Chapter 2 - Costs Through Supply Chain

Question 1

What is a supply chain?

Answer 1

• the network of orgs & activities involved from creation of a product through its distribution and sale to the final consumer
• grape growing forms the first stage the supply chain in wine.

Question 2

List the 8 costs within the supply chain for wine

Answer 2

• Grape growing costs: Vineyard establishment & vineyard managmeent
• Winemaking costs: winery establishment & winemaking costs
• Transportation costs (in bottle vs in bulk) & insurance
• Importation costs
• Sales costs
• Marketing costs
• Impact of Legislation on cost
• Impact of Fluctuation in Currency on cost

Question 3

What are capital costs vs operating costs

Answer 3

capital cost: money spent by a business in acquiring, improving or maintaining long-term assets such as land, buildings and equipment; aka cost incurred in establishing a business (establishing a vineyard & establishing a winery)
operating costs: day to day costs relating to producing & packaging wine (maintenance, labor, electricity, etc)

Question 4

What are the categories of grape growing costs?

Answer 4

• vineyard establishment
• vineyard management

Question 5

Describe the capital costs associated with vineyard establishments

Answer 5

Cap costs can be very high and include:
* Cost of buying/renting land: vary within region, due to land’s potential, reputation, scarcity
* Survey land to check suitability for viticulture & deciding grapes - satellite imaging, taking soil samples
* site clearance - remove vegetation, large rocks, etc
* building access roads into vineyards / btw plots
* buying & planting vines
* buying stakes & wires for trellis
* install deep drainage channels/pipework
* establish irrigation system
* protection again weather hazards (eg windbreaks, protective mesh, frost protection)
* protect from animal pests (high fences, netting)
* buying machinery & equpment (tractors, spray equipment, harvest machine, shed to store them); some will hire when they need machinery

Question 6

How can cost of buying and renting land vary? What impacts price of land?

Answer 6

• can vary within region (ex: Napa 10x more than Central Valley and Bordeaux’s Prestigous Medoc AOCs 100x more than generic Bordeaux)
• prices reflect lands potential to produce high quality fruit
• reputation of the appellation (Napa has high reputation vs Central Valley known for inexpensive wines)
• scarcity of land increases price; Champagne land rarely comes on market, so sold to highest bidder

Question 7

What are some sources of funding for vineyard establishment?

Answer 7

• personal/company wealth to fund vineyard, but others dont have this
• loans, but interest and capital repyaments have to be factored into long term biz plan
• funding from investors, but they expect a share in profits and ROI, may want wish to get involved in managing the biz
• govt subsidies: some govt encourage establishing vineyards, and offer subsidies to prospective producers, either in form of tax incentives or lump-sump contributions

Question 8

What are the main vineyard management costs?

Answer 8

Costs start as soon as vines are planted:
* Labor: amt of labor depends on size, topography, etc. Steep slopes and organic/BioD vineyard more labor intensive; cheaper unskilled pickers for harvest vs expensive skilled works for rest of year;
* Maintenance of Machinery & fuel
* Supplies: materials for repairs to trellis, pruning sheers, gloves, etc
* Vineyard treatments: agro-chemicals for convention; can be reduced by IPM; cost for own weather station or pay for access to gov owned station; traditional treatments also incur costs
* Water: pay authories for right to extract water from river or buy it elsewhere; dry years = irrigation water price rises
* Electricity: irrigation systems, bird scarers, some frost protection equipment
* Insurance & depreciation: insurance against fires/flood/etc; and depreciation of replaceable assets; normally businesses include sum of depreciation, the reduction of value of assess over time based on useful life (eg amt of replacing tractor or trellis system)

Question 9

What’s the balance to consider in terms of labor costs in vineyard management

Answer 9

balance btw labort cost and capital cost of machinery;
where labor cost is low (Chile), less incentive to use capital intensive eqipment;
where labort cost high or labor difficult to find (Coonawarra) investment in machinery beomces better option

Question 10

How can type of labor vary through the year in the vineyard?

