Hard times for Australian wine

“From now on, every wine company will need a good reason to be there. The smaller companies must be specialists, with distinctive skills, styles and other marketable advantages such as the qualities and reputation of their wine region. They must be known for something that stands out.”

The speaker was Lindemans’ Managing Director, Peter Barnes, just days after the shock announcement that Penfolds had bought out Lindemans, lock, stock and barrel, in the biggest takeover the Australian wine industry has witnessed for many years. This buy-out may herald a new era for Australian wine, as it attempts to confront the many challenges that face it, from declining domestic and export markets to anti-drinking pressure applied by today’s gathering anti-alcohol lobby.

Until recently the wine industry believed it was exempt from the changes taking place around it. Beer consumption has tottered and teetered around, emburdened by inflation-indexed price rises, at the hands of a government keen to eke out every cent from any industry it felt could take it. Beer barons piled big money into lobbying politicians in a huge, costly and concerted effort to put wine aboard the same, leaking ship. But as Australians continued to drink less alcohol, they kept on buying more wine.

The breweries needn’t have worried. Australian wine is taking a caning, here and overseas. The honeymoon is over and there is a very real possibility of falling prices and hard times for the industry at large. If one compares the twelve months from January 1989 to December 1989, the latest figures available from the Australian Wine and Brandy Producers’ Association, total wine sales are down 5.7 on the previous twelve months. If we look at financial years, the domestic wine market declined by 6.8 on the previous year, a volume of 22.3 million litres. The last time domestic sales fell was back in 1971, by a mere 0.3.

Wine consumption per capita peaked in 1985/86 with 21.6 litres per head and in 1986/87 fell to 20.6 litres per head, in a continuing trend that presents a real concern to all individuals involved in wine.

What are the reasons for the changes? In no particular order, I present these considerations. People have listened to the many warnings related to drink-driving and are genuinely fearful of the consequences of being caught out. For most people, the penalties involved are a severe deterrent. It should, however, be stated that research in New Zealand and the United States have found very little correlation between wine consumption and road trauma. Wine represents a mere fraction of the threat imposed to the community by spirits and beer.

Many individuals are deeply concerned at the health-related aspects of eating and drinking. There is nothing wrong with this, but on a diet of misinformation fed by today’s underground movement of neo-prohibitionists, which the wine industry has yet to successfully counter, it’s little wonder people are running scared. There is only silence in response to the supposedly health-related coverage that condemns the drinking of wine as a dangerous, irresponsible, anti-social and subversive activity.

Health warnings are now to be found on all American wine labels. Warnings signs are posted in Californian restaurants, wine outlets and are required to be present whenever ten or more people gather to taste wine, even if none is for sale.

In Europe the movement is referred to as ‘health fascism’. English wine commentator Robert Joseph describes those involved as “people who want to control all our lives and make us healthy for our own good. In the US the wine industry cannot advertise now and cannot speak. You in Australia have not got to that situation yet, but that American influence is coming and many industries, not only the wine industry, will be sorely tested”, he says.

All this in face of accessible scientific evidence provided by eminent health academics such as Professor David Whitten, Assistant Professor of Physiology, University of California, San Francisco. Whitten’s presentation at the Wine 2000 Conference in Adelaide linked sensible wine consumption with a lower incidence of heart disease and a myriad of other health benefits.

Most of the decline in wine consumption is due to the decreasing popularity of the the wine cask or softpack. To the end of December last year, sales are down by 5.5 on the previous year, representing a massive quantity of unsold wine. This figure is due in part to a huge decline in sweet white cask sales of 29.7 on the previous year. In comparison, bottled sweet white wines are down by 12.3. Australians are also beginning to drink drier, it appears.

Reasons for the decline in cask sales relative to bottles appear to be the improvement in packaging quality of cheaper bottled wines, including the appearance of back-labels on some $3.00 wines, genuinely poorer cask wine quality across the board and cheaper bottled wines, which are now almost direct price-competitors to cask wines.

The wine industry has acknowledged the unfashionability of the larger four and five-litre casks by introducing the smaller two-litre casks, but I have noticed an overall decline in their quality over the last two years. Perhaps they are only a short-term solution.

The bottled wine market has until recently grown steadily as wine-drinkers move up-market and drink less. Industry statistics reveal an irregular buying pattern with the figures for the current twelve month period oscillating above and below the previous levels. Until last September bottled wine sales had indeed fallen by 1, led by a 1.9 reduction in red wine in the twelve months between October 1988 to September 1989. However the numbers for the year ending in December 1989 reveal a revival in total bottled wine consumption to a level 3.1 above that of the preceding twelve months. On the face of it, December’s figures appear optimistic, but the reality is that 1990 has been extremely difficult to date, and that the trends have not reversed.

