Factors that Affect the Price of a Bottle of Wine - Supply and Demand

Question 1

Name social factors influencing demand for wine?

Answer 1

• Changes in consumption habits
• Changing consumer preferences
• Changes in reputation
• Changes in spending patterns

Question 2

How has the wine consumption habits changed globally in the past 20 years?

Answer 2

Global wine consumption increased rapidly in the first part of the 2000s. However, it began to fall back again after the global
financial crisis of 2008 as many consumers reduced their spending on non-essential products.

Question 3

How have wine consumption habits changed in the top 5 countries?

Answer 3

USA has increased
France has decreased
Italy has decreased and slightly increased again
Germany has stayed flat
China has increased

Question 4

Why is wine consumption falling in certain countries?

Answer 4

Younger people drinking less wine – In many countries, younger people (legal drinking age to mid-thirties) are drinking lesswine. This may be partly because they regard wine as old-fashioned – something their parents or grandparents drank – andhave turned to other alcoholic drinks (for example, gin is very fashionable amongst younger drinkers in Spain). In countries suchas the UK, younger people are also spending less time in bars, preferring to contact their friends via social media.

Health concerns – Another reason given for reduced wine consumption, particularly amongst younger drinkers, is increasing awareness of the negative health effects of alcohol.

Changes in lifestyle – Busy, modern lifestyles mean that there is often less time for longer meals at which wine was traditionallydrunk.

Reduced availability of cheap wine – In many traditional wine-producing countries, there were large volumes of cheap wine available for local consumers. In those countries, various steps have been taken to reduce over-production resulting in smaller volumes of these winesbeing available. Instead of buying more expensive wine, some consumers have simply switched to other, cheaper alcoholicdrinks.

Question 5

How have consumer preferences changed in recent years?

Answer 5

Consumers’ wine preferences change over time. In recent years, for example, rosé has become extremely popular, especially inthe USA. Similarly, Prosecco sales in markets such as the UK have increased significantly. In fact, according to IWSR, sales of sparkling wine have been increasing globally, against the trend of a reduction in wine consumption.

Due to the health issues referred to above, there is also increased demand for lower-alcohol wines. Conversely, drinkers areturning away from fortified wines (15-22% vol.).

Another style of wine which has gone out of fashion is medium-sweet German wines, such as Liebfraumilch. These were popular inthe USA and the UK in the 1950s, 1960s and 1970s. However, as drinkers turned to drier styles of wine.

Question 6

Explain some changes in reputation of wines?

Answer 6

As the reputation of a region, producer or even an individual wine grows, demand will increase and producers may be able to justify higher prices. Good reviews from leading wine publications and critics (such as Wine Spectator in the USA or JancisRobinson in the UK) are particularly valuable to producers and can encourage them to increase their prices for subsequent vintages. In some markets, online influencers and key opinion leaders (KOLs) can also have an impact on the reputation and desirability of a particular brand or style of wine, as can the presence of certain wines in popular culture e.g. films, television series, music lyrics or celebrity lifestyle news. The influence of peer opinions and behaviour should also not be underestimated.

A loss of reputation can have the opposite effect, although it usually takes several years to have an impact, if any, on prices.

Question 7

Explain changes in spending patterns?

Answer 7

Another factor is how much consumers, even the more affluent ones, are willing to spend on wine. In some countries, such as Germany and UK, many consumers are unwilling to pay more than the lowest price possible for the style of wine they want to buy. These are known as ‘price-sensitive markets’. In contrast, in other markets, such as the USA, many consumers are willing to pay above the minimum price in order to buy a wine which they perceive to be of better quality than the cheapest option on offer.

Competition is often fierce in price-sensitive markets, as producers are competing within a reduced price range. This results in lower prices for consumers but makes these markets unprofitable for some producers, who may simply choose not to sell to them.

