May (No. 496)
Living with retail consolidation in the wine industry
Mark Watson , mhm Business Advisors
Like it or not, retail consolidation has changed the face of the Australian wine industry forever. Its impact has been far-reaching and varied. For consumers, it has meant deals aplenty, while for many independent retailers it has completely altered their competitive environment. Significantly, it also has forced many wineries, growers and distributors to reassess their operations. Long gone are the days of independent retailers scattered liberally through the suburbs. Now large supermarket chains Coles Myer and Woolworths are estimated to account for a combined 45% of liquor sales in Australia.
The retailer’s mark-up traditionally has been around 30-35% of the end selling price, and as the dominant players flex their muscles in the market place and look to maintain margins, the effect of retail price reductions is felt all the way down the supply chain. Ultimately, this leaves the others - the wineries, distributors and growers - with less financial room to move. However, this does not mean each cannot be prosperous. Wine is a robust industry and has shown it can ride out cyclical movements in its long history.
What it does mean though, is that the industry is likely to be faced with depressed margins, forcing participants to work harder than ever before at reducing costs and improving general operational efficiency. It is the pro-active wine producer, grower and distributor who will prosper at the expense of the reactionary.
In my opinion, many comparisons can be drawn between the current Australian wine experience and that of the United Kingdom. Large supermarket chains such as Tesco, Sainsbury’s, Asda and Safeway have a strong hold on British liquor retailing. In the UK, consumers can walk from the dairy or meat aisle straight into the wine aisle, without the need to leave the supermarket. The big chains are offering an increasing number of special deals to lure the consumer dollar. And the smaller retailers are often forced to follow suit in a bid to remain competitive, resulting in better deals for consumers wherever they choose to shop.
If there is to be a clear winner from retail consolidation, it must be the consumer. However, it has been suggested that a potential down-side for consumers is a reduction in choice. Certainly the trend with the leading UK chains has been towards fewer choices and better prices.
While Australian consumers in general are reaping the benefits of this rapid retail consolidation, independent retailers - perhaps above all others - have found things most challenging. Some have tried to tackle the big chains head-on, only to collapse, while others have simply surrendered to a rival whose buying power and marketing budgets dwarf those of the independent retailer. To survive and prosper the independent retailer must offer a point of difference, whether it be more varied product choice or higher levels of customer service. Put simply, they must offer something the big chains cannot.
Distributors have long been an integral part of the wine industry, but they also are feeling the effects of retail consolidation. Coles and Woolworths are dealing direct with some wineries, placing even more pressure on distributors to offer a cost-effective service. Indeed, many of the larger wineries have their own marketing and distribution arms.
Pro-active distributors are constantly seeking ways to increase their effectiveness and highlight their worth. Certainly the value of a distributor for a winery has not decreased when dealing with on-premise outlets such as restaurants. Meeting the demands of such clients is extremely labour and time intensive and is something few wineries can manage. The worth of a distributor is undeniable in these circumstances.
There is no doubt that distributors and wineries must work hand-in-hand as the pressure on margins becomes increasingly apparent. Both must be more flexible, perhaps moving away from traditional fixed-payment arrangements and towards a more workable structure for both. A distributor, carrying a comprehensive, multi-region portfolio, may have a much better chance of dealing with the large chains than a small-to-medium-sized winery.
The difference though is in the cost to the distributor of servicing, say, ‘on-premise’ as opposed to supermarket customers. The fact that the same rate is often charged irrespective of the channel means that many of the small-to-medium wineries have a reduced chance of representation in the supermarket system.
Progressive distributors overseas, recognising these types of challenges have agreed to vary distributor margins by channel thereby allowing small-to-medium wineries more of a chance to participate at a more competitive level. Ultimately both distributor and winery appear to be benefiting from this approach. It is therefore crucial for medium-sized wineries, in particular, to solidify their relationship with distributors within this changing environment.
The impact of retail consolidation also has been felt by the grapegrower. Like the wineries and distributors, the growers have been forced to reassess their growing practices and operating costs. For all three sectors, operating costs are paramount. Keep them under control and prosperity can follow. But let them run away and the consequences could be dire.
From a financial viewpoint, there are two vital components in a successful operation: cashflow and access to ongoing funding. Each of the participants within the wine industry supply chain are consumers of relatively large amounts of capital. Growers require significant infrastructure to grow the grapes, wineries the processing and storage capacity to produce the product and distributors the sales and distribution infrastructure to reach the end consumer.
Given the agricultural nature of the industry and its general cyclical nature, this can have significant cashflow and funding impacts on each of the contributors within the supply chain. Access to cashflow as needed and ongoing longer-term funding is crucial for all players. Perhaps above all else this highlights the importance of fostering a strong relationship with financiers. The value of finding a financier who understands the intricacies and complexities of the wine industry and appreciates the many changes that are taking place within it is almost immeasurable.
The impact of retail consolidation already has been marked. And as Coles Myer and Woolworths strive to claim an even bigger share of the retail market, that impact is likely to have even more widespread ramifications.
Mark Watson is a principal in the Corporate Finance Division of business advisory firm mhm. Before joining mhm he worked as the chief financial officer and company secretary at a leading Australian winery. He can be contacted on (08) 8373 4877 or firstname.lastname@example.org