D2C01/C02 Factors that Affect the Price of Wine - Supply, Demand, & Costs

Question 1

Explain the ‘perfect world’ balance in supply and demand.

Answer 1

Producers would be able to sell all the wine they make at the price which

• covers the cost of production
• pays a dividend to any shareholders
• finances future investment
• still leaves a profit.

Consumers would be able to

• buy the wine they want
• of a style they enjoy
• at a price they are willing to pay.

Question 2

Explain the effects when supply of a particular product exceeds demand, in very broad terms

Answer 2

Prices tend to fall as consumers have a greater choice of cheaper alternatives.

Producers therefore need to lower their prices (so reducing profits) to remain competitive.

However, the fall in prices may lead to increased demand which may benefit producers in the long run.

Question 3

Explain the effects when demand of a particular product exceeds supply

Answer 3

Prices are likely to increase.

(Generally when perceiving that there are no alternatives,) consumers may be willing to pay higher prices for some wines.

Other consumers may not be willing to pay more and may simply switch to another wine or a different alcoholic drink altogether.

Question 4

What are the generic factors affecting the demand of wine?

Answer 4

(A variety of)

• Social factors
• Economic factors
• Legislative factors
• Political factors

(These are all connected and cannot be considered in isolation)

Question 5

What categories of habits and preferences of wine drinkers will affect demand?

Answer 5

Changes in…

1. Consumption habits
2. Consumer preferences
3. Reputation
4. Spending patterns

Question 6

How did global wine consumption (habits) change since 2001?

Answer 6

• Rapidly increased in first part of the 2000s
• Fall back after global financial crisis in 2008, as many consumers reduced spending on non-essential products
• Sales of still wines declined very slighlty in recent years
• Sales of still wines due to remain stable to 2021
• Strong growth seen in sparkling wine sales in recent years, due to continue to 2021

Question 7

What are the top 5 countries for wine consumption?

Answer 7

1. USA
2. France
3. Italy
4. Germany
5. China

Question 8

How has wine consumption (habits) changed in the top 5 countries for wine consumption?

Answer 8

• Falling or static in the ‘traditional’ wine drinking countries (e.g. France, Germany)
• Increasing in countries were wine has not historically been a major part of culture (e.g. USA, China)

Question 9

What is the country with the largest wine consumption worldwide? And how did this change in recent years?

Answer 9

• In 2011, USA overtook France & Italy to become the #1 consumer of wine
• Last 20-30 years wine drinking became part of mainstream culture

Question 10

Which 2 drivers helped wine drinking to become mainstream culture in the USA?

Answer 10

1. Increasing globalisation of food & drinks industry
2. Increased & improvements in wine production in USA’s domestic market

Question 11

What drives the wine consumption in China? And what wine markets profit from this?

Answer 11

China has a growing middle class that wishes to show their wealth and status by drinking wine instead of local drinks.

At first they chose primarily French wines (above wine produced domestically).

Not they are increasingly looking elsewhere, for example Australia and Chile, profiting from bilateral trade agreements.

Question 12

Name 4 possible reasons for the falling wine consumption (in traditional wine drinking countries)

Answer 12

1. Younger people drinking less wine
2. Health concerns
3. Changes in lifestyle
4. Reduced availability of cheap wine

Question 13

Why do younger people drink less wine in many countries?

Answer 13

• Wine is regarded as as old-fashioned
• They have turned to other alcoholic drinks (e.g. gin is fashionable in Spain).
• Younger people also spending less time in bars, preferring to contact their friends via social media.

Question 14

What 2 lifestyle changes cause decreasing wine consumption?

Answer 14

• Busy, modern lifestyles mean that there is often less time for longer meals at which wine was traditionally drunk
• Consuming alcohol during the working day (lunchtime) is being increasingly forbidden by employers

Question 15

How did consumer preferences change in recent years?

Answer 15

1. Rosé has become extremely popular, especially in USA
2. Prosecco has become popular, e.g. in UK
3. Sparkling wine is increasingly popular globally
4. Increased demand in lower-alcohol wines due to health issues
5. Decreased demand in fortified wine (15-22%) due to health issues
6. Medium-sweet German wines gone out of fashion

Question 16

What can positively change the reputation of wines?

Answer 16

1. Good review from leading wine publications and critics
2. Online influencers and key opinion leaders (KOLs) in some markets
3. Presence of certain wines in popular culture, e.g. product placement in films, TV series, music lyrics or celebrity lifestyle news
4. Influence of peer opinions and behaviour

Question 17

Define ‘price-sensitive markets’

Answer 17

Markets in which consumers are unwilling to pay more than the lowest price possible for the style of wine they want to buy.

(Examples are UK, Germany)

Question 18

Define ‘premiumisation’ of markets

Answer 18

Markets in which consumers are increasingly willing to pay more for individual bottles of wine, often because they are buying less wine by volume.

(examples are USA and partly even the ‘price-sensitive’ UK)

Question 19

How do some producers hope to avoid losing sales to competition in price sensitive markets?

Answer 19

By building up ‘brand loyalty’ for their products as part of their marketing campaigns.

Question 20

What economic factors will influence the demand for wine?

Answer 20

1. Strength of the economy
2. Fluctuations in currency exchange
3. Changes to the market

Question 21

How will the strength of the economy influence the consumer demand?

Answer 21

Sales of wine will change with the level of consumer disposable income (i.e. the amount of money a person has after paying taxes):

When disposable income falls, as in a recession, wine consumers are likely to trade down to cheaper wines or switch to other, less expensive alcoholic drinks (e.g. beer or cider).

