A case study of the South Australian wine industry
Dr Steven Barrett
Managing Director [DRAFT Version 13, 15 August 2013 (c)]
ECON 7200 Economic Principles (M) On-Campus Tutorial program
Tutorial questions Week 1: No tutorial
Week 2: Icebreaker: Me in a bag
Week 3: Duloc Case Study: Topic 2
Students: Questions 4 5 6 7 9 and 10.
Tutor: Question 8.
Week 4: Duloc Case Study: Topic 3
Students: Questions 4 6 7 8 9 and 10.
Tutor: Question 5.
Week 5: Duloc Case Study: Topic 4
Students: Questions 4 5 7 8 9 and 10.
Tutor: Question 6.
Week 6: Duloc Case Study: Topic 5
Students: Questions 2 3 6 9 and 10.
Tutor: Question 1.
Week 7: Duloc Case Study: Topic 6
Students: Questions 4 5 6 9 8 and 10.
Tutor: Question 9.
Week 8: Duloc Case Study: Topic 7
Students: Questions 1 2 3 4 5 and 6.
Tutor: Question 7.
Week 9: Duloc Case Study: Topic 8
Students: Questions 2 3 4 5 and 10.
Tutor: Question 1.
Week 10: Duloc Case Study: Topic 9
Students: Questions 1 2 3 6 8 and 9.
Tutor: Question 4.
Week 11: Duloc Case Study: Topic 10
Students: Questions 1 2 3 4 5 and 6.
Tutor: Questions 9 and 10.
Week 12: Duloc Case Study: Topic 11
Students: Questions 1 2 3 5 6 and 7.
Tutor: Questions 9 and 10.
Introduction to the Australian wine industry
The First Fleet brought grape vines to Australia when it arrived in Botany Bay in 1788. Since then Australia has developed a history of producing and exporting wine. The first reported wine export occurred in 1822 when a barrel of fortified wine was sent to London. The export market has grown substantially from these humble beginning. In 2004 Australian wines exports were worth $2.7 billion. As a result of substantial growth over the previous ten years, Australia is producing more wine than ever before. The 2004 vintage was about 1.9 million tonnes of grapes, with about 65 per cent of the wine that was produced form these grapes being exported.
The UK (which accounts for 43 per cent of our exports) and the USA (which accounts for a further 40 per cent of our exports) are our biggest consumers. Other important markets include Canada, New Zealand, Ireland, Germany, Japan, Singapore and Scandinavia. Australia is now the fourth largest wine exporter in the world, exporting to more than 100 countries. The success of the so-called “New World” wines, which includes those produced in Australia, has come at the expense of traditional or “Old World” wine producers, such as Spain, France, Germany and Italy, whose exports have declined in recent years.
The Australian wine industry is currently in a state of re-organisation and consolidation. Over the past decade, wineries with a turnover of less than $1 million grew at the rate of about 100 per cent per annum. On the other hand, wineries with a turnover of more than $20 million have consolidated. This is evidenced by such actions as the recent takeover of Southcorp by Fosters, Australia’s largest brewer. This merged operation now produces about 40 per cent of the wine that is sold in Australia.
Large retailers, such as Coles and Woolworths, are also transforming the market due to the rapid expansion of the industry. Over recent years they have pursued aggressive programs of buying hotels and smaller liquor retailers and re-branding them as BWS, Super Cellars, Vintage Cellars, Liquor Land, Dan Murphy’s, 1st Choice, Quaffers and Mac’s Liquor. At present, these two retailers control over 40 per cent of the Australian retail market. Coles and Woolworths are able to use their buying power to negotiate much cheaper prices with producers than small retailer chains and independent liquor stores. Consequently, smaller independent retailers are finding it increasingly difficult to compete and hence their numbers are declining.
Meeting customer needs Australian wine producers are diverse and consumer tastes are evolving, no doubt reflecting the increasing diversity of the Australian population and changing lifestyle factors, which reflects a stronger preference for wine. Since the 1970s, there has been an upward trend in wine consumption per capita from less than 10 litres to more than 27 litres in 2007. However, while Australia’s per capita rate of consumption has grown substantially, we still lag behind consumers in “Old World” wine producing countries, where per capita consumption has fallen.
As discussed above, Australian wines have increased in both volume and value over the past 30 years. Australian wines are now highly regarded internationally in terms of quality, consistency and price stability. One reason for the expansion in exports is the fact that Australia produces consistently fresh wine styles that match the needs of its major export markets, that is, the UK and the USA.
