Rough Diamond

The South African wine industry is comparatively new to the global wine market, and its development over the next five years will be crucial. Julie Sheppard identifies the key challenges

Gold. Platinum. Diamonds. The three words that send Ivana Trump in search of her nearest jeweller have also spelled success for South Africa, part of the mineral wealth that has helped to make it the 20th largest global economy today. The world’s biggest platinum producer, responsible for 73% of the annual global output, South Africa is also a world-leading producer of gold and has the largest global reserves of both metals along with minerals such as manganese and chromium.

No-one could dispute that it’s a land of plenty then, least of all South Africa’s wine producers who have been promoting the rich biodiversity of the country in a marketing campaign devised by generic body, Wines of South Africa (WoSA). Indeed, if I had a diamond ring for every time I’ve been told that there are more species of flora on Table Mountain than in the entire UK, I’d need at least 10 extra hands and a much bigger jewellery box.

Such activity shows a keen awareness of the need to position South African wine on the global stage at a key time in the industry’s development. “Essentially wine production in South Africa is a 10-year-old industry,” says André Morgenthal, WoSA’s communications manager. Wine has actually been made in the Cape since 1659, thanks to the pioneering efforts of the Dutch East India Company. But the same European settlers who introduced the vine set in motion a period of South African history defined by racial oppression, that only ended when the system of apartheid was abolished and the country became a democracy in 1994. Before this date the state-controlled wine industry had effectively been stuck in a rut. Sanctions resulted in minimal exports and a lack of exposure to viticultural and vinicultural technology; while the domestic market was dominated by lager and brandy consumption.

Grape variety
Today the picture is rosier. According to SAWIS (South African Wine Industry Statistics) domestic consumption of wine stands at 350 million litres, while exports account for over 268m litres. The area under vine has grown to almost 125,000 hectares (ha) from under 85,000 in 1994 and the wine industry contributes R16.3 billion to South Africa’s economy, all of which are testament to the changes that have occurred in the last decade. But where should the industry go from here?

Producers are addressing that question for themselves with an expanding range  of wine styles. “We’re seeing an acceleration of experimentation,” says Charles Back of Fairview, whose vineyard in Paarl includes plantings of Tannat, Tempranillo and Grenache Blanc, alongside Italian varieties Sangiovese and Barbera. “And I haven’t even touched on the Greek varietals yet,” he quips.

As well as interest in new varieties, there’s ongoing effort to improve the quality of wines made from the most widely planted grapes and to stylistically define them as uniquely South African. Take the workhorse variety Chenin Blanc, which accounts for 19,148 ha of the total 54,074 ha of white grapes planted. Bruwer Raats of Raats Family Wines in Stellenbosch has such firm belief in its potential that he has focused his entire white production on it. “South Africa has a unique opportunity to position the country as the leading producer internationally of this variety,” he says. 

Anthony Hamilton Russell of Hamilton Russell Vineyards in Walker Bay feels much the same way about Pinotage, which has been feted as South Africa’s USP. “It was a mistake to think that Pinotage could be South Africa’s signature red at all price points,” he notes. “I’m increasingly convinced that it only really shines at the top end, in the hands of focused boutique producers. If more top producers had the courage and confidence to put their backs into Pinotage with more persistence, we would create a top-end sector of great interest to international consumers, and of great value to the industry.”

Viticulturalist void 
Hamilton Russell believes some South African producers began to lack confidence as their industry became more international, making them avoid anything that had not already been done successfully by international competitors. As a result, he says, “South Africa runs the risk of entrenching a ‘follower’ mentality and being imitators not innovators.” It’s important here to differentiate between playing it safe or jumping on a bandwagon – which, let’s face it, is often a commercial necessity in an industry subject to consumer trends – and using the example set by others to create your own benchmarks.

Bruce Jack of Flagstone Winery encourages comparisons between New Zealand and South Africa when it comes to Sauvignon Blanc. He is part of a small group of producers pioneering winemaking in South Africa’s coolest growing area, Cape Agulhas in Elim. It’s one of several new regions, including Elgin, Langkloof, Prince Albert and Ceres, which are currently creating a buzz. But Neil Ellis, an industry stalwart who worked at KWV, Groot Constantia and Zevenwacht before founding Neil Ellis Wines, warns that a long-term view must be taken for such areas. “We’re only starting to scratch our true potential,” he believes. “It would take an above average viticultural team 10 years to understand a new region, then another 10 years to understand the winemaking.”  

This highlights a pressing problem for South Africa; viticulture. While larger companies such as Graham Beck have been able to invest heavily in research, using satellite imaging technology, for example, this is not the norm. And according to David Finlayson, cellarmaster and MD of Glen Carlou, that represents a real shortcoming for South Africa. “We’re short on top viticulturalists,” he states simply. It’s his belief that there are only four viticultural experts working in South Africa at the moment.