When an economy is growing, such as has been seen in China, disposable income increases and consumers are often willing to buy more expensive wine.

Question 22

Explain the effect of currency exchange on wine demand.

Answer 22

If a wine-exporting country’s currency gains value cf. the importing country, the exporter can:

• Increase the price of the wine, risking losing sales to another country.
• Keep the price stable and lose profit.

Conversely, if the exporting country’s currency falls in value cf. the importing country, the exporter can”

• Lower the price of the wine, potentially boosting sales.
• Keep it stable, and improve profits for future investment.

Question 23

What is the downside of a weak currency (next to the positive effect of an improved price advantage)?

Answer 23

The downside to a weak currency, however, is that it costs producers more to import equipment and supplies, such as barrels, corks and yeast, which may offset any additional profits.

Nevertheless, the recent boom in Argentinian wines can be traced back to the early 21st century when a weak peso meant the wines were very competitively priced on the global market.

Question 24

Explain the effects if a product disappears from a particular market.

Answer 24

If a product disappears from a particular market, supply decreases. This will create opportunities for the competition, which could increase their sales.

However, the introduction of a new lower-priced or better-value wine may cause a fall in demand for other similar products and may force producers to lower their prices to remain competitive or look to alternative markets.

On a very simple level, for example, if a supermarket has run out of Echo Falls White Zinfandel, demand for Blossom Hill White Zinfandel may increase (or vice versa). If supply is limited, it may also be possible to raise prices.

Question 25

Name 5 legislative and political factors influencing demand

Answer 25

1. Laws prohibiting or limiting the sale of alcohol
2. Government policies to reduce alcohol consumption
3. Taxation
4. International trade (agreements)
5. Wine laws

These factors vary from country by country.

Question 26

Name some examples of laws prohibiting or limiting sale of alcohol

Answer 26

• The sale of alcohol is completely prohibited in a number of countries.
• Other countries permit sales but these are tightly-controlled: for example, by limiting the sale of alcohol to state-owned monopolies and the USA’s three-tier system. Any such controls inevitably limit the supply of wine and usually increase prices.
• Even in countries where alcohol is freely available, there is usually a minimum legal drinking age and sales of alcohol are generally limited to particular hours of the day.

Question 27

Why is excessive alcohol a concern in many countries?

Answer 27

Excessive consumption of alcohol is a concern in many countries. Illness and injuries caused by regular or heavy drinking are placing an increasing strain on health services and drunkenness is seen as a significant factor in criminal behaviour.

Question 28

What is the Loi Evin?

Answer 28

In France, the Loi Evin introduced in 1991, has greatly restricted the advertising of alcoholic drinks and is considered a significant factor in the reduction in wine consumption in France.

However, as a result, France is not now regarded by other wine-producing countries as a market with growth potential for premium wines.

Question 29

What policy did the Scottish Government implement to reduce alcohol consumption?

Answer 29

The Scottish Government is the first to introduce ‘minimum unit pricing’ to reduce the availability of cheap alcohol.

The minimum price of an alcoholic drink will be GBP 0.50 per unit.

Therefore, a 75cl bottle of white wine with 12% abv (i.e. 9 units as defined in the UK) must cost at least GBP 4.50. Bottles were previously available for as little as GBP 3.

Question 30

What policies do countries implement to reduce death and injury in traffic?

Answer 30

Most countries impose a limit on the amount of alcohol that can be consumed before a person drives a motor vehicle.

The Blood Alcohol Concentration (BAC) limit varies between different countries but tends to move in a downward direction as countries try and reduce death and injury caused by drunk drivers.

For example, both New Zealand and Scotland have recently reduced the maximum BAC from 80mg/100ml to 50mg/100ml.

However, this is still higher than some countries: the maximum BAC in Norway and Sweden, for example, is 20mg/100ml.

Question 31

What do government taxation policies on alcoholic drinks aim for?

Answer 31

Another aspect of government policy is the imposition of taxes and duty on alcoholic drinks.

On the one hand, higher prices may reduce consumption.

On the other hand, tax and duty on alcoholic drinks is a major revenue generator for many governments.

For example, the UK Government earned GBP 4.06 billion in duty from wine sales in 2016.

Question 32

How can the level of taxation on alcoholic drinks influence demand?

Answer 32

Because the level of duty usually varies between different categories of drink, it can influence demand by impacting price.

For example, in the Republic of Ireland, the large difference between the excise duty on still (EUR 3.19/bottle) and sparkling wines (EUR 6.37/bottle) has greatly reduced the demand for sparkling wine.

Sales tax (known as VAT in the EU) applies to alcoholic drinks in the same way as other products and is paid at the point of sale. However, many countries also impose specific excise duties or taxes on alcohol, which are payable at the point of manufacture. This is also a minimum pricing mechanism, although the rates are much lower than envisaged under the Scottish ‘minimum unit pricing’ system discussed above.

Question 33

What did the Government of Hong Kong try to achieve by abolishing the duty on wine altogether?

Answer 33

In 2008, the government of Hong Kong (a Special Administrative Region of China) abolished excise duty on wine altogether with the aim of becoming the ‘wine trading hub’ of East Asia. The result has been a massive increase in auction sales of fine wine through Hong Kong

Question 34

How did the value of wine exports develop in the last fifteen years?

Answer 34

Exports have come to play a very important part in the global wine industry.

The value of wine exports has more than doubled during the last fifteen years.

Question 35

What are trade tariffs? And why are they applied?

Answer 35

Trade tarrifs are customs duties on imported goods imposed by many countries.