In price-sensitive markets, producers are often reluctant to pass on increases in production costs to consumers for fear of losing sales to competitors. Some producers hope to avoid that problem by building up ‘brand loyalty’ for their product as part of their marketing campaigns.

Spending patterns can change; however, this is usually a slow process. In recent years, there has been a trend for ‘premiumisation’ in the USA and even in price-sensitive markets such as the UK. This means that consumers are increasingly willing to pay more for individual bottles of wine, often because they are buying less wine by volume.

Question 8

Name economic factors influencing demand for wine?

Answer 8

• Strength of the economy
• fluctuations in currency exchange
• Changes to the market

Question 9

How does the strength of the economy affect demand for wine?

Answer 9

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 10

How does fluctuations in currency exchange affect the demand for wine?

Answer 10

If a wine-exporting country’s currency gains value compared to that of the importing country, a producer has two options: increase the price of the wine and therefore risk losing sales to another country’s wines or keep the price stable and lose profit.

In contrast, if the exporting country’s currency loses value against that of an importing country, a wine exporter can either lower the price of the wine, which should boost sales, or keep it stable and improve profits for future investment.

Question 11

How does changes to the market influence the demand of wine?

Answer 11

Markets are constantly changing: new companies and products are always entering, whilst others disappear. If a product disappears from a particular market, supply decreases. This will create opportunities for the competition.

Question 12

Name legislative and political factors that influence the demand for wine?

Answer 12

• Laws prohibiting or limiting the sale of alcohol
• Government policies to reduce alcohol consumption
• Taxation
• International Trade
• Wine Laws

Question 13

How do laws prohibiting or limiting the sale of alcohol influence the demand for wine?

Answer 13

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 controlsinevitably 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 generallylimited to particular hours of the day.

Question 14

How do government policies to reduce alcohol consumption influence the demand for wine?

Answer 14

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.

For this reason, a number of countries have implemented laws intended to encourage their citizens to drink less. For example 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-producingcountries as a market with growth potential for premium wines.

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, meaning that a 75cl bottle of white wine with 12% abv (i.e. 9 units as defined inthe UK) must cost at least GBP 4.50, whereas bottles were previously available for as little as GBP 3.

Most countries also 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 themaximum BAC from 80mg/100ml to 50mg/100ml. However, this is still higher than some countries: the maximum BAC in Norwayand Sweden, for example, is 20mg/100ml. Again, the imposition and tightening of drink-driving laws have been shown to reduce alcohol consumption.

Question 15

How does taxation influence the demand for wine?

Answer 15

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[1].

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.

Because the level of duty usually varies between different categories of drink, it can influence demand. For example, in the Republic of Ireland, the large difference between the excise duty on still (EUR 3.20/bottle) and sparkling wines (EUR 6.37/bottle) has greatly reduced the demand for sparkling wine.

Whilst governments tend to increase duty over time, sometimes they reduce it to make certain categories more competitive. 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 16

How does international trade influence the demand for wine?

Answer 16

Exports have come to play a very important part in the global wine industry and the value of wine exports has more than doubled during the last fifteen years.

However, trading relations between countries can fluctuate over time, affecting demand for products traded between those countries.

Many countries impose customs duties (also known as trade tariffs) on imported goods. 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.

The European Union is a free-trade area allowing member states to import and export goods between themselves tariff-free. Tariffs are still payable on goods imported from most non-members (e.g. Australia), making them relatively more expensive. Some non-member states (such as South Africa and Chile) have entered into trade agreements with the EU, as a result of which they enjoytariff-free or reduced-tariff trade, giving wines from those countries a competitive edge over those from Australia.

It remains unclear whether the UK will continue to benefit from this free-trade arrangement when it leaves the EU (Brexit). If it doesnot, the UK may be able to negotiate free-trade arrangements with other countries, such as Australia, which could make Australianwine comparatively cheaper than EU wine. This could change the wine-buying habits of the British public.