Californian viticulturalist Dr Phil Freece of consultancy WineGrow, is one of that select band. He believes South Africa has already made a certain amount of progress viticulturally. “Much of the basic work is done as to physiology, disease and pest-related issues,” he says, adding that there has been a rapid adoption of new techniques developed both in South Africa and in other parts of the world. The problem now is economic. “Application of new viticultural techniques requires a robust business condition,” points out Freece. “There is some stratification going on within the South African industry, with those producers who have developed market presence and access to foreign currency business finding themselves with more resources right now.”  But for others it doesn’t make economic sense to implement newer, more costly techniques.

Further viticultural progress will not be achieved without an effective central funding mechanism or significant international investment. Freece thinks there is currently less direct government funding, not just for viticulture, but for agriculture in general, as the government focuses on other priorities. Without government backing the industry itself can hardly be expected to compete on the same scale as some of its new world competitors; the Australian wine industry invested A$28 million in viticultural and oenological research last year, for example.

But this shortcoming leaves the way open for private investors. “Private funding of work on production viticulture is on the upswing,” confirms Freece. “With private service and consulting businesses bringing added resources to the industry.”

Freece himself consults to Thelema, Tokara, De Wetshof, Meerendal, Warwick Estate and Ridgeback and also co-owns Vilafonté, a boutique vineyard located in the Paarl-Simonsberg region, with his wife, winemaker Zelma Long, Mike Ratcliffe of Warwick Estate, and US importer Bartholemew Broadbent. Vilafonté is the first American/South African joint venture, which is surprising when you consider that South Africa has been identified by the US Department of Commerce as one of the world’s top 10 emerging markets in terms of potential for US investment. 

But other countries have already been getting in on the act. The Swiss Hess Group bought a 50% share of Glen Carlou in 1995 and since 2003 has assumed total ownership of the winery. The French were swift to follow, in the shape of Alain Moueix, owner of Château Fonroque in St-Emilion and Chateau Mazeyres in Pomerol, who bought Ingwe estate in Stellenbosch in 1997. He has been working with viticulturalist Francois Baard since 1999.

International investment
In 2003 May de Lencquesaing of Château Pichon-Longueville Comtesse de Lalande in the Médoc purchased Stellenbosch estate Glenelly, investing R55m in a new winery building. Hubert de Boüard de Laforest of Château Angelus in St-Emilion and Bruno Prats, formerly of Château Cos d’Estournel, bought a 50% share in Anwika winery also in Stellenbosch in 2005 with plans to release their first wines this year. While Michel Rolland consults to Remhoogte Estate, working with a French viticulturalist, Jacques du Toit, and winemaker Auguste Natter.

It’s hardly a full-scale international invasion, but it’s a clear signal that the potential is there. Not only for European producers who can take advantage of the timing of the South African harvest to exploit two vintages a year, but for investors from anywhere in the world with the available capital and expertise. Put simply, the South African wine trade represents a huge business opportunity for investment in general and consultancy in particular. It’s a proposition that is made even more attractive when you take into account the potential for growth in the export and domestic markets.

“The domestic market is over-traded at the moment; there are too many products. But I see this as a temporary situation,” says Vernon Davis, CEO of Winecorp. Like many others, he believes that, as democracy continues to develop, significant growth in the wine market will be driven by the aspirations of urban middle-class blacks. According to Simon Halliday MD of Raisin Social, this is already happening in Johannesburg and Pretoria, while convenience stores in Soweto are stocking wine for the first time. As a result Halliday is currently negotiating to secure distribution of his own brand, Beyerskloof, in the townships. “A buoyant domestic market is essential if you want to succeed in emerging export markets,” he believes.

Discovering America

Those emerging markets are already being identified and although WoSA predicts declining year-on-year export growth of 11% for 2006 and 10% for 2007 based on recent trends, successful penetration of new markets could change the picture. “The Far East, America, South America, Russia, India, the Middle East and many other parts of the world have hardly been touched to date and this is a huge opportunity,” believes Mike Ratcliffe of Warwick Estate.

The US is a key market according to Su Birch, CEO of WoSA. “If you have a reputation for success in the US, you tend to find that the markets of China and Japan take their lead from that,” she explains. Piet Momberg, KWV’s business executive for the Americas, UK and the Far East backs this up: “A lot of young Japanese consumers are following American trends and they are a real
target market.”

KWV currently has a 40% share of the South African category in Japan, but for Momberg the real challenge is China. “Asia is a promising market once you can really get into China,” he believes. “But it’s an extremely difficult market because of its distribution networks and legislation.”

