Wine industry over a barrel
After 20 years of prosperity, the Australian wine manufacturing industry is in crisis. Since the mid-2000s, the industry has been hit by a perfect storm of demand and supply-side shocks.
Exports have been hurt by recession in key export markets, a soaring Australian dollar (which has made wine exports uncompetitive) and rising competition from new low-cost wine producers. At the same time, a total loss of market power to the dominant supermarket giants, changing consumer preferences and a vast oversupply of wine and wine grapes, have forced down prices, squeezed margins and forced many producers out of business.
Having belatedly come to terms with the chronic oversupply of wine in the market, producers are addressing the problem by writing off assets, closing down wineries and destroying vines. Early signs are positive but the industry faces a long and painful process before the market returns to balance. Conditions are expected to remain challenging in 2010-11, with subdued economic conditions in key export markets and a rising currency curtailing export demand and eroding repatriated earnings. IBISWorld estimates industry revenue will increase at an average annualised rate of 0.1% over the five years through 2010-11. Revenue is expected to reach $6.8 billion in 2010-11, representing 0.9% growth from the previous year.
Growth will remain moderate during 2011-12 as the strong dollar and sluggish global economy take a toll on exports, while weak price growth constrains domestic revenue performance and profitability. In the two to three years leading up to end of 2015-16, producers will shift their focus to premium wines, while Asian export markets will play an increasingly important role in the industry's future. IBISWorld forecasts that in the five years through 2015-16, industry revenue will grow at an average annual rate of 2.5% to $7.7 billion.
After a tough period for wine producers, conditions in the industry should gradually improve during the next five years. Having belatedly come to terms with the chronic oversupply of wine in the market, producers are addressing this by reducing production and closing down wineries. Growth will remain moderate during 2011-12 as the strong dollar and sluggish global economy take their toll on exports, while weak price growth constrains domestic revenue growth and profitability. Later in the five-year period, producers will shift their focus to premium wines. IBISWorld forecasts that in the five years through 2015-16, industry revenue will grow at an average annual rate of 2.5% to reach $7.7 billion.
Growth will improve
Conditions in the wine production industry are expected to improve in 2011-12, but growth will continue to be constrained by oversupply, weak price growth and soft external demand. Exports should lift over the year in line with improving economic conditions in key export markets, with moderate growth in premium wine in the United States a highlight. However, export value will remain soft overall as the strong Australian dollar continues to undercut export competitiveness and also eat into major producers' repatriated earnings. Demand conditions in the domestic market will be stronger, with the strengthening consumer environment boosting demand for wine from both on-licence and off-licence sectors.
Sales of premium reds, pinot gris and rose varieties should all be strong. However, revenue growth will continue to be limited by heavy discounting and the chronic oversupply of wine. Efforts to reduce the oversupply should reap benefits but this will not be enough to put upward pressure on prices. Growth in private label wine will continue to take market share from mid-tier producers. Wine producers will focus on lifting profitability by moving up the value chain and directing marketing and promotions at premium brands. IBISWorld forecasts revenue will increase by 1.6% in 2011-12.
Dealing with oversupply
The most challenging issue facing the industry is the current structural oversupply of wine in Australia. In November 2009, the Winemakers' Federation of Australia, Wine Grape Growers' Australia, the Australian Wine and Brandy Corporation and the Grape and Wine Research and Development Corporation released a joint statement highlighting the structural surplus of wine and wine grapes in Australia, which called on producers to take steps to reduce production. According to the research conducted by these bodies, at least 20% of bearing vines in Australia are surplus to requirements and at least 17% of vineyard capacity is uneconomic. The study asserted that Australia is producing 20 million to 40 million cases a year more than it is selling. The oversupply of wine continues to have a major influence on the industry, entrenching a culture of heavy price discounting, devaluing the Australian brand internationally and reducing producers' profitability. At the same time, demand for Australian wine, both at home and abroad, has fallen due to a variety of factors. These include recessionary conditions in key export markets, the emergence of other low-cost producing countries, unfavourable exchange rate movements, heavy discounting by liquor retailers, rising imports and growth in private labels.
