WineLaw.ca

VICTORIA, BC. March 20, 2015 5 pm.

The “S.S. Liquor Policy Review” ran aground on a small island in Georgia Straight late Friday afternoon en route from Victoria to the mainland. Tragically, the ship took on water quickly and sank before rescuers arrived. The island is a known marine hazard and is clearly marked on charts of the area as “The Isle of Lack of Consultation”. Early indications are that the ship hit the island due to conflicting navigational information from its two onboard guidance systems, colloquially known as LDB Wholesale and LDB Retail. It appears that a software update known as “Flat Tax” had not been installed, which would have prevented the errors.

The ship went down with all souls aboard, including prominent socialites “BC Food & Wine Culture” and “BC Hospitality Industry”. Also lost was considerable cargo including 12 independent wine stores, the workable profit margins from hundreds of other retail stores and the business models from restaurants throughout the province. The captain of the ship was not aboard, having travelled from Victoria earlier in the day by a private sector helicopter.

Vessels from BC Ferries and Translink were in the vicinity but, unfortunately, were using the same faulty communications systems as the stricken ship and did not receive the distress call. Despite the enormous popularity of the route in its first year of operation, recent sailings had been plagued with mechanical difficulties causing a loss in confidence. Government appeared unprepared for the disaster and, thus far, has indicated that the route will not be replaced. A spokesperson stated: \”we have no backup plan … for the moment, consumers should make the trip from Victoria via Washington state or Alberta\”.

The BC Government has announced its initial rules regarding the sale of wine and liquor in supermarkets in this policy directive, Phased-In Implementation of Liquor in Grocery Stores, and this press release, Lottery Announced for Liquor Store Relocation. The rules and process are fairly complicated … and the ability of a supermarket to sell various types of liquor or wine, and the way that they sell them, will depend upon the license type that they are able to obtain via relocation. A lottery process is being established for relocation applications since the relocation of LRS and GLS stores will be subject to the 1 km rule (newly extended to GLS stores). The relocation of VQA or IWS stores will not be subject to the 1 km rule and do not need to be part of the lottery. The current documents do not refer to the issuance of new licenses for supermarket sales which has been referred to previously by government. 

As has been widely reported in the mainstream media, the BC Government has revised its previously announced wholesale pricing formula (which would have significantly increased the prices for all wine over about $15 – see previous story) and replaced it with a new formula which is intended to \”align\” end consumer retail prices with what they are today (see press release: Minister\’s Statement on Wholesale Wine Prices for Industry). The announced change was a reduction in the second tier \”liquor board markup\” from 67% under the old formula to 27% under the new one … a significant change of 40 percentage points.

I have now analyzed the formulas and provide both wholesale and retail price comparisons in the following PDFs for wine at various price points under both the old and new systems: Price Comparisons $7-$12; Price Comparisons $15-$25 and Price Comparisons $30-$70. There are some interesting issues that arise from the comparisons.

Wholesale Prices for LRS Stores. If wholesale prices for wine are compared for LRS private retail stores under the old and new systems, it is apparent that wholesale prices will go down for all wine that currently retails for less than about $15 (see the PDFs for examples). In contrast, wholesale prices will go up slightly for wine that currently retails for $20 or more. 

Wholesale Prices for IWS Stores and Government Stores. Wholesale prices will go up significantly for all independent wine stores as they will now be paying the same wholesale prices as LRS stores (i.e. effectively losing the additional wholesale pricing discount that they previously had). Government liquor stores previously did not pay wholesale prices at all. Under the new system, they will purchase at the same wholesale prices as both LRS and IWS private stores.

Retail Profit Margins for LRS Stores. Under the old system, the LRS wholesale discount was 16% off government store retail prices. This meant that if an LRS matched government store prices, its profit margin was 16%. However, this is a very thin margin for the retail business and most LRS stores chose to retail for higher than government store prices to create a healthier margin. Under the new system, the margin will be better for LRS stores for wines currently retailing for less than about $15. At the very bottom end of the price spectrum, margins increase to about 21-22% (based on current government store pricing). However, for wines that currently sell for about $20 and above, the retail profit margin is slightly reduced to between 15-16%. As noted this is a very thin margin. Grocery stores usually run on something in the 30% plus range. Most normal retailers run somewhere in the 40% plus range.  Costco (likely the most efficient retailer in North America) runs on a 14% margin.