Industry wine and structure The Australian wine industry can best be described as an oligopoly with a very large competitive fringe. The firms in the competitive fringe are perfectly competitive or monopolistically competitive. About 90 per cent of domestic sales are controlled by just 22 producers. Moreover, just four large firms, Southcorp (which as discussed above has been taken over by Fosters), Hardy Wine Company, Orlando Wyndam and McGuigan Wines, produce 80 per cent of total market production. On the other hand, the 1,850 or so small and medium wineries in Australia compete with each other for the remaining 10 per cent of the market. Of these producers, 1,250 are classified as small, crushing less than 100 tonnes of grapes per year and hence producing less than 8,000 cases of wine per annum, that is, about 700,000 litres of wine per year. The number of small wineries has increased over the past 10 years at an average rate of 100 per cent per annum, which is probably an unsustainable rate of growth. Our case study starts with Duloc being a very small producer, essentially wine making is a hobby for James Barnes. But by the late-2000s, Duloc has grown into a medium sized winery producing and crushing over 3,000 tonnes of grapes annually.
Pricing Australian consumers are more likely to look at the price of a bottle of wine and any medals or trophies that it may have received to guide their purchase decision. Arguably, the consumer does not have any idea about the costs involved in the production of the wines they buy. Hence, they rely on other cues, such as brand name, wine style, age, marketing activities and price. For Australian consumers, all things being equal, price largely determines the purchase decision. In order to prevent the commoditisation of wine, wine companies develop brand names, undertake promotional activities and other marketing activities that are designed to differentiate their products in the market and to command the highest possible price. Prices have traditionally been used by those in industry to brand and categorise their wine. There are five distinct price segments in the Australian market based on price.
Icon: price range over $50, for example Penfolds Grange, Henschke Hill of Grace, Wolf Blass Black Label, one per cent of the market.
Ultra-premium: price range $15 to $50, for example Wolf Blass Grey Label, Orlando St. Hugo, 5 per cent of the market.
Super-premium: price range $10 to $15, for example Penfolds Koonunga Hill, Jamison’s Run, 10 per cent of the market.
Premium: price range $5 to $10, for example Banrock Station, Jacobs Creek, 24 per cent of the market.
Basic: price range under $5 to, 24 per cent of the market.
The remaining one third of the market is accounted for by cask wine, flagons, wine coolers, fortified wines and brandy.
This introduction is based on the material presented in Quester, P.G., McGuiggan, R.I, Perreault, W.D.Jr. and McCarty, E.J. (2007) Marketing: Creating and Developing Value, 5th ed., McGraw-Hill, Sydney, Case Study 18, In vino veritas: Australians viticultural industry, pp. 730 to 738.
This case study only covers the period up to 2006 and hence ignores recent changes in the industry, especially the effects on the industry of the entry of Constellation Wines into the industry.
Topic 1 Introduction to Duloc The case study starts in late-1984. Duloc is a 320 acre, or half a square mile, farm located in the Southern Vales of South Australia, about halfway between McLaren Vale and Willunga. Duloc has been in the Barnes family since 1838 when Samuel Barnes, who arrived in South Australia on board the Buffalo in 1836, took up his land allocation soon after the southern districts were surveyed. Soon after establishing the farm, Samuel planted a small area of vines following the successful demonstration by John Reynell that grapes could be grown on the rich alluvial soils of the Southern Vales.
Duloc is now owned and operated by Samuel’s great grandson, James Barnes. Over the preceding century and a half, the area plated to vines has increased to about 80 acres. Samuels’s first experimental plantings of Shiraz, Grenache, Doradillo and Pedro Xeminides were added to by his son John and his grandson Edward during the latter part of the nineteenth century and the first half of the twentieth century, such that by 1974 about 50 acres of these older varieties in total had been planted. James then planted 30 acres of Riesling grapes during the late-1970s and early-1980s to take advantage of the boom in demand for white wines that occurred in Australia during the latter half of the 1970s. Then in the hope that the boom in white wine consumption would lead to a boom in the red wine consumption he planted more red wine grapes. Some of the vines that were planted by James’s father, grandfather and great grandfather are not as productive as they used to be, but they are reputed to be some of the oldest and best vines in the entire Southern Vales. On the whole wineries in the Southern Vales tend to focus on ultra premium and super premium wines.
