In 1985, legendary wine critic and industry shaker Robert Parker did something he had never done before: he gave a bottle of California wine a 100 rating. The perfect score went to a 1985 Reserve Cabernet Sauvignon produced by a struggling start-up, Groth Vineyards & Winery. In Napa Valley, the geographic heart of the U.S. wine industry, a perfect score from “The Nose” is a big deal. A Parker rave often triggers a market frenzy, lifting reputations and prices. Conversely, a bad review can leave thousands of bottles sitting on warehouse shelves.
The 100 score from Parker put Groth on the map, catapulting the obscure winery to stardom. Amid the industry buzz, however, few observers noted a small irony: the perfect balance of grapes in that 1985 Cabernet was produced by a lifelong bean-counter. Dennis Groth spent 13 years at accounting firm Arthur Young and Co. and was CFO at electronic-game maker Atari when he plowed money from his profit-sharing plan into a 121-acre vineyard nestled in Oakville, California. Although Groth and his wife, Judy, initially lost their bank financing, they persevered, pouring more of their own money into the project. “It took us 24 months to sell our 1983 vintage,” the CFO-turned-vintner remembers. “But we were determined to demonstrate we could make a good wine.”
Two decades later, Groth still produces good wines, harvesting mainly cabernet and sauvignon blanc grapes from the vineyards dotting the lush valley in Oakville. But for Groth — and executives at smaller wineries in Napa — the landscape is changing.
An industrywide consolidation is beginning to squeeze smaller producers along nearly every price segment of the market. Well-capitalized global beverage conglomerates like Diageo Plc, Foster’s Group Ltd., and Constellation Brands Inc. have brought risk management and financial discipline to the wine business, fashioning small empires that can withstand blips in the marketplace. And cheap imports from Australia, a country flush with an overabundance of grapes, have come to dominate the slurp-and-burp sector. The most successful Aussie import, Casella Wine’s Yellow Tail brand, is now the ninth most popular wine brand in the United States, and the single biggest seller in grocery stores. Says Barbara Insel, managing director at MKF Research LLC: “Everybody’s getting out of their way.”
The crush of competition has made things difficult for finance executives at many of the 4,000 wineries operating in the United States, most of which are small, family-owned businesses like Groth. As with finance managers at small-to-midsize businesses in other consolidating industries — software, banking, telecommunications — these CFOs must control costs, protect brands, and, above all, maintain margins.
It’s no easy task. Although domestic wine buying jumped 4 percent (to $23 billion) in 2004, sales are increasingly going to brands owned by large, acquisitive multinational corporations. Constellation, in particular, has been picking off wineries like so many dead-ripe grapes on a late summer day in Sonoma — and in the process, transforming the industry. “The traditional way of growing the business was beating the pavement and selling more wine,” says Jon Fredrikson, president of wine consultancy Gomberg, Fredrikson & Associates, in San Francisco. “But Constellation has been very successful at digesting acquisitions and leveraging deals. And others are now trying to do the same thing.”
In this changing industry, bigger appears to be better. While Groth sells 40,000 cases of wine a year, Constellation sells 56 million in the United States (second only to E&J Gallo Winery among U.S. producers). Constellation’s sheer size affords it huge advantages in distribution, risk management, and marketing. Says Mark Swartzberg, an industry analyst at Legg Mason: “The value of scale in the wine business is going up.”
Right now, few wine operators have more scale than Constellation. In the late 1990s, an overabundance of grapes led to a slump in the wine industry and a drop in prices of the few publicly traded wine corporations. Constellation pounced. Its buying spree over the past few years has given the global beverage conglomerate the kind of cachet it often takes small wineries decades to attain. The acquisitions include Franciscan Oakville Estate in 1999 (and with it, that winery’s well-regarded Cabernets), Zinfandel specialist Ravenswood in 2001, and last year, in a $1.36 billion deal, Napa fixture Robert Mondavi. Says Dennis Lohouse, a principal at Bryce Capital Management: “Constellation’s plan is, if you put a blindfold on somebody in a liquor store, what’s the probability of touching a bottle of their wine?”
