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Whats behind warm inland winegrape prices? 2018 Murray Valley Information Forum Murray Valley Information Forum 10 May 2018 Page 1 The Agenda The BAD NEWS for warm inland winegrape prices is that, warm inland winegrape growers are

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Murray Valley Information Forum Page 1 10 May 2018

What’s behind warm inland winegrape prices?

2018 Murray Valley Information Forum

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The Agenda

The BAD NEWS for warm inland winegrape prices is that,

warm inland winegrape growers are price-takers,
winegrape prices are derived from wine prices, and
warm inland fruit becomes a second option in times of
versupply.

Nevertheless, there is GOOD NEWS. Supply and demand still operates and … warm inland fruit is in high demand in times of under-supply. This means for the well-informed grower, supply and demand conditions can be leveraged to wrest back some negotiating power – and it is potentially worth it. This presentation sets out to demonstrate this.

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The bad news (1) –price-takers

Warm inland winegrape growers are PRICE-TAKERS “A market-player whose size is small in relation to the market and doesn’t influence the market price” Australia’s major wine companies are relatively better positioned in terms of negotiating power relative to their buyers – they are fewer than warm inland winegrape growers, and they are larger. Wine companies will exert their relative power advantage to claim as much margin as possible from winegrape growers. .

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Prima facie, WC growers are price-takers

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Bad news (2) – wine-derived pricing

Winegrape price is derived from the price wine is sold for. When wine prices suffer so do winegrape prices. In fact they suffer more, due to winegrape growers being price- takers (previous point and next point).

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100 200 300 400 500 600 700 800 900 1 000

89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17

0% 10% 20% 30% 40% 50% 60% 70% Average Australian winegrape price ($/t) [line] Warm Inland price as a share of Cool- temperate [bars]

Bad news (3) – some warm inland fruit is a second

ption in times of over-supply

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So, with this bad news, where have we got to …

If the news is all that bad about the grower’s ability to influence prices – do growers have any options? Some sage advice – “The best thing growers can do is become INFORMED. Read the stuff that MVW provides. Once informed, speak up. Respond to price offers. Object. Lodge notice of dispute. Don’t stay mute.”

M Stone, MVW Executive Officer, January 2018

Handled properly, this is called NEGOTIATION.

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Here’s the good news …

The rules of supply and demand still apply and for the actively informed grower

Supply and demand can be used to gain advantage and

benefits through negotiation. So, on with the demonstration of this …

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100 200 300 400 500 600 700 800 900 1 000

89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17

0% 10% 20% 30% 40% 50% 60% 70% Average Australian winegrape price ($/t) [line] Warm Inland price as a share of Cool-temperate [bars]

Note the following …

While prices and the relativities between warm inland and cooler temperate fruit prices follow general trends over time – as explained in an earlier slide – there are also differences each year. With yearly differences, there are worthwhile negotiations to be had each year.

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BUT …

What price to ask for? … and how to sound convincing?

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The negotiating position

At the end of the day you want to achieve a margin (profit) over your costs – and the buyer does also. What you will be doing is asking the buyer to share the profits available to be shared between you – so you need to know

their likely margin,
your desired margin,
the drivers of both and
what you consider reasonable in terms in a sharing

arrangement. To do this, we need to understand the whole value chain from dirt to slurp. Let’s do some modelling …

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Some notes on the nature of modelling

The following modelling will not generate numbers that are directly relevant to your business. Averages are being used – across winegrape colour and varieties, wine prices, costs and so on. As such, they are not necessarily your numbers or circumstances. The full relevance to your business can only be understood by using your business numbers and your best intelligence on your own buyer’s numbers. The model will however, tell the general story about

margins available to all members in the value-chain,
what could be achievable in terms of margins/winegrape prices

and

what needs to be negotiated to get there.

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Value-chain analysis (1)

For Bulk Wine prices in 2018, I have used $1 per litre for whites

and $1.25 for reds.