In Argentina in the early 2010s, trade restrictions were imposed which not only affected wine imports but also severely limitedimports of winery equipment, such as barrels, cork and yeast. This significantly increased wine production costs. As part of thesame policy, the government also imposed restrictions on foreign ownership of land, significantly slowing down the foreigninvestment which had played an important role in its rapid growth.

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

An extreme form of protection is when a country bans imports from or exports to a particular country (an embargo). This can be forpolitical or economic reasons. For example, Russian wine imports have fallen considerably due to various trade embargos imposedfor political reasons on Russia and by Russia.

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.

Question 17

How to wine laws influence the demand for wine?

Answer 17

Another legal factor is the increasing global creation of Geographical Indications (GIs), such as Protected Denominations of Origin(PDOs) and Protected Geographical Indications (PGIs).

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

Legal changes often come about relatively slowly, giving producers the time to adapt. However, sometimes sudden changes inlegislation can have particularly significant effects. For example, in China in 2012, the new leader, Xi Jinping, wanted to stop the practice of ‘lavish gifting’.

As a result, demand for premium Bordeaux Premier Cru Classé and Grand Cru Burgundy wines dropped almost immediately.

Question 18

What production factors influence the supply of wine?

Answer 18

• Area under Vine
• Human factors
• Natural factors

Question 19

How does area under vine influence the supply of wine?

Answer 19

One factor that can influence wine production volumes is size of vineyard plantings. Generally speaking, the greater the area under vine, the greater the volume of wine that can be produced. As Figure 8 shows, the area under vine in Europe has fallen in the 21 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 20

Name several factors that have resulted in the loss of vineyard land, particularly in the EU?

Answer 20

Vine pull schemes – 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. Vine pull schemes have also been used in other countries, such as Australia, New Zealand and Argentina.

EU restrictions on planting new vineyards – The EU scheme was part of a broader policy to reduce wine production, which also included limits on the planting of new vineyards. However, those restrictions have now been relaxed such that the area under vine in the EU may start to increase again, but in a controlled way so that this is an increase in quality wine production rather than a return to excessive bulk wine production.

Conversion of vineyard land to other uses – 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.

Abandonment of rural areas – 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 themover. Generally speaking, rural economies are suffering from a lack of labour and investment and it is sadly not uncommon to seeabandoned vineyards, even in prestigious wine regions.

Question 21

How do human factors influence the supply of wine?

Answer 21

A decline in vineyard area need not result in reduced production: 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. The relaxation of laws banning irrigation of vineyards in Spain, whichmeans that areas that were previously not able to support vines are now viable, and the increased use of more modern higherdensity planting have increased production in certain areas, which has offset the reduction in the area under vine.

Throughout the wine world, as explained in the Wine Production study guide, 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 a resulted in a greater volume of higher-quality wines that can be produced at a retail price which consumers are willing to pay.

Question 22

How do natural factors influence the supply of wine?

Answer 22

Variation in weather conditions from year to year can also 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.

Europe is particularly susceptible to vintage variation and, because over half the world’s vineyard area is there, bad vintages will have a major impact on global wine production. For example, in 2017, a combination of devastating spring frosts, hailstorms and severe heat waves resulted in a 14% fall in production in Europe compared to 2016 .

In some regions, longer-term climate change is threatening wine production. 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 and the Chilean government estimates that 95% of the country’s vineyard area will have shortages of irrigation water by 2050.

As examined in detail in the Wine Production study guide, these natural factors will influence the yield that can be produced. Whilst yields do not necessarily correlate with quality, reduced yields will generally lead to lower production and, due to the shortage in supply, higher prices, which consumers are not always willing to pay, especially if the adverse conditions result in a drop in quality.

Question 23

How do legislation factors influence the supply of wine?

Answer 23

The main legislative influence on the supply of wine is 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).

