Chile Analysis: Growing pains

Chilean wine exporters are seeing their margins slashed by a strong peso, but this is precisely when they should be investing in top-end brand building to drive the industry forwards. It’s time for Chile to deliver

Many in the Chilean wine industry are suffering this year. Quite a few are talking about crisis. Others are a little more pragmatic about the situation. There is no doubt, however, that Chileans have it tough at the moment. Export volumes were down in seven of their top-10 markets between 2004 and 2005. In 2006, while volumes seem to be holding steady, value is under pressure compared to the previous year. According to the official figures published each year by Wines of Chile, the average case price FOB for the top-20 Chilean exporters is just over US$21 to the end of 2005, a figure that does not leave much room for any real margin to be made, even under normal trading conditions.

Yet, despite all of this, a recent article entitled “New Harvest” in the Saturday glossy of El Mercurio, one of Chile’s leading nationals, highlighted seven Chilean families, most of whom had made their money elsewhere, investing in new vineyards and wineries. The opening standfirst ran, “Despite the ups and downs that the business has suffered in recent times, vineyards continue to attract people. More than a question of winning or losing, for some the production of wine is a way of life.” An easier way of life if you already have millions sitting in the bank; not so much the case for those who have to make their living from it.

For the more pragmatic among Chilean producers, this period is part of the cycle of the industry’s development. As Aníbal Ariztía, general manager at Santa Rita, points out, “In the 19th century, smaller exporting wineries were founded by people who had made money outside the industry and wanted to invest in wine. This is what is happening again now. But people turning to the wine industry have to look at the economics of the proposition and what business model they want if they are going to succeed.” And that’s the crux of the matter for those at the sharp end of the business; the reality at the moment is about winning, or at least surviving, and definitely not losing.

It seems that what Chile is facing now is a period of adaptation, a time when companies are being forced to change the way they do business because of external pressures. This is not necessarily a bad thing for the long-term future of the business, but it does mean that what has happened this year and what will happen over the next 12 months could decide the future of Chile in the mid- to long term.

Peso power
The principle issue for Chilean exporters, as has been well documented, has been the increasing strength of the peso. On 7 May of this year, the peso reached its strongest exchange at 510 pesos to the US dollar. Good for the general economy but not so good when, as is the case for wine producers, you’re used to trading at around 750 pesos to the US dollar. The fact is that up to 25% has been eroded directly from their bottom line. Coupled with record grape prices for the 2005 vintage, this has made business conditions hard. But as Thomás Domeyko, export director for Concha y Toro, states, “The last 12 months may have been difficult, and many companies have taken a direct hit on profitability. However, now is when we really have to look at our business from a long-term point of view. We have to work to maintain stability in our products and not stop investing in the vineyard or our brands or their development.” This is now the real challenge for Chile.

“If you want to put your head under the pillow and cry for the next few years, that’s fine,” says Jorge Coderch, managing director at VIA, “but you won’t succeed that way. No one knew that copper was going to be as strong as it is, and that has brought about 12 to 18 months of artificial trading conditions. In three years’ time, Chile won’t have the dollar problems it has now. But at least now we know what we are going to be facing for the next four years.”

Raúl Katz, CEO at Viña La Rosa, is of a similar opinion: “Yes, the exchange rate is a problem, but in business you have to be able to adapt to the commercial rules in place. You can start bitching and screaming about the exchange rate, but the reality is that we cannot change it. What Chilean producers need to do is to look to diversify and find those market niches that are open to us and then go out and exploit them. If you want to be a serious player in every market, then every market sector has to be interesting and has to count, now more than ever. Currency is the reality rather than the crisis.”

The exchange rate now seems to have stabilised at 540 pesos. Most would like a more commercially realistic figure around the 600-peso mark, but this does not appear to be on the cards at the moment, and the consensus is that the peso will remain strong for the next two to three years. Ricardo Urresti, managing director at Errázuriz, says, “In my opinion, the peso will stay as strong as it is at the moment for a good 12 to 18 months owing to the US dollar and copper. Chile is very dependent on what happens in the US and what our neighbours are doing, and I don’t think that we will ever return to the trading conditions we enjoyed two or three years ago.”

But as Stuart Downes, export sales director at VSP Wine Group, says, the Chileans can’t really complain too much about the current situation. “We’ve had it good for a few years now,” he says. “We came in at the entry level, and consumers just lapped up the wines. But at our current average price point, with the exchange rate at these levels and with the existing retailer-margin aspirations, the reality is you can’t make the same amounts of money. Those in the business with their wits about them must have seen it coming. When an industry is going through tough times like these, the only solution is to buckle down, focus on the brand and be positive.”