In terms of Bottled Wine from the Murray Valley, or possibly other

warm inland regions, I have relied on a brief personal survey of prices in some major outlets (done in Feb 2018). The categories of wine I found were ... 1. Proprietary Brands (Australian Vintage, McGuigan, Lindemans) 2. Premium Buyer-Own-Brands (a basic identifiable label indicating both source region [premium] and variety [the classics]) 3. Non-premium Buyer-Own-Brands (Aldi brands, labelled as an ‘imaginary’ wine company, the variety indicated but not the source region) 4. Cleanskins (a very basic functional label ie no ‘branding’, variety identified).

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Value-chain analysis (2)

This is how the prices came out – compared to a similar exercise conducted in 2014.

* Labels with dedicated format and identified by premium region and by variety ** Identified by variety only

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The Model – using Proprietary Brands as an example

Value chain Units Data input Outcomes Comment

YIELD t/ha 19.0 Warm inland (sustainable) TONNAGE t 19 WINE CONVERSION RATE L/t 750 Mega/bulk processing facility VINEYARD COST OF PRODUCTION $/ha Warm $7,500 VINEYARD UNIT COST OF PRODUCTION $/t $395 GROWER NET MARGIN %

Significant margin sacrifice GRAPE SALE PRICE $373 GRAPE COST PER LITRE $/L $0.50 WINE CONVERSION COST per LITRE (excl wg cost) $/L $0.35 $0.35 Mega/bulk processing facility WINE PROCESSING COST per LITRE (incl wg cost) $/L $0.85 WINE - OAK AND MATURING $/L Non-prem $0.15 WINE BOTTLING, BOXING, WAREHOUSING, FREIGHT $/L Non-prem $1.10 WINE COMPANY TOTAL COST $/L $2.10 WINE COMPANY NET MARGIN % 30% Standard margin WINE SALE PRICE pre-WET $/L $3.00 WET % 29% Yes WINE SALE PRICE BY WINE COMPANY (litre) $/L $3.86 WINE SALE PRICE BY WINE COMPANY (750ml bottle) $/bottle $2.90 DISTRIBUTOR MARGIN % 30% Standard margin DISTRIBUTOR SALE PRICE $/bottle $4.14 DOMESTIC RETAILER MARGIN % 40% Super-normal margin RETAILER WINE PRICE $/bottle $6.90 GST % 10% SHELF PRICE $/bottle $7.59

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Assumptions behind the model

Vineyard Cost per hectare Cost slashing (unsustainable) $6,500/ha Average season $7,500/ha Yields Tonnes per hectare (unsustainable) 25 t/ha Tonnes per hectare (sustainable) 19 t/ha Winery Conversion rates Mega/bulk processing facility 750 L/t Medium/large processing facility 700 L/t Conversion costs Mega/bulk processing facility $0.35/L Medium/large processing facility $0.60/L Oak, maturing Non-premium wine $0.15/L Bottling, boxing, warehousing, freight Non-premium wine $1.10/L Margins All players Sub-normal <30% Normal 30% Super-normal >30% Hierarchical norms apply Players further down the value-chain have greater negotiating power and will exercise this to extract a higher margin

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My accounting system (Mary Retallack model)

VINEYARD PRODUCTION COSTS (aka ‘cash costs’) Operating Costs (aka ‘proportional costs’) Includes …

Hired labour

Fixed costs (aka ‘overheads’, ‘non-proportional costs’) Includes …

The owner’s salary
Debt servicing (roughly 15% of production costs on average)

BUSINESS RETURN (aka ‘margin’ or ‘profit’) Covers …

Replacements/depreciation
Principal repayments
Business improvements
Wealth generation (super top-up)

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The results (don’t worry you can look at this at your leisure)