Outside the EU, that is as far as it goes. Systems such as American Viticultural Areas (AVAs) in the USA, Wines of Origin in SouthAfrica or the Geographical Indications of Australia have none of the strict rules found in the PDO systems of Europe. The AOPs of France and DOC/Gs of Italy dictate what grapes can be grown in that area, the maximum yields and what winemaking and maturation techniques may be used. Such restrictions can further limit the volume of wine produced.

One aim of GIs, especially the European PDO system, is to define the style of wine produced in a particular region. Another aim is 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.

However, where demand for a particular wine is rising, 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 adilution in overall quality.

In Europe, PDOs have a governing body which helps set and enforce the rules (as well as other roles such as marketing). Some, for example the Comité Champagne and the Sherry Consejo Regulador, actively limit the amount of wine which may be released in any one year, ensuring the market is not oversupplied and maintaining price levels.

The strict PDO rules led to complaints from some European winemakers that they 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, such as the South of France, PGI wines are extremely important and production (but, importantly, also quality) has increased considerably since this system was introduced.

Question 24

What are the challenges if there is an oversupply of wine?

Answer 24

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 discussed in the previous sections.

When there is more wine available to sell than consumers wish to buy, prices tend to fall as consumers can easily find a cheaper alternative. Oversupply makes it 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 maybe 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 (how consumers perceive the brand) and create lasting damage to the brand.

Question 25

What are the challenges if there is an undersupply of wine?

Answer 25

A global lack of supply of wine is unusual although it can happen: for example, following the bad harvests across Europe in 2017. However, undersupply is more common in the case of particular wines.

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 Cru Burgundy) but, in most cases, producers prefer to issue wines to their main distributors on allocation.

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 (e.g. Accolade Wines, Treasury Wine Estates, E&J Gallo) will often have wines at different price points, styles and regions of origin. This means that, if there is an undersupply of a particular wine, they 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 26

What cost does grape growing entail?

Answer 26

• Vineyard Establishment

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.

Scarcity of land can also increase the price.

• Vineyard Management

Question 27

What costs are associated with vineyard establishment?

Answer 27

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 tostore them in. Some producers cannot justify the cost of buying expensive machinery and equipment which they only use for ashort period of time each year. Instead, they will pay to hire it just when they need it.

Question 28

What costs are associated with vineyard management?

Answer 28

Labour – The amount of labour required varies greatly according to the topography and other factors in the vineyard: forexample, considerably more labour is required in the steep vineyards of the Mosel where mechanisation is impossible than in theflat vineyards of, for example, California’s Central Valley. Also, organic and biodynamic vineyards are more labour intensive thanconventionally-farmed ones due to the additional procedures that need to be carried out.

Machinery and equipment running costs e.g. fuel and maintenance.

Vineyard materials e.g. replacement vines and trellising.

Vineyard treatments – Conventionally-farmed vineyards use large amounts of agro-chemicals such as herbicides, fungicides andinsecticides. The more modern products are very efficient and, in the case of insecticides, better at targeting insect pests ratherthan beneficial insects.

Water – If a vineyard is irrigated, it may be necessary to pay the authorities for the right to extract water from a river or buy itfrom elsewhere. In dry years, when the price of irrigation water rises, the increased cost of irrigation can make grape growingunprofitable: for example, in Australia, it can reach AUD 3,000 per megalitre.

Electricity – Certain systems in the vineyard require electricity: e.g. irrigation systems, bird scarers and some frost protectionequipment

Question 29

What costs are associated with winemaking?

Answer 29

• Winery Establishment
• Winemaking Costs

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 otherinert 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).

• Maturation

If the wine is to be matured at the estate, the winery will need to include storage space.

Maturing wine can add significantly to production costs. 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.

• Packaging

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 30

What costs are associated with transportation?

Answer 30

• Transportation of wine in bottle

There are four ways of transporting wine around the world. These are listed below in order from the most to the least expensive; however, this is only a rough guide as transportation costs vary greatly over different routes.