In some cases, this is simply a form of revenue generation but, in many instances, it is the basis of a protectionism policy intended to encourage the sale of domestic rather than imported goods

Question 36

What are the effects of (EU) trade agreements?

Answer 36

The European Union is a free-trade area allowing member states to import and export goods between themselves tariff-free.

Some non-member states (e.g. South Africa and Chile) have entered into trade agreements with the EU, as a result of which they enjoy tariff-free or reduced-tariff trade, giving wines from those countries a competitive edge over those from other countries e.g. Australia.

It is unclear if the UK will continue to benefit from its free trade agreement with the EU when it leaves the Union. If it does not, the UK may be able to negotiate free-trade agreements with other countries e.g. Australia, potentially making Australian wine cheaper than EU wine. This may change wine-buying habits of the British public.

Question 37

What sort of import trade restrictions did Argentina impose in the early 2010s, and what impact did they have?

Answer 37

Trade restrictions imposed not only affected wine imports, but also severely limited imports of winery equipment, such as barrels, cork, and yeast. This significantly increased wine production costs.

As part of the same policy, the government also imposed restrictions on foreign ownership of land, significantly slowing down foreign investment, which has played an important role in the industry’s growth.

Question 38

What are the effects of a trade war?

Answer 38

In many cases, trade wars can result in negative feelings among consumers and therefore, even when restrictions are lifted, consumers may continue not to buy these products out of a matter of principle.

A timely example is the US/China trade war in which China has imposed tariffs on US wine (and other products) in response to US tariffs on Chinese products.

Question 39

What is an extreme form of protection when it comes to trade?

Answer 39

An extreme form of protection is when a country bans imports from or exports to a particular country – an embargo.

This can be motivated by economic or political reasons.

For example, Russian wine imports have fallen considerably due to various trade embargoes imposed for political reasons on Russia and by Russia.

Question 40

What can be the positive effects of creating a Geographical Indication (GI)?

Answer 40

Many consumers are drawn to wines from a particular GI, either because they have enjoyed wines from there in the past or due to its strong reputation. The creation of a GI may therefore increase recognition and demand for wines from that region and allow producers to increase the price of their wines.

Question 41

What can be the negative effects of creating a Geographical Indication (GI)?

Answer 41

In Europe, PDO rules can be very strict, limiting producers to certain grape varieties, methods of production, maturation periods and so on.

In constrast, producers outside the EU are rarely subject to such limitations, leaving them free to react more quickly to changes in wine consumers’ preferences and maintain demand for their wine, in a way that producers governed by PDO rule cannot.

Question 42

Legal changes often come about relatively slowly, giving producers the time to adapt. However, sometimes sudden changes in legislation can have particularly significant effects.

Give an example of a legal change that had a direct and significant effect on wine sales?

Answer 42

For example, in China in 2012, the new leader, Xi Jinping, wanted to stop the practice of ‘lavish gifting’ in business contexts.

These gifts often included super-premium priced wines, especially Bordeaux Premier Cru Classé and Grand Cru Burgundy.

An Anti-Extravagance campaign was launched explicitly to prohibit the gifting to or consumption by government officials of luxury wines and spirits. As a result, demand for those wines dropped almost immediately.

Question 43

How did wine production in Europe versus outside Europe change in recent years?

Answer 43

Question 44

What are the top 5 wine producing countries? And how did they develop in recent years?

Answer 44

1. Italy
2. France
3. Spain
4. USA
5. Australia

Question 45

Name 3 generic factors influencing the production levels of wine

Answer 45

1. Area under vine, such as establishing new vineyards
2. Human Factors, such as advances in viticulture and winemaking
3. Natural Factors, such as annual weather condition fluctuations

Question 46

How did the world total area under vine change in recent years?

Answer 46

The world total area under vine is in decline since 2002

Please note the ‘area under vine’ data come from the International Organization of Vine and Wine (OIV) which does not separate vineyards producing wine grapes from other fruit, such as table grapes. However, it is estimated that, globally, 90 per cent of vineyards are used for wine production.

Question 47

What are the regional differences in area under vine changes in recent years?

Answer 47

The area under vine in Europe has fallen in the 21st century.

In contrast, there has been growth outside Europe and this is largely due to the establishment of new vineyard areas, particularly in China which now has the second largest area under vine in the world, even if production has yet to catch up.

Question 48

What are the global top 5 countries measured by area-under-vine?

Answer 48

1. Spain
2. China
3. France
4. Italy
5. USA

Question 49

What are the 4 factors that have resulted in the loss of vineyard land, particularly in the EU?

Answer 49

1. Vine pull schemes
2. EUR restrictions on planting new vineyards
3. Conversion of vineyard land to other uses
4. Abadonment of rural areas

Question 50

What is meant with (the EU) ‘wine lake’?

Answer 50

By the mid 1980s, EU wine production was much greater than demand, creating a surplus that came to be known as the ‘wine lake’.

National governments and then the EU itself paid growers to pull up poor quality vines, especially in southern France, Italy and Spain, with the result that, for example, in the 1980s, several hundred thousand hectares of European vines were pulled up.

Question 51

Describe the EU policy regarding limiting planting of new vineyards.

Answer 51

The EU vine pull scheme was part of a broader policy to reduce wine production, which also included limits on the planting of new vineyards.

While those restriction have no been relaxed, such that the area under vine in the EU may start to increase again, this will be done in a controlled way, so as to lead to an increase in quality wine production rather than a return to excessive bulk wine production.

Question 52

What is the main reason for conversion of vineyard land to other uses?