Answer 10

• unskilled hand harvesters/pickers can be taught quickly (relatively cheap unless shortage)
• smaller staff of more expensive, skilled workers needed for rest of year
• if machinery used, staff need to be trained

Question 11

Describe winery establishment costs

Answer 11

numerous of cap costs: land to purchase, cost od building winery, fitting it out w/ new equipment (presses, tanks, pipes, pumps, refridgeration equipment, maturation vessels, btling line)

Question 12

Describe winemaking costs (10)

Answer 12

• Grape growing costs or cost of bought in fruit: price of fruit will be significant cost if bought in, vary depending on quality of grapes, the variety and vintage; can blend more expensive variety with less expensive grape to reduce costs
• Labor: small no of highly skilled staff FT; some more casual labor around harvest (unloading crates/moving equipment)
• Machinery & equpment running cost: fuel, electricity, maintenance
• Winery materials: sugar, deacidification/acd agents, cultured yeast, Co2/inert gases, fining/filtering agents
• Water: large amts for cleaning; where water is expensive, some find it cost-effective to invest in water treatment plans so they can reuse water
• Electricity: for refrigeration, ventilation, presses, pumps, lighting; some estates generate their own electricity (via solar panels)
• Maturation: vessels costly, storage space needed if maturing at estate, new oak expensive, cheaper to buy staves/chips or older oak; need labor for monitoring; less cash flow;
• Packaging: bottles, closures, labels, cartons, pallet costs; heavy bottles or elaborate labels more expensive; bottling line required - either purchase or hire and labor to operate it; designer for labels
• Depreciation: budget for replacement cost of equipment; cellar overheads- cost of water, electricity, winery-related deprepciation
• Other; tax, duties, transporation, sales, marketing etc)

Question 13

What are the costs associated with wine maturation

Answer 13

• cost of the vessel
• cost of storage space at estate
• cost of labor to monitor maturation
• loss of cashflow - money tied up in maturing stocks
• some styles/PDOs require longer aging (Brunello - 5 yrs after harvest)

Question 14

What does depreciation refer to in the context of vineyard management?

Answer 14

The reduction in the value of assets over time based on their useful life.

Question 15

Why might a vineyard opt for machinery over manual labour?

Answer 15

If labour costs are high or difficult to find, investment in machinery becomes a better option.

Question 16

What economic principle is important in high vol, inexpensive wines? How can costs be recouped?

Answer 16

• economies of scale - the cost of the initial investment being spread/recouped across a very large production.
• The investment is aimed also to maximise the efficiency of production.
• As a result, price to the end user is low so that the wine can be competitive in its market.

Question 17

how does profit margin work for high vol inexpensive wines? how are cost recouped?

Answer 17

• Tiny margin per unit sold, but aiming for high-volume sales.
• high vol, low margin wine
• cost recouped by high vol processed (economies of scale)

Question 18

how does profit margin work in low vol, premium wines? how is costs recouped?

Answer 18

• Significant margin per unit sold, but only have a small number of units to sell.
• low vol, high margin wine
• equipment and storage recouped by much higher price of wine
• minimal economy of scale, so final price to end user will be higher

Question 19

What can be the biggest GRAPE GROWING COST DIFFERENCES in inexpensive high vol wines vs premium low vol wines?

Answer 19

• Labor: biggest difference due to labor costs to grow fruit for super premium wine due to: more intervention in vineyard (pruning by hand, disbudding, leaf removal, croppin thinning); more manual work (time consuming & labor intensive), smaller vineyard, lower yields = no economices of scale for any work done
• Real estate tax - higher value of land for premium;
• Depreciation: higher replacement costs for expensive wines

Question 20

What can be the biggest WINEMAKING COST DIFFERENCES in inexpensive high vol wines vs premium low vol wines?

Answer 20

• grape growing cost can account for large proportiom of total production cost (in example)
• most significant winemaking cost: Oak ( higher proportion of oak used for premium wine and barresl will be replaced after 3-4yrs
• Cellar overheads - higher for expensive wines due to longer maturation
• larger cellar space required for premium wine matured in individual barrels
• cost like higher quality material, closures, labgesl, packaging etc

Question 21

who usually transports wines?

Answer 21

• industry prefer specialist freight forwarders (eg JF Hillebrand)
• more expensive but have considerable expertise in such fragile product;
• bottles can be easily broken, wine inside subject to heat/sunlight/excessive vibrations;
• some take steps to limit risk of loss/damage, using speciability temp-controlled shipping containers

Question 22

Describe the main ways to transport wine in bottles around the world?