Air – The cost of air freight is heavily dependent on weight, due to the additional fuel required. Bottles of wine are very heavy in relation to their size and value and are therefore very expensive to transport by air. This method is therefore only used in special circumstances, such as sending bottles to a competition or samples to a trade/consumer fair, for very high value wines or where deadlines are important – such as Beaujolais Nouveau for the Japanese market.

Road – Most wines will travel short distances by road freight at the beginning and end of their journeys. For short journeys (e.g. Epernay to Brussels), road freight is very efficient as it takes the wine directly from the winery to the point of delivery. However, for long distances (e.g. Mendoza to New York), it is excessively expensive. If a journey involves crossing a small body of water, such as the English Channel or the Irish Sea, the truck can drive directly on to and off a ferry. This is the quickest, and therefore,cheapest way of moving goods through a port but the costs of the overall journey may outweigh this benefit.

Rail – The cost of rail freight will vary according to the length of the journey and how goods are loaded onto the train. If individual palates need to be loaded and unloaded from the train, the cost freight would probably be too high. However, that cost can be reduced by containerization, i.e. the goods are loaded into a standard container which is lifted onto the back of a truck and then onto the rail wagon. This could be cheaper than transporting the goods all the way by road; however, freight rates vary considerably depending on the route.

Sea (also known as ‘deep-sea’) – This is usually by far the cheapest method (in cost per mile) for transporting wine over long distances: for example from the USA, South America or Australasia to Europe. Containerization is essential for deep-sea shipment. The downside to this method is that it is slow (for example, the journey time from Australia to the UK is typically 40days), so companies that import wines must factor in that time when ordering goods, especially for peak trading periods.

• Bulk Transportation

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

One key advantage of bulk transportation is that the wine in tank is much lighter than in bottle. It is also much more efficient: astandard shipping container can hold around 9,000-10,000 litres of bottled wine, whereas the largest flexitanks can carry up to 24,000 litres of wine in bulk and ISO tanks can hold up to 26,000 litres of wine in bulk. This means that over double the amount of wine can be carried in the same size of container. As this significantly reduces the amount of fuel required to transport the same amount of wine, bulk transportation is much cheaper and more environmentally-friendly than transporting the wine in bottle.

• Insurance

As with all goods, it is essential that wine is correctly insured throughout its journey, in case it is lost, damaged or spoiled. Modern transport is very safe and reliable but accidents do happen: in 2013, the container ship MOL Comfort broke and sank off Mumbai. Amongst the cargo were two containers of wine from New Zealand’s St Clair winery destined for Sweden.

The party taking out the insurance should be the one 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 riskand many offer insurance as part of their service (usually at extra cost).

Question 31

What costs are associated with importation costs?

Answer 31

On top of transportation costs, there are additional costs which will payable if a wine is to be imported to another country. Customs duties and taxes have already been discussed in Factors influencing Demand for Wine - Legislative and Political Factors. Different countries also have different labelling laws with which the imported wine will need to comply.

It would take producers a significant amount of time to learn about all these different requirements and comply with them, which is why many producers employ distributors to deal with foreign markets. This also has the advantage that the importer has knowledge of their market and an established list of potential clients.

Question 32

How is the distributors ‘margin’ calculated?

Answer 32

Distributors will charge a fee which will add to the cost of the wine. This is called the ‘margin’. 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 topurchase, the percentage margin would be (1 ÷ 11) x 100 = 9.09 percent.

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 33

What costs are associated with sales?

Answer 33

Property costs – Retail premises of any sort are expensive. In most countries, retailers can choose between buying a property or leasing it for a period of time. Buying the property will incur significant capital costs, although the retailer may be able to fund the purchase through a property loan or mortgage. Taking a lease will be cheaper initially but the retailer will have to pay rent andother expenses during the term of the lease and, when the lease comes to an end, they may have to move out.