Answer 52

In many parts of the world, wine grapes are a low value agricultural crop and growers may want to switch to higher value products.

For example, some growers in Elgin (South Africa) are removing their vineyards and replacing them with apples which give five times more the financial return than grapes.

In some regions, vineyard land is being bought up for property development, often for tourists, as in Madeira, but also for business, as in Santa Clara Valley (or Silicon Valley), California.

Question 53

What is the main reason for abandonment of vineyards?

Answer 53

There has also been a trend for younger people to leave rural areas and go to live and work in urban areas.

This is reducing the available workforce for vineyard work and in some cases leaving family-run estates with no-one to take them over.

Generally speaking, rural economies are suffering from a lack of labour and investment and it is sadly not uncommon to see abandoned vineyards, even in prestigious wine regions.

Question 54

What human factors have resulted in a greater volume of higher-quality wines that can be produced at a retail price which consumers are willing to pay?

Answer 54

Throughout the wine world modern techniques, such as

• better site selection
• clonal selection
• improved canopy management and pest and disease control

​have made it possible to produce a greater amount of healthy grapes.

This, coupled with modern winemaking technology, has resulted in a greater volume of higher-quality wines.

Question 55

Why does a decline in vineyard area need not result in reduced production?

Answer 55

The relaxation of laws banning irrigation of vineyards in Spain, which means that areas that were previously not able to support vines are now viable.

Furthermore, the increased use of more modern, higher density planting have increased production in certain areas.

Both of these factors have offset the reduction in the area under vine.

Production in Spain has increased despite the area under vine decreasing. Average yields in Spanish vineyards have traditionally been (and still are overall) much lower than, for example, in France or Italy, due to the very dry climate in many of Spain’s wine-producing regions and also the use of traditional low-density planting systems.

Question 56

Why will variation in EU weather conditions have a major impact on global wine production?

Answer 56

• Variation in weather conditions from year to year can have a significant impact on the volume of wine produced. Whilst good weather can lead to higher than average harvests and wine production, bad weather will have the opposite effect.
• Because over half the world’s vineyard area is in the EU, bad vintages in the EU will have a major impact on global wine production.
  
  • For example, in 2017, a combination of spring frosts, hailstorms, and severe heatwaves resulted in a 14% fall in production in Europe vs 2016.

Question 57

Give examples of how longer-term climate change is threatening wine production in some regions.

Answer 57

• Serious droughts have recently affected South Africa and California, where low rainfall has reduced the level of water in the state’s main underground reserves to almost nil
• The Chilean government estimates that 95% of the country’s vineyard area will have shortages of irrigation water by 2050.

Question 58

What is the main legislative influence on the supply of wine?

Answer 58

The increasing number of geographic indications (GIs) around the wine world.

All of these define where grapes for wines with specific geographical names can be grown, thus limiting the amount of wine that can be produced there (although GIs vary enormously in size).

Question 59

What is the one commonality between all worldwide Geographic Indications (GI)?

Answer 59

All of the GIs define where grapes can be grown for wines with specific geographical names, thus limiting the amount of wine that can be produced there (although GIs vary enormously in size).

Question 60

What is the difference between European GIs and GIs outside the EU?

Answer 60

The PDO systems in Europe have strict rules on what grapes can be grown in that area, the maximum yields and what winemaking and maturation techniques may be used. Such restrictions limit the volume of wine produced.

Outside the EU, GIs only define where grapes can be grown. Systems such as American Viticultural Areas (AVAs) in the USA, Wines of Origin in South Africa or the Geographical Indications of Australia have none of the strict rules found in the PDO systems of Europe.

Question 61

What are the aims of GIs, especially the European PDO system?

Answer 61

1. to define the style of wine produced in a particular region.
2. to bring supply and demand more into line and so reduce the risk of downward price pressure.

For example, if a retailer’s market research showed that a large number of that retailer’s customers wanted to buy a Sauvignon Blanc at an inexpensive price, the retailer would be able to select Sauvignon Blanc wines from around the world and to switch country of origin from one year to the next to gain the cheapest price. Alternatively, if market research showed that a large number of consumers wanted to buy Marlborough Sauvignon Blanc the retailer is constrained to buy from a small area (in global terms) in New Zealand. In the latter example the producer has more control over the price. The retailer cannot source the wine from anywhere else.

Question 62

What is the potential effect when a GI is being very succesful and demand is rising?

Answer 62

There is often pressure to extend the permitted production area, as has been the case, for example, for Prosecco DOP. Subject to limitations on the planting of new vines, this allows new vineyards to be planted and for production to be increased. Unfortunately, however, this often involves extending the GI to less suitable sites and a dilution in overall quality.

Question 63

What was the reason for introducing the vin de pays system in France?

Answer 63

The strict PDO rules led to complaints from some that European winemakers were not able to compete with their counterparts in less heavily-regulated regions.

For this reason, in the 1970s the French introduced the vin de pays system, which formed the basis of the European PGI system to offer greater freedom. These still require 85% of grapes to come from a particular geographical area but they permit a wider range of varieties and do not impose rules on viticulture and winemaking.

In some areas, e.g. South of France, PGI wines are extremely important, and production (but importantly also quality) has increased considerably since the system was introduced.

Question 64

Is the longterm market condition been one of oversupply or undersupply? And how and why has that changed in recent years?

Answer 64

Oversupply Global wine production has consistently exceeded global wine consumption. The level of oversupply has been reduced in recent years thanks to growth in wine consumption in the USA and China and the limitations on production (see other cards).

Question 65

Describe the challenges if there is an oversupply of wine.