Producers have responded to this by writing down assets, shutting down or selling vineyards and destroying vines. Recent figures from the Australian Bureau of Statistics (ABS) suggest the total planted area of vines has fallen by about 8,000 hectares or 5.0%, with another 10,000 hectares left unharvested. This will help address the industry's woes, but more action is required. Demand will not increase enough to eliminate the surplus of wine and wine grapes. With the global economy recovering only slowly, export competitiveness continues to be challenged by the strong dollar and the market power of the supermarket giants likely to increase further. The growing Chinese market has looms as a destination for some bulk exports, but the only viable solution to the industry's problems is for major producers to continue to remove vine plantings and mid-tier producers to leave the industry altogether, particularly those producers in areas around the Murray Darling basin. Producers need to move away from the low-cost, high-volume model favoured in the past decade and focus on improving Australia's reputation for producing fine wines. IBISWorld believes the industry will not return to balance until 2014.
IBISWorld forecasts that by 2015-16, Australian wine exports will reach $2.8 billion. The growth in industry revenue is dependent on the further opening up of emerging export markets such as Ireland, Canada, Germany, China, India, South Korea and Japan. However, competition is expected to be intense in export markets, as wine producers in other countries also become more reliant on exports. Growth in exports is expected to remain low in 2011-12, as global demand for wine remains weak. As a relatively high-cost producer, Australia is expected to lose some share of international trade, while demand conditions in major importing nations (such as the United States, the United Kingdom and Germany) remain poor.
Historically, wine exports from Australia have had an advantage in quality and quantity, and have been sold at lower price points than many competing countries. However, a relatively strong exchange rate and increasing production from other New World producers, which are able to produce wine at lower price points, has curbed demand for Australian wine at the lower end of the market. Competition will come from countries such as Chile and South Africa. The challenge for the Australian industry is to create a reputation for quality in order to compete successfully in higher price points. The Australian Wine and Brandy Corporation has developed a branding strategy for Australian wine exports. Establishing a consistent image of Australian wines overseas will require industry coordination.
Consumption of wine in the United States has been increasing, and is expected to increase further in the next three to five years. Australian wines have good exposure in the United States, particularly Casella wines (through its Yellow Tail brand). Thus, increases in US consumption are expected to have a positive effect on exports. While per capita consumption in the United States is presently low by international standards, it is estimated to be the largest single market for wine. A constraint on the growth of wine consumption in the United States is the consumer slowdown associated with the global financial crisis. As conditions improve, demand for Australian wines is expected to grow.
Another challenge for the industry is that two of the most prominent export markets, the United Kingdom and the United States, are becoming more polarised in terms of preferences. While American consumers prefer fuller, richer wines and are happy to drink wines with higher alcohol content, consumers in the United Kingdom are shifting toward subtler, lighter varieties with more finesse. The difference in preferences presents a difficult decision for producers in whether they should produce a variety of wines to appeal to both of these prominent export markets or concentrate on one export market. These decisions may be further complicated by relative abundance or scarcity of the necessary types of grape.
Exports to China
Australian producers may also be able to expand into countries that presently have low levels of per capita consumption. Producers are more likely to be able to introduce innovative products to markets that do not have a history of consuming wine. Non-wine producing nations are more willing to accept other packaging (for example soft packs or plastic bottles), without penalising producers on the price they receive. China is growing fast as a wine importer: Australian exports to China increased by over 34% in the year to September 2010, totalling 22.3 million litres. However, this growth is coming off an extremely low base and will take time to significantly affect producers' earnings. At present, China is mainly an importer of Australia's cheap, bulk wine, with Chinese drinkers preferring the prestige associated with Old World wines, particularly French, when it comes to choosing a mid-range to top-end wine. The industry – producers and the Australian Wine and Brandy Association – need to change this image in the years ahead.
Over the next five years, it is expected that the Chinese market for middle to high-end Australian wines will increase as domestic producers introduce products that rival the Old World wines. Chinese buyers are already paying more for an average bottle of Australian wine ($5.48 per litre) compared with the United States ($3.60 per litre) and the United Kingdom ($3.34 per litre). The signing of two memoranda of understanding (MOU) with China and Hong Kong is further expected to ease trade between the countries, which is expected to bode well for exports to that region.
IBISWorld forecasts that over the five years through 2015-16, industry profit levels will grow moderately. Some growth in profit margins is likely to arise from an export emphasis on higher value premium wines, and cost savings will come from a rationalisation of the industry. A rise in wine grape input costs will negatively affect profitability.