To a lesser extent distribution is also problematic in the US due to its three-tier system. But if the US is as pivotal for South Africa as Birch suggests – and some statisticians predict that by 2008 it will have overtaken the UK as the world’s biggest wine market – it’s a market that needs to be explored sooner rather than later. Exports to the US currently stand at 7.7m litres, so there’s room for growth. Many producers are looking to the phenomenal success of Casella’s Yellow Tail brand, which was budgeted to sell 50,000 cases when it launched, but actually achieved first-year sales of 500,000 cases, as an indication of what’s possible.

It’s tempting to think that cracking the US market could be a simple case of coming up with the right brand proposition, but that’s not the reality. Australia has a logistics advantage over South Africa in terms of production volume, shipping time and costs. There is also much greater consumer understanding and awareness of Brand Australia.

Storm in a Stormhoek
Educating US consumers is being tackled generically by WoSA, with major trade and consumer tastings in New York, San Francisco, Chicago and Los Angeles planned for May. But individual producers are taking matters into their own hands. The Stormhoek brand is set to launch in the US this month and Nick Dymoke-Marr, MD of Orbital Wines that owns the brand has pioneered an unconventional route to consumers, blogging on the internet. As reported in the drinks business in January, his idea has helped to significantly grow Stormhoek’s market share in the UK. “And what we’ve done on the internet has already created a buzz in the US,” says Dymoke-Marr. It will be interesting to chart Stormhoek’s development to see if this is a viable marketing model for other South African producers.

So much for new and developing markets, what about existing ones? The UK is the single biggest export market, with sales worth £401m (ACNielsen MAT to end of December 2005), accounting for 46% of South Africa’s total exports in 2004. The second largest market, the Netherlands, doesn’t even achieve half of this volume; while third-placed Germany stands at less than a quarter.

However, both South Africa’s volume and value share in the UK declined last year, with brand leader Kumala dropping 5.7% in volume and 6.1% in value. But the picture isn’t totally bleak, since top-10 brands Stowells, Evolution and Two Oceans all experienced volume and value growth of at least 30% or higher. However, it’s a sign that South Africa must up the ante and devise clear UK market strategies for both the short and long term.

Rand in the hand

A series of challenges lie ahead, which will determine South Africa’s performance both in the UK and globally. Overshadowing all of them is the volatility of the rand. “Economically no-one knows what will happen to the rand,” says Simon Halliday. “If it devalues, 50,000-to 250,000-case producers will have the most difficulty. They are the ones that face the real problems with economies of scale.” According to André Morgenthal the most successful producers will be those who build into their market strategies contingeny plans for a 30% fluctuation in the value of the rand. 

Concerns about the value of the rand link directly to the issue of pricing, a thorny subject for South Africa. Currently the industry doesn’t have the capacity to compete effectively in the lower-end mass market. “The only countries who can afford that are the ones with a significant surplus,” explains Nick Dymoke-Marr. So there’s a choice for South Africa; become cost-effective at lower price points or shift the bulk of its offering towards the mid to high price range. The majority of producers seem to favour the latter approach, though neither is a particularly easy option.

“When we entered the market after becoming a democracy, we entered at the bottom end and the hardest thing in the world is to shift your price points up,” says Su Birch. WoSA is actively encouraging new producers to pitch their offering at mid-price points. As worldwide surpluses start to decrease there will be a natural hardening of prices and possibly higher price to quality ratio, which would be good news for the growing number of boutique producers in South Africa. The fact that the industry isn’t shareholder-driven may work in its favour if this happens.

Competitive edge
But will this scale of production be enough to grow the cateogry as a whole? “By its nature, the huge number of small boutique producers is not an efficient economy of scale,” says Mike Ratcliffe. “On the other hand, it is one of the attractions and a huge strength for our industry which we should not gamble away in pursuit of size.” He’s not alone in believing that developing economies of scale without moving away from quality artisan production will be an important long-term challenge.

But what about the possibility of becoming cost-effective at lower price points? Gary Proctor, MD of Edward Cavendish, believes that in the UK market, at least, both ends of the price range must be considered. “South Africa does have the scale to produce one or two million-case brands, but there’s most potential for brands in the 50,000 to 250,000-case sector. Although South Africa can’t offer chunky margins like Australia or South America, there’s no reason why it shouldn’t be competitive,” he argues.

Shimmer and shine
This competitive edge would increase if there was more consolidation in the industry, which is slowly starting to happen. Vinfruco merged with Stellenbosch Vineyards to form Omnia Wines in 2004, and if the planned merger between Winecorp and Cape Coastal Vintners goes through, by the end of April we’ll see another new major player on the scene.

Maybe this will mark the start of a new era of consolidation for South Africa. But one thing is certain, the choices this young industry makes over the next five years will be crucial in terms of positioning itself successfully in the global marketplace. Like a rough diamond, South Africa’s wine industry must be polished and fitted into the right setting to truly shine.  db  March 2006