Answer 65

• Prices tend to fall as consumers can easily find a cheaper alternative.
• It is harder for producers to sell their stock and, in some cases, means that they may end up with unsold wine in tank.
• In order to get some income from the wine and free up winery equipment for the next harvest, producers may be forced to sell the excess wine at a much lower cost than they would like - sometimes below production cost.
• Other, more proactive producers will try to find new markets and outlets for their wines. However, it takes time for producers to develop contacts and so this may only be an option for those who already have a presence in a particular market or have a distributor who can find new customers for them.
• Another option for producers with larger volumes of wine would be to bottle the wine under a different label and offer it to a supermarket, deep discounter, bar or restaurant as a private label wine.
• If a producer is forced to sell their wine at a lower than usual price, or if a retailer orders too much wine and then has to lower the price to sell it, this can devalue the ‘brand image’ of the wine and create lasting damage to the brand.

Question 66

Describe the challenges for the producer if there is an undersupply of wine.

Answer 66

The obvious problem for the producer is not having enough wine to sell, disappointing clients (and ultimately consumers) and leading to strained business relationships. If the producer has a contract with a large retailer, the retailer may impose a financial penalty or cancel the contract if the required volume of wine is not available.

In most businesses, an excess of demand over supply would result in an increased price for the product. In some parts of the wine business that does happen (e.g. Bordeaux Premier Cru Classé and Grand CruBurgundy) but, in most cases, producers prefer to issue wines to their main distributors on allocation.

Question 67

How does the market respond if there is an undersupply of wine.

Answer 67

If wine buyers for retail outlets and their customers consider that the origin of a wine is not important, cheaper alternatives from other grape varieties and/or countries may be found. That is especially true in price-sensitive markets.

The wine production business is much more fragmented than for spirits, beers or soft drinks: there are very few large-scale producers. Those few large companies will be able to offer an alternative from within their portfolio. They will also sell to different markets, meaning that if price increases because of undersupply cause sales to drop in one country, they can sell wine into less price-sensitive markets instead.

Question 68

What are capital costs?

Answer 68

Costs which are incurred in establishing a business are known as capital costs.

Question 69

What determines the price of land for vineyards?

Answer 69

1. In part, prices reflect the land’s potential to produce high-quality fruit and the name of the appellation within which the vineyard is situated. In California for example, the high land prices in Napa Valley arise from its reputation for producing high-quality grapes from which premium and super-premium wines can be made, whereas Central Valley is more usually associated with bulk wine production.
2. Scarcity of land can also increase the price. Land in prestigious regions such as Champagne and Burgundy rarely comes on the market and so, when it does, it will be sold to the highest bidder. Similarly, because GIs limit the area of land which can produce wine under that appellation, in small GIs, there is only a limited amount of land available.

Question 70

What are typical costs that will need to be incurred before the vineyard can become operational? (10 examples)

Answer 70

• surveying the land to check its suitability for viticulture and deciding which grapes are most suitable – this may include satellite imaging and taking soil samples;
• site clearance: e.g. removing vegetation, large rocks etc.;
• building access roads into the vineyard and between vineyard plots;
• buying and planting vines;
• buying stakes and wires etc. for establishing and maintaining trellising;
• if the site is badly drained, installation of deep drainage channels and pipework;
• in dry areas, establishing an irrigation system: e.g. drilling boreholes, building reservoirs, laying pipes to bring water into the vineyard, installing pumps to bring up underground water; installing a system of delivering water to the vines;
• protection against weather hazards: e.g. windbreaks, protective mesh (if the area is prone to the risk of hail), frost protection;
• protection from animal pests: e.g. high fences, electric fences, netting;
• buying machinery and equipment: e.g. tractors, spraying equipment, harvesting machines, and building garages or sheds to store them in. Some producers cannot justify the cost of buying expensive machinery and equipment which they only use for a short period of time each year. Instead, they will pay to hire it just when they need it.

Question 71

What three sources of financing the initial vineyard investments are typically considered?

The capital costs needed to establish a vineyard can be very high and the situation is not helped by the fact that vines take at least three years from planting to come into production. Whilst some people have sufficient personal wealth to fund the establishment of their vineyard, many prospective producers need to find a way to fund these capital costs.

Answer 71

• Loans are one way of raising the money; however, the interest and capital repayments will have to be factored into the long-term business plan.
• Another way is to get funding from investors; however, they will expect a return on their investment and a share in any profits and some may wish to get involved in managing the business.
• In some countries, governments are trying to encourage the establishment of vineyards (either specifically or as part of a wider agricultural policy) and offer subsidies to prospective producers to help with the capital costs. These can either take the form of tax incentives or lump-sum contributions.

Question 72

What are the main vineyard management costs?

Answer 72

• Labour
• Machinery & Equipment running costs, e.g. fuel and maintenance
• Vineyard materials, e.g. replacing vines and trellising
• Vineyard treatments, e.g. herbicides, fungicides, insecticides
• Water, water extraction costs
• Electricity, e.g. irrigation, bird scarers, frost protection equipment

Question 73

What determines the amount of labour (cost) in the vineyard?

Answer 73

The amount of labour required varies greatly according to the topography and other factors in the vineyard:

For example, considerably more labour is required in the steep vineyards of the Mosel where mechanisation is impossible than in the flat vineyards of, for example, California’s Central Valley.

Also, organic and biodynamic vineyards are more labour intensive than conventionally-farmed ones due to the additional procedures that need to be carried out.

Question 74

How do labour costs required in a vineyard vary?

