Examination case Schultz Wines Limited

Pre-seen information Semester 2 2009

Schultz Wines LimitedPre-seen information

A. B. Introduction to Schultz Wines Limited The Australian winemaking industry
1. 2. 3. Viticulture and the winemaking process Vintage 2020a vision for the Australian winemaking industry Industry segments
3.1 3.2 3.3 Table wine Sparkling wine Fortified and other wine The global economy Future trends Grape growing Wineries Distribution and retailing Costs and gross margins of winemaking

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Demand and consumption trends

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Industry structure and distribution channel trends

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Key success factors Exports and imports Basis of competition Summary of key competitors
2.1 2.2 2.3 2.4 2.5 2.6 2.7 Allens Group Limited Brooks Wine Company Limited Capricorn Wines Pty Limited McMillan Chamber Wines Limited Stefano Wines Pty Limited McFarlane Wines Limited Other

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C.

Industry competitors
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D.

Schultz Wines Limited

1. 2. 3. 4. 5. 6. 7. History Business strategy Operations Distribution Performance Management Latest developmentsAugust 2009
7.1 7.2 7.3 7.4 International expansion of the Schultz Wine Cellar Club India 2010 Commonwealth Games Air Australia developments Schultz Wines considers acquiring Stefano Wines

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Schultz Wines LimitedPre-seen information

A. Introduction to Schultz Wines Limited
Schultz Wines Limited was established in the 1840s by one of the founding winemaking families of the Barossa Valley in South Australia who had immigrated from Germany. The company was listed on the Australian Stock Exchange in 1992. Today, the company ranks 8th among the Australian wine producing companies. The variety of soils and micro-climates within the Barossa Valley has enabled Schultz Wines to produce a range of ultra-premium and premium varietal 1 wines, including red and white table wines, sparkling wines and fortified wines which are sold in both domestic and export markets. The current managing director, Frederich (Fred) Schultz, is a fifth generation winemaker, a direct descendant from the original Schultz family and widely regarded for his prestigious career to date, maintaining the tradition of being an independent family wine company with premium brands, despite being a publicly listed company. As Fred Schultz reviewed the companys 2009 vintage 2 reports, which showed another strong harvest for the company, he was satisfied with the companys current performance, especially given the volatile economic climate and the challenging outlook for the industry. He was encouraged by several options which had been identified to provide growth opportunities for Schultz Wines and maintain performance in the future. Fred was aware that continued success would probably require the acquisition of an appropriate local competitor to alleviate the pressure that would be placed on the production capacity of Schultz Wines.

B. The Australian winemaking industry 3

The Australian winemaking industry is a mature industry with a global focus. It has achieved a significant presence in world markets with international product successes. In 2009, the industry had total revenue of $5.9 billion. It produced 4.74 per cent of the global wine production from 2.1 per cent of the global vine planting area. This made Australia the worlds sixth largest producer of wine and fourth largest wine exporter. Domestic winemakers have a flexible, quality varietal grape supply and world-class technology, and Australian technology and production skills are highly sought by overseas winemakers. In past years, significant growth had been created by innovation in viticulture 4 and wine processing technology. This, combined with changing consumer preferences towards a Mediterranean diet stimulated by European immigration, an increasing trend towards dining out, a growing concern about health and social responsibility (e.g. drink driving laws) and a series of complex demographic and sociological factors (such as the changing role of women and the ageing of Australia's population) have all contributed to the evolution of the industry to its current state. In 2009, total world wine production was 31 805 million litres of which an estimated 72.8 per cent was consumed domestically in the country of origin (compared with Australia at about 41 per cent). World production volumes over the last 10 years have been predominantly a function of declining consumption trends among the major old world wine drinking nations of Europe, particularly France and Italy. This is also reflected in the low growth rate of global vine planting areas. In Australia, conversely, the large increases in production over this 10 year period has been the result of significant vine plantings made during 2000 to 2002 yielding fruit for the first time 5 . These vine plantings were a result of the Australian winemaking industrys strategic framework Vintage 2020 which aims to ensure Australias place as a leading global wine exporter. (Refer to the section on Vintage 2020 for further details.) The increase in vine plantings has contributed to an increase in wine stockholdings because export sales demand has not grown at the same rate as production growth. Industry experts predict these excess stockholdings will contribute to depress wine prices over the next five years. The decline in production in 2008 was the result of a severe outbreak of downy mildew 6 in the South Australian wine regions which resulted in significantly reduced harvest yields, combined with prolonged drought conditions across most
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Varietal wines are produced from recognised grape types. Common varietal wines include Chardonnay, Cabernet Sauvignon and Shiraz The vintage denotes the year in which the grapes for the wine were picked. Where a blended wine uses a spread of defined vintages, the vintage given is the youngest vintage in the blend Noteall figures presented are for the year ended 30 June unless otherwise stated. Viticulture is the term used in the industry for the cultivation of grapes and all aspects of vineyard management. A time delay of five years exists from the time of vine planting to yielding fruit for the first time. Downy mildew is a disease of grapes caused by a fungal infection which causes significant yield losses.

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Australian wine producing regions. Table 1 shows wine production volumes for the worlds major producing countries over the last 10 years. Table 1: World wine production (million litres)
2000 France Italy Spain United States Argentina Australia China Germany South Africa Portugal Chile Other 7 Total production Global vine area (000 hectares) Aust vine area (000 hectares) 5 979 6 127 2 297 2 054 1 808 555 770 1 091 892 507 419 5 323 27 822 8 680 80 2001 6 276 6 465 3 410 2 077 1 395 741 825 950 989 1 068 420 5 701 30 317 8 571 89 2002 5 892 5 598 3 654 2 420 1 485 679 990 935 969 673 501 5 675 29 471 8 525 99 2003 5 794 5 961 3 430 2 255 1 394 817 1 172 1 191 898 413 603 5 118 29 046 8 541 106 2004 6 648 6 210 3 709 2 096 1 379 936 1 129 1 333 1 005 865 529 5 080 30 919 7 916 135 2005 6 329 5 678 4 586 2 563 1 742 946 1 155 1 084 921 736 706 5 055 31 501 8 036 154 2006 6 406 5 643 3 424 2 618 1 337 1 186 1 188 979 822 772 660 5 569 30 604 8 063 163 2007 6 092 5 752 3 403 2 530 1 742 1 342 1 232 999 837 738 622 5 697 30 986 8 162 174 2008 5 209 4 850 3 960 2 585 1 298 1 196 1 232 912 837 748 633 5 426 28 886 8 153 173 2009 5 794 5 712 4 125 2 739 1 546 1 508 1 265 980 908 773 660 5 795 31 805 8 630 187

The Australian industry is now experiencing slowing export and domestic consumption growth, increasing numbers of wine brands and industry consolidation through a number of mergers and acquisitions. Low average prices in 2008 and 2009 have made it difficult for small and medium-sized producers to compete. Economies of scale, marketing, distribution and export capabilities are critical as local supply continues to exceed demand. The need for these capabilities has driven much of the merger and acquisition activity.

1. Viticulture and the winemaking process 8

Wine is an alcoholic beverage produced by the fermentation of fruit, typically grapes. All aspects of a vineyard including climate, sun, soil and drainage affect the quality of the grape and the flavour of the wine produced. Certain wine varieties differ in palate 9 based on the age of the vine and the grape growing region. Australia is divided geographically into a number of wine regions and, according to European Commission regulations, wine based on the name of a particular region must have 85 per cent of the fruit sourced from that region. Wine production generally occurs in well irrigated regions of Australia due to the relatively high water needs of vines. Winemaking facilities are usually located on-site at vineyards to ensure timely crushing of the freshest and best quality grapes. The process comprises the key steps shown in Figure 1.

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Other includes Romania, Greece, Russia, Brazil, Hungary and Austria. None of these countries has a significant share of world wine production. The winemaking process is known in the industry as oenology Palate is referred to in the winemaking industry as the taste of the wine.

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Figure 1: Winemaking process

Harvesting picking grapes from vines, either mechanically or by hand. Crushing via centrifuge technology, with juice drained off Fermentation yeast is used to turn juice into wine in vats. Bottling wine is strained, bottled and labelled.

The major technological changes affecting the industry today have resulted from improved knowledge of biotechnology. Use of this knowledge has led to better quality control, greater product consistency and a significant reduction in maturation time for most wines.

