AUSTRALIA: Going Up Down Under

Scare stories regarding the future of Australian wine may prove spurious but prices are likely to rise. Fionnuala Synnott reports on the implications for the category’s dominance

Much has been made of the drought in Australia with predictions of quasi-apocalyptic conditions threatening the future of the country’s wine industry. But, as any classical scholar will tell you, the drawback to prophecies is that they tend to put a rather dramatic spin on things.
Although viticulturalists have suffered as a result of diminished rainfall, the situation varies greatly according to where your vineyards are located on the continent. Different regions have recorded varying levels of rainfall and, almost more importantly, water rights throughout the country differ greatly, with growers in Victoria granted 16% of their usual allocation, while many growers in New South Wales have access to 80% of their usual allowance.
Brian Walsh, director of winemaking at Yalumba, says: “The water situation is not too bad in the Barossa Valley. Water has been protected for a good 20 years and people have learned to do more with less.” The situation in Victoria is more worrying, however. “We have had below average rainfall for 10 years. Water trading has already started. Dairy cattle are being slaughtered and people are living off their water rights,” says Viv Thompson, winemaker at Best’s.
Rather perplexingly, given the macroeconomic implications of the water shortage, water rights in Australia are decided on a state, not a federal, basis. And, judging by politicians’ refusal to touch this political hot potato in the run-up to the last federal election, water management seems unlikely to be resolved any time soon. As Astrid Lewis, marketing manager, Negociants UK, explains: “Historically, Australia has repeatedly had to deal with drought issues. Nowadays, the biggest ongoing concern is the drought coupled with water management.”

The category is also facing supply issues. Poor climatic conditions (including heavy frost) led to diminished yields last year, with Australia’s grape supply dropping from 1.8 million tonnes to 1.2m, the same level harvested in 2005. But the shortfall, which represents 35 million cases, need not, in itself, be cause for concern.  In fact, some see this shortfall as an opportunity for the category, which has been plagued by oversupply for the past eight years.
The real issue for Australia is rising costs. Many winemaking costs are fixed, regardless of the volume of wine produced. When you add the rising cost of water to the equation (up from AU$30 to AU$1200 per megalitre), it seems inevitable that these supply issues will have important implications for the pricing of the category and, given Brand Australia’s dominance in the UK off-trade, potentially its position in the UK off-trade.

Price rises
With rising production costs and lower yields, it is difficult to see how Australia can avoid putting its wine prices up. Adrian Atkinson, wine development director for Pernod Ricard UK, comments: “Increased water costs, predicted higher prices for grapes from the 2008 vintage and lower yields mean higher costs per litre as overheads are essentially fixed.” Paul Schaafsma, McGuigan Simeon’s regional director for Europe, thinks it will be difficult for the Australian wine industry not to make some sort of price increase but “it is difficult to say at what level”. He continues:  “People are also predicting a 25p increase per bottle [of table wine] in the next Budget, which could lead to the disappearance of several brands on shelf. The status quo will therefore probably be maintained until then.” Brett Fleming, European manager at Yerings, comments: “Production costs have risen from AU$28 to AU$42 per litre but the buyers aren’t necessarily going to accept price hikes.” However, Schaafsma is not convinced that the buyers will walk away from Australia if prices go up. “The key buyers have been out there – they know what’s going on. Producers need to consider what they are doing in terms of the retail price point so they don’t alienate their consumers or the retailer buyers. They will act appropriately and won’t make sweeping changes without thinking. It is about working in partnership rather than being arrogant about it.” Atkinson agrees: “As long as the reaction to the market conditions is measured and not kneejerk, we believe consumers will stay loyal to Australia.”

Protecting market share
The trade and the media have spent a lot of time trying to guess what all of this means for Australia’s position in the UK off-trade with some suggesting that it may not be able to retain its number-one position in the marketplace.  “Increasing grape prices, the lack of water and decreased grape supply will certainly lead to Australian brands vacating the very low price points, where considerable sales volumes are achieved. It stands to reason then that our overall sales in the UK will decrease and this may result in Australia losing the number-one spot,” says Alister Purbrick, CEO of Tahbilk.
However, Laura Jewell, HwCg agency director, does not think the situation is that simple. She says: “Certainly, part of Australia’s success has been down to its ability to supply a large volume of wine at a low price. But it is also down to understanding what consumers want – pleasing them was an important part of the strategy.”

Atkinson agrees that being successful in the UK is not all about supply: “There still has to be a contender that is more attractive for the consumer. Clearly, France is the closest at the moment. While there may be no volume restrictions from other countries, can they truly match Australia in terms of quality, range, consumer affinity and strong marketing support?” Jewell adds: “The question is who would overtake Australia? It’s not the only country with problems. France is down 20% and in California domestic demand outstrips supply.”
But George Wahby, CEO of McWilliams, sees things differently: “For Australia, the focus is more about sustainability than dominance. If sustainability means sacrificing dominance then so be it but we probably won’t lose our lead position as we have built a strong consumer franchise as Brand Australia.”
Australia has gone to a lot of trouble to build its market-leading position in the UK. It therefore seems unlikely that producers will jeopardise this position, regardless of diminished grape supply. In fact, there have been reports of producers raising their prices or withdrawing supply from emerging markets in a bid to protect their UK market share. Pernod Ricard’s Atkinson explains: “The UK is key to the Australian category and I’m sure some resources will be diverted to protect the UK supply. We at Jacob’s Creek are putting in place initiatives to prioritise availability to key export markets.” Meanwhile, at Foster’s, wine is allocated according to the brand’s position in a given market. James Craig-Wood, PR and communications manager, adds: “We won’t have absolutely everything we want but there will be enough for us to maintain our position.”
Jewell observes: “I can see that big brands are keen to keep their market share as they have invested so much in the UK market but others may prefer to focus on countries where they can get the best prices. If you are a small business, in particular, you have to look for short-term profits to survive.” John Angove, CEO of Angove’s agrees: “The UK is Australia’s largest market and there is important reason for us to protect our position in the UK as best we can, but from a profitability point of view the UK market is not one to chase.”  Emerging markets need to be handled with caution. David Hodgson, general manager, UK, Palandri, agrees: “We have to be prudent with new deals we’re doing as we don’t want to build up a market and then have to pull out.”