These figures appear relatively harmless until one considers that in the last financial year domestic bottled red wine sales grew by 3.5 and all bottled export sales improved by 3.0. I believe the growth in red wine consumption has much to do with the dramatic improvement seen in the quality of our local reds over the past decade. Before the decline the average Australian consumer was drinking four and a half times as much white as red in casks, but only twice the amount of bottled white as red.

Australians are drinking far less fortified wine than in previous years, although the consumption of port has remained stable, at the expense of other drinks like sherry and muscat. Sherry’s decline has contributed a whopping 81 to the overall drop in fortified consumption between 1983/84 and 1988/89 of 21.9. The reasons why are relatively simple. We prefer sparkling wine, which has been through a boom period itself, to sherry as an aperitif, but continue to accept port as a regular after-dinner beverage.

Last financial year and perhaps due in no small degree to the excitement generated by the Bicentenary, sparkling wine consumption in Australia went through the roof. Despite the Ashes win and the Commonwealth Games, there hasn’t been as much to celebrate recently and sparkling wine sales have since fallen by 4.9. However the public is now choosing more bottle-fermented sparkling wine ahead of bulk-fermented, of lesser quality, although most of the gains in the bottle-fermented area have been with the cheaper brands.

Another important reason for wine’s declining market is its increase in price, which has kept well ahead of the CPI in the last three years. Grape prices have risen astronomically and the federal government has imposed a 20 sales tax on wine, in the process breaking a promise to the wine industry not to do so. Australian wine is now the most heavily-taxed of the world’s wine products. The profitability of wineries has fallen to the point where Hardy’s Wines’ Group Managing Director, Wayne Jackson says that the wine companies would make more money by investing in bank savings accounts. Profits shrank by 86 between 1984 and 1986, when the tax was imposed.

There is concerning evidence that at the cheaper, bulk end of the market, consumers are switching back to beer as an alternate beverage, a move exacerbated by the fall in the price of beer after changes to the beer taxation practices announced in the 1988 federal budget. There appears to be a cross-elasticity of demand between beer and wine at the cheaper end of the market.

Australia’s worsening economic conditions have obviously played a role in wine’s decreasing consumption, for consumers have less spending power than in the past.

With a declining local market and faced by increasing production, it’s simple to see why the wine industry needs to export. But exports of Australian wine are in danger of stagnation. The volume of wine exported grew by 97 in the ’86/’87 financial year and 84 the year after. Last financial year it grew, but by only 3.3. The news is now far worse. In the ten months from January 1989 to October 1989, the total exports of Australian wine fell by 11.8 in volume and by 6.2 in value from the level achieved in the previous corresponding ten-month period, despite an increase in sparkling wine exports of around 10.

The fact remains that Australia should be able to do better. In an address to the National Press Club in 1988, Hardy’s Wayne Jackson said that Australia should pose a major threat to the European wine producers in the future, citing the following reasons. Australia has huge areas of arable land suitable for viticulture. We have clean air, water and soil; pollution is not an agricultural problem for wine. Unlike the European regions, he said, we are not hamstrung by traditions which can retard progress and innovation. Our winemaking technology is arguably the best in the world and our management, viticultural, winemaking and packaging skills are undoubtedly world-class.

For our wine industry to survive in a profitable form a correction to the imbalance between the supply and demand of grapes needs quickly to be found. If export continues its present shaky performance the wineries may be faced with chronic over-supply. Large plantings of the premium varieties of cabernet sauvignon and chardonnay will come ‘on stream’ in the next two years when their demand is expected to fall, thereby adding to the problem. The price of grapes must stabilise. In all probability it will fall dramatically in a couple of years. A future decline in domestic sales, especially in cask wine, must be anticipated and taken into consideration, although whether bottled wine sales increase or fall must remain uncertain.

In response to the recent and dramatic changes in wine industry ownership, Lindemans’ Peter Barnes believes that middle-sized companies will have to find their niches. “Wolf Blass has his niche and Seppelts have their sparkling wines and Woodleys”, he continues. “Most companies will not be big enough to take on the broad-range companies like Penfolds and Orlando.” But it’s not price that will make it tough, he argues, but the sheer cost required to mount ventures and to stay in the wine industry, where returns on capital invested are famously low.