2. Vintage 2020a vision for the Australian winemaking industry

The Australian Wine and Brandy Corporation (AWBC) released Vintage 2020 in June 2000 as a strategy designed to drive industry growth. The vision is that by the year 2020, the Australian winemaking industry will achieve $4.5 billion in annual sales (a significant increase from $1.75 billion in 2000), and be the worlds most influential and profitable supplier of branded wines (promoting wine as the universal first choice lifestyle beverage), leading the world in flavour as well as offering a diversity of style and an extensive range. Through leadership in product innovation, Australian wines would be among the best selling global brands and be well represented in the elite category of the worlds best wines. To realise the increase in annual sales, the industry set itself the target of increasing production from 2.5 per cent to 6.5 per cent of world wine production by 2020. Combined with aggressive export targets, this meant that industry grape production would need to double from approximately 817 000 tonnes in 2003 to 1 650 000 tonnes in 2020. This would require 40 000 hectares of new vineyards, 570 million litres of extra processing capacity, 1100 million litres of new storage, 10 500 new workers and $5 billion in corporate, grape grower and equity funding. To encourage the required investment, the Australian government offered tax incentives to growers planting vines of premium grape varieties. As a result, Australian wine grape production reached record levels. From 2006 to 2007, there was an enormous 25 per cent increase in the production of grapes, with red wine grape varieties surpassing white wine grapes for the first time. This reflected growing consumer preference towards red wines (such as Shiraz and Cabernet Sauvignon) in domestic and international export markets. By 2009, some 11 years ahead of the Vintage 2020 target date, the number of wine companies had grown from 892 to 2000, employing an estimated 30 000 people directly and in associated industries. The industry had achieved revenue of $5.9 billion and exports of $2.8 billion. However, the record production of 1.96 million tonnes of grapes in 2009 was not expected to be repeated in 2010.

3. Industry segments
The Australian winemaking industry has three major product segments: Table wineincludes red and white varieties. This segment accounts for approximately 92 per cent of sales volume and 93 per cent of sales revenue. Sparkling winecomprises carbonated white and red wines. This segment accounts for approximately 5 per cent of sales volume and 4 per cent of sales revenue. Fortified and other wineincludes port, sherry and other specialty products. These wines are typically higher in alcohol content and account for 3 per cent of sales volume and sales revenue. Growth has occurred in all product segments of the market. Table wine dominates the industry in terms of both production and sales. This is due to its increasing popularity in both the domestic and export markets. While both domestic and export sales have grown over the last 10 years, export sales have contributed the most growth. These exports are predominantly to the United Kingdom (UK) and the United States (US).

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The increase in revenue per litre of table wine is largely due to the change in sales mix from soft pack (i.e. cardboard casks) and bulk 10 wine to premium bottled wine. However, total industry volume is growing at a rate faster than per litre revenue growth. This is a function of the low revenue per litre growth experienced by table wine over the last five years, due to exports being increasingly subject to price pressure from strong buyers in the UK and US markets. A relatively strong Australian dollar on foreign exchange markets has further compounded the decrease in the sales value per litre. The average selling price per litre of imports is double that of exports, reflecting the speciality nature of imported wine. (Refer to the section on Exports and imports for further details.)

3.1 Table wine

Table wine describes any still, non-sparkling wine with an alcohol content up to 15.5 per cent. With an annual turnover of $5.469 billion in 2009 and a gross margin of 16 per cent, this product segment accounts for 93 per cent of total industry revenue. Table wine can be classified by major types as follows: Red winesthese account for about 62 per cent of table wine production and 56 per cent of sales. White winesthese account for 38 per cent of table wine production and 44 per cent of sales. Table 2: Table wine production and sales (million litres)
2000 Red White Total production Red White Domestic sales Red White Export sales Sales of imports* Total sales 154 273 427 72 204 276 46 74 120 22 418 2001 204 378 582 75 197 272 57 80 137 21 430 2002 211 329 540 92 204 296 74 90 164 20 480 2003 298 363 661 97 208 305 96 109 205 19 529 2004 367 425 792 109 208 317 111 116 227 22 566 2005 419 377 796 126 212 338 159 145 304 16 658 2006 605 451 1 056 139 221 360 198 165 363 9 732 2007 657 540 1 197 144 220 364 257 190 447 10 821 2008 580 479 1 059 157 222 379 338 210 548 13 940 2009 826 499 1 325 162 229 391 400 225 625 13 1 029

* Noteimported wine sales are red wine only.

Table 2 summarises table wine production and sales for the last 10 years. The increase in red table wine production is consistent with the vine plantings in accordance with Vintage 2020. The years 2004 and 2005 were the first years of a significant increase in red wine production as the new vines yielded fruit for the first time. Red wine production is now almost double that of white wine production in Australia, the reverse of the situation in 2000. Table 3: Proportion of table wine sales volume as bottled container type
2000 Domesticred wine Domesticwhite wine Total domestic wine Total export wine 48.6% 30.4% 35.1% 75.5% 2001 50.7% 30.5% 36.0% 77.0% 2002 50.0% 31.9% 37.5% 77.2% 2003 53.6% 33.7% 40.0% 79.8% 2004 55.0% 37.5% 43.5% 82.8% 2005 56.3% 38.7% 45.3% 83.6% 2006 57.6% 38.9% 46.1% 81.7% 2007 56.9% 38.6% 45.9% 82.3% 2008 56.1% 41.0% 47.2% 79.5% 2009 57.4% 41.9% 48.3% 79.3%

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Bulk wine represents wine sold in bulk quantities such as in vats or barrels rather than being bottled. It is generally used for sale in either cardboard casks or for blending purposes.

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Table 3 shows the changing mix of wine sales in Australia. There is a clear trend towards bottled wine and away from soft pack or bulk sales. Bottled red wine now makes up nearly 60 per cent of total red wine sales reflecting the general trend towards premium bottled red wines. A larger proportion of white wines are still sold in bulk form, currently about 58 per cent. This is due to a higher level of blending that occurs with white wine varieties and a general acceptance of cardboard casks for storage of low-end white wines. Table 3 also shows the proportion of bottled wine sales for export over the last 10 years, again highlighting the trend towards bottled wine. The significantly higher levels of bottle packaging in the export market compared with that in the domestic market demonstrates the premium nature of the product being exported. This in turn contributes to the increasing price per litre of table wine. This trend is the same for both red and white table wines. The slight decline in the bottled export sales in the previous two years (with a corresponding shift towards bulk wine sales) is mainly a result of winemakers in the US using Australian wines for blending purposes. The mix is expected to stabilise around current levels. Table 4 shows the change in the average sales price per litre for table wines over the last 10 years. Table 4: Table wine average sales revenue per litre ($ per litre)
2000 $ Red wine White wine Table wine Total $ per litre 4.17 3.05 3.43 2001 $ 4.63 3.25 3.74 2002 $ 4.33 3.85 4.04 2003 $ 5.45 3.74 4.43 2004 $ 5.95 4.91 5.35 2005 $ 5.48 4.76 5.09 2006 $ 6.28 5.24 5.73 2007 $ 6.24 5.49 5.86 2008 $ 5.30 5.36 5.33 2009 $ 5.15 5.52 5.31

The movements in the average sales price per litre achieved over this period can be attributed to several factors: The changing mix in terms of packaging. Sales of bottled wine have increased as a proportion of total sales, reflecting more premium wines being sold at higher prices. An oversupply of export market red wine (predominantly bulk and lower price red wines) resulting from the significant vine plantings undertaken in the early 2000s. This has depressed the price of red wine on the export market, particularly in the last two years, where the price per litre of red wine has fallen below that of white wine. The decline in export prices driven by strong buyers in the UK and the US. A relatively strong Australian dollar impacting on export sales in general.

3.2 Sparkling wine

The sparkling wine segment comprises carbonated wines varying from slight bubbliness to the classic champagne style which can be white, pink (ros) or red in colour. Sparkling white wines make up over 75 per cent of the segment with the methode champenoise accounting for most of these sales. The notation methode champenoise is used in Australia to denote product that has been made using the same processes as traditional champagne, as champagne is legally defined as a sparkling wine originating from France. Sparkling wine accounts for about 5 per cent of wine production and sales volume, with an annual turnover of $228 million in 2009. Gross margins for this segment are lower than table wine due to the additional processing required. Including both carbonated white and red wines, 62.2 per cent are bottled fermented and 37.8 per cent are bulk sales. Sparkling wine has experienced little growth over the last 10 years. However, sparkling red wines have achieved some growth as winemakers experiment with new styles. Table 5 summarises the key statistics for this segment.