Answer 22

in order of most expensive to least
* Air: cost depends on weight, due to fuel required; btls are heavy relative to size/value and expensive to transport, so only used in certain circumstances
* Road: short journeys are efficient; long journeys are excessively expensives; if crossing small body of water (eg English Channel) truck can directly drive onto/off ferry, quickest/cheapest way of moving goods through port but cost of overall journey may outweight beneift
* Rail: varies on length of journey, route, and how goods loaded; if individual pallets, cost higher; if goods in standard container thats lifted on back of truck and then onto rail wagon - can be cheaper
* Sea: (deep sea) - cheapest method for transporting wine over long distnance; containerisation is essential; however its slow so much factor in the longer time

Question 23

when is transporting wine bottles via AIR used?

Answer 23

only used in special circumstance b/c expensive:
* sending samples for trade fair or competition
* very high value wines
* when deadlines important ( Beaujo Nouveau for JP market)

Question 24

Describe bulk transportation of wine & its advantages vs disadvantages

Answer 24

• large increase in bulk transport; used to be cheaper wines, now more interest for expensive wines
• transported in either plastic flexitanks (more common) w/ standard steel shipping container OR non flexible ISO tanks
• advantage: lighter than btl & more efficient (holds 24-26K liters to 9-10K) over double the amt can be carried, reducing fuel required, cheaper, more environment friendly (plus D1 - thermal inertia, shelf life, measure wine parameters b4/after)
• disadvantage: only suiltable for large vol of same wine (good for supermarkets/major brands who sell large vol like 3-4 containers per year), not for small production (plus D1 - lose relationships w producer, transfer of business & employment to final market)

Question 25

Describe insurance costs for transporting wines

Answer 25

* insurance is important in case of lost, damage, spoilage * party taking out insurance shoudl be the one taht assumes risk for loss/damage' normally, party who is sending goods (eg the winery) * import company responsible for getting wine safely to retailers/consumers * using specialist freight forwarder reduces risks

Question 26

Describe importation costs

Answer 26

* includes c**ustom duties & taxes** * **different labelling law**s to comply w/ (ex EU ABV must be nearest whole/half unit; USA permits 1.5% variance and US health warning), so need diff labels for specific markets, adding costs vs just ordering larger number of 1 single labvel * **employing distributors**: too much time to learn & comply w. diff requirements, so producers employ distributors to deal w/ foreign markets (who have knowledeg of market and established list of clients) * **distributors fee**: adding to cost of wine, fee called "margin" * retailers buying from distributors need to pay delivery costs

Question 27

What is the distributor's margin & typical trends for range and costs of working w/ different biz sectors

Answer 27

* when distributors charge a fee, which add to cost of the wine, usually quoted as a % and calculated as the fee (operating costs & profit) divided by revenue (multiplied by 100) ; * generally margin ranges from 5-25% * generally those selling to hospitality sector tend to have charge higher prices to hospitability sector and have larger staff than retail sector (distributors expect higher margins from hospitaility than retail) ## Footnote can be avoided if retailers buy directly from producers, but somtimes worth paying for distributor to handle logistics

Question 28

What are 6 **sales costs** associated with price of bottle at the retail/hospitability end of the supply chain?

Answer 28

* **Property cost**: buy or lease property; buying incurs high capital costs, but can fund through property loan/mortage; lease can be initially cheaper but need to pay rent and may have to move out; prime locations are expensive; money to decorate/furnish to suit business image and running costs (maintenance, security, water, energy, insurance, etc) * **Labor**: some countries require legal **min wage**; **higher skill level**/epxerise, the higher the wage expected; training staff has costs; supermarket labor low, but specialist retailer employ knowledge staff; bars/restaruants have higher labor costs to wait on tables, clean, wash up; fining dining staff expected to be highly knowledgable, typically head somm who select wines & offers advice - can command impressive salaries vs non destination restaurants * **Equipment & materials:** til system, fridge, shelves, cabinets, displays, cleaning equipment, etc; restaurants needs kitchen/bar equipment, tableware, glasses, wine preservations (profits on food help cover cost) * **Storage costs**: some store on premise, may need expensive wine fridges for constant cellar temps; others keep in external storage, incurs costs and transport to/from; supermarkets have centralised warehouses and distribute to branches as needed (cheaper, accessible, out of town location) * **Delivery costs**: delivery to end consumer can be most expensive element; wine is heavy, so costs more to deliver and extremely fragile; costs to retailer depends on distance but some charge fixed fees (even though it may cost more); some offer free over certain amt; * **Margin at point of sale**: margin varies from country and retailer type; specialists look for 30-50%; bars & restaurants higher margin (~66.6%) to cover higher operation costs; margin higher on wines by glass (as risk that once open, wine may spoil b4 emptied)