In early January, Lindemans was swallowed by the biggest fish in the pool, Penfolds, ending over a decade of speculation that its erstwhile owner, Phillip Morris, was going to concentrate solely on tobacco. The announcement however, stunned Lindemans staff all around Australia, who had grown used to years of repeated denial by Phillip Morris that the company was ever for sale.

Tack onto the equation the fact that Orlando has just bought the Wyndham Estate group and Hardys now own Chateau Reynella, Houghtons, Moondah Brook and others – and haven’t things changed? Australia’s major wine companies are now Penfolds, Orlando and Hardys and there’s quite a gulf to the next biggest.

Ian Mackley, Managing Director of Penfolds Wines, puts his company’s new share of the national retail trade around 27-32 with the Lindemans takeover. Informed wine industry estimates put Orlando’s share of the wine market between 18-21 and Hardys around 12-14.

In a rationalisation process that began in 1986 which many believed was primarily designed to make the company a more saleable proposition, Lindemans have streamlined their management, vineyards, number of wines produced and reduced their staff numbers. Each year since the process began has shown a steady improvement in profitability, but 1989 was by far Lindemans’ best year yet in terms of operating income.

The Lindemans purchase brings to the Penfolds stable a number of valuable assets, including the huge state-of-the-art Karadoc winery at Mildura, the excellent Rouge Homme winery in Coonawarra, the massive and proven high-quality vineyards at Padthaway and Coonawarra south-east South Australia, Clare and in the Hunter Valley, to the highly profitable cellar door operation in the Hunter.

Tack on to this Lindemans’ superior export network in the United Kingdom, United States and Canada, Lindemans’ excellent white wine portfolio and reputation Penfolds are justly regarded as Australia’s leading makers of red wine, Lindemans the best with whites, Lindemans’ superior market penetration in New South Wales and generally in wine casks and the price of between $110M – $140M nobody’s saying exactly what looks a genuine bargain. And let’s not forget Lindemans’ huge goodwill factor and excellent reputation.

Despite this, Mildara’s Managing Director, Ray King, questions whether or not the Penfolds-Lindemans merger makes economic sense, while accepting the general view that it will produce a stronger organisation. “Whatever I buy must be earning a required return. Assets are only valuable if I can sell them to someone else. The business cemeteries are full of those who have purchased assets without being able to cover the interest. It will be difficult for Penfolds to get the sort of return that John Spalvins will be after.”

Many people are deeply concerned at the polarisation occurring within the wine industry, with the giants at one end and the small or ’boutique’ wineries at the other. But Lindemans’ Peter Barnes expects the domination of the wine industry by the three large companies of Penfolds, Orlando and Hardys to clarify the existent uncertainty surrounding the future of Australian wine.

Many have suggested that Australia’s medium-sized wine companies, such as Mildara, Wolf Blass and Seppelt, may have to combine to meet the expected challenge and power of the big three. “There is no need for Mildara to look around just because of the merger”, says Ray King. “But if there is a good reason for us to get together, we should talk. Mildara, and presumably the others, will wait and see if the Penfolds-Lindemans company does in fact improve its market share.”

At present King sees no reason for concern and is eyeing the possibility that Mildara may benefit as a result. “Retailers will either approve or disapprove of the takeover. Some will look for less business with Penfolds, fearing the company has become too powerful; although those already doing a good business with the company may even do better.”

King isn’t too concerned at all and says that people should put the merger activity into perspective. “I’ll take the maverick’s view. It’s not all bad, and may even be a good thing”, he says. “I’ve been in the wine business for twenty years. Every five to six years there’s huge panic, saying that by the end of the decade there’ll only be ten wineries left in the country. I’ve heard it all before. There are five times are many wineries in Australia now as there were in 1970.”

Ray King doubts the “mega-merger” will exert leverage in the market above which the two companies were able to achieve as individuals, in either determining grape prices for growers or in terms of forcing retailers into better deals at the expense of their competition. “Their bark is probably worse than their bite”.

Despite this, there have been objections. John O’Neill, Senior Assistant Commissioner at the Trade Practices Commission is conducting a preliminary examination of the case. Although he is yet to receive objections in accordance with Section 50 of the Trade Practices Act, which forbids an acquisition if it creates or enhances a position of dominance, he has however, received complaints from the United Farmers & Stockowners of S.A. Wine Grape Section and another grape growing association in Victoria, concerning the increased power available to Penfolds in their negotiation of grape prices. The Trade Practices Commission has received no complaints from wine retailers.