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Table 5: Sparkling wine key statistics (million litres)

2000 Production Domestic sales Export sales Import sales Total sales Total sales $ per litre 51 31 4 3 38 $2.55 2001 53 33 4 3 40 $2.85 2002 52 36 5 3 44 $3.05 2003 55 34 6 3 43 $3.40 2004 57 36 7 3 46 $3.52 2005 61 36 9 4 49 $3.33 2006 62 34 7 3 44 $3.75 2007 69 33 8 4 45 $3.71 2008 63 35 8 4 47 $4.26 2009 84 38 10 5 53 $4.30

3.3 Fortified and other wine

Fortified wines are generally sweeter and have a high alcohol content (at least 15.5 per cent). This is due to the fermentation process being stopped by the addition of a spirit, such as brandy, to produce a wine with a greater amount of residual sugar and hence sweetness, for example, port. Fortified wines are usually made for specialised markets and are consumed less regularly and by a small percentage of the population. Table 6 summarises the key statistics for this segment. Table 6: Fortified and other wines key statistics (million litres)
2000 Production Domestic sales Export sales Import sales Total sales Total sales $ per litre 77 37 1 2 40 $5.50 2001 106 35 1 2 38 $5.92 2002 87 35 3 2 40 $6.15 2003 101 33 2 2 37 $5.35 2004 87 31 3 1 35 $5.97 2005 89 33 2 2 37 $6.08 2006 68 31 2 2 35 $6.31 2007 76 28 3 2 33 $6.33 2008 74 29 3 2 34 $5.97 2009 99 30 3 3 36 $6.03

With an annual turnover of $217 million in 2009 and a gross margin of 30 per cent, this segment accounts for 3 per cent of wine production and sales. Growth in this segment has been relatively low over the last 10 years, reflecting changing consumer tastes away from fortified wines to lighter, less alcoholic table and sparkling wines. An increase in the consumption of non-grape based spirits, such as whisky, bourbon and rum, has also contributed to this decline. The difference between production and sales levels on an annual basis reflects the aged nature of a large proportion of this product.

4. Demand and consumption trends

In 1970, Australian domestic wine consumption was little more than two litres per person per year and 78 per cent of this consumption consisted of fortified wines such as port and sherry. Premium varietal table wines comprised only a small proportion of sales. For example, only 700 tonnes of Cabernet Sauvignon was processed in Australia and Chardonnay did not exist. By 2009, the consumption of wine in Australia had increased to an average of 23.3 litres per person per year. This is still low by world comparison, although comparable with consumption rates in the UK and the US. Given the high level of beer consumption in Australia, similar to that experienced in Germany, the UK and the US, industry experts do not anticipate Australian wine consumption levels to reach those of the traditional wine drinking nations of France, Italy and Spain. It is estimated that wine consumption will increase to about 26 litres per person per year and stabilise at this level. Table 7 illustrates the consumption trends for major world wine markets over the last 10 years.
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Table 7: Per capita consumption of selected countries (litres per annum)

2000 France Italy Portugal Argentina Spain Germany Australia 68.8 63.6 64.8 47.5 35.4 24.9 20.5 2001 69.3 61.3 63.9 45.2 33.7 24.4 20.2 2002 66.0 59.6 62.3 45.2 33.3 25.4 20.1 2003 66.0 58.9 60.0 44.3 38.6 25.3 20.9 2004 63.9 57.2 56.1 42.7 39.2 25.1 21.5 2005 62.9 56.7 52.8 42.6 37.4 25.3 21.7 2006 61.5 56.1 50.6 41.6 35.2 25.4 22.4 2007 62.6 55.0 51.7 39.9 33.0 26.4 22.6 2008 61.6 56.1 47.3 39.7 32.6 26.6 22.6 2009 53.4 52.3 46.2 39.3 33.7 26.0 23.3

The sophistication of Australian society through the restaurant and caf culture introduced by post-World War II European migrants increased the initial acceptance of wine in Australia. Characterised by eating out and informal entertaining, these lifestyle changes have expanded the number of occasions where wine can be consumed. In addition, improvements in viticulture and winemaking, adaptation of products to suit consumer tastes, the ability to supply a variety of wine styles and improved packaging choices have facilitated wines expanded appeal. Wine is now a mainstream alcoholic beverage. It is no longer only purchased when dining out, but increasingly acquired to accompany meals in the home. Over time, consumer preferences have shifted towards varietal bottled wine. These are of higher quality, have more flavour and are more stylishly presented. One notable industry commentator stated recently that the proposition of wine is being redefined from special occasion to everyday, from beverage to aspirational product. This radical shift in the composition of wine demand is reflected in the growth of the premium and super premium price categories at the expense of the basic price category as shown in Table 8. Table 8: Price ranges of table wine in Australia ($ per bottle)
Price category Basic Premium Super premium Ultra premium Icon Price range < $5.00 $5.00 - $9.99 $10.00 - $14.99 $15.00 - $49.99 > $50.00 1989 Share % 50% 34% 10% 5% 1% 2009 Share % 15% 25% 35% 20% 5%

New consumers are also being attracted to wine. Market research shows that new consumers look at the brand and label design more than any other feature when selecting wine. Brand has consistently been the strongest influence across all consumer segments when browsing for wine. Consistency in quality and continued support for a brand over time is critical to ongoing market success. Research has also supported wine consumption by showing that the regular and moderate consumption of wine (three to four standard drinks per day for men and one to two for women), in particular red wine, may reduce the risk of cardiovascular disease and increase overall lifespan. This combined with an ageing population means there is a trend towards higher quality wines, in particular red wines. Despite strong historic growth, however, only low organic growth is predicted in the future. The domestic market can no longer be relied upon to absorb over-production and export success is critical for the future of the Australian winemaking industry.

4.1 The global economy

Before the global financial crisis began in mid 2008, the global economy had experienced sound growth for some years. This had been echoed by strong growth in the Australian economy. This expansionary phase of the economic cycle provided a strong impetus to the growth in wine demand, especially for the more expensive price categories. The relatively low inflation and interest rate environment in which the growth
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occurred was very beneficial for the expansion of capital intensive wine producers. However, the current economic climate has been impacted by the global financial crisis. High household indebtedness, volatile exchange rates, reduced asset values and vulnerable share-market valuations have led to major uncertainty in global markets. Discretionary purchases, such as wine, are often the first item to be sacrificed in more difficult economic conditions. While Australia appears to be faring better than most developed nations, and interest rates are now at record lows, key export markets have been badly affected. In addition, the stronger the Australian dollar, the more disadvantaged Australia is in the export of wine to global markets. Despite the current economic climate, the trend towards globalisation of consumer preferences is expected to continue to extend western behaviours and tastes to Asia providing growth opportunities. For example, India is a significant emerging market. Currently the worlds 11th largest economy with a population of about 1 billion people, India has a large and growing middle class of up to 300 million people. Annual gross domestic product (GDP) growth has averaged about 6 per cent since 1995 making it the worlds second fastest growing economy. While Chinas per capita wine consumption is 375 millilitres, Indias per capita consumption is currently a mere 4.5 millilitres. It is expected that consumption in India will grow tenfold in 10 years driven by increasing disposable incomes, changing lifestyles, an increasing number of professionals returning to work in India from overseas and a growing awareness of the health benefits of wine. The emergence of wine clubs in a number of cities and the perception that wine is upmarket and sophisticated will influence demand. However, the imported wine category in India is fragmented. There are over 1000 labels on offer from numerous manufacturers. French wines are the most popular, although wines from Australia and California are also making strong inroads, principally to hotels. Australia does not export wine direct to India as the market size has been relatively small to date. Instead, Australian wines are sold through wine merchants in other Asian countries such as Singapore and China. Another important shift that has occurred in the marketplace relates to the supply-demand equation. In recent years, global demand for premium wines (especially red wines) has exceeded supply. However, supply is rapidly catching up. As worldwide vine plantings yield fruit over the next five years, a surplus will emerge similar to that currently being experienced in Australia and New Zealand. In 2004, Chile expanded its vineyards to cover 174 000 hectares compared with 125 000 hectares in 1996. The 890 000 hectares that France and Italy each had in 2004 has changed little from 1996, but consumption in both countries is shrinking by about 1 per cent per year. In the US, wineries have expanded to such an extent that supply also exceeds demand and California's winemaking industry is working through a surplus that peaked in 2004. Many of these American wineries introduced less expensive brands of wine to offload excess supply. At the same time, the prices of some of California's most expensive wines have plummeted and are not expected to increase in the foreseeable future. It is estimated that a large proportion of the additional global wine supply will fail to meet market specifications for the premium and super premium categories. However, the global oversupply of grapes may make the Australian wine surplus insignificant and the sale of excess production extremely difficult, particularly with depressed export prices projected to persist for the next 10 years. Industry observers have expressed concern that some Australian winemakers might be tempted to solve the oversupply problem by selling bulk, unbranded wines to the world market. Being a blend of excess grapes from a variety of geographical areas, these wines would be lower in quality in terms of taste and cellaring. Australia has fought hard to gain its internationally renowned wine reputation. Its branded wines outclass blended wines from other winegrowing regions around the world. Therefore, various industry stakeholders are keen to avoid solving the oversupply problem in such a manner.