Further consolidation
Although Australia may not lose its market-leading position, a certain amount of restructuring within the industry seems inevitable. John Graham Brown, director, Brown Brothers, comments: “There has been a fair bit of consolidation already and I expect it to continue with the supply problems and the drought.”
Purbrick thinks that, given the amount of consolidation that has taken place in the last 10-15 years, there won’t be much more. But, he says: “There will be a significant number of vineyard takeovers in the next few years as growers feel the full effect of the drought, and the expense of water purchase.” Steve Webber, chief winemaker/manager at De Bortoli, agrees: “No one wants to admit there’s a shortage of wine but we receive prospectuses from wineries for sale on an almost monthly basis, as the drought begins to bite.”
The current situation will also change the relationship between grape growers and producers, putting growers firmly back in the driving seat. This will please those who feel that producers took advantage when there was an oversupply of grapes by putting unecessary pressure on growers.
Jewell believes that growers will organise themselves differently: “Vineyards are unlikely to be sold as many growers know that they can get premium prices for their fruit. But they may group together, whether formally or informally, to ensure their long-term survival and ensure their future.”

It goes without saying that business models that are founded on unrealistic water prices, be they citrus orchards, rice fields or vineyards, will find the current conditions difficult. But, for some types of business, Australia’s change in circumstances represents a great opportunity. Fiona Barlow MW, sales director, Bottle Green, thinks there may be opportunities  for more individual players in 2008. “The UK market has been dominated by big brands offering a decreasing amount of choice, albeit giving some very good value deals to the consumer. Now is the time for interesting wines from interesting producers to make their way onto the shelves.”
Chester D’Arenberg, chief winemaker at D’Arenberg, is also looking on the bright side: “Having a small ’07 was a blessing for the Australian wine industry. It has brought everything back into balance. Some of the larger companies are getting their act together. They have realised they have to promote individual wineries and not a wine factory.”

Large or small?
Fleming thinks that, in the short term, the current situation could be an opportunity for mid-sized – not large – companies. “You can’t meet shareholder expectations with the regional heroes strategy as the numbers don’t stack up.” Mitchell Taylor, MD, Wakefield/Taylors Wines, says: “I don’t believe the publicly listed wine companies will do well as they are too focused on share price and making short-term decisions. It is the family wineries that have the ability to make the right long-term strategic decisions and understand the concept of ‘patient’ capital.”

Angove goes one step further: “I believe we will see an unravelling of some of the largest players in the Australian industry as they see that the wine industry does not often offer the return on investment that the average shareholder requires.”
However, the large companies don’t share this perspective. Foster’s Craig-Wood says: “I believe there will be some consolidation in the Australian brands and wineries seen in the UK market. It will be tough on some wineries, particularly the medium-sized ones.”
Angove also thinks life will get harder for the smaller winemakers. “Many are struggling to survive and many will close up – there are far too many for the industry to be able to sustain at the present.”
Despite the apparent lack of consensus among members of the industry regarding who will suffer most (“anyone but me” seems to be the answer), the situation will undoubtedly be harder for companies that have based their business model on supplying bulk or own-label wine on thin margins. As costs go up, there will be little room for manoeuvre when it comes to pricing. Hodgson comments: “The own-label business will probably decline or they will have to pay more for it.” Fleming adds: “If you are doing own-label or BIB there is no question – you will have a problem.”
Australia’s change of circumstance could also be an opportunity for certain cool climate regions such as the Yarra or Clare valleys, where producers claim to use 200,000 litres of water per acre compared to 2-3m litres per acre in other parts of the country.
Whatever 2008 brings, be it another low-yielding harvest or duty hikes from HM Government, it seems certain that many Australian wine businesses will have to adapt their strategy to changing conditions. Kate Harborne, marketing manager, New World, Enotria, comments: “Big companies will have to change their strategy and focus on the differences rahter than the price, with less discounting.”

Unsustainable approach
It is no secret that promoting on price is unsustainable. Adam Marshall, commercial director, Bottle Green, thinks next year will be a challenge for those who have got used to it: “The most affected will be the mid-price brands that have relied on heavy, repetitive discounting to generate their volumes. If they don’t have consumer loyalty, they may struggle.”
According to Fleming, the impact of 2007’s shortages  won’t be felt until well into ‘08: “It is too early to see what the effect will be on Australia’s dominance. But the situation is not as doom and gloom as has been reported. 2008 will be the year we discover if Australia is in trouble.”
If the doomsayers are proven right and Australia loses its lead position in the UK (a scenario that seems unlikely given the significance of its lead), it may work to the advantage of the category in the longer term. Marshall says: “It is possible that in two years’ time (if there is no let up in the weather), Australia may not be number one, but the category may be in a more sustainable, long-term position of strength with more understanding and interest from the consumer.”
One thing seems sure, however: Australia will be using less water to make its wine – this can only be a good thing. 

© db January 2008