2018 2018 2018 2018 2017 2018 2018 2018 2017 2018 2018 2017 2018 2018

Scenario 1 Scenario 2 Scenario 1 Scenario 2 Scenario 1 Scenario 2 Scenario 3 Scenario 4 Scenario 1 Scenario 2 Scenario 3 Scenario 1 Scenario 2 Scenario 3 Wine company claims available margin Needed for winegrape grower break- even Wine company claims available margin

Downstream

margin sacrifice needed for grower profit 2017 wine/winegr ape prices 'Normal' margin for grower Equal margin sharing Margin sharing according to hierarchical power 2017 wine/winegr ape prices Margin sharing according to hierarchical power Sustainable vineyard yields 2017 wine/winegr ape prices Margin sharing according to hierarchical power Sustainable vineyard yields Assumed wine processor Mega/bulk processing facility Mega/bulk processing facility Mega/bulk processing facility Mega/bulk processing facility Mega/bulk processing facility Mega/bulk processing facility Mega/bulk processing facility Mega/bulk processing facility Mega/bulk processing facility Mega/bulk processing facility Mega/bulk processing facility Mega/bulk processing facility Mega/bulk processing facility Mega/bulk processing facility Assumed vineyard yield (t/ha)

28 28 25 25 19 19 19 19 25 25 19 25 25 19

Total cost of production ($/ha) $7,500

$6,500 $7,500 $6,500 $6,500 $7,500 $7,500 $7,500 $6,500 $7,500 $7,500 $6,500 $7,500 $7,500

Targets

Winegrape price

$290
$290
$290
Target wine price

$1.00 $1.00 $1.25 $1.25 $6.92 $7.59 $7.59 $7.59 $4.87 $4.99 $4.99 $4.69 $4.80 $4.80

Outcomes

Winegrape price

$167 $232 $275 $313 $290 $566 $517 $373 $290 $414 $414 $290 $353 $353

Winegrape grower margin

17%

30% 24%

10% 28% 5% 10% 15%

Wine company margin

10% 10% 10% 10% 27% 21% 24% 30% 10% 10% 10% 10% 10% 10%

Distributor margin

30% 19% 30% 25% 30% 30% 30% 30% 15% 15% 15% 15% 15% 15%

Retailer margin

na na na na 40% 40% 40% 40% 43% 40% 40% 41% 40% 40%

Proprietary Brand Buyer-Own-Brand/Non-premium Cleanskins White Red Bulk

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Breakdown – Proprietary Brands

Comments Profits are possible at 2018 in contrast to 2017 when losses were inevitable at an average winegrape price of $290/tonne. Moreover potential 2018 profits will be at full cost and sustainable vineyard tonnes/hectare. However, realising a profit will be highly dependent on negotiations of margin with the wine company. This is illustrated by the comparison between Scenarios 3 and 4. The standard wine company margin of 30% will result in a winegrape loss (Scenario 3) but each 1 percentage point of wine company margin transferred to the grower will improve the price

utcome by roughly $24/tonne. Slide 16 shows

this will be break-even – more margin transferred will be better still.

2017 2018 2018 2018

Scenario 1 Scenario 2 Scenario 3 Scenario 4 2017 wine/winegr ape prices 'Normal' margin for grower Equal margin sharing Margin sharing according to hierarchical power Assumed wine processor Mega/bulk processing facility Mega/bulk processing facility Mega/bulk processing facility Mega/bulk processing facility Assumed vineyard yield (t/ha)

19 19 19 19

Total cost of production ($/ha) 6,500

7,500 7,500 7,500

Targets

Winegrape price

$290

Target wine price

$6.92 $7.59 $7.59 $7.59

Outcomes

Winegrape price

$290 $566 $517 $373

Winegrape grower margin

30% 24%

Wine company margin

27% 21% 24% 30%

Distributor margin

30% 30% 30% 30%

Retailer margin

40% 40% 40% 40%

Proprietary Brands

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To clarify this important point ….

Negotiating 1 percentage point of the wine company’s margin …

boosts the grower’s

margin by 5.6 percentage points

and the winegrape price

by $24/tonne1. Worth it?

