Recent substantial increases in the input costs for producing wine have caused consternation and concern for most wineries in North America. There will be obvious and consequent effects on the bottom line for producers when they look at their annual financial statements. But should wineries wait to assess the impacts? We believe that wineries should take more proactive steps to ensure that their business models are not being quietly eroded. One useful metric is for a winery to calculate its per bottle production costs for each product in its range and ensure that pricing and production strategies are still sound given increased costs.
Our consulting work often provides us with visibility into the financial statements of wineries. While larger wineries have accounting departments that constantly monitor financial issues, many smaller producers do not. Recently, we have noticed that some wineries do not regularly track the “per bottle” production cost metric. In some cases, we have observed that this information can be useful in revealing surprising realities regarding the profitability of certain products and growth strategies.
The basic idea is to conduct an accounting exercise that will identify “direct costs” (e.g. grapes/juice, bottle, label, cork), “indirect costs” (e.g. winery overhead such as rent, labour, utilities, administrative costs) and “selling costs” (which may vary depending upon what channel the wine is sold in but for on-site sales would include the costs of running your on-site store) and then allocating these costs amongst your production such that you can generate a cumulative cost of production for each wine product. There may be some arguments about how to allocate certain costs, but with some creative math, you should be able to divide all of the costs of running the winery amongst your annual production such that you can see how much revenue is needed from each product in order for you to break even.
A few years back, I asked one winery owner about this. He ran a local winery that would be categorized as small to medium sized in BC (which means small on a global scale). He had tracked this metric and provided the following information that showed the profitability of one white wine that they produced:
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As you can see from the above the “direct costs” for this wine were $6.72. The “indirect costs” totalled $6.20 and the selling costs were $3.86. The profit margin for the winery was slim, only $2.59. Other products in the winery’s range were more profitable and the winery was profitable overall. In our recent experience, these numbers have been quite typical for smaller producers located in BC. We have seen a number of wineries where the calculations ended up in a similar range (e.g. about $10 per bottle for combined indirect and selling costs). The numbers may well be lower (or a lot lower) in other places since BC’s production costs are generally quite high and production is small, but the principles will be the same.
Nevertheless, in this example, you can see that even a small increase in the winery’s costs would have rendered the production of this particular wine unprofitable at this price point. We are concerned that this may be happening surreptitiously for many wineries since significant input cost increases have occurred in the past year or so. A relevant analogy may be that of the frog who placidly sits in a pan of water while the heat slowly rises. The frog does not notice the gradual increase in temperature until it is too late and it has expired. Similarly, while wineries will be well aware of increased costs, they may not have tracked the effects back to individual products and may discover rather late that they could have changed pricing or production strategies to minimize the damage.
More broadly, this metric can be useful for a winery’s strategic planning. Obviously there will be tensions and adjustments related to production levels for each product and an assessment of pricing tolerances within the consumer marketplace as well as how a particular product fits within the winery’s overall growth strategy and production. However, if indirect costs are relatively high at a particular annual production level, then it may not make sense to focus on low margin products … the path to profitability may lie only in products which produce better margins or for which you can, at least, cover your costs.