Answer 74

The type of labour required in a vineyard varies through the year.

At harvest time, the producer will hire a team of pickers – they can be relatively unskilled as the harvesting procedure can be quickly taught. Harvesting labour is relatively cheap but, if there is a shortage, they can choose to work for the highest offer.

For the rest of the year, a smaller staff of more expensive, skilled workers will be needed, often under the supervision of a vineyard manager. Organic and biodynamic viticulture in particular needs highly skilled staff.

Location may also determine labour costs, dependent on national wage levels or local labour availability (e.g. cheap in Chile; high in Coonawara).

Question 75

What are typical initial costs of establishing the winery?

Answer 75

There are similar capital costs for establishing the winery as for setting up the vineyard:

• The land on which the winery will be built may need to be purchased.
• There are then the costs of building the winery and fitting it out with equipment such as presses, tanks, pipes and pumps, refrigeration equipment and a bottling line (unless the wine is going to be sold in bulk or a mobile bottling line hired).

Question 76

There is a variety of costs involved in making wine. Name a few of these costs.

Answer 76

• Labour – An estate is likely to employ a small number of mainly skilled staff full-time. Some casual labour may be required around harvest time to help with manual tasks in the winery, such as unloading crates and moving equipment.
• Machinery and equipment running costs e.g. fuel, electricity and maintenance.
• Winery materials e.g. sugar for enrichment, de-acidification agents, acid for acidification, cultured yeasts, carbon dioxide or other inert gasses, fining and filtering agents.
• Bought-in fruit – If a winery is buying in grapes, rather than growing any or all of its own, the price of the fruit will be a significant cost. This can vary significantly according to the quality of the grapes, the grape variety and the vintage. If a winery has to meet a low price-point, it could blend cheaper varieties (e.g. Airén, Ugni Blanc, Colombard or Semillon) with a more expensive variety (e.g. Chardonnay) to reduce the production costs.
• Water – Wineries use large volumes of water for cleaning. In areas where water is expensive or scarce, some wineries have found it cost-effective to invest in water treatment plants so they can re-use as much water as possible.
• Electricity – Significant amounts of electricity are needed for refrigeration, ventilation, presses, pumps and lighting. Because of this, some estates generate some or all of their own electricity (e.g. using solar panels).

Question 77

Maturing wine can add significantly to production costs. Explain how.

Answer 77

• If the wine is to be matured at the estate, the winery will need to include storage space.
• New oak barrels from the top barrel producers can be very expensive. It can be much cheaper to buy second-hand barrels, although, of course, these will give little or no flavour characteristics to the wine. Another alternative is to use oak chips or staves but, whilst they are less expensive than oak barrels, they are still not cheap.
• Wineries also need to employ labour to monitor the maturation process.
• Another long-term, but less obvious, cost of maturation is the loss of cashflow: there can be a large amount of money tied up in maturing stock.

Question 78

Name and explain the costs involved in packaging

Answer 78

• If the winery bottles its own wine, it will need to buy materials such as bottles, closures, labels, cartons and pallets. Heavy or unusual bottles and more elaborate labels (embossed, textured paper) will often be more expensive than standard options.
• A bottling line will be required to bottle the wine. Estates may invest in their own but these are very expensive and may not be cost-effective if they are only used once a year. They may therefore prefer to hire a bottling line, and the labour to operate it, when needed. Another alternative is to send the wine to another estate and pay to use their equipment.
• As well as the labour required to bottle and package the wine, the estate may also wish to employ someone to design their labels (and sometimes even their bottles) for them.

Question 79

What is the most common way to transport wine?

Answer 79

In bottle

These bottles are packaged in boxes, which are in turn loaded into crates and pallets.

Question 80

Who carries out the job of moving goods around the world? And name one specialised in wine, explaining why specialisation matters.

Answer 80

• Freight forwarders.
• JF Hillebrand
• Whilst it is possible to send wine using the well-known multinational logistics companies, the wine industry tends to prefer those which specialise in the transportation of wine. Although they charge more, these companies have considerable expertise in transporting what is a very fragile product. Bottles can be easily broken and the wine inside can spoil if subjected to hot temperatures, direct sunlight and excessive vibrations. The specialist freight forwarders take steps to limit the risk of loss or damage, such as using highly-specialised (and consequently very expensive) temperature-controlled shipping containers.

Question 81

In what type and size of containments is wine shipped in bulk?

Answer 81

Bulk wine is transported in either plastic flexitanks (more common) within a standard steel shipping container or non-flexible ISO tanks:

1. the largest flexitanks can carry up to 24,000 litres
2. ISO tanks can hold up to 26,000 litres.

Question 82

What is the key advantage of bulk transportation?

Answer 82

Bulk transportation is much cheaper and more environmentally-friendly than transporting the wine in bottle, because wine in tank is much lighter anf more efficient than in bottle, reducing the amount of fuel required to transport the same amount of wine

Over double the amount of wine can be carried in the same size of ISO or Flex container compared to a standard shipping container (that can hold around 9,000-10,000 litres of bottled wine).

Question 83

What is the main disadvantage of bulk transport of wine?

Answer 83

One disadvantage of these tanks is that they are only suitable for moving large volumes of the same wine. If a single consignment is less than 15,000 cases there is no cost advantage over transporting in bottle. Therefore, whilst it is an attractive option for supermarkets and major brands who can sell large volumes of wine, it is not suitable for smaller-production wines.

Question 84

What are recent (business) developments in bulk transport of wine?