Labour – Staff costs vary according to the type of retail outlet. 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. Training staff to bring them up to the required level of skill and expertise can alsobe a significant business cost.

Equipment and materials – The requirements vary considerably between different types of retail outlet. For example, 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.

Storage costs – Individual bars, restaurants and shops will usually store their wine on the premises. They may invest inexpensive wine fridges to keep the wines at a constant cellar temperature. In some cases, a lack of storage space means they have to keep the wine in external storage until it is needed, incurring additional costs for the storage space and transporting the wine to and from it.

Delivery costs – Delivery of wine to the end consumer is one of the most expensive elements of the supply chain. Wine is relatively heavy and therefore costs more to deliver than other goods of a similar size. It is also extremely fragile and, as discussed above, there is always the risk that bottles will get broken or the wine becomes spoiled in transit.

Margin at the point of sale – 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. Specialist wine retailers usually look for a margin of 30-50%.

Question 34

What costs are associated with marketing?

Answer 34

Labour – Larger producers and brand owners will employ their own in-house marketing teams. However, smaller producers will not be able to afford these and so, if they want to run a marketing campaign, they will have to pay an external marketing company to do this for them.

Design and production of bottles and labels – Again, this could either be done in house or by an external agency.

Marketing campaign – Producers may want to pay for advertising and promotional materials. If they want to send sample bottles to tastings or competitions, they will have to provide them free-of-charge from stock which could otherwise be sold. Also, as explained further in Promotion, price promotions are an important part of wine marketing, especially in larger retailers. However, it is usually the producer that bears the cost of these.

Question 35

What is the impact of legislation on the cost of wine?

Answer 35

As has already been seen, the cost of wine can be affected by various types of legislation including: taxes, duties, trade barriers, subsidies, minimum pricing and labelling laws.

Producers cannot choose whether or not they comply with these laws but, in certain circumstances, they can decide how to do so. For example, in the UK, excise duty is payable on wine entering the country unless it is stored in what is known as a ‘bonded warehouse‘. Importing companies (e.g. some distributors) who wish to hold on to stock therefore have a choice to either pay the duty as soon as the wine arrives in the UK and then store it in their own facility or store the wine in a bonded warehouse and only release it when someone wants to buy it (who 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.

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

Similarly, onerous labelling laws may put off new entrants to a particular market.

Question 36

List ways to mitigate the impact of fluctuations in currency on the cost of wine?

Answer 36

Options – Options is one of the key strategies used in currency hedging. 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.

Fixing the price in the currency of the importer at the date of ordering – Producers may not agree to this or charge a premium as it shifts the currency risk to them. They welcome the certainty of knowing how much they will receive for the wine so prices are usually in the currency of the producer. However, many retailers prefer to do this so that they have the certainty of knowing how much they are paying and can work out their retail price based on that figure.

Buying currency to cover specific orders – 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, purchasing currency to cover wine purchase contracts, is an important business activity and is not considered speculation!

Entering a contract to fix the exchange rate – This is another common strategy for hedging currency. Some retailers which conduct a lot of business in a particular currency will enter into a formal contract with a bank or other supplier of foreign currency to purchase a given amount of currency at an agreed exchange rate on a specified date. The retailer buyer is legally committed to purchasing the currency purchase. Whilst the exchange rate may go up or down, again the retailer has the certainty of a fixed exchange rate and can budget accordingly.

Trading in USD/EUR – Many producers in countries with unstable currencies prefer to trade in more stable currencies such asthe 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.

Opening a foreign currency account in a local bank – If a buyer opens a foreign currency account in a local bank, payment for goods can be made direct to the seller in the seller’s own currency. At some point, though, foreign currency will still need to be bought and keeping a substantial sum of foreign currency in a current account may not be the most efficient use of those funds.

Opening an account in an overseas bank – Opening an account in an overseas bank has all the disadvantages of opening a foreign currency account in a local bank but with an added cause for caution.