Question 29

What are some examples of **marketing costs** that impact price of wine?

Answer 29

* **Labor**: larger producers/brand owners employ own in house marketing teams; smaller producers may pay external marketing comp; some may be member of industry association/generic trade body (fee paid by members) who market members wine collectively * **Design & production of bottles & labels**: inhouse or external agency * **Marketing campaigns**: may pay for ads & promo materials; send samples FOC; price promos at larger retailers usually producer bears costs; larger producers have budget to run expensive campaigns, play in part on price of wines ## Footnote *(more in marketing chapters)*

Question 30

what is the **impact of legislation on cost** of wine?

Answer 30

* cost of taxes, duties, trade barriers, subsidies, min pricing, labelling laws, etc. have effect on cost * producers must comply w/ laws but sometime can choose how they do so * Importers in UK have to pay excise duty upon entering country OR can store in bonded warehouse, and only release when someone want to buy it (who will cover cost of taking wine out of bond, including duty payable) * bonded warehouse costs money, but helps importer with cash flow * legal factos may impact if producer enters a market: if import duty too high, producer may not be able to sell competitive price, so they focus on diff market (ex: few mid price US wines in EU b/c cant compete w/ Chile and SA who have trade agreements w EU) * onerous labelling can put off new entrants to a market

Question 31

What is the **impact of fluctuations in currency** on the cost of wine?

Answer 31

* When wine is imported/export btw countries with different currencies, fluctuation of exchange rate btw those two currencies can effect the price of wine considerably. * For example, the payment at time of ordering can be different from payment due at the point of delivery due to fluctuations for large number of bottles.

Question 32

What are 7 methods the wine industry can **mitigate effect of exchange rate fluctuations** (aka hedging currency)?

Answer 32

* **Options** - importer take option/reserve on ceratin amt of wine at agreed price. producer set aside agreed vol, and at an agreed time, importer decides to take it out not, this can leave producer with unsold stock, so they may charge higher price than normal contract; can also take an option on certain amt of currency at agreed price (instead of stock) * **Fixing price in currency of importer at date of ordering**: producers may charge a premium as the currency risk shifts to them; importer prefer to fix price to work out reatil price while producer want to certainity how much they receive * **Buying currency to cover specific orders**: requires proactive stance, only larger company w/ in-house skills to manage currencies this way; they purchase currency to cover wine purchase contracts * **Entering a contract to fix the exchange rate**: if importer conduct a lot of biz in a certain currency, can enter formal contract w/ bank or supplier of foreign currency to purchase given amt of currency at agreed exchange rate on a specified date; importer legally commited to buy; fix rate allows to budget accordingly * **Trading in USD/EUR**: producers w/ unstable currencies prefer to trade in more stable ones like USD or EUR; better certainity for importer; help for producers who buy vineyard/winery materail in USD/EUR - less exposed to fluctuation of their domestic currency * **Opening a foreign currency account in a local bank**: (a bank account in your home country with foreign currency) buyer can pay for goods in sellers own currency; foreign currency need to be bought at some point; keep big sum of foreign currency not most efficient use; makes sense for producer who buys parts in EU, produces product UK, and sell product in EU (all transactions in EUR); not suitable when goods bought in one currency and sold in another; * **Opening an account in an overseas bank**: has all disadvantages of opening foreign currency account in local bank, but more added caution - banking regulations diff greatly in diff countries, need to ensure all rules are understood

Question 33

How does the production scale affect the final price of wine to the end user?

Answer 33

Low price for high-volume wines, high price for low-volume wines

Question 34

What is the profit margin relationship for high-volume versus low-volume wines?