Answer 84

• In the past decade, there has been a large increase in bulk transportation of wine. in 2016, 38% of the world’s wine was exported in bulk and it has been estimated that bulk wine accounts for 58% of German; 35% of UK and 24% of US still wine imports.
• At first, bulk transportation was favoured for cheaper wines (whilst 35% of the world’s wine by volume was transported in bulk in 2017, this only accounted for 8% by value). However, there is now increasing interest in transporting more expensive wines in bulk too

Question 85

What is the party that normally is taking out insurance for transport?

Answer 85

This should be the party which assumes the risk for loss or damage. Normally, this will be the party who is sending the goods.

For example, the winery will be responsible for ensuring the wine makes it safely to its distributor and the distributor will then be responsible for getting the wine safely to retailers. Using a specialist freight forwarder should reduce the risk and many offer insurance as part of their service (usually at extra cost).

Question 86

Name the 3 major costs involved in importing wine to another country.

Answer 86

1. Custom duties & taxes
2. Custom localised labeling
3. Involving distributors

Question 87

Explain why labeling can be an issue when importing to another country.

Answer 87

Different countries also have different labelling laws with which the imported wine will need to comply. Producers dealing with a number of different countries may therefore have to order a number of different labels for specific markets. This will be more expensive than if they were dealing with a single market, in which case they could simply order a larger number of a single label.

For example, in the EU, the ABV of a wine must be shown to the nearest whole or half unit, whereas US law permits a 1.5% variance, meaning American wines may need to be relabelled if going to the EU. US law also requires bottles to display a health warning, which will need to be added to wines entering the country.

Question 88

Why do many producers employ distributors to deal with foreign markets?

Answer 88

1. It would take producers a significant amount of time to learn about all the different requirements per country and comply with them
2. The importer has knowledge of their market and an established list of potential clients.

Question 89

What is the ‘margin’?

Answer 89

The margin is the fee that distributors will charge (that will add to the cost of the wine).

The margin is usually quoted as a percentage and is calculated as the profit divided by the revenue (multiplied by 100 for a percentage figure). For example, if a distributor added a fee of EUR 1.00 (EUR 1.00 of profit) to every bottle of wine that cost them EUR 10.00 to purchase, the percentage margin would be (1 ÷ 11) x 100 = 9.09 per cent.

Question 90

What is a typical margin (range) that distributors charge? And what drives margin differences?

Answer 90

The margin will vary from distributor to distributor and from country to country but can range from 5-25 per cent.

As a general rule, those selling to the hospitality sector tend to have higher costs and a larger staff than those specialising in the retail sector and will therefore expect higher margins. Wholesalers may charge more than agents as they have to cover the cost of warehousing. Retailers buying from distributors may also need to pay delivery costs.

Question 91

What is typically understood by the ‘retail end of the supply chain’?

Answer 91

The point of sales of wine to end consumers, meaning both the retail and hospitality sector

Question 92

What are the retailers’ main six costs?

Answer 92

1. Property costs
2. Labour
3. Equipment & Material
4. Storage costs
5. Delivery costs
6. Margin at point of sale

Question 93

By what are property costs for retail premises affected?

Answer 93

Retail premises of any sort are expensive:

• Retail premises, especially bars and restaurants, tend to be in prime locations which are the most expensive to buy or lease.
• Retailers will need to spend money decorating and furnishing it to suit their business image.
• Once the shop, bar or restaurant is open, there will be additional running costs. Some such as maintenance, security, water, energy and insurance are fairly universal; others vary from country to country, such as commercial property taxes and waste disposal.

Question 94

Why are property costs for online retailers lower than for on-premises?

Answer 94

Property costs will be lower for online-only retailers, as they only need to buy or lease warehousing space, which is often located in areas away from city centres where property prices are much cheaper

Question 95

Explain the staff costs variances for different type of retail outlets.

Answer 95

Some countries require staff to be paid a legal minimum wage. Other countries are more flexible but, in all cases, the higher the level of skill and expertise a member of staff has, the higher the level of wage that person will expect to receive:

• In supermarkets, labour costs are relatively low as highly-skilled staff are not required on the shop floor.
• However, specialist wine retailers will employ highly knowledgeable staff who can engage with customers and advise them on the range of wines available
• Bars and restaurants have much higher labour costs than shops as additional staff are required to wait on tables, clean and wash up.

Question 96

Explain staff costs variance for different types of restaurants.

Answer 96

• In ‘non-destination’ restaurants staff will not necessarily need to know much about wine and will therefore not be paid as much as more skilled and knowledgeable staff in ‘casual dining’ establishments.
• In a ‘fine dining’ restaurant, staff will be expected to be highly knowledgeable about wine; there will also be a head sommelier who selects the wines for the wine list and must be able to offer diners detailed advice about which wines to select – these positions are very prestigious and can command impressively high salaries.

Question 97

How will the requirements for equipment & materials vary between different types of retail outlet?

Answer 97

• A specialist wine retailer will need, at the very minimum, a till system, a fridge (if chilled wine is to be sold), shelving, display cabinets, materials to enhance displays and cleaning equipment.
• A restaurant will need much more, including kitchen and bar equipment, tableware and glasses.
• Bars and restaurants are also increasingly investing in expensive wine preservation systems to prevent wine available by the glass from oxidizing once it has been opened. However, in restaurants and bars which serve food, the profits made on food may also help cover costs.

Question 98

What costs are one of the most expensive elements of the supply chain?

Answer 98

Delivery costs

Wine is relatively heavy and therefore costs more to deliver than other goods of a similar size. It is also extremely fragile and there is always the risk that bottles will get broken or the wine becomes spoiled in transit.

