment based on the visible facts, it is extremely difficult to judge. The real key, as it always is, is people. People have options. The choices between doing one thing or another, or doing nothing at all. Time and again history proves that people react to situations in very similar ways, so that the critical requirement for breaking out of past behaviour and grabbing at opportunities is the willingness to actually be prepared to look out at what options might be there.

There will never be a single one-size-fits-all solution. A better analogy is that of the toolbox that allows one to fix or improve all manner of problems inside a house. But outside, the cladding and the roof, we are much more reliant on the protection of the Building Code and on the councils, engineers, professionals and materials that have a duty to ensure the house is habitable.

One of the top wine stories in last week’s press in New Zealand, front page news in fact, was a report that wine prices (as a proxy for liquor in general) had fallen to such an extent over the last decade that they are now cheaper than bottled water.

The inference from this story was that the Government needed to act by increasing excise to stop the harm being caused by cheap alcohol.

This was of course the latest in a series of reports, this and several others emanating from the University of Otago, pushing the anti-alcohol agenda that dominates the Law Commission’s recent work (see https://doubtlesswinebusiness.wordpress.com/2010/07/23/the-tip-of-the-new-temperance-iceberg/ ).

Interestingly, the international press has cited the report as being “published in the New Zealand Medical Journal” when what was actually submitted to the Journal was a letter, meaning that it must have been accompanied by academic references (although presumably, as a letter, not subject to the standards of peer review required for full articles of scientific journals).  If it had been subject to such peer review it is surely questionable whether, on the grounds of either methodology, statistical sampling or analysis, it would have been accepted for publication.  Why? Simply because the article is patently polemical in nature and extraordinarily flimsy on each on each count as regards methodology or analysis.

By the next evening TV One News in New Zealand was already running a story scrutinising (and contradicting) the specific headline-seeking claims made in the report, even while missing the bigger picture analytical issues altogether.  The print media had missed this opportunity completely before going to print.

Of much greater importance is the stark reality that this type of lobbying, adopting an attitude of faux scientific rigour or justification, will continue to emerge and is frankly winning the publicity battle even if the Government has adopted a reform package missing some of the key Law Commission recommendations, such as huge excise increases.  Before that package is even fully in place, the anti-alcohol lobby is adopting a campaign designed to undermine confidence in the reforms (consistently criticised as inadequate even before there has been a chance to see if they have an effect).

What was claimed?

The headline was simple: alcohol is cheaper than water.  The report claimed that as a consequence of long-term trends alcoholic beverages could now be purchased for less than the price of water, the implication being, in other words, artificially cheap (because how else could it be cheaper than water, after all).

The published findings were that a 250ml glass of milk cost, and of bottled water cost “somewhat more at 67c a glass”.  By contrast alcoholic beverages, all cited as “standard drinks” rather than 250ml equivalents – a substantial difference in actual volume terms, especially as regards an “apples with apples” comparison – “can be purchased as low as” cask wine at 62 cents a standard drink, beer at 64 cents, bottled wine at 65 cents and spirits at 78 cents. The “can be purchased as low as” was strangely underplayed or missed altogether by much of the print media coverage.

It was conveniently pointed out by the report author, however, when queried by the TV News coverage, which found bottled water as low as 21 cents, cask wine at 71 cents and beer at $1.10,  that prices fluctuate and the low prices resulted from “specials” (which surely was worthy of having been spelt out in the original report if it was of such numerical significance).

In the meantime, the report, and its analysis, continues to gather international press coverage.

The Report Conclusions

Quite aside from the “results” of the analysis, the conclusions drawn in the press release have little causal nexus with the study itself.  A study purporting to be of the price of alcohol over time, and in particular as it compares with the average wage (presumably gleaned, unlike the price data, from Statistics New Zealand), concluded with a number of assertions including the need for an increase in tax on alcohol, restrictions on alcohol marketing and sponsorship, limiting off-licence premises and reducing the legal blood alcohol level for driving.

The news release on the report also referred to both the drink drive alcohol limit and binge drinking despite these being two quite different (and unrelated) forms of alcohol-based harm.