4.2 Future trends

The following factors summarise the trends that will impact the industry in the future: The demand for wine, at least in the longer term, is relatively price elastic. While it is difficult to ascertain the extent of substitution between wine and other alcoholic beverages (such as beer), substitution does occur at the lower end of the wine market in the basic and premium categories. The demand for wine is income elastic. Growth in income and rising living standards over the last two decades has raised per capita wine consumption in Australia. As income has increased, it has facilitated more meals being eaten away from home that are quite likely to be accompanied by wine. Similarly, meals eaten at home are also increasingly being accompanied by wine. Overall, worsening general economic conditions are expected to result in reduced demand for wine.
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In the past 10 to 15 years, as wealth and incomes have increased, consumer tastes have changed both in Australia and overseas. As such, premium products are favoured more, including premium wines. The increasing significance of exports means that relative exchange rates are an important determinant of demand, as are incomes and the general economic conditions in key overseas markets. Concentration of major retailing buyers will continue to see producer margins squeezed in both the domestic and export markets, particularly the UK.

5. Industry structure and distribution channel trends

The processes involved in winemaking are relatively simple, as indicated in Figure 2, from the growing and crushing of grapes to fermentation and bottling. Figure 2 Australian winemaking industry value chain
Distribution channels Export sales Grape growers Wineries Domestic sales Wine merchants Retailers Direct to public

Customer

End consumers

5.1 Grape growing

Grapes for winemaking are supplied by about 7000 independent growers to about 2000 winemakers. Grape growing requires long lead times before vines come into production, making it critical to forecast future market trends. Grapes are supplied either on the spot market or under contract with a winemaker. Typically, contract duration is between 3 and 10 years. Even in a season of grape oversupply, growers under contract must still be paid by the large wine companies according to the terms of their contract. With the current oversupply of wine grapes, the spot price offered to uncontracted growers may be less than break-even. Where the large wine companies are so oversupplied with many thousands of tonnes of wine grapes that cannot be used, they may elect to pay growers to leave the fruit to wither on the vines. Average grape prices have declined from $1049 per tonne in 2003 to $755 per tonne in 2009. White grape prices are expected to continue declining till 2014 and red grape prices are expected to decline until 2011, and then recover. For many growers, grape prices are now below the cost of production and this, combined with drought conditions, has led to many growers switching to other agricultural produce. Certainty and quality of grape supply has become increasingly important for major winemakers. Given the high risk of disease and unfavourable climatic conditions that can impact the industry, self-sufficiency is critical. Winemakers need to guarantee the quantity and quality of supply, particularly in premium varieties, to ensure year-on-year wine consistency. As a result, consolidation has occurred with major wine companies purchasing significant parcels of vineyard land from smaller wineries in premier winegrowing areas. It is estimated that the top 10 winemaking companies are now 50 per cent self-sufficient in grapes.

5.2 Wineries
While it is estimated today that there are about 2000 wineries in Australia, over 70 per cent of the total industry volume is produced by the industrys three largest companies that are now major global market competitors. Rationalisation in the industry has occurred as large winemaking businesses have sought economies of scale in order to protect profitability, given the reduced prices and increasing oversupply. In the shift towards grape self-sufficiency, larger wineries provide contract winemaking services to smaller wineries. Contract activities include crushing, fermentation, maturation, filtration and blending. Most large wineries operate bottling lines and provide these services to smaller wineries to achieve economies of scale.

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Wine packaging has been an area of significant innovation in Australia. Bulk wine cask packaging was first developed and introduced in this market. Screw caps and plastic corks have also been introduced in the search for cost-savings and improved product quality and consistency. More recently, glass bottling has been the focus of attention. This is a major cost in the production of wine in terms of materials, the weight of packaging for transport and environmental issues surrounding the use of energy and greenhouse gas emissions in production. Development has focussed on reducing the amount of glass needed per bottle whilst maintaining strength, as well as developing polyethylene terephthalate (PET) bottles. However, PET bottles are permeable to air which oxidises the wine, meaning that shelf-life is reduced to less than 12 months. While 90 per cent of wine sold in Australia is consumed within 48 hours, consumers are yet to embrace plastic wine bottles. Such bottles seem better suited to high-turnover wines in the $10 to $15-a-bottle category.

5.3 Distribution and retailing

As the domestic market has matured and export markets have been developed, distribution channels for Australian wine have changed significantly over the last 20 years. This is illustrated in Table 9. Table 9: Major distribution channels for Australian wine
Share of total revenue Distribution channel Exports Domestic wholesale wine merchants Domestic retailers including liquor stores Direct to general public 1989 14% 70% 15% 1% 2009 47% 27% 23% 3% Share of domestic revenue 1989 n/a 81% 17% 2% 2009 n/a 51% 43% 6%

Export channel
The export channel represents almost half of the value of the total wine market and over 57 per cent of total sales volume. Despite the higher volume through this channel, the average price per litre of Australian wines has been declining in the highly competitive UK and US markets. The impact of unfavourable exchange movements in the Australian dollar has also contributed to a reduced price per litre for export wine. About 60 per cent of exports are shipped direct to large retailer customers, including the major supermarket chains. The remainder is sold to overseas wine merchants who then on-sell to liquor chains, independent liquor shops, hotels and restaurants. These merchants are critical to support favourable product placement and brand awareness. For example, supplying particular wines to the in vogue hotels and restaurants can generate strong demand from consumers for those wines through the liquor chain and supermarket channels. Strong relationships with these merchants as well as strong branding and marketing support are therefore vital to ensuring penetration into the highly fragmented markets in the UK and the US. Major winemakers use their own branding as the generic Australian brand no longer provides brand differentiation, which is particularly important in the super premium and higher categories.

Domestic wholesale wine merchants

The second largest distribution channel is domestic wholesale wine merchants, who supply independent liquor chains and outlets, hotels and restaurants, and have as much power as overseas wine merchants in determining a brands success or failure. Most major wine companies have entered into long-term distribution agreements with the major merchants in order to provide security of supply and certainty as to market placement of their products. As retailer penetration of the wine market grows, particularly by the major supermarkets, the wine merchants share has been eroded. The major retailers prefer direct distribution from the winemaker in order to improve their profit margins by removing the distributor.

Retailers
The third and fastest growing distribution channel is retailers. Wine, and alcoholic beverages in general, have been targeted by major supermarket chains due to their strong growth compared with grocery lines. Intensifying rivalry between major supermarket chains in liquor retailing has seen the Australian market
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mirror liquor retailing in the UK. Having gained majority market share, the major UK retailers exercise strong control over the industry, particularly in relation to pricing, thereby squeezing winemaker margins. The increasing power of the supermarket chains has also been cited by major wine companies as a reason for deteriorating performance. Retailer demands for high margins and strong promotional support have squeezed producer margins and created a dilemma. If dissatisfied with the trading terms, the retailers can decide to not allocate shelf space to wine brands and this can have a negative impact on sales and profitability. In response, several large wine companies have increased their own direct sales distribution capacity (e.g. mail order and wine clubs), thereby bypassing wholesalers and retail outlets. A small proportion of sales are made direct to the public through cellar door sales and winery tours. It is estimated that in South Australia alone, more than 1 million people visit winery cellar doors each year, spending about $375 million.