1. Based on the assumptions employed in this example

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Breakdown – Bulk wine

Comments Even with improved prices in 2018, bulk wine still struggles for profitability. Based on the modelling here, losses are still a prospect at full accounting for winegrape growing costs. Break-even for white bulk wine and a small profit for red, are achievable only by pushing the vines to high yields, unsustainable cost-cutting, and negotiating margin sacrifices further downstream in the value-chain. Even then, these are false profits since they are based on cash costs only.

Note: brokerage and contract winemaking are accounted for by 30% and 10% margins respectively.

2018 2018 2018 2018

Scenario 1 Scenario 2 Scenario 1 Scenario 2 Wine company claims available margin Needed for winegrape grower break- even Wine company claims available margin Downstream margin sacrifice needed for grower profit Assumed wine processor Mega/bulk processing facility Mega/bulk processing facility Mega/bulk processing facility Mega/bulk processing facility Assumed vineyard yield (t/ha)

28 28 25 25

Total cost of production ($/ha) 7,500

6,500 7,500 6,500

Targets

Winegrape price

Target wine price

$1.00 $1.00 $1.25 $1.25

Outcomes

Winegrape price

$167 $232 $275 $313

Winegrape grower margin

17%

Wine company margin

10% 10% 10% 10%

Distributor margin

30% 19% 30% 25%

Retailer margin

na na na na

Bulk White Red

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Breakdown – Non-premium Buyers-Own-Brands

Comments Based on the modelling here, the retailer benefitted from the average $290/tonne winegrape price in 2017 – enabling an above-standard margin. In 2018, near-normal winegrape grower margins are achievable at full cost accounting (good!), high tonnes/hectare levels (bad!) and standard retailer margins (good!). However, winegrape grower margins suffer considerably if tonne/hectare yields are reduced to sustainable levels.

Note: distributor (wholesaler) and contract winemaking are accounted for by 15% and 10% margins respectively.

2017 2018 2018

Scenario 1 Scenario 2 Scenario 3 2017 wine/winegr ape prices Margin sharing according to hierarchical power Sustainable vineyard yields Assumed wine processor Mega/bulk processing facility Mega/bulk processing facility Mega/bulk processing facility Assumed vineyard yield (t/ha)

25 25 19

Total cost of production ($/ha) 6,500

7,500 7,500

Targets

Winegrape price

$290

Target wine price

$4.87 $4.99 $4.99

Outcomes

Winegrape price

$290 $414 $414

Winegrape grower margin

10% 28% 5%

Wine company margin

10% 10% 10%

Distributor margin

15% 15% 15%

Retailer margin

43% 40% 40%

Buyer-Own-Brand/Non-premium

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Key points

1. Despite general price trends over time, each year presents different opportunities for winegrape price negotiations based on supply and demand characteristics of that year. 2. Improved bottled wine prices in 2018 make winegrape margins possible with sustainable costs and vineyard management practices – but only by negotiating margin sacrifices by wine companies. 3. On fruit destined for proprietary brands, one percentage point of wine company margin transferred to the grower could equate to around an additional $24/tonne in 2018. 4. Even with improved 2018 wine prices, bulk wine still struggles for profitability. 5. By-passing profit-taking players downstream in the value chain, vastly improves the prospect of improved winegrape prices. 6. Only your and your buyer’s numbers and circumstances will determine if these messages apply to you. 7. There are also system-level changes that can improve winegrape price outcomes. More time is needed to discuss this.

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Summary

The factors limiting negotiating power over winegrape prices include,

being price-takers,
becoming the second choice in times of oversupply, and
winegrape prices that are derived from wine prices

achieved by the wine companies who have negotiating power over the grower. However, supply and demand still operates and for the knowledgeable grower, value chain analysis can inform negotiations and provide these negotiations with some credibility. Knowledge of the value-chain enables knowing how much and with what confidence negotiations can occur.