Friday, May 1, 2015

How Much Did Wineries Really Make in 2014?

     The Only Place You Can Get This Information

Silicon Valley Bank is many things but chief among them is focused. We only handle the fine wine business, the innovation economy (technology companies), and the technology funding universe (VCs, Hedge Funds, etc.). I've had clients who ask if we will handle the banking for their totally credit-worthy non-wine companies, and my answer is always: "If I did that, you wouldn't like me as much as you do now."

Extreme focus provides the opportunity to allocate all of our resources into the two industries we serve. We put all our eggs in two baskets ....... or maybe we should say we put all our grapes in one basket press?

Because of our all-in approach to the wine business, my time is fully invested in this industry and as a consequence, I get to see more relevant information than probably anyone else in the US. If we diluted that focus and started to bank an assortment of non-wine businesses as is the case with virtually all other commercial banks, we wouldn't be able to spend the time and effort required to understand this unique industry and develop the content and expertise which helps our client's find success. 

Our approach gives us the unique opportunity and platform to give fact supported answers to questions such as, How much do wineries really make?

     Peer Group Analysis - A Unique Analytic Tool

One of the tools we invented 20 years ago is what we call PGA which stands for Peer Group Analysis. Its a financial benchmarking database. The Database is composed of thousands of reviewed and audited financial statements going back to 1990.

We can sort the data into different groups and provide a snapshot to a client based on the region, varietals produced, cases produced, business model and many other factors. We have the ability to narrow it down to wineries who are mainly direct, with a tasting room, and sell primarily pinot noir. The output has proven invaluable to our customers.

     How's Your Winery Doing Neighbor?

If you aren't in the wine business, you might be saying to yourself at this point, "Self? Shouldn't the wineries know what good financial performance is? Should you really trust a banker's perspective over your own?" 

We all know that you can't trust bankers or politicians, but moving by that fact - the wine business is virtually all private. Even Gallo which is the largest wine company in the world is private, so financial statements aren't just lying around for winery owners to review.

You might also reasonably ask, "Don't winery owners share information between them?" That answer is yes and no. Sure, wineries might share a glass of wine across the fence line, but they only see their own financial results.

There's a sense in the business that your neighbor is just that; they are your neighbor, not a rival or a competitor, so lots of information and stuff is shared. If you need a tractor because yours is mired in a soggy field, no problemo! Need a little welding and custom fabrication on a pump? I'll be right over with a welding rig. Stuck fermentation? I'll send over a portable heating unit.

That kind of sharing happens all the time. But ask for a customer list, or ask "Can you show me a copy of your financial performance so I can compare my winery to yours?" The answer is always just < ..... crickets ..... >. When it comes to that question you'll just get a mixture of liars dice, false bravado, partial truths and ..... well ..... the following video we put together is the best explanation of how that game is played in wine country.......

You might be able to fool your neighbor on your cost of goods sold per case, or put your marketing hat on and fudge your growth rate upward from actual, but as bankers we get the real financial information. We're a little harder to fool but since I'm going to share some of the inside information with you too, now you can call out fact from fiction when your neighbor spins tales.

     How Much Do Wineries Really Make?

The following chart is one that I present each year in the State of the Industry Report and use in many of my speeches. (You can see a larger view with by clicking on it.) It's a summation of the financial performance of the wine business since the 2006 calendar year and has just been updated this week to include the 2014 fiscal year end results.

It's important to understand the data are not weighted by case size. Had we weighted the results by case size, the largest volume producers which grow by about 2%-3% annually, would dominate the data making the benchmarks useless for most of the wine business. The "average" winery is quite small by case production measures but higher in sales growth rates compared to the largest wineries.

In the following PGA chart, the red bars represent gross margin (sales minus the cost of sales), and the green line is pretax profit. The blue line is industry sales growth. You can back into total operating expenses if you are interested, by adding pretax profit and gross margin and subtracting the sum from 100%. The scales for each point of information are on the right and left vertical axes.


Accrual Statements

When the statements were all collected and input this year, wineries ended up having a better overall year in 2014 than we had earlier estimated, showing a 8.0% pretax profit margin on overall sales growth of almost 12%, an increase from 9% sales growth in the prior year. That robust growth rate was above our predicted sales growth range of 6% - 10%, a forecast we released in January of 2014 in the State of the Industry Report.
What you notice from the chart is gross margin in the wine business is far from consistent. Even if grape sales were constant, trade discounts and pricing opportunity will vary year to year changing the gross margin.
The reality is purchased grapes run through cycles based on supply and demand. Estate wineries have higher and lower costs of goods based on farming costs and harvest yield. Estate grown grapes in a heavy yielding year have lower costs per gallon because the more fixed nature of farming costs can be spread over more tons harvested.
The industry average gross margin at this point is almost back to a cyclical high at 56.8% which is an increase of a whopping 200 basis points from 54.8% gross margin in the prior year. That increase is reflective of lower costed estate juice from the heavy 2012 yield, and a changing business model for small wineries who without wholesaler support, have to go direct to the consumer to sell their wine now.