So far, the plan is working. In its fiscal year 2005, the $4 billion (in revenues) Constellation reported a 19 percent increase in wine sales. The task of examining potential acquisition targets falls, in part, to the company’s Harvard-trained executive vice president and finance chief, Thomas Summer. The Constellation CFO says the beverage company conducts detailed due diligence to make sure a potential acquisition “fits our filter.” If a target passes the initial tests, management then analyzes financial models and the assumptions driving those models — in particular, cost savings from synergies. “We’re not turnaround specialists,” insists Summer. “We like to buy good businesses.”
At exactly the right time, too. Constellation’s ongoing hostile bid for Canadian rival Vincor International, for instance, was launched when the Toronto-based company’s revenue was sagging and its stock price was near its 52-week low. A resistant Vincor management has dubbed the bid for the company (and its highly prized brands such as ice-wine specialist Inniskillin) “opportunistic.” But Constellation’s initial $31 (Canadian) tender price worked out to a 39 percent premium for shareholders. That kind of windfall tends to put pressure on a board of directors. Says Lohouse: “Constellation knows how to price a deal.”
One Sip and It’s Over
Constellation’s approach to good taste — buying it — has raised hackles in some wine circles in California, which produces 64 percent of all wine sold in the United States. But even those who see Big Wine as the rootstock of all evil say it’s hard to fault a strategy that hedges risk in a business where a cold snap can ravage an entire vintage. By purchasing vintners of all sizes, varietals, and locations, global beverage companies have been able to cap their exposure. Within limits, grapes from one region can be mixed into wines from another. Hence, a mediocre growing season in Napa Valley can be offset by a great vintage in Barossa Valley.
Smaller wineries, on the other hand, are pretty much stuck with what’s in their blending tanks. Most sell only a few varietals made almost entirely from their own supply of grapes (known as estate wines). Additional grapes can be purchased, but for producers of expensive, ultra-premium wines, such a move can soil a brand’s hard-earned reputation.
Even many midsize houses produce much of the fruit they use. J. Lohr Vineyards & Wines, for example, supplies 95 percent of the grapes that go into its wines from the 3,000 acres of vineyards the company owns in Paso Robles, Monterey County, and Napa Valley. James Schuett, CFO of the winery, which produces 750,000 cases a year, says monitoring inventory throughout the wine-making process is crucial. Toward that end, the winery is currently integrating its database of bulk-wine and case-wine inventory with the company’s general ledger. Keeping track of Lohr’s raw materials, says the finance chief, ensures quality and consistency.
While the au chateaux approach does produce some heady wines (J. Lohr’s Estates Seven Oaks Cabernet from Paso Robles has won numerous awards), it also can lead to supply headaches. When Lohr launched its Cypress value brand in the late ’80s, sales of the inexpensive but solid wine outstripped supply. “We couldn’t meet demand,” recalls Schuett. “We lost some momentum.”
An oversupply of grapes is even more disastrous, which explains why finance executives in the business spend so much time rejiggering 5- and 10-year forecasts. Such long-term planning is necessary in an industry where part of the supply chain is weather-dependent, and it often takes years to bring a finished product to market. “Most businesses want to hang on to inventory as little as possible,” notes Rob Morris, onetime controller at David Bruce Winery and now senior manager at accounting firm MKF/Frank Rimerman. But with the aging of wine, producers have no choice but to hold on to inventory for a long time.
Even with forecasting, smaller wineries have no idea what awaits them at the end of what is often a five-year production cycle. Says Groth controller Carl Ebbeson: “Shipbuilders and other businesses with such long lead times have contracts before they start. We don’t.”
Good reviews from Parker’s Wine Advocate or rival The Wine Spectator pretty much guarantee sold-out stock. Glowing write-ups — transformed into in-store marketing blurbs called shelf talkers — greatly influence customers. But while wine critics can propel a small house like Groth to stardom, they can also poleax 10 years of planning. “Demand is the great unknown,” laments Ebbeson. “All it takes is one wine writer to [take a sip] and say, ‘What is this crap?’”