Delivering diversity

And Chile has a lot to be positive about:new plantings on hillside vineyards, experimentation with varieties that are new to Chile, and improvements and investment throughout the production process mean that the quality of the raw material is continually getting better. Chile is beginning to discover the real potential of its own versatility, which is exciting, especially when you hear it from people like Downes’s colleague, Irene Paiva, chief winemaker at VSP. “We are only now really beginning to see what potential we have in terms of diversity,” she says. “We are beginning to see fruit from some very interesting hillside sites, the quality of which is unparalleled. This is where Chile has to invest both its winemaking skills and its communication skills. We really have to start to show the trade and the consumer what we are capable of producing.”

It is important that producers do not lose sight of this fact as they face the current harsh economic realities. Coderch has his strategy clearly marked out: “Now is the time for us to cut out the fat in our business; it is not the time to stop investing, however. I am investing at the moment in the vineyards, in sales people and in new concepts and marketing. It’s probably the worst time to have to do it, but we have to realise that it has to be done. Chile has the chance to come out of this difficult period with a better name and in a more stable economic state than ever before; we have the chance to reposition the identity of Chile, and now is an opportune moment.”

Cristián López, MD at Concha y Toro UK, agrees that now is the time for brands that are serious about securing and growing their position to continue to invest. However, he wonders whether the industry has already missed the boat. “We have to overinvest in the category in order to continue to drive it, and we have to innovate. Under these difficult trading conditions we need to raise prices and take the consumer with us; in order to do that you have to have brand equity,” he says. “The reality is that Chile should have taken some bold decisions six to nine months ago. It is the responsibility of individuals to put together strong, well thought-out proposals, and I’m not sure whether we haven’t missed our opportunity, especially in this market.”

Market consolidation
The commercial factors faced by the Chilean wine business give rise to the question of whether there will be further consolidation over the next 18 months. Opinion is divided. As yet there has been no real multinational interest to scoop up any Chilean brands, but the situation is decidedly different for the mid-sized and smaller companies.   

Daniel Picciotto, director at Undurraga, comments: “Smaller firms will go under, I am sure, but it’s a weird market right now, and I am not sure whether we will see significant renewal for another two years. Everyone here is expecting consolidation to happen, but I believe that the bigger companies will be okay, while the small ones will go through hell. When business gets tough, the banks get harder, and that will bring huge pressure to bear eventually. But diversity is stronger than concentration, and I’d rather see 10,000 Chilean wineries than the same old 10.”

The hard commercial reality, according to Ricardo Urresti, managing director at Errázuriz, is that the companies producing fewer than 200,000 cases without at least one strong brand will find it tough to make money at the moment. He says: “My belief is that there will be some consolidation, and that will be healthy for us. We’ve sort of been waiting for consolidation to happen on a grand scale but it hasn’t; it might happen at the mid-level, but that’s probably all.”

Claudio Cilveti, marketing director at Tarapacá, believes that, “70% of the brands in the market must be losing money at the moment, which implies that there will be some sort of consolidation here. Look at a typical 50,000-case brand; that’s about US$1.5 million of sales, but once you’ve taken out all your direct costs and margin, under the current exchange-rate conditions, there is no way they can be making any money. There’s just no way they can afford to be in the market. So in the mid-term, the bigger brands will probably snap up their holdings.”

If consolidation is going to happen, then the brands being acquired are either going to have very strong distribution in particular markets or very good vineyards, otherwise any big moves to acquire are not going to happen. Luis Felipe Edwards believes that there is one very important commercial factor preventing any real threat of large-scale consolidation similar to what has happened in Australia, for example. “If I can’t buy a winery for less than book price, what’s the point?” he says. “It will always be cheaper to plant your own vineyard or, under current market conditions, buy the grapes in the open market. That is why consolidation won’t happen.”

Smaller players could suffer
But, as ever, opinion is divided. Héctor Torres, export director at Viña Carmen, predicts, “Consolidation is definitely on the cards, because so many companies are struggling with the price of the dollar. Smaller wineries at the entry level don’t have the critical mass; a winery selling fewer than 20,000 cases a year just can’t survive. As a consequence, I think that others will make the most of the situation and buy the land.”

So what is the real prospect for Chile? Taking the market exigencies into consideration, it’s not as bad as perhaps the Chileans themselves think. Even when you are faced with very taxing exchange rates for the first time in a long time, it would be hard to lose sight of the fact that, as Patrick McGrath MW, managing director at Hatch Mansfield, points out, Chile has some of “the best viticultural conditions in the world”. Add to this what is going on in the vineyards, and high quality and diversity are strong messages that can be easily communicated.