Answer 34

High-volume wines have tiny margins per unit, low-volume wines have significant margins per unit

Question 35

What are some of the additional labor costs associated with super-premium wine production?

Answer 35

* More interventions in the vineyard * Manual work that is time-consuming * Smaller vineyard and lower yields

Question 36

What percentage of the total production cost do grape growing costs typically represent?

Answer 36

Roughly 70 percent

Question 37

What is a significant added cost for super-premium wine during the winemaking phase?

Answer 37

Cost of oak barrels

Question 38

What materials are typically used for the packaging of super-premium wines?

Answer 38

* Higher quality glass * Premium closures * Quality labels and case packaging

Question 39

What additional costs must be considered beyond direct production costs?

Answer 39

* Sales and marketing costs * Transport costs * Taxes and duties * Overheads of running the business

Question 40

How do fluctuations in currency affect the cost of wine?

Answer 40

* Fluctuations in currency exchange rates can significantly change the price of wine when importing or exporting between countries. * changes in the exchange rate could mean they end up paying more, or less, for the wine than if they paid on delivery. * Can depend on if buyer pays when ordering or pay when upon delivery. * Stronger buyer currency (vs seller's): the wine becomes cheaper for the buyer. * Weaker buyer currency (vs seller's): the wine becomes more expensive for the buyer.

Question 41

What are additional costs associated with importing wine?

Answer 41

Customs duties, taxes, and compliance with labelling laws ## Footnote Different countries have various regulations regarding wine labelling and importation costs.

Question 42

What does EU vs US law require regarding the abv of wine?

Answer 42

For EU, must be shown to the nearest whole or half unit. This contrasts with USA law, which allows a 1.5% variance.

Question 43

What additional requirement does USA law impose on wine bottles?

Answer 43

A health warning must be displayed. This requirement must be met for wines entering the USA.

Question 44

Why might wine producers need to order different labels for different markets?

Answer 44

To comply with varying labelling laws of each country. This can increase costs compared to dealing with a single market.

Question 45

What is the role of distributors in the wine import process?

Answer 45

To handle foreign market compliance and logistics. Distributors possess market knowledge and client lists.

Question 46

What is the 'margin' in the context of wine distribution?

Answer 46

The fee charged by distributors, expressed as a percentage. It includes operating costs and profit.

Question 47

How is the margin percentage calculated for a distributor?

Answer 47

(Fee ÷ Revenue) x 100 ## Footnote Example: If a distributor adds EUR 1.00 to a EUR 10.00 bottle, the margin is (1 ÷ 11) x 100 = 9.09%.

Question 48

What is the typical range for distributor margins?

Answer 48

5–25 percent ## Footnote Margins may vary by distributor and country.

Question 49

Why do distributors selling to the hospitality sector tend to have higher margins?

Answer 49

They generally have higher costs and larger staff. This results in increased operational expenses.

Question 50

What is one advantage of buying directly from producers?

Answer 50

Avoiding distributors' margins. However, logistics management can be more challenging without a distributor.

Question 51

What is one method used in currency hedging for wine imports?

Answer 51

Options are used to reserve a certain amount of wine at an agreed price.

Question 52

What is the risk for producers when taking options on wine?

Answer 52

Producers risk having unsold stock if importers decide not to take the wine.

Question 53

What is a disadvantage of fixing the price in the currency of the importer?

Answer 53

Producers may charge a premium as it shifts the currency risk to them.

Question 54

What is an important business activity in currency management for larger companies?

Answer 54

Purchasing currency to cover wine purchase contracts.

Question 55

What does entering a contract to fix the exchange rate involve?

Answer 55

Importers commit to purchasing a specified amount of currency at an agreed exchange rate on a set date.

Question 56

Why do many producers prefer to trade in stable currencies like USD or EUR?

Answer 56

It provides greater certainty about the price of wine and reduces exposure to fluctuations in domestic currency.

Question 57

What is the benefit of opening a foreign currency account in a local bank?

Answer 57

Payments can be made directly to the seller in their own currency.

Question 58

What is a disadvantage of having an account in an overseas bank?

Answer 58

There are significant differences in banking regulations between countries that must be understood.