5.4 Costs and gross margins of winemaking

The breakdown of a bottle of wine as a percentage of the final retail selling price is estimated as: 24 per cent for government taxes; 22 per cent for retailer margin; 14 per cent for sales and administration expenses, depreciation and interest; 13 per cent for grapes; 10 per cent for distributor margin; 10 per cent for bottling, packing and input material costs, including processing and storage costs; and 7 per cent for winery margin. This breakdown highlights several significant issues regarding industry profitability. Firstly, the retailers margin and taxes account for nearly 50 per cent of the retail selling price of a bottle of wine. Another issue is the marginal size of the grape cost component relative to the final selling price. (Note: the grape costs include capitalised land and vineyard costs as well.) The analysis assumes self-sourced grapes from a winemakers own vineyard. The cost of market-purchased grapes would double as a percentage of the selling price which in turn would halve the winemakers margin. It is also important to note that processing and storage costs are higher for red wine production than white wine, due to the longer maturation period and the cost of oak barrels. Depreciation is increasing due to the trend towards mechanical harvesting and warehousing automation. In addition, depreciation is slightly higher for wine than other beverage industries (such as beer and carbonated soft drinks), mainly due to greater initial capital costs required for wine maturation equipment and storage.

Global competitiveness
The Australian winemaking industry is internationally competitive, with industry consolidation assisting in maintaining this competitiveness. Cost structures vary across industry competitors depending on the level of vertical integration and grape self-sufficiency. More generally, Australian wine producers have a significant cost advantage over American and European winemakers due to the relatively inexpensive access to land. However, Australian winemakers have a cost disadvantage in packaging due to the high control of the glass bottle market in Australia. It is estimated that the cost of bottles in Australia is 15 per cent above the average price in France and the US. Also, with the exception of the major winemakers, although their own wines take precedence over contract work during peak bottling periods, most wineries use contract bottling services provided by the major winemakers.

Profitability
Winemakers are differentiated by either selling lower-margin bulk wine or blending, bottling and branding the product themselves. Winemakers who sell their own branded wine through their own cellar door or other direct channels (e.g. direct mail) tend to have higher profit margins, as direct sales have higher margins than sales through wholesalers and retailers. The need for economies of scale and large-scale production facilities has reduced marginal production costs. This is particularly true for larger producers where economies of scale are critical to improving profitability. Wine companies that sell branded products tend to spend between 5 and 10 per cent of annual revenue on marketing. For the industry as a whole, the average marketing spend is about 5 per cent of revenue. However, this is likely to increase in the future as branding and marketing expenditure by Australian winemakers is set to increase (especially in the UK and the US) as competition for sales continues to intensify. Table 10 shows industry returns over the last 10 years.

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Table 10: Ten year average industry profit margins

2000 Weighted average industry gross margin Weighted average industry net margin 44.1% 29.7% 2001 41.8% 27.4% 2002 41.7% 27.0% 2003 39.8% 25.1% 2004 39.1% 24.6% 2005 40.3% 22.9% 2006 41.0% 19.8% 2007 39.5% 17.0% 2008 36.6% 16.1% 2009 34.9% 16.3%

During this period, profits declined due to lower wine prices in key export markets and higher grape costs caused by drought conditions in 2007. While competition levels in most markets led to higher promotional spending and some price discounting, larger winemakers were able to sustain higher profit levels (typically 16 to 20 per cent) than small to medium-sized winemakers (10 per cent or lower), mainly due to effective restructuring following acquisitions. Indeed, half of the small to medium-sized wineries reported a loss in 2008. The declining margins in Table 10 can be summarised as the result of the following factors: production exceeding demand; panic selling by inexperienced winemakers when faced with oversupply, forcing prices down; the relatively strong Australian dollar making exports less competitive; retail consolidation reducing winemaker margins; poor understanding of demand trends by winemakers; and a large increase in the number of winemakers in the past decade.

6. Key success factors

Industry experts summarise the following factors as critical to future success in the industry: Production of wine varieties currently favoured by the marketTo be able to cater for a market that has ever-changing tastes is critical. This means producers need to have security of access to a wide variety of grape types and be able to change production and blending processes quickly as tastes change. Guaranteed supply of grapes and other key inputsAssurance of grape supplies through buying from several geographic regions, via contract growers or self-sufficiency gives winemakers an advantage. In addition, contracts for raw material supply such as yeast, and packaging materials such as bottles, corks and screwcaps, capsules 11 , labels and cartons are necessary. Economies of scaleIncreasing size and scale are required to reduce production costs in light of declining sales margins. Survival is often a case of acquire or be acquired. Funding capabilityAvailability of funds is necessary in order to acquire new assets and ensure healthy cash flows that can prevent takeover. Establishment of export marketsExport market development is crucial since the domestic market is small and mature. Control over distribution channels within these export markets is also critical, to dilute the effect of strong retailer power particularly in the case of the major export markets. Strong branding and marketing relationshipsTo stimulate consumer demand and counter retailer power, strong branding and relationships with wine merchants are required.

11

Capsules are the plastic or foil that covers the cork and part of the neck of a wine bottle.

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7. Exports and imports

Table 11 summarises the global trade in wine over the last 10 years. Australias share of this world trade was 7.4 per cent in 2009. In addition, with wine exports accounting for 2.5 per cent of Australia's total exports, wine is the country's 12th largest export industry and receives substantial support from the Australian government. Australia competes favourably in global trade. If the volume of Australian wine projected to be available for export is shipped, the Australian share of world-traded wine will grow from about 7 per cent in 2009 to 12 per cent in 2014. Table 11: World wine exports (million litres)
2000 France Italy Spain Australia Chile United States Portugal South Africa Other Total exports 1 385 736 2 168 125 142 145 187 85 1 701 6 674 2001 1 521 814 1 756 142 198 179 216 98 1 552 6 476 2002 1 838 1 150 1 778 172 238 227 275 122 1 653 7 453 2003 1 951 1 291 1 926 213 254 279 249 130 1 368 7 661 2004 1 900 1 005 2 272 237 259 292 217 142 1 214 7 538 2005 1 828 1 099 2 132 315 305 307 207 154 1 187 7 534 2006 1 890 1 174 1 835 372 336 267 177 190 1 311 7 552 2007 1 799 1 164 1 812 458 380 286 194 248 1 394 7 735 2008 1 752 1 319 1 480 559 435 363 279 387 1 696 8 270 2009 1 619 1 571 1 557 638 523 432 396 325 1 604 8 665

Australias principal export markets are summarised in Table 12 below. Table 12: Major Australian wine export markets ($ million)
2004 United States United Kingdom Canada New Zealand Germany Japan Other Total exports 237 491 56 66 27 28 183 1 088 2005 349 649 81 72 45 32 254 1 482 2006 459 759 100 85 55 32 284 1 774 2007 642 927 136 93 53 33 285 2 169 2008 943 943 192 112 67 35 334 2 626 2009 996 946 226 108 85 39 401 2 801

Australia's largest export market by volume in 2009 was the UK (248 million litres), closely followed by the US (189 million litres). Australia is the largest wine exporter to the UK, with 38 per cent of Australias total export wine volume in 2009 going to this market. However, pressure from supermarket buyers in the UK has depressed the price per litre received for wine exports. Australian winemakers receive only $3.81 per litre for UK exports compared with $5.27 per litre for sales to the US. While there is competition from imported wine, tariff duties have provided some protection to local winemakers. Tariffs on wines have declined since the early 1990s, in line with general tariff reduction policies and are now set at 5 per cent (except for a concession rate of 4 per cent for developing countries).
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There is also a flat charge per litre, which varies according to the type of wine and its alcoholic content. However, given the large volumes of wine produced locally, only speciality wines are imported. Australias geographic location provides a natural disadvantage for imports due to the high transportation costs of bulk or bottled wine.

C. Industry competitors
Table 13 summarises the market share of the competitors in the industry. Table 13: Australian winemaking industry market analysis 2009 (share of revenue)
Red wines Allens Group Limited Brooks Wine Company Limited Capricorn Wines Pty Limited McMillan Chamber Wines Limited Stefano Wines Pty Limited McFarlane Wines Pty Limited Schultz Wines Limited Other 30.0% 25.0% 10.0% 1.5% 2.3% 3.5% 2.3% 25.4% White wines 22.0% 22.0% 17.0% 7.7% 4.0% 2.0% 1.0% 24.3% Sparkling and fortified wines 10.0% 15.0% 35.0% 0.0% 1.0% 1.0% 0.5% 37.5% Total industry market share 25.6% 22.6% 13.6% 4.0% 2.9% 2.7% 1.6% 27.0%

In 2009, the three largest Australian winemakers collectively accounted for over 60 per cent of the industry revenue. The two largest Australian wine companies are in the global top 20 wine companies and the global top 10 premium wine production companies. Some 10 per cent of industry production is handled by medium-sized wineries and about 1050 boutique wineries make up the rest of the Australian winemaking industry. The growth in boutique wine producers has been significant over the last decade, despite major industry rationalisation in the late 1990s. At that time, the major winemakers sought to acquire premium grape growers and other winemakers to secure grape supply and reduce the cost of production. In the last 25 years, there have been over 120 takeovers of which 70 have occurred in the last 10 years.