Retail Profit Margins for IWS Stores and Government Stores. IWS Stores previously had a 30% margin if they matched government store prices. Under the new system, their margin will be cut significantly to the numbers noted above for LRS stores. Government stores will also have to run on these same profit margins which would appear difficult as the declared operating costs for government retail stores are 17-18% (i.e. the operating costs of the stores may exceed the profit margin).

Predicted Effects on Retail Prices in LRS Stores. It is possible that the least expensive wine may get cheaper under the new system as wholesale prices go down somewhat for LRS stores at the lower end of the price spectrum. However, for wines above $20, wholesale prices increase slightly … so it may well be that pricing in LRS stores will not change much as stores seek to balance their profit margins across the price spectrum.

Predicted Effects on Retail Prices in IWS Stores and Government Stores. IWS Stores will have to raise their prices as their wholesale prices will go up significantly for every price point. The Government has indicated that end consumer prices in Government Stores will stay the same. However, for this to be achieved, the government stores would have to stick to a margin of 15-16% for wines above about $20. As noted above, this margin is below their declared operating costs and it would mean that the stores would lose money on these sales. It is possible that Government Stores may seek to shift their product mix to lower price points in order to create sustainable margins.

Restaurants/Bars/Hotels. Despite being some of the largest wholesale liquor customers in BC, restaurants/bars/hotels continue to be denied wholesale pricing. These \”hospitality\” customers still have to pay full retail prices and are restricted in terms of whom they can purchase from (government liquor stores and approved BC manufacturers such as wineries). The lack of a wholesale discount puts the hospitality industry at a competitive disadvantage as compared to our neighbours in Alberta and Washington state.

Move to Pre-Tax Pricing. Government stores have announced that they will change their shelf pricing to pre-tax pricing. It remains to be seen whether LRS and IWS stores will follow suit … although it would seem likely since this is the standard form of pricing for other retail sectors and there may be a \”psychological\” advantage to lower pre-tax shelf prices.

Two pieces of news today, both of which are good for DTC winery sales …

Firstly, the Nova Scotia government has sent out a message to stakeholders indicating that it will proceed with its previously announced plans to permit inter-provincial DTC shipment of wine to consumers in that province. The responsible Minister noted that the most frequent comment during a consultation process was that Nova Scotia should \”be a leader by adopting regulations to allow direct to consumer shipping of wine and encouraging other Canadian provinces to reduce interprovincial importation restrictions to help create an open Canadian market\”. The applicable legal changes are expected this year.

Secondly, in British Columbia, the LDB has announced that it will switch on April 1st from \”tax included\” shelf prices to pre-tax shelf pricing in all government liquor stores. Up until now, it had become the standard for all liquor retailers including wineries to also use \”tax included\” pricing. A switch to pre-tax pricing will be beneficial for winery DTC sales because the sales taxes on a DTC sale will vary depending upon the destination … and it was previously confusing for out-of-province customers to see web site pricing that included BC sales taxes.

The Saskatchewan government is in the midst of a consultation process to determine the future of its liquor retail system (which is currently mostly a government retail system with a policy of opening only new private stores). A web site has been set up that asks for citizen input (Liquor Retailing in Saskatchewan) and a number of options have been set out for the future (Future of Liquor Retailing). This PDF sets out the full history, analysis and options: Green Paper- Liquor Retailing. The options section is particularly interesting given the current proposed changes to BC\’s liquor retail system.

The 6th annual BC Wine & Liquor Law Conference is set for February 23rd in Vancouver, BC. This is an exciting year for the conference because a raft of significant changes to BC\’s wine and liquor policies are scheduled to come into effect shortly. We will provide an update on these changes including detailed discussion of upcoming reforms to BC\’s retail environment, wholesale pricing structure and distribution system, all of which are planned for April 1st. We\’ll also discuss developments in the branding and marketing sector as well as issues related to succession planning for wineries. New for this year, we have also included a panel on issues related to raising capital. Full schedule and registration information for the conference is here: BC Wine & Liquor Law Conference 2015.