Price and Position
Global beverage companies hedge WITC risk by offering a diverse range of wines. Multinational operators like E&J Gallo, The Wine Group, and Constellation sell wines at nearly every price point, from jug wines at less than $3 a bottle to ultra-premium products (more than $14 a bottle).
At California-based Delicato Winery, which sold 1.5 million cases under its own label in 2004, management has developed what current chief executive and former CFO Chris Indelicato dubs “a portfolio of risk.” The idea, says Indelicato, is to sell 200,000 cases each of seven or eight brands, rather than one-and-a-half million cases of one varietal. “We spend time and money examining each varietal by price point,” Indelicato says of the family-run winery, which launched its first Delicato-branded product in 1994. “We want to determine where the opportunity is.”
Sizing up an opportunity — and seizing it — are often two different things for smaller wineries. By law, a spirits company must sell its products to licensed wholesalers, which, in turn, sell to licensed retailers (the so-called three-tier system). But small wineries don’t get on the radar screen of retailers without good relationships with distributors. And industry watchers note that a wave of consolidation has dramatically pared the number of U.S. wholesalers. Big market states such as Illinois and Florida now have 2 major distributors where before there were a dozen. All told, the top 10 distributors account for nearly 60 percent of the wine and spirits distributed in the United States.
Large multinational beverage companies have spotted an opening in the rise of these megadistributors. Some are trying to get large distributors to focus solely on their wide array of brands. The one-stop shopping approach has some appeal, too. Says Groth’s Ebbeson: “The advantage of a large winery is that they go to a distributor and say, ‘Here, we’re selling this Cabernet.’ If the distributor doesn’t like it, they then say, ‘OK, here’s another one.’”
Groth recently lost two-thirds of its sales force at a sizable distributor. The reason? Ebbeson says Diageo Plc insisted that the distributor sign a sole-supplier agreement for California sales — all part of a national strategy the UK-based Diageo calls “Next Generation Growth.”
The arm-twisting is taking its toll. According to Steve Gross, director of state relations for the Wine Institute, a trade association of wine producers, in San Francisco, only 17 percent of its members currently have complete national distribution. “If you’re a little winery,” says Gross, “getting an appropriate share of the attention of retail licensees can be difficult.”
With dwindling shelf space, some wineries have resorted to cutting prices. But Stuart Bockman, CFO at midsize winery The Hess Collection, based on Mount Vedeer in the Napa Valley, warns that discounts can have unintended consequences for sellers of ultra-premium brands. “Price is one of the main indicators of positioning of a wine,” explains Bockman. “Discounting can damage the brand.”
Come to the Cabernet
A number of wineries are attempting to move up the price ladder, where the margins on expensive Cabernets and Pinot Noirs are healthier (see “Chateaux Boxing” at the end of this article). Getting there won’t be a snap, however. “Everybody wants to move up,” says Hess’s Bockman, “but it’s easier said than done.”
Rather than face that uphill slog, some vintners will likely sell off individual brands — akin to biotechs selling hot new drugs to global pharmaceutical companies. Indeed, asset sales have already started in the wine business. In September, in a move that underscores the growing importance of clout in the industry, Hahn Estates sold its wildly popular Rex Goliath brand to Constellation. “Because of our size and scale,” says Summer, “we can take those brands and get greater distribution without spending a penny.”
Some industry observers believe such cherry-picking isn’t good for the grape business. But Indelicato, a competitor, sees the value in these kinds of deals — for both buyer and seller. “Hahn took Rex Goliath as far as it could. Constellation can take it and double it overnight.”
Back in Oakville, Groth, too, has plans to double its sales. But Dennis Groth says it will take the winery several years, plus a fair amount of cash, to get there. The wine business, he says, is a lot different from what it was when he got that 100 score from Robert Parker 20 years ago. Thinking back on the old days — and the changes currently roiling the wine industry — the former CFO pauses. “If I knew then what I know now,” he says, “I probably wouldn’t have gotten into this business.”
John Goff is technology editor of CFO.
Wine sales by price points