1. Basis of competition
With a global oversupply of wine and increasing levels of concentration in the domestic market, competition in the industry is high for both local and export markets. The basis of competition is summarised as follows: PriceCompetition is highest among Australian winemakers within the mid-price bottled range since this is the market that the majority of companies have targeted. Within Australia, there has traditionally been a significant part of the industry producing bulk wines and competing on the basis of price and value for money. In the international market, Australian winemakers compete mainly on the basis of price for a given quality of wine. Marketing and brandsExisting competitors discount prices and implement aggressive marketing strategies to maintain current levels of sales. This requires strong capabilities in marketing. Increasingly, consumers are influenced by the brand and label design when purchasing their wine. Distribution capabilitiesConsolidation of the Australian liquor retailing industry and the tendency for large retailers to deal with large suppliers means that smaller wineries often have to sell output through cellar door sales and mail orders. It is likely that distribution considerations will drive future mergers between medium-sized operators. The size of a winemaking business is playing an increasingly important part in the ability to compete, both within the domestic and international market, in terms of determining access to markets and distribution channels.

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QualityAs consumer tastes have become more sophisticated, competition among those winemakers producing premium wines has been based on quality, branding and distribution. Lower quality wines are more susceptible to competition from substitute beverages, such as natural water, mineral water, soft drinks, beer and spirits.

The major Australian winemakers compete on a global basis. It has been predicted that by 2020, there would be only five major global wine producers and that Australia would hold at least two of the five places.

2. Summary of key competitors

The key industry competitors are summarised below.

2.1 Allens Group Limited

Allens Group Limited, a listed Australian company, has interests in the manufacture and distribution of beer, wine and spirits. The wine division, Allens Wine Estates has a large portfolio of premium wine brands and aims to be the leading premium wine company globally. The company has worldwide wine supply chain operations (winemaking, viticulture and production facilities) along with global wine brand marketing activities and sales and marketing operations in the Americas, Europe, the Middle East, Africa and Asia. The international wine portfolio includes more than 50 individual brands of sparkling, table and fortified wines. The company controls more than 15 000 hectares of vineyards in premium winegrowing regions of Australia, California, New Zealand, Italy and France and operates more than 20 wineries across the world. Grape self-sufficiency levels are currently about 50 per cent. Through Allens Global Wine Clubs and Services, customers are provided with wine solutions ranging from winemaking, packaging, labelling and distribution through to consumer direct marketing, selling and fulfilment. It also provides contract bottling services with five bottling plants (three in Australia, two in France) and can provide specialist bottles, closure solutions (cork, metal caps, synthetics), maturation systems and design services. The wine clubs sell premium wine and related products to more than one million members in 11 countries across the Asia Pacific, Europe and North America.

2.2 Brooks Wine Company Limited

Since 2003, Brooks Wine Company Limited has been the Australian wine division of Starfire Corporation, the largest wine company in the world. Brooks Wine Company has approximately 2500 hectares of company-owned vineyards within Australia, predominantly in South Australia, which makes the company about 45 per cent self-sufficient in grapes. In addition, the company sources grapes from over 1000 independent growers. The company strategy is to shift towards higher margin bottled products and to increase exports of its well known brands. Brooks Wine Company has a broad and comprehensive portfolio. As well as vineyards, it has wineries in all the major wine producing regions of Australia and owns a number of iconic brands. With about 25 per cent of the domestic market, its brand range covers all price points and makes the company one of the largest suppliers of wines in Australia. Its wines are also distributed in over 80 countries around the world. The company has global sales of more than 100 million bottles annually. The Brooks Wine brand is the second largest selling label in the UK, bringing to fruition the aims of the companys founder to create quality wines that will be prized in the markets of the world.

2.3 Capricorn Wines Pty Limited

Capricorn Wines Pty Limited is owned by the Confidis Liqueur Group, the French-based international liquor distributor. The group currently holds about 2000 hectares of vineyards, mostly in South Australia, and owns a large number of well known brands. It is perhaps best known in export markets for the Barossa Springs range which has been the UK's biggest selling wine since 1996. This brand accounts for more than 20 per cent of Australian table wine exports and is the single largest selling Australian bottled wine in the UK, Ireland, Norway, Japan, Singapore and New Zealand. When the Confidis Liqueur Group took over Capricorn Wines in 1989, there were 600 000 cases of Barossa Springs wine sold annually. In 2009, this
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number had increased to 6.7 million cases of the brand. The plan is to sell 10 million cases annually within the next five years, looking to new markets in China, Japan, India and the US. Capricorn Wines approach to growth contrasts dramatically with that of the other large winemakers in Australia. Its best-known wines tend to be its less expensive ones. The company is focused on the growth of its existing brands rather than on acquiring other brands or establishing new labels. Its relatively small number of brands and their scale reflects a distinctive and long-term philosophy. Capricorn Wines main production facility is in the Barossa Valley where white wines and sparkling wines are produced and packaged. Its second Barossa Valley winery has been converted into a large specialised red wine facility.

2.4 McMillan Chamber Wines Limited

Predominantly a non-varietal bulk wine producer, McMillan Chamber Wines Limited was formed through the merger of John McMillan Wines Limited and Chamber Wines Limited in 2003. The company now also produces sparkling wines, premium red and premium white varieties, with a focus on increasing its premium red wine business. One of its major customers is Capricorn Wines, with which it has a major contract for winemaking services involving increased volumes of wine through to 2018. However, in view of the declining margins for domestic wine, the company is increasing its focus on exports rather than contract winemaking. Recent poor performances mean that McMillan Chamber Wines is a potential takeover target for large overseas companies seeking to source inexpensive Australian wine. The key brand range for the company, McMillan White Label, increased its sales in 2009 to more than 250 000 cases. Total export sales grew by 105 per cent, with bulk and bottled wine showing similar increases. Its UK sales increased by 47 per cent after the company established its own dedicated distribution network in the UK. Sales in the US increased by 300 per cent after the company signed an agreement with US market leader, Fallow Corporation, to make wines for its White Cygnet range. But the cancellation of a large overseas order about 12 months ago has led to flooding of the local market with a range of discounted McMillan wines.

2.5 Stefano Wines Pty Limited

Established in 1932, Stefano Wines Pty Limited is a family owned wine company based in New South Wales. Its winemaking philosophy is that good wine begins in the vineyard and the winemaker should use minimal interference in the winemaking process. Further, the wine should have a sense of regionality and be an expression of the soil from which it is derived. The winemaking team is overseen by third generation family winemakers. Giuseppe Stefano is now nearing retirement and succession planning is an issue that needs to be addressed. In the early 1980s, Giuseppe Stefano created the world acclaimed Gallant One which had set the industry benchmark for dessert wines. The company owns three wineries producing premium quality wines in three very diverse premium wine regions, all with cellar door operations. Vineyards are located in four key grape growing regions of New South Wales. During the late 1980s, encouraged by international acclaim for its dessert wine, Gallant One, Stefano Wines began exporting to various countries around the world. Its wine is now available in more than 60 countries and distributed by wine merchants to restaurants throughout Europe and some of the finest hotels and restaurants in Asia, Canada and the US.

2.6 McFarlane Wines Limited

McFarlane Wines Limited is a private company dating back to 1881 and owned by sixth generation winemakers. The business sells more than two million cases of wine and spirits per year. The company has been awarded a total of 32 trophies and over 480 medals for a number of its well known brands. Winery operations are located in a number of wine regions in New South Wales. The company has a reputation for being innovative, introducing new production techniques and some of the world's most advanced technology in its wineries and vineyards. Over the past six years, McFarlane Wines has made significant investments in vineyards, processing capacity and wood maturation facilities.