Ian Mackley puts down the South Australian complaint to internal politicking. He remarks that Penfolds grow around a third of the grapes they use, have a third on long-term contracts and buy the remaining third on annual contracts. To date, he says, only a single grower has cancelled a contract.

We are talking big numbers. That’s why wine has been so expensive lately. Last year riverland irrigated chardonnay fetched $1500 per tonne. This year Penfolds have offered $800. But before the company is condemned, this is exactly the price proposed by the grape growers in the large irrigated Riverina area of New South Wales around Griffith. A major grower at Griffith has denied that Penfolds forced the price or are at fault. “The growers can still have their fast cars”, he joked.

Ian Mackley says the merger makes no difference to grape growers, saying they must understand that a grape is only worth what a winemaker can get for it. “Prices have been ridiculously high over the past two vintages and now there is a surplus of wine. In actual fact while the prices were are offering this vintage are not generally as high as they were last year, they are higher than they were in 1988.”

Mackley concedes that while Penfolds are digesting their new company in the short term, their total demand for grapes may fall. However he expects Penfolds to show positive market growth and says the total demand for grapes by Penfolds-Lindemans will be higher than ever before in the near future.

King that much of Penfolds’ fate will depend on how they manage their distribution system. “Unless they get rid of all the Lindemans sales team, they will find it hard to justify the purchase”, he says. “I believe they have to increase the profitability of Lindemans by two or three times to make it work, so somewhere they have to save a lot of money.” Ian Mackley broadly agrees with that assumption, but says he will make significant savings by operating out of one premises in each state, sharing common winemaking equipment and with the inevitable personnel casualties.

King estimates there is a potential $8-10M to be saved if the Lindemans sales network is disbanded, but that in itself will put excessive pressure on the Penfolds sales team, whose portfolio of products would increase to a potentially unmanageable number. Could they maintain their sales level? If not, companies like Mildara would clearly benefit.

“We’d never remove all the Lindemans staff”, says Mackley. “We’ll need more legs on the ground and we’re taking a very close look for the best people. After all, they’re the scarcest resource.” In spite of this remark, Penfolds only retained two of the Lindemans sales staff in Victoria, from an original number of fourteen.

Another possibility would be for Penfolds to reduce the number of Lindemans product lines, or to decrease the number of brands to sell. There is, however an army of very loyal Lindemans consumers. If lines are removed, one can’t assume that purchases would automatically revert to the existing Penfolds brands.

“We’re not getting rid of any of the Lindemans brands”, says Ian Mackley. “Rouge Homme, Leo Buring, Matthew Lang, Lindemans, etc. will all remain, but we’ll examine the range within the brands. Any wine between $5-$7 and selling only 2,000 cases would have to be considered for removal.”

Fortunately Penfolds will keep specialist wines like St George Cabernet Sauvignon sacrosanct and specific to that particular individual vineyard. But a brand like Rouge Homme, already made with fruit taken from several Coonawarra vineyards, allows more flexibility. Remember, Penfolds own Wynns and the old Penfolds’ Coonawarra vineyards, which with the Lindemans vineyards must account for approximately half the area under vine in that most prestigious of Australian wine regions. The potential to gain full value out of a brand such as Rouge Homme is therefore enormous. I expect Rouge Homme Claret to pose a major threat to Wolf Blass Yellow Label in the near future.

To complete the picture, Ian Mackley believes the future for Australian wine future to be excellent, although many others would like to say that. He expects strong growth in export and expects to arrest the decline in the local market with lower wine prices once grape prices become more rational.

“Export is particularly important for Australia. If Penfolds and others are successful, the smaller companies can ride in on the back of larger firms”, he says.

“The economies of scale given us by the merger should be sufficient to arrest the decline in the cask market, which would also be in the interests of the grape growers. The retail price for a good four-litre cask should be between $6.99 and $7.99. Once we recover to that, the wine industry will be on track again.”

Another spectre hanging over the wine industry is the possibility of an excise tax on wine, which would be likely to be imposed before the sales tax, leading to a tax-on-tax situation. Its introduction, according to Tony Crawford of the Australian Wine and Brandy Producers’ Association, “would have an adverse effect on the 70 of table wine sales which are still in the form of casks and flagons. The livelihood of thousands of independent growers is at stake, for they rely on these markets. Also put at risk would be the ability of Australian companies to maintain a competitive position overseas.”

Australian wine is clearly at the crossroads. Its future will depend, in part, on what you choose to drink this year. Please login to post comment