While Napa County gross margins improved year over year in 2014, 2/3rds of the industry improvement in gross margin was from non-Napa wineries. It's hard to say from this angle if that is due to the inability of Napa to fully pass on higher grape costs compared to other regions, the fact Napa is ahead in direct sales that carry higher margins and the other regions are closing the gap, or the result of higher grape costs alone in Napa compared to other regions. That's something to sort out for another day.

      Direct Sales Fallacy

It should also be noted that while the gross margin is better on direct sales versus selling through the 3-tier system, there are substantial costs incurred with staffing, facilities, and an investment in digital infrastructure that are not included in cost of goods sold. It's a fallacy to think higher margin DtC sales will solve all the issues associated with small wineries inability to get wholesaler representation. Many of those costs are embedded in the General and Administrative expense load. So while gross margin has returned to near historic highs, net profits have not recovered because of the higher costs in direct consumer sales. There is quite a long way to go to get back to those halcyon days of 10%+ pretax profitability.

Net profit in 2014 was still a very respectable 8.00%, up from 6.60% but a quick review of the PGA chart shows profit is still a long ways off the highs experienced in the middle 1990's and again in 2006 and 2007. That is the impact of the changing business model and the required investment in direct sales.

     Cash Flow Impacts

Accounting profits are different from annual cash flow in the wine business. A great example is the 2012 harvest. When that harvest was underway, wineries were selling essentially 2010 bottled wine which was a short harvest year. They were paying for grapes in 2012 that had moved higher out of the recession as inventories were feared to be running short, and with estate wineries, the costs were higher due to the short crop. They were also working on smaller inventories to sell.
At the time of the 2012 harvest the consumer was still recovering, so wineries were unable to pass on any price increases to the consumer. That's a different situation in 2015 as we have come off a 3rd consecutive heavy harvest so the cellars are full. As we noted in the 2015 State of the Industry Report, we are just now starting to see wider participation in a consumer recovery and that may lead to some modest price increases in 2015 for wine producers.

          What Do You Think?

So now you know how much wineries really made in 2014. Any surprises to you? Of course there will always be some neighbors who cast disdain upon bloggers, don't care about benchmarks, and have their own sense of reality. I've known a few of them in the past 30 years but none who wore a red sweat suit like this neighbor .....

      Weigh in with Your Thoughts and Opinions!!

  • How do you see winery profitability? Can wineries pass on higher grape costs and increase margins further in 2015? What concerns should owners have with the solid financial performance of the fine winery producers at this stage in the cycle? How can wineries get back to the kind of profitability experienced prior to the great recession? Do you have a red sweat suit?
    Please join the site in the upper right hand of the page and offer your own thoughts for the benefit of the wine community. And if you think the discussion is worthwhile, please promote this on your favorite social media platform.


    1. Rob - amazing content as usual! I am glad someone more intelligent than I is trying to dispell the DTC fallacy. Just because a winery is able to do some accounting magic to show higher gross margins doesn't mean they are making any more money. Do you have numbers for the average SG&A costs associated with DTC?

      1. Juan - Thanks for logging in and the comments.

        I don't have the SG&A data, but we are looking right now at seeing if we can break out the models by profitability, so in theory we should (might) be able to back into them. If we can get something digested, we will post on that when available.

      2. Rob - Thanks for the response. I would be very interested. My gut tells me that even though many small to medium wineries (500 to 15,000 cases) are able to sell "95% of my wine DTC and have no reason to seek distribution" those wineries are not maximizing shareholder profits.

      3. I wouldn't be so quick Juan. For most, they can't get distributors to pick up the phone, so DtC is all they have

        I go back to the early 90's in Napa when declining sales led owners to open tasting rooms and start wine clubs. It wasn't because they wanted to. It was because they had to. That led to Napa Winery Definition Ordinance but by the mid 90's when distributors couldn't find wine for demand, tasting rooms became after-thoughts.

        Point is, if wineries could have someone else sell their wine and focus on production, I guarantee they would because it's easier and less expensive.

      4. Juan,

        "Seconding" Rob's observation about distribution, wineries are farms -- owned and run by farmers.

        In the argot of business school, growing grapes and making wine are their core competencies.

        Marketing their brand(s) and selling wines is not their forte.

        Anyone who had taken an advanced accounting or finance course in business school is taught about "make or buy" corporate decisions.

        Some wineries "make" their own sales force: we call them the founders' children.