2.7 Other
The balance of market share is held by a large number (estimated to be around 2 000) of small wineries in the various winegrowing regions in Australia.
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D. Schultz Wines Limited

1. History
One of the first families to settle in the Barossa Valley in 1844, the Schultz family were originally mixed farmers tending to orchards and vegetable gardens as well as grazing sheep and cattle. The family planted grape vines in the early 1840s and their wines won awards from that early stage of the Australian industry. Today, the company obtains its grapes from a combination of local grape growers and its own vineyards, many of which are classified as mature, ranging from between 20 and 100 years old. Currently ranked 8th in size among the Australian winemaking companies, Schultz Wines Limited produces a diverse range of high quality premium varietal wines from delicate whites, elegant, rich and robust reds, world-class sparkling wines through to much sought after fortified wines. Current managing director, Frederich (Fred) Schultz, is a legend in the Australian winemaking industry. At the age of 17, he embarked on a prestigious career in wine at Lyndoch Wines. Later, in 1964, he was appointed winemaker/manager at Linke Wines. He held this position for nearly 20 years and during that time, he developed strong and enduring friendships with his local grape growers. Fred Schultz returned to Schultz Wines upon his fathers retirement in 1983. His first vintage was produced in the following year. During the 1980s, the business focused on building the Schultz Wine brand as a premium quality Barossa Valley wine. In the late 1980s a serious oversupply of grapes brought great hardship to the Barossa Valley grape-growing community. To accommodate the glut, the multinational owner of Linke Wines ordered the cancellation of contracts with growers, leaving them with no market for their grapes. While he was winemaker at Linke Wines, Fred Schultz had developed significant relationships with some of these growers. Now at Schultz Wines and seeing the severity of the situation, Fred Schultz called on friends and family to put together a financial package to purchase grapes for the company from these growers. It was a huge gamble but two vintages of wine were produced, buyers were found for the wine and the growers were saved from financial ruin. Many old Barossa Valley vineyards were therefore saved and in the years that followed growers were able to capitalise on the industry's successful export strategy and the high demand for Barossa Valley grapes. Schultz Wines was listed on the Australian Stock Exchange in 1996 in order to raise capital to invest in the future development of the business and to ensure a strong financial position to take advantage of future market growth. The golden grape was chosen as the companys corporate logo, reflecting Fred Schultzs ambition for a golden future for the company. The float was significantly oversubscribed with share applications from grape growers, staff and thousands of other small investors. Winery staff and growers wanted to hold shares in what Fred Schultz encouraged them to think was their own company.

2. Business strategy
The vision of Schultz Wines Limited is to be Australias most prestigious winemaker and be in the top five wine companies in Australia. It aims to achieve this vision through the following strategic goals: Being a producer of superior ultra premium and premium varietal wines. Expanding the distribution base of Schultz Wines products in both the domestic and export markets through widely recognised brands and strong distribution relationships. Acquiring top quality grapes by further developing the strong relationships between the company and the grape growers. Maximising returns to shareholders, while at the same time conserving adequate funds to provide the necessary working capital for the continued operation and growth of the company, and using resources in an environmentally sustainable way.

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3. Operations
The company purchases grapes from about 185 local independent growers who look after about 900 individual vineyards in the Barossa Valley. Many of the grape growers families have worked the same vineyards for five, and in some cases, six generations, providing their grapes to Schultz Wines Limited for all of this time. A special relationship exists between these grape growers and Schultz Wines. The company has adopted the philosophy that the winery serves to protect the livelihoods (and the Barossa Valley vineyards) of the growers, who over the years have become friends first and suppliers second. The trust, loyalty and friendships that have endured and grown over the years mean that Schultz Wines has access to the widest variety of the best Barossa Valley grapes available. It is for these reasons that the company took the conscious decision not to invest heavily in its own vineyards. The vineyards that the company does own only produce about 20 per cent of its requirements. Winemaking operations are carried out at a single site located in the Barossa Valley. In 2007, the company completed a major upgrade of its production facilities to bring them to world-class standard. The winery now has the capacity to crush 30 000 tonnes of grapes per annum. Once aged, the companys wines are bottled by a nearby contract bottler that also packs them ready for despatch to the various markets, both domestically and internationally. The company takes its responsibilities to the community, the environment and sustainability seriously. Due to the importance of food safety issues, the company was the first Australian winemaker to implement a Hazard Analysis Critical Control Points (HACCP) plan for food safety system. This has provided Schultz Wines with a strategic advantage over other winemakers in relation to export sales. Schultz Wines also has policies relating to water, energy and chemical usage, greenhouse gas emissions and packaging management. The company has been successful in reducing the volume of water used to below the industry average. In addition, approximately 95 per cent of the cardboard purchased by the company (for use as cartons to package the wine bottles) is manufactured from recycled material. As well as making wine for sale, Schultz Wines also crushes grapes for other wineries. This extra activity enables the company to achieve production economies of scale and keep its costs competitive with its larger rival winemakers. In 2008, 18 per cent of the total grapes crushed were for other wineries, although this percentage, as a proportion of the total annual crush, has been declining for some time. An increase in the companys sales of wine has meant that greater tonnages of grapes are crushed for its own use.

4. Distribution
Schultz Wines are distributed in Australia by a well respected, family owned wine merchant established in 1927. Internationally, the company has established a solid presence in the UK, Continental Europe, as well as North America, New Zealand, Asia and the Pacific region. Export wine sales are distributed through well established wine merchants in these major markets, with whom Schultz Wines has forged strong relationships. This has proven to be a great asset for the company. Such relationships have enabled Schultz Wines to secure access to prestige hotels and restaurants in the UK and the US, thereby ensuring strong consumer demand for its wines in these markets. Combined with strong brand marketing and promotion, its relationships with all of its wine merchants has protected Schultz Wines to a certain degree from the global economic crisis and declining margins in the supermarket sector, both domestically and internationally. The Schultz Cellar Club was established in 1999 as a mail order operation within Australia. This concept was developed by Schultz Wines to strengthen the loyalty ties with its large customer base in Sydney and Melbourne. Through this club, the member customers are offered special deals. These include access to new vintages of wine (at discounted prices) prior to their general release, as well as the ability to purchase reserve cellar wines not otherwise available to the general public. The Schultz Cellar Club also encourages members to taste rare vintages when visiting the cellar door and to buy new vintage wine at competitive prices. Cellar door sales are an important part of the business of Schultz Wines. The cellar door sales area is located inside the original buildings, including the ironstone cellar. The old walls display contemporary artwork of various acclaimed and aspiring South Australian artists. The wine sales achieved through the cellar door and The Schultz Cellar Club have been so successful that about 12 per cent of the total domestic wine sales are now made direct to the public in this way. With a cellar door team of passionate locals, Schultz Wines has won the Best winery tourism (National) and Best winery (South Australia) awards each year for the last
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five years. Over the years, the company has received numerous other medals and trophies along with great accolades from wine judges in Australia and throughout the world. Domestically, the company has held the coveted industry award for the best ultra premium red wine for the last 10 years. Many medals have also been won on the international stage, including the prestigious Vin Rouge award for the best red wine at the 2008 Paris International Wine Show.

5. Performance
Schultz Wines performance over the last five years has generally outperformed the industry overall and the major competitors in the Australian industry. This is reflected in both profitability and productivity measures. Some key financial measures are summarised in Table 14. Table 14: Summary of performance
2005 2006 2007 2008 2009

Sales ($ million)Australian winemaking industry sales only Allens Group Limited Brooks Wine Company Limited Capricorn Wines Pty Limited Schultz Wines Limited Gross margin % Industry average Key competitor average Schultz Wines Limited Net margin % Industry average Key competitor average Schultz Wines Limited Return on assets % Industry average Key competitor average Schultz Wines Limited 6.1% 7.9% 8.1% 6.1% 8.2% 8.4% 6.1% 8.2% 8.6% 6.0% 8.1% 8.2% 5.8% 7.7% 8.0% 22.9% 20.9% 22.9% 19.8% 17.8% 21.5% 17.0% 15.0% 21.1% 16.1% 14.1% 20.9% 16.3% 14.3% 20.7% 40.3% 38.4% 42.3% 41.0% 39.3% 43.2% 39.5% 37.6% 41.8% 36.6% 34.8% 38.9% 34.9% 33.1% 37.2% 1 243 853 484 55 1 475 1 067 571 63 1 505 1 333 657 68 1 235 1 270 695 80 1 516 1 336 804 95

6. Management
The culture and the values that define Schultz Wines Limited have evolved around loyalty, hard work, talent, patience, teamwork and recognition of other peoples talents. The constant quest for improvement distinguishes Schultz Wines from other companies. Near enough is never good enough, but the demands of premium winemaking are always tempered with fun and a glass or two of wine at the end of the day. The small winemaking team is involved in all major decisions and works closely with the operations manager and other teams in the cellar, laboratory, maintenance and packaging departments. A grower liaison officer is the key point of contact for the independent grape growers. The wine quality lays the foundation for bringing the wine to market through the talent and creativity of the sales and marketing team. Their marketing and promotion ideas around the concept of the golden grape have won the Wine marketer of the year award several times. The finance and administration team is located in the winery which encourages better financial management, communication and prompt follow-up for customers and the sales and production teams.
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Senior company employees hold positions in the industrys peak bodies and research organisations, ensuring that Schultz Wines stays abreast of the latest improvements in viticulture, oenology and technology and can influence research directions. For example Schultz Wines is currently a partner in trials at an Adelaide plant to reduce the weight of selected wine bottles by between 18 and 28 per cent.

