- Tuesday, 16 February 2010 00:00
This article discusses the current structure of the BC wine industry and Canada's various trade agreements such as NAFTA and GATT. I haven't written about this issue before because it is a tricky one for the BC industry. However, I have recently been asked many questions on these issues by various players in the industry as well as by lawyers and wine consumers. I am aware that a number of our trading partners are pursuing these issues.
The Problem: I'll explain in greater detail below but there are potentially serious trade agreement problems with the current structure of the BC wine industry because the current system provides preferential treatment for BC wine (with respect to liquor board markups and distribution) which is not provided for imported wine. Why is this a problem? It's a problem because two of Canada's most important trade agreeements, NAFTA and GATT, only allow preferential treatment in very limited circumstances. Generally, we are obliged to treat domestic wine and imported wine the same. This issue is of particular concern to me because much of the BC wine industry seems unaware of the issue and particularly unaware of the potential economic consequences of changes that may be required to comply with our trade obligations.
Our Distribution Systems: Import vs. BC
Essentially, British Columbia has two entirely separate distribution systems for wine. One system applies to imported wine (including wine imported from other Canadian provinces) and one applies to BC wine.
The system for imported wine requires that all wine landing in BC go through the monopoly wholesale distribution system run by the BC Liquor Distribution Branch (BCLDB). Typically, the importer/agent must request that the BCLDB order the wine on their behalf from the winery. The winery then ships the wine to BC. When the wine arrives, it is held in a bonded warehouse to which the importer does not have access. The wine can only be accessed when someone places an order for the wine which must be processed through the BCLDB (e.g. private store, restaurant or government store). Even the importer himself cannot access the product without purchasing it through the BCLDB. Once an order is processed, the wine will be transferred to the BCLDB warehouse and then eventually sent out to the customer. Without getting into great detail, this system has many problems, the most serious of which is an inability for the importer to deliver the wine in a timely fashion to customers. It often takes months for wine to be ordered and eventually delivered ... importers ordering wine for Christmas often have to ensure that orders are placed in the preceding spring!
In contrast, the system for BC wine is a model of simplicity and efficiency. BC wineries are permitted to "direct deliver" wine to customers (individuals, private stores, restaurants, etc...) straight from the winery. The BCLDB's distribution system is not involved. As a result, if a retailer wants to order a case of BC wine, they can simply call the winery and, if the wine is in stock, have the wine shipped direct from the winery to their store. The time from order to delivery is commonly a few days and can be as short as 24 hours.
As you can see, there is a huge difference in efficiency between these two systems. In addition, "Cellared in Canada" wines (which are really imported wines that are bottled here) can be delivered using the BC wine distribution system even though they are not really BC wines.
Differences in BCLDB Markup and Fees
British Columbia also has two different systems for charging liquor board markups, fees and taxes on wine.
As noted above, all imported wine is sent through the BCLDB system. Wine sent through this system is subject to a wide range of markups, fees and taxes. The most egregious of these for wine is the BCLDB "markup" of 123%. Taxes (12% HST) are piled on top after the liquor board markups and fees have been applied. For more info on these fees, check out these BC liquor store price and markup calculators.
In contrast again, the system for BC wine is more sensible. BC wine that is "direct delivered" does not go through the BCLDB system and no LDB fees or markups are applied. The customer will only pay the sales taxes (HST at 12%) and recycling fee. This system obviously provides a substantial benefit to BC wineries, enabling them to keep a large portion of the sale price.
However, BC wine that is sold through government liquor stores is subject to BCLDB markup and fees. However, a portion of that markup is rebated back to the winery through a program usually known as the VQA Support Program or QEP (Quality Enhancement Program). This was done to encourage the sale of BC wine in government stores which would otherwise have been an undesirable channel for BC wineries from an economic perspective. Ontario has recently introduced (actually re-introduced) a similar program.
Once again, as you can see, there is a huge difference between these two systems. Customers end up paying 12% total taxes/markups in the BC direct delivery channel or more than 135% in the BCLDB channel.