According to Miguel Luis Amunátegui, export director at Tarapacá, “Things will continue to be difficult for another year, and this will force us to be creative. The consumer is fashion-conscious; Chile was fashionable, it isn’t so much at the moment. Now we have to concentrate on finding our own niches and promoting them innovatively while adding value to the product.”

And, he adds, putting his finger on the real issue, “What we need to do is invest in selling good volumes of quality product.”
And he’s right. But Chile still has one major issue to overcome; that of image. What is Chile? What does it mean to the consumer? It’s good, well-priced and reliable – and perhaps that is where the key lies. As Carlos Serrano, export manager at Montes, explains, “We need to find our personality, and I don’t know whether this means we have to create one, but we have to communicate a single positive message. Maybe the excitement for Chile will come out of the very reliability of its wines. Whatever that message is, Chileans need to get behind it wholeheartedly, which is always a challenge in a totally free market.”

If anything, this difficult process that the Chilean wine industry is now experiencing needs to be viewed as a learning experience, a period of change and adjustment where new business models are developed and the brand owners and growers alike realise that the potential for Chile is still encouraging.

Pragmatism appears to be the key. Companies are striving to improve the efficiencies within their businesses in order
to deliver a better offer in export. Those that get it right will be the ones that will come out of this whole process in a much stronger position. Pablo Turner, the relatively new CEO at VSP Wines, perhaps sums it up in the most pragmatic way: “The reality is that wine is just another consumer packaged good, and if you are going to perform effectively going forward, you have to perform like a global brand. Polarisation will happen in this market for Chile and for all other wine-producing nations.

All of the acquisitions that have been going on – FGL, Constellation – are just part and parcel of the process of creating global brands. Chile has to go through more of the brand-building process while continuing to invest in the vineyards and in its winemaking. If those things are done, then the real key to Chilean success will lie in the distribution; that, and the way in which its wines are marketed.” 

The export challenge

Cristián López, managing director at Concha y Toro UK, is not alone in seeing the UK as challenging for Chile at the moment. Sales of Chilean wine were down by 3% (ACNielsen, MAT 20.05.06) and down by 1% in value over the same period, even though the average price rose by £0.06. John Osborne, business development manager at PLB Wines, says that trading conditions are tough as exporters are facing pressure at both ends. “It’s now an operational issue,” he says. “Exporters are having to cut dry-goods costs at source and improve on their commercial efficiency as fast as they can. Some are prepared to invest, but you have to be able to see light at the end of the tunnel. I’m not sure they can at the moment.”

   Despite these factors, the UK market is still a key component in Chile’s export strategy. The work of Michael Cox and his team at Wines of Chile UK is constantly cited by Chile’s principal players as being a great success for the category. Christian Wylie, commercial director at Santa Carolina, says, “The UK is still one of the most important markets for Chilean brands to make their mark. You might be able to make more money more quickly in Asia or America, but if you can make it in the UK, it gives you the economies of scale to be able to perform worldwide. The UK market gives you the image, puts you ahead of the curve and make you operate in a slicker way. It might be a tough market, but if you want to be a global player you have to be there.”
   Patrick McGrath MW, managing director at Hatch Mansfield, also sees the UK as being essential for Chile and is very optimistic about the category’s potential, though he still sees the value issue as a problem. “The future is still bright for Chile,” he says. “It needs to continue to excite the trade and the consumer. There is lots of potential for innovation, new varieties like Pinot Noir and Pinot Gris are coming on line from cooler climates, and this is producing some interesting results. But the decline in value is a real issue. Unless individual companies adapt to the new set of economic conditions, the future for Chile is not going to be as a value product. Chile has the best viticultural conditions in the world, it has no choice now but to fulfil its promise.”
   Chile is no different to many wine-producing countries at the moment in seeing the US market as the solution to at least some of its problems. Having said this, both value and volume were down in 2005, and the larger branded players have suffered some sizeable losses of business within the market in the last 12 months. Despite this difficulty, Miguel Luis Amunátegui, export director at Tarapacá, says that Chile still has a lot of potential in the US. “We see it as a priority market for our brands, and one that is worth investing in as it can be much more profitable than going the extra mile in another market,” he says.