        Other wineries, bereft of future heirs who wish to enter the family business, are forced to contract out sales to the three-tier distribution system.

        Wineries without future heirs seek an exit strategy as the founders approach/enter their retirement years.

        See this Wine Spectator article:

        “West Coast Wineries Are Up for Sale -- Quietly”

        [Summary: A wave of recent deals show investors see opportunities in wine, while owners see an exit strategy.]


        ~~ Bob

      5. Rob and Bob - Couldn't agree more! That is my point. I don't think many wineries want to be in the sales and marketing profession. Yes they are farmers and I don't think I could name many farming industries that are vertically integrated the way wineries are. What I am getting at is that many wineries, when asked if they would like distribution, have responded that they are fine with DTC. Perhaps they have been doing it for so long now that they have forgotten the opportunity costs associated with it??

      6. Thanks Juan. Hopefully we'll be able to shed some light on that in the near future if we can pull the research together.

      7. Juan, it's a stretch to assert most wineries are in the farming business. It's like SVB being in the adding numbers business. It's something they do to support their core business of producing and selling wine.

        Whatever world we'd like to exist, the reality is that wineries have no choice but to pursue DTC. Outside the tasting room, most are crap at it... but maybe that's because they don't have any platforms and are left to fend for themselves with, what, a website that no one visits?

        Even cozy knitters have Etsy.

      8. Michael,

        We all agree that wineries are in the agriculture business. They grow an annual crop that gets harvested.

        I'd call that farming.

        Production is their core competency.

        Wineries elect whether to sell off their picked grapes or crushed grape juice as a commodity to others (bulk market, négociants).

        Or "add value" by elevating the grape juice to wine, branding it, and distributing it -- thus creating an "augmented" consumer good.

        (See Harvard Business School professor Theodore Levitt's classic article on this subject:

        "Marketing Success Through Differentiation—of Anything"


        We all agree that many wineries fail rather badly at marketing/selling.

        That is not a core competency of wineries. That is an elective task.

        The three-tier distribution system fills that need.

      9. Bob, I agree that the typical small winery is bad at marketing/selling. I completely disagree that this condemns them to the bottom of the supply chain and is no excuse to rely on the three-tier system to take care of them.

        What 100% of wineries do is sell wine. A lot of them produce their own wine. And a smaller number employ farmers that grow fruit. Logically it doesn't make sense for the defining characteristic of a market participant to be something that only a modest portion have. Wineries sell wine.

        If I follow your logic, then small wineries (who are not good at marketing) should only sell to three tier. However, since distribution is less and less an option for these wineries, then maybe they should simply make bulk wine and sell it to larger wineries. But since their production economics are unlikely to support this, they should just sod off and go home?

        My silly comment about Etsy still holds. I view this less an issue of the marketing capabilities of small wineries and much more an issue about the complete lack of direct sales channels designed for small wineries.

      10. The salient quote from the cited Wine Spectator article:

        "While small wineries can succeed by selling most of their inventory direct to consumers, and large producers have muscle with wholesalers, those in the middle -- annual production of 5,000 to 15,000 cases, for example -- can’t get much attention from distributors unless the brand is hot."

        DTC (mailing lists, tasting rooms) can't move enough inventory in a timely way (vexing problem: irregular cash flow from unpredictable monthly and quarterly sales) at that middle tier production level.

        Those wineries may need to downsize to "boutique" level. Produce less branded wine. Sell off grapes as a cash crop.

        Or stay at that production level and avail themselves of the three-tier distribution system.

        Aside: the "Long Tail" argument has been challenged by Harvard Business School professor Anita Elberse.

        From The Wall Street Journal “Marketplace” Section
        (July 26, 2006, Page B1):

        “It May Be a Long Time Before the Long Tail Is Wagging the Web”

        [Part 1 of 2 Columns]


        By Lee Gomes
        “Portals” Column

        -- and --

        From The Wall Street Journal “Marketplace” Section
        (August 2, 2006, Page B1):

        “Many Companies Still Cling to Big Hits To Drive Earnings”

        [Part 2 of 2 Columns]


        By Lee Gomes
        “Portals” Column

        -- and --

        From The Wall Street Journal “Marketplace” Section
        (July 2, 2008, Page Unknown):

        “Study Refutes Niché Theory Spawned by Web”


        By Lee Gomes
        “Portals” Column

      11. Michael,

        Just so we aren't talking past each other: I am discussing middle sized wineries, not SMALL "boutique" wineries.


    2. Replies
      1. Thank you Paula. Now if I could only make money writing! Thankfully, some wineres take pItty and come to bank with me. They correctly reason they can Bank with am expert, or pay the same to bank with a non-expert. (Gratuitous plug for me. Sorry.)


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