Trade Agreement Trouble
The legal problem with the above system is that under NAFTA and GATT, we (Canada and British Columbia) are obliged to generally treat imported and domestic wine the same when it comes to tax treatment and liquor board markups. Historically, this has proved to be a contentious issue. In fact, the EU made a trade complaint under GATT against the Canadian provinces (including BC) back in the 80s. At that time, the BCLDB applied lower markups to BC wine than to imported wine. Canada lost that dispute and a settlement was entered into under which Canada agreed to afford non-discriminatory treatment to imported wine with some limited exceptions based on practices that were in existence in 1987 (see this federal government article for details, particularly the Trade Related Factors section). Significantly, price differentials between domestic and imported wine as applied by the BCLDB were supposed to be removed completely by 1995. As you can see from the distribution and pricing descriptions above, BC's current system does not do this.
Benefits for BC Wine Industry
The BC wine industry obtains substantial benefits from the above structure. Firstly, BC wineries have a competitive advantage in terms of distributing product more easily and efficiently.This makes it easier to get wine into restaurants/bars/hotels as well as to retailers. Secondly, and more importantly, imported wine is subject to the hefty 123% LDB markup which results in imported product being priced higher in the BC market than it otherwise would be. As such, BC wineries can price competing products higher than they would otherwise be able to plus they will either avoid all LDB markup if they sell it through the direct delivery channel or get a much reduced markup if they sell it through government stores and the VQA Support Program.
Why We Should Be Worried
The following are the main reasons why we should be concerned.
Markup Gap. As noted, the gap in the application of LDB markup as between imported wine and BC wine is huge. This is a source of contention for EU wineries, for U.S. wineries, for importers and for retailers. I am frequently asked about this issue and the number of questions has increased recently. Some of these groups are very frustrated. Sooner or later, there is bound to be a NAFTA challenge or another GATT challenge or this topic will become a critical part of a trade negotation (such as the current EU-Canada negotation).
Distribution System. A lesser but still important concern is the gap in distribution treatment between imported and BC wine. The importers, EU wineries and U.S. wineries are also frustrated with the inefficiency of the LDB distribution system. This frustration has been amplified by recently by the fact that Cellared in Canada wines (which are really imported wines) can take advantage of the more efficient direct delivery system. If things do not improve on this front, this will simply add fuel to the fire for a trade challenge.
Economics of BC Wine Production. Nearly everyone in the BC wine industry knows that it is very expensive to produce quality wine in BC. We have high labour costs and high land costs. We do not have the economies of scale which make it easier to absorb cost increases or fluctuations in input costs. These factors are very difficult to change. Many recent entrants into the BC wine industry have based their business models on the current pricing structure which enables BC wineries to charge relatively high prices for their products.
Economic Assistance. It is my view that the BC wine industry needs some form of economic assistance in order to continue its focus on quality and to cope with high structural costs. However, as described above, the current system is focused on the retail level. The system is in conflict with the interests of the consumer who is then effectively overpaying for all wine that is purchased. I am not aware of any other significant wine-producing country that uses such a system. Most wine producing countries use smarter "back-end" assistance which does not skew the prices at the retail end.
IILA (the "shipping law"). As many BC wineries know, the Importation of Intoxicating Liquors Act is the post-prohibition era law that prevents them from shipping wine to consumers in other provinces. However, this law is also the foundation of the monopoly liquor boards' ability to cut off the interprovincial and international trade in wine (and liquor generally). As such, it is the law that also enables the BCLDB to force all imported wine into its distribution system replete with huge markups. Most lawyers who are knowledgeable in the area believe that this law is unconstitutional. If the law is struck down, which it is likely to be at some point, then the monopoly's power to create preferences will be damaged, perhaps irrepairably so.
I am very concerned that the current system is a prelude to major problems for the BC wine industry. The BC wine industry has come to depend upon the current system and many wineries rely upon it for their business models and profits. Unfortunately, the preferential treatments are unlikely to survive for much longer because they are not permitted by the relevant trade agreements. Many knowledgeable individuals in the industry have confided in me that they are very surprised that the preferences have lasted as long as they have.
I am aware of numerous groups that are currently pressing hard for change and I would be surprised if at least one of them did not succeed. However, a sudden collapse of the preferential system will be a disaster for BC wineries because they will simply have no chance to adapt or to restructure their operations. It is my view that the whole system needs to be reformed sooner rather than later in order to address these serious issues and to bring our system into compliance with international trade obligations. A measured plan for reform is much more likely to benefit the industry as a whole and for the long term. I would really like to hear what you think on these issues ... please let me know.