Selling closer to home

Similarly, as with most international exporters, eyes are turning to Asia and a little closer to home. As Aníbal Ariztía, general manager at Santa Rita, elaborates, “Brazil and Mexico should be huge markets for good wine consumption, but the recent boom in Venezuela has meant that we have seen the biggest growth there this year.”
   Cristian Sotomayor, export director at Valdivieso, argues, “The South American markets are an excellent proposition at the moment. They are our oldest customers, and their economies are performing well. In markets like Brazil, Chile is in a very strong position to start building better market share, and it is potentially much easier to do so there than in other markets further afield.”
   Given the currency conditions at the moment, this may be a more profitable route.

Michael Cox, director, Wines of Chile UK

“The UK off-trade market is at its most competitive at the moment, and deep-cut promotional activity in supermarkets and key multiple specialists is creating substantial spikes in market-share trends. These well-documented retailing trends are making the big brands bigger, and there is no doubt that some countries, notably the US and Australia, are benefiting from the consumers’ fatal attraction to the siren promotional temptations.

   “Brand owners with neither the desire nor, perhaps, the promotional weaponry to enter into these retail skirmishes need to develop in more subtle ways to build their brands and gain market share. Chile’s brand owners are prime examples. Chile needs more strong brands to help the country climb more swiftly up the country ranking charts. There has been substantial progress already with some notable examples helping to reinforce Chile’s reputation for offering exceptional value for money at a variety of price points, but more is needed for the country to make a greater impact against the inexorable rise of the bland and the blush.
   “Our market share in the off-trade has stalled a little and remains at around 6.5% in a market that has slowed markedly since the heady growth of the last two years. With the general economic conditions giving the consumer reasons to tighten spending belts, the bargain-seeking mentality is clearly not going to disappear in a hurry. Paradoxically, Chile’s relative absence from the promotional slots has some benefits; it is gratifying that Chile’s average price in the off-trade in the 12 months to end May 06 has risen by 6 pence to £3.78, its highest ever. An additional reason for this is the increasing distribution of top-quality Chilean wines that are priced at between £6 and £10.
   “Another cause for optimism is the on-trade, where Chile’s sales have grown by four times that of the market, and its share has risen to 7.2%.
   “Such is the strength of the Chilean economy and its exports of copper that the US dollar provides the exporters with 30% fewer pesos than two years ago. Inevitably, profitability and investment suffer in broadly equal measures. The whammy does not end there: costs of producing demonstrably better wines each vintage are rising despite the short-term fluctuations in grape prices at source. Premium wine is more expensive to produce, and premium wine is what the vast majority of Chilean wineries are committed to selling on the UK market. However, brand owners have to maintain some form of momentum and visibility in this fiercely competitive retail environment, and it is thus no surprise to see some disparity in the trends in export prices while the market remains volatile.

   “In the export figures of bottled wine from Chile to the UK for the 12 months to June 2006, the overall average export price per case dropped a modest 1.6%. However, 12 of the top-20 exporting wineries managed to increase their average export price over 2005.

Overdelivering is Chile’s vital hallmark
“The overwhelming mantra for all exporters and their agents is ‘price/quality ratio’. Chile overdelivers in the £5-£10 sector and, despite it being an overused phrase, it is Chile’s vital hallmark. Much work has been done, and continues to be done, to reposition Chile in the minds of both trade buyer and consumer, and increasingly the message is being heard and understood. The medium- to long-term strategies that are required by all concerned to see this essential objective achieved is taking Chile through some turbulent waters, but the sails are trimmed, the course set and, with a fair wind, calmer and more bountiful seas lie ahead!”

Ricardo Letelier, managing director, Wines of Chile

“The level of the dollar has gone down by 30% during certain parts of this year, but the real problem we face is volatility of the peso, and this has really been the main issue for many companies when it comes to forecasting. It’s hard for companies to adjust up and down quickly in a short period of time. Similarly, the strength of the dollar has put pressure on our performance at the lower price levels, where we have traditionally done well. It means we have less money available for price promotion, which is an issue and a situation that I don’t see changing in the short term. Brand owners are going to have to find new models and ways of doing business.“I believe the route we are taking is pretty logical; our aim is to work on the quality of the wines and educate the people who make the decisions about why Chile justifies being on shelf at higher price points. We are currently working hard to influence the value chain, focusing on prioritising our markets, talking to the gatekeepers. Chile has low consumer recall and a confusing image. What we are now aiming to do is to create meaningful positioning. Chile needs to have good distribution at different levels of the trade to continue to develop well both on-shelf and on-list. We are looking at specialist programmes for the on-trade and specialist retail sectors. If we can expand opportunities out across the different price brackets, then we will start to penetrate the higher price brackets meaningfully.”

© db September 2006