Oz prepares to move in new Directions

18 May, 2007

The days of the cheap Australian own-label are all but over. Australia has finally recognised that it cannot compete in a sustainable way for the title of the world's cheapest wine producer.

According to Stephen Strachan, chief executive of the Winemakers' Federation of Australia : "There is no sustainable future for us with unbranded wine. The future of our business starts with our brands."

Australian wine has steadily been adjusting to this reality. The outcome of the tiny 2007 vintage and the likely implication of an even smaller and more difficult harvest in 2008 makes this adjustment more imperative, even inevitable. The recent release by the Australian wine sector of Directions to 2025 - a deeply detailed blueprint to assist all Australian wineries to become more sustainable and profitable - will help the industry turn its intentions into action.

Kevin McLintock, deputy chairman of McWilliam's Wines and chairman of the Australian wine industry taskforce that prepared Directions to 2025, said: "Australia cannot be the lowest cost producer. Not even the biggest players will go back to those places."

The sun has indeed set on Australia's former ambitions. Perhaps, before the sun rises on a new and different Australian wine industry, it will need to withstand a period of twilight that is partially of its own making. Why of its own making? Because Australian producers now acknowledge that, in their eagerness to gain and protect UK off-premise market share, they were complicit in letting the pendulum swing too far t o the supermarket buyer.

Now, the circumstances have changed. All of a sudden, Australia has less cheap wine to sell, a will to add more value, as well as a powerful means of providing greater returns to all levels of the off-trade by taking the consumer with them.

While the short 2007 vintage has brought these issues to an immediate head, it is the 2008 vintage that could ultimately have the most impact . Hammered by a biblical combination of once-in-a-century drought, global warming, frosts and fires, Australian grape growers in 2007 could produce only 1.3 million tonnes of fruit, 29 per cent less than the previous vintage. Tellingly, red wine was hardest hit, with the shortfall of red grapes amounting to 39 per cent.

The obvious and immediate impact is that the Australian oversupply has disappeared in smoke. Judging by the way that several major wine producers are now attempting to re-sign growers to medium-term contracts, Australia is fast approaching a deficit in fruit supply, if it hasn't reached it already.

Triggering a big crunch

Another immediate impact of 2007 is its crushing effect on the cost structure of Australian wine. For a start, it cost wineries between 15 and 20 per cent more for the fruit; and with the massive reduction in the volume of intake, processing costs increased by around 33 per cent. Most fixed costs associated with winemaking remained exactly that, as the only real ­areas where savings can be made in a short vintage are in power and to some extent in new oak.

So, if 2007 is perhaps the trigger point for change, what could 2008 ultimately mean? "It's the big crunch," says the managing director of Orlando Wines (Jacob's Creek), Stephen Couche. "The Murray Basin (Australia's major river system) is running on empty and (until further announcement) there are no water allowances for any irrigation. By October, the industry will have an idea about what is likely for 2008. If it rains like hell for ages, and there is some snowmelt, we might get 1.5 million tonnes (against 1.85 million in 2006). With another year of weather like this, it could be disaster."

McLintock believes that UK buyers will accept that they have enjoyed a good run over recent years, with "maximum efficiencies and high volumes" from Australia. As far as the UK supermarkets are concerned, McLintock argues that: "The communication (Directions to 2025) that has gone to the market is so strong and so compelling that it's clear that the market below £3.75 is no longer an issue for Australian wine. That can be switched to Chile, Argentina or California. More importantly, the consumers are telling us that they have a relationship with Australia at different price points. Our relationships are with the consumers, not just with the trade.

"There has to be a price increase for Australian wine - our reduction in tonnage demands that. It's neither possible nor sustainable for the industry to hold its prices. Will we lose market share? It's possible, but we hope not," says McLintock. "Retailers will accept this," he believes, and argues that the same has already occurred with French wine. "Once consumers get clear knowledge that we have wine styles that deliver everything they want between £7-£10, they will get excited," he says.

The penny will drop

Contrary to the views of many, Australia actually outperforms the off-trade in the UK market above £3.75 - it is also well above the market above £5.25 - and ­underperforms below. McLintock believes Australia's key challenge is to "vacate the sub-£3 market and defend our performance at £3.75 and above". Meanwhile, while Australia leads the on-trade's £11.25-£14.99 segment, it does poorly in the £7.50-£11.24 segment and is close to invisible in the segments above £15. It's obvious that Australia needs to become more of a player in this prestige area.

"With a looming shortage on the horizon, some people haven't yet realised this in a trading sense," says Couche. "The penny hasn't dropped yet, but it will."

The other major recent change in dynamic is the wine industry's release of the Directions to 2025, a document likely to have at least the measure of international impact recorded by its predecessor of 1996, Strategy 2025. Directions brings forward by several years the industry's goal of adding value and profitability .

The plain truth is that without a significant short-term improvement in the profitability of growing and making wine in Australia, the wine industry will fail to be sustainable. Directions seeks to increase the value of the Australian wine business by AUS$4 billion from AUS$26 billion to AUS$30 billion over the next five years. This number is almost entirely dependent on increasing value, and based on achieving a wholesale price increase of AUS $1 per litre indexed across the entire range of price points in domestic and export markets.

Australian producers are hoping that -without the burden of having to sell wine simply to clear inventories and maintain cashflow, and with the likely positive impact of a new brand strategy in the UK and other markets - there will be a shift in the balance of their relationships with major UK retailers.

To some extent it's a waiting game. With Directions, however, the industry has done as much as possible to place its destiny in its own hands.




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