Vineyards in the Southern Vales tend to be unirrigated, but they produce high quality grapes and wines. However the yields are low, five to eight tonnes per acre, depending on the weather. The yields are highest when the winters are wet and mild and the summers dry and cool. As compared to the Riverland, which extends along the River Murray in South Australia from Waikerie to Renmark. The Riverland is an irrigated wine producing region which produces about 60 per cent of all the wine produce in South Australia. The yields there are much higher, eight to ten or even twelve tonnes per acre, but this region focuses on low quality grape varieties and produces low quality bulk wine that is used in casks, for blending or for use in wine based products such as coolers.
It really needs to be acknowledged at this stage that the Southern Vales is not just one of South Australia’s premium wine grape growing areas, it is one of the best wine grape growing regions in the whole world. This is due to the unique combination of climate, soils and topography. Although a wide range of agricultural crops can be grown in the Southern Vales, the unique combination of climate, soils and topography means that this region is ideal for growing grapes and hence grape growing is the best use for this land.
Duloc is a traditional vineyard. The grapes are hand-picked by family members and then sold either to local wineries or increasingly to the more lucrative “trailer trade”. The move towards having customers pick their own grapes is driven by demographic changes. At the turn of the twentieth century families in rural Australia were large, typically women had five to seven children. So, farming families could mobilise large amounts of free family labour during peak periods of labour demand. However, these days, families are a lot smaller, the total fertility rate is about 1.8 children per women. So farming families find it difficult to mobilise large quantities f labour and hence they seek labour saving techniques. The trailer trade involves hobby wine makers from Adelaide driving to the Southern Vales, usually in a utility or a car with a 6x4 trailer in tow, to purchase grapes. This is a more lucrative market as these people pay a sizeable premium for the grapes, compared to what wineries are prepared to pay, and they pick the grapes themselves, which reduces production costs.
The remaining 240 acres of the farm is divided into six 40 acre paddocks that are leased to local farmers. The land is then used to grow a variety of broad acre crops, such as wheat, barley, oats and canola, depending on who leases the paddocks.
James, who is now 64 years old, has two children. Matthew, who is 28, recently completed studying oenology at Roseworthy. He is currently living at home with James and is working as a wine maker at a large local winery. Matthew was named Australian young wine maker of the year at the Sydney Wine Show in September 1984. Zoë, who is now 30, has recently been promoted to Senior Lecturer in Economics at Roseworthy Agricultural College. Zoë returned to Australia in the late-1970s after completing her PhD in Agricultural economics at the University of Oklahoma. James was widowed in 1974.
James is also a bit of a hobby wine maker and has installed some wine making equipment on the farm. James never does anything by halves. James acquired this wine making equipment from Sir James Harry, owner of Harry’s Wine Company, one of the largest vineyard operators and wineries in South Australia. In, the late- 1970s Harry’s decided that it needed to invest heavily in new wine making equipment to capitalise on the boom and to cater for changing consumer tastes. James successfully tendered for the removal of this outdated equipment. Much of it was sold for scrap, but much of it was transported to Duloc where over time James has re-assembled it. So, the capacity of this equipment far exceeds the needs of any hobby wine maker. Indeed, the equipment that was installed by James could be used to make commercial quantities of wine. The question is just how much wine could Duloc produce?
James was a bit of dreamer. He dreamt of the day that Duloc would be a player in the Australian wine industry. Hence, his decision to salvage all of the wine making equipment that was being replaced by Harry’s in the late 1970s. Surprisingly, James was a fitter and turner by trade, as a result of his time in the army. Although James had a vision for Duloc, he lacked focus and so his plans for expansion were not achieved.
Zoë is the older sister. Her mother used to describe her as a bit mercenary and would do anything for money. She was always a bit frustrated by James’ lack of focus and the consequence poor returns that James was getting on the family’s main asset, the farm. She constantly pushed her father to stop being a hobby farmer and get on with the job of building a profitable integrated vineyard and winery operation. However, Zoë is essentially a philistine. She does not appreciate wine, she is strictly a beer and spirits person. So, she does not think that a focus on quality is appropriate. She feels that their focus should just be to produce a product that people will buy. Her plan revolves around producing large volumes of poor quality, cheap bulk wine.
In many ways Matthew is very much like his father, a bit of dreamer. But a dreamer with huge talent. Matthew is something of an artist. He sees wine making as his vocation. So, his goal is not really to maximise profit, but to make the best wine he could and to be something of a leader, rather than a follower in the industry. His plan revolves turning Duloc into a winery, after all they have all the equipment, that focuses selling small volumes of high priced, high quality wines.