Major wine producers have responded to major oversupply of wine by writing billions of dollars off their wine assets and selling vineyards. During 2009, Foster's axed 37 wine brands and sold 31 vineyards, while Constellation Wines sold 10 wineries and 23 vineyards. Although this has had a disastrous effect on profitability during 2010-11, it should improve profitability in the longer term.
Improvements in profitability are expected to be realised from 2012-13 onward, as wine inventories are sold down and the industry returns to balance. Small decreases in production along with increases in price will allow producers to increase their margins while controlling costs. Wine grape prices are expected to increase on average. However, the increase will have only a moderate effect on costs of production. At the same time, high-volume, low-value producers will find it difficult to maintain their business models. It is expected that such producers will shift to higher-value production. Across the industry, wine prices are expected to rise at a marginally higher rate than the prices of inputs.
Over the five years through 2015-16, industry employment is forecast to continue to decline, reaching 12,370 people. Despite faster growth in industry revenue, economies of scale achieved through wine industry consolidation and further investment in automated processes will lead wine manufacturers to become less labour-intensive.
Water and environment
The future of wine grape supply depends on the availability of water. There are a large number of wineries and wine grape producers that depend on the Murray Darling River basin for irrigation water. According to the ABS, 53.6% of wine grape acreage is watered using irrigation water. Although this would not entirely be sourced from the basin, a significant proportion would be. The total water volume in the river system as of 30 November 2007 was 1,885 gigalitres, the lowest seasonal level since the 1940s. High temperatures have caused increased precipitation, which has exacerbated low rainfall. Present low water levels will cause low water availability for irrigation into future growing seasons. This will reduce the availability of wine grapes.
High water use by the industry, and in particular the treatment of wastewater, is likely to come under increasing public scrutiny. The industry is being proactive in addressing the issue. The CSIRO, with financial support of the Grape and Wine Research Development Corporation, is conducting research into viable options for water treatment at wineries. The sodium and organic content of wastewater can be harmful to the environment and limits its potential uses. Industry participants estimate a cost of $2,000 to $8,000 per megalitre for treatment, depending on the technology and size of the plant, and vineyard soil type. The goal will be to help industry participants select solutions that return the appropriate quality water for the destination for the lowest cost. Solutions include evaporation ponds, treatment for crop irrigation and new types of cleaning agents. Over the five years through 2015-16, the level of capital intensity is likely to increase marginally due to investment in water treatment.
Consumer concern for the environment will have an increasing effect on wine manufacturing operations and marketing. For instance, Hardy Wine Company has established a corporate relationship between its brand Banrock Station and the environmental organisation Landcare Australia. A small premium is charged on this product with a portion of the proceeds being donated to Landcare. The consumer not only purchases a quality wine product but they also receive utility from having donated to an environmental agency. In less than four years, sales increased from virtually nothing to about 1.0 million cases per year. Hardy is attempting to establish a similar relationship between other brands and overseas environmental organisations as part of its export strategy.
Key success factors
- Production of goods currently favoured by the market: An ability to switch production for a market that has ever-changing tastes is critical to success. Industry wine-tasting awards are an effective means of marketing wines with an appealing taste.
- Financial position of the company (as against financial structure): Asset backing is sometimes necessary in such a capital-intensive industry as this to compete with the production, technology and market power of multinationals. Survival is often a case of acquire or be acquired.
- Supply contracts in place for key inputs: Contracts will ensure a steady stream of grapes for specific varieties produced into wine.
- Economies of scope: Manufacturers that produce a range of wine varieties, wine brands and other beverages, can achieve efficiencies in activities such as distribution, marketing and administration.
- Guaranteed supply of key inputs: If grape supplies are assured by buying from several geographic regions and also via contract a firm will have an advantage over many other producers.
- Establishment of export markets: Strong ties to export markets have been a critical growth factor for players during the weak domestic conditions of the last five years.
- Financial structure of the company: The extent of a company's debt and the way in which it is financed will affect the ability to acquire new assets and ensure healthy cash flows.
- Economies of scale: Wine manufacturers with larger production facilities can achieve lower average costs, which can in turn facilitate lower pricing, increased marketing expenditure or capital investment.
Karen Dobie is the general manager of IBISWorld, Australia’s richest source of business information.