Question 99

The end consumer will usually be expected to pay a fee for delivery. What considerance is made by retailers on these fees?

Answer 99

• Many retailers feel that their customers would not be willing to pay the full delivery cost. The actual cost to the retailer will also vary depending on distance. Retailers often therefore charge fixed delivery fees, knowing that in some cases it may cost them more to deliver the wine.
• Some charge more for special delivery, delivering wine on a specific day or at a specific time requested by the consumer.
• Some retailers also offer free delivery for orders over a certain amount, even though there is still a cost to them to deliver the wine. This is a way of giving the consumer a discount without reducing the price of the wine.

Question 100

To be financially viable, retailers need to make a profit from selling the wine. The amount of margin varies between countries and types of retailers.

What are typical margins at the point of sale? Explain the variance.

Answer 100

• Specialist wine retailers usually look for a margin of 30-50%.
• In many bars and restaurants, the margin is much higher, sometimes as much as 66.6% (i.e. the wine is sold for three times what the bar/restaurant bought it for). This is in part to cover the higher operation costs.
• Profit margins are usually higher on wines available by the glass, as there is the risk that, once opened, the wine may spoil and need to be poured away before the bottle has been emptied.
• Some also allow customers to bring their own bottles of wine, which the restaurant will open for a fixed ‘corkage’ fee.

Question 101

What are certain costs associated with marketing which can add to the price of a bottle of wine?

Answer 101

• Labour. Larger producers and brand owners will employ their own in-house marketing teams, smaller producers will have to pay an external marketing company to do this for them.
  
  • A producer may be a member of an industry association (e.g. a consorzio in Italy; the VDP in Germany) or a generic trade body (e.g. Wines of Australia, Wines of South Africa). One of the roles of these organisations is to market their members’ wines collectively. They are funded by a levy paid by members, usually on the value of their sales; this will also need to be reflected in the final cost of the wine.
• Design and production of bottles and labels. this could either be done in house or by an external agency.
• Marketing campaigns. e.g. advertising and promotional materials. Sample bottles including shipment for tastings or competitions, are provided free-of-charge from stock which could otherwise be sold.

Question 102

In the UK, excise duty is payable on wine entering the country unless it is stored in what is known as a ‘bonded warehouse‘.

Explain why this could help to improve cashflow.

Answer 102

Instead of paying the duty as soon as the wine arrives in the UK, importing companies who wish to hold on to stock can store the wine in a bonded warehouse and only release it when someone wants to buy it.

This consumer will then cover the cost of taking the wine out of bond, including the duty payable.

Whilst hiring space in bonded warehouse costs money, it means the importer does not need to pay duty out of their own funds which can help their cashflow situation.

Question 103

Legal factors may impact on a producer’s decision whether or not to enter a particular market. Give an example.

Answer 103

If import duty is too high in a particular country, they may decide that they cannot sell their wine at a competitive price there and simply choose to focus on other markets.

For example, there are relatively few mid-priced US wines on sale in the EU as, due to trade tariffs, they cannot compete on price with wines from countries such as Chile and South Africa which have trade agreements with the EU.

Question 104

Explain how exchange rates can impact on the profits which the producer or the buyer might earn.

Answer 104

When wine is being imported and exported between countries with different currencies, the constant fluctuation of the exchange rate between those two currencies can affect the price of the wine considerably.

These small differences can become significant if the order is for a large number of bottles and can impact on the profits which the producer or the buyer might earn.

For example:

Consider the situation if a buyer in the Eurozone orders wine from Australia when the exchange rate is AUD 1.50/EUR 1.00 but, by the time of delivery, the exchange rate has changed to AUD 1.37/EUR 1.00. If the buyer pays for the wine when ordering, they will save EUR 0.13 per bottle. However, if the buyer agrees to pay on delivery, they will end up paying an extra EUR 0.13 per bottle.

Question 105

What methods can the wine industry use to mitigate the effect of exchange rate fluctuations? (7 examples)

Answer 105

• Options
• Fixing the price in the currency of the importer at the date of ordering
• Buying currency to cover specific orders
• Entering a contract to fix the exchange rate
• Trading in USD/EUR
• Opening a foreign currency account in a local bank
• Opening an account in an overseas bank

Question 106

How do options mitigate the effect of exchange rate fluctuations?

Answer 106

One possibility is for a retailer to take an option/reserve on a certain amount of wine at an agreed price. This means that the producer must set aside the agreed volume of wine and, at an agreed time, the retailer may decide whether or not they want to take it.

This decision could be based on the exchange rate but it can also be influenced by market conditions at the time. Because the producer runs the risk that the retailer will not take the wine, leaving them with unsold stock, the producer may want to charge a higher price than under a normal contract. However, usually, it is the larger retailers who have the negotiating power to demand such arrangements.

It is also possible to take an option on a certain amount of currency at an agreed price, rather than stock.

Question 107

What is currency management?

Answer 107

Buying currency to cover (specific) wine purchase contracts

This requires a proactive stance and only larger companies are likely to have in the in-house skills necessary to manage currency or currencies in this way.

Please note currency management is an important business activity and is not considered speculation!

Question 108

How will trading in USD/EUR mitigate exchange rate fluctuations?

Answer 108

Many producers in countries with unstable currencies prefer to trade in more stable currencies such as the US dollar or Euro. This is also attractive to retailers who have greater certainty about the price of the wine.

As the producer may buy vineyard and winery materials in dollars or Euros, it reduces the number of times they have to exchange currency, leaving them less exposed to the fluctuations in their domestic currency.