7. Latest developments August 2009

7.1 International expansion of the Schultz Wine Cellar Club
Given the success of The Schultz Cellar Club domestically, the marketing team undertook a review of the UK and US markets to consider whether establishing a direct sales model would be viable. The results of this review were highly positive. It was estimated that the extension of The Schultz Cellar Club would increase direct-to-public sales to about 20 per cent of total company sales, significantly improving the profitability of export sales. This will also assist in protecting the company from the strong margin pressure being exerted by the major supermarket customers. Detailed planning was now underway so that expansion could be incorporated in the companys operating plan for the next financial year. The strong branding and promotion activities had already been undertaken in these markets through existing distribution channel. Consistent with the brand position the company wanted to have, it was expected that the launch would include several prestigious events in exclusive hotels in New York, Los Angeles and London. There it would be announced that wine lovers around the world would be able to take advantage of special offers and rare releases. Expansion would mean that that the companys web site would need to be upgraded to enable international customers to place orders directly and pay over the internet. In addition, implementing this option would require a contract to be entered into with a distribution partner in the target markets to enable direct-to-consumer delivery of the companys wine.

7.2 India 2010 Commonwealth Games

Following the announcement that Delhi would host the 2010 Commonwealth Games, an Indian delegation recently came to Australia as invited guests of the Australian federal and Victorian state governments to promote trade between the two nations. Australian businesses seized on this as an opportunity to showcase their capabilities and provide information on products and services for the games specifically and the Indian market in general. India has a rapidly growing demand for products and services sought by a large and increasing middle class. With one of the largest and most diverse mixes of races in the world, it is very heterogeneous in terms of culture, business dealings and language and comprises a series of markets with many regional variations. The visit by the Indian delegation was highly successful. A number of Australian companies were invited to tender for business to provide products and services to the 2010 Commonwealth Games. In particular, Schultz Wines was invited to tender for the supply of ultra premium wines, notwithstanding that the company does not currently sell wine to the Indian market. Undertaking business in India invariably takes longer than normally expected, requiring great patience. Knowledge is therefore required of the local culture and how business is transacted. These skills could be learned over time or acquired through an agent, an employee or a consultant. Reports by the Australian Trade Commission (Austrade) reveal the following critical success factors for doing business in India: Good local partnersIt is essential to find good local associates and staff. Companies need to exercise great care when choosing agents, associates or staff if the intention is to build long-term relationships or establish local offices within India. While there is the opportunity to send Australian management teams to India, it is mandatory to have joint venture arrangements with local Indian firms in order for exporters to set up Indian business operations. Technology and knowledge transferFollowing decades of relative isolation, Indian professionals are anxious to achieve best international practices. In addition, the Indian government is keen to up-skill the Indian population through the transfer of technology capabilities and gain knowledge through training (either in India or Australia), technical workshops and secondments to enterprises.

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Political intelligenceIndia has a federal system of government based on strong provincial state rights and a national government. Major projects take a long time to be negotiated and approved as they need approval at both the national and state levels. If companies are to be successful in gaining project approvals, it is important to understand the bureaucratic processes in both the capital, Delhi, where national decisions are made, and the states. Having knowledgeable local staff is a key asset in this respect. Generally, it is a lot quicker and easier to do business in the private than in the public sector. Links with financial institutionsThe growing trend in India towards private infrastructure development means that effective links with financial institutions is becoming an important criterion for success in project development. Being able to package local and international equity and loan finance for build, operate and transfer (BOT) projects is becoming as important as technical capabilities. Repatriation of earningsThere are no restrictions on the repatriation of earnings by foreign companies from India, but every transaction requires Indian Reserve Bank approval and delays are commonplace. The Indian government, however, is addressing this problem by introducing measures to provide full convertibility of the rupee to other currencies.

The Australian government recognised the opportunity to position Australia as a supplier of high quality value added consumer goods and services, particularly where Australia has unique and competitive advantages. These include wine, high quality food products, tourism and entertainment. Therefore, the Australian government would assist Australian companies invited to tender for business in India to ensure their success, supporting company operations and trade through its Austrade offices in New Delhi, Mumbai and Chennai. These offices would assist with sourcing products and services from Australia, identification of potential business partners, and facilitate business investments both into and out of Australia, considering that India would be a new export market for many. The Indian government recently announced the successful bidders for contracts to supply wine to the 2010 Commonwealth Games. As the major wine producing nation within the Commonwealth, Australian winemakers featured prominently among the successful tenderers. Capricorn Wines Pty Limited was awarded the contract to supply premium sparkling wines while Allens Group Limited won the lucrative beer contract. Highly impressed with the quality of the wines produced by Schultz Wines Limited, the Indian government awarded the company with the contract to supply ultra premium red wines. This represented a major coup for Schultz Wines, as it was generally expected that these contracts would be awarded to larger suppliers. In addition, it created significant growth opportunities in the Indian market for its wines, as the company would now be able to export directly into this growth market. The contract would also provide high branding exposure for the companys wines in the lead up to the Commonwealth Games. An Austrade hosted delegation will provide the first opportunity for the winning wine companies to meet their Indian counterparts. Employees of Schultz Wines will travel to India as part of this Australian trade delegation in late October 2009 to establish initial relationships and organise the details of the contract.

7.3 Air Australia developments

Schultz Wines is working with Air Australia to develop a new product line of 150ml wine bottles for passengers on flights to India, showcasing its premium and ultra premium wines. The company has previously sold wine to Air Australia in the standard 750ml bottles. However, this would be the first time it would offer these new smaller sized bottles which are the equivalent to one standard glass of wine. Such sized bottles are already a well established container type used by the airline industry. Gift packs of three different wine styles are also being developed for Air Australia, incorporating distinctive artworks privately owned by Schultz Wines. The contract was to supply in glass bottles and the bottler employed by the company had provided a number of options for Schultz to select from, as it already packages wine in these smaller bottles for other winemakers. However, Air Australia had made an unexpected change to the terms of the project originally negotiated with Schultz Wines, asking that wine be delivered in 150ml bottles made from plastic polyester terepthalate (PET). This was part in anticipation of a future ban on glass bottles during flights by the Commonwealth Government for reasons of safety, and part because they considered PET bottles preferable from an environmental perspective. They noted that Besco, a leading supermarket in the UK, had successfully trialled the packaging of Australian and New Zealand wine in PET bottles in a move to reduce carbon emissions and the weight reduction of the packaging. This trial had also recorded reduced carbon emissions during
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transportation. With forecast high oil prices, the cost of aviation fuel was an ongoing concern for Air Australia and they considered PET bottles to have significant benefits to them in this regard. Air Australia reminded Schulz that a screw top cap on a wine bottle was once seen as radical, that consumers would become accustomed to them and that they needed to be proactive ahead of expected changes in legislation.

7.4 Schultz Wines considers acquiring Stefano Wines

With the successful tender for the 2010 Indian Commonwealth Games and the positive estimates for sales growth from Air Australia and the Cellar Club expansion, Schultz Wines had commenced negotiations with Stefano Wines with regard to possible acquisition. They had the finance available if they were to proceed with the deal. A further supporting rationale for the acquisition was that Fred Schultz saw the possibility of being able to use Stefano wine for the Air Australia project and thereby avoiding the erosion of the Schultz brand value that might be associated with plastic bottles.

End of the pre-seen information

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