Professor Doug Sellman of the Alcohol Action Group (also an academic from the University of Otago) was quoted as saying the new study made the issue clear-cut – “No one can say you’re talking it up. Low prices equal harm.”  He may be an academic, but it would appear he is not a logician. The fact is that this analytical conclusion simply cannot be conclusively drawn from the study, regardless of the efficacy (or lack thereof) of the data.

Quite what several of the report recommendations had to do with the specific analysis is obscure.  In the absence of spelling out the causal relationships, it is difficult not to conclude that the research project suffered from analytical bias and predetermination of results.

For example, there is a strong appearance that the study avoided the lowest possible prices for bottled water but sought out the lowest possible prices for alcohol.  If so, this would amount to intellectual dishonesty.

Quite aside from the numbers (where different types of alcohol are priced), in the balance of the report alcohol is treated as a universal concept with no differentiation as regards the widely varied behaviour of different consumers of different alcoholic beverages in different settings.  The things that actually make up “drinking cultures”.

It is all the more a pity, because for some people this was really a missed opportunity to criticise the level of profiteering in bottled water prices (especially when compared with the low price of generally very reliable New Zealand tap water).

The two main flaws in the report are:

  1. Questionable methodology – not simply pricing water high and alcohol low, but the process of checking and verifying the alcohol prices.  Is wine really readily available (let alone sought out by binge drinkers) for $5.00 per bottle (65 cents per standard glass assuming 13% alcohol – probably high for most cask wine – and accordingly 7.7 standard glasses per 750ml bottle)?  Remember that at this level the ex-winery excise impost would be over $2.02 per bottle, including GST but before allowing for the fact that supermarket/retail margins are also marked up on the excise inclusive price they receive and if there is a distributor there would be an additional margin on excise as well.  The GST rate used here is 12.5%, presumably the level applied in the research despite the fact that this has increased to 15% since 1 October, and despite the fact that all wine will carry the additional GST on excise regardless of whether the price of the wine has been increased or not at retail level. 
  2. Lack of context. Given the sweeping pronouncements made regarding the price of different forms of alcohol, the fact of the economic environment was not mentioned in the University press release. The fact that the wine trade has been in the deepest recession in more than a generation is ignored, let alone the enormous implications this has for wine prices.  Not only is the industry globally dealing with issues of oversupply, but individual firms are responding with survival strategies that must affect pricing.  Ironically, the situation is exacerbated by the wine businesses that don’t survive, when the receivers and liquidators of such businesses drop stocks on the market at heavily discounted prices.  This is nothing to do with alcohol policy.  It is cold, hard reality. Having said that (and having seen examples of three such liquidation wine clearances in one supermarket today), I strongly question whether much if any of this wine has ended up being consumed as part of an alcoholic binge by a teenager or by someone older.  In the absence of any form of contrary proof, I must assert that the causal nexus of harm, surely fundamental to research of academic standards, is woefully missing.

While on this subject, the attack on supermarkets’ prices must also be scrutinised. Supermarkets have long been accused, sometimes with reason, of using alcohol as a loss leader to attract customers.  It is not so clear, however, how prevalent this practice is any longer.  Both the major supermarket chains in New Zealand now maintain that they refrain from using alcohol as a deliberate price loss leader.  Despite the occasionally very low (not $5.00 though) level of prices in supermarkets, this assertion is credible.  The vast majority of low priced wine (although not necessarily other forms of alcohol) in supermarkets is brought about by the factor discussed above – businesses competing by lowering prices, in order to move stock, in order to maintain cash flows, in order to survive.  Forcing minimum prices is simply going to cut off the short-term ability of some businesses to survive.  It is not going to solve any social problems.

In the meantime another argument is lost, and that is whether the sale of liquor (at the moment meaning beer and wine) through supermarkets is on balance a socially positive thing rather than a negative.  Quite aside from the views of many in the wider wine industry regarding supermarkets, the fact is that supermarket shoppers are more likely to be buying wine to go with food.  Surely that is something to be encouraged rather than discouraged? Surely that is a huge step toward a more responsible drinking culture, rather than the opposite.