Please note that those employed in the wine and liquor industry are eligible for a significant discount in the conference fee – a reduction from $645 USD to $300 USD. The conference always sells out so please register early!

The BC Government issued a press release today indicating that its model for the sale of BC wine on regular supermarket shelves will apply to any wine made from 100% BC grapes, rather than be limited to VQA products. This model is scheduled for introduction on April 1st, 2015. The release indicates that existing VQA stores and independent wine stores may relocate to supermarkets, although there are likely to be no takers on the latter offer since a condition is that they limit sales to BC wines (IWS can currently sell all types of wine). Apparently, a \”limited number\” of new licenses will also be issued for supermarket sales.

The press release does not mention how the above model complies with Canada\’s international trade obligations. It is my view that this model is not compliant with NAFTA, GATT or the EU-Canada Agreement on wine sales.

(UPDATE: I am hearing that the following pricing model may be adjusted … however, there has been no confirmation of that yet.) Here is a short summary of the proposed changes to wholesale pricing for BC set for April 1, 2015 with some new examples. Some information has been circulating that the price projections presented here earlier (Liquor Law Changes 2015) were \”speculative\” and that \”end consumer prices would not change\”. I respond to those claims below.

On the first point, the price projections are estimates but they are not speculative in the sense that they are mere guesses. They were based on the pricing formula that has been publicly released and confirmed by the LDB. Any end consumer price projection that is based on wholesale pricing needs to assume a retail profit margin. These estimates were made assuming profit margins equivalent to the current 16% margin for LRS stores and the 30% margin for independent wine stores. The 16% margin is actually a very low assumed profit margin given that the declared operating costs for LDB retail stores are 17-18% and that Costco, probably the lowest margin retailer, works on 14%. As a result, please note that the low end price projections, in my view, are an absolute best case scenario. The price increases will likely be in the higher end of the range because most retailers would use a margin of greater than 16% (e.g. BC LDB stores would lose money at 16% because their operating costs exceed the margin).  

In respect of the latter issue, it is my view that it is not possible for end consumer prices to stay the same for medium to high priced wine using the new pricing formula (nearly all retailers that I have spoken to agreed with this conclusion).  The wholesale markup (liquor taxes) on medium to high priced wines will increase substantially for all wine above a wholesale cost of $8.81 per 750 ml bottle. Indeed, for some higher priced wines such as those listed below, the new BC wholesale price will actually exceed the current pre-tax retail price! It is not possible to increase wholesale prices substantially without having an effect on retail pricing.

The following examples provide cost comparisons for some relatively well-known high end wine products, showing a range of projected prices between the 16% and 30% retail margins:

And this table provide some cost comparisons for relatively well-known medium priced wines, again showing a range of projected prices between the 16% and 30% retail margins:

In the chart above, note the substantial increases in wholesale prices for BC retailers, the fact that those wholesale prices are far higher than Alberta wholesale prices, and the substantial increase in end consumer pricing. As a result, there will likely be price increases at the high end of at least 25-30%, probably much more. I\’ll add some medium priced wine examples shortly.

(UPDATE: I am hearing that the following pricing model may be adjusted … however, there has been no confirmation of that yet.) The BC Government announced a new wholesale pricing model for wine today, which will become effective April 1, 2015. On the same day, BC will start limited supermarket liquor sales as well as introducing changes that are intended to \”level the playing field\” between government retail stores and private liquor retailers: press release on liquor changes is here.

The new wholesale pricing model will mean that all retailers (government and private) will pay the same wholesale price when they purchase liquor from the wholesale arm of the LDB. At the present time, private retailers pay different prices depending upon their license type. Government stores don\’t pay wholesale prices at all because their revenue is simply blended between their retail and wholesale divisions. Under the old model, the LDB applied a 117%/51% markup on wine to generate a fixed retail price which was used as a reference point for all retail sales. Under the new system, the LDB will apply an 89%/67% markup on wine to generate a wholesale price – retailers will then be free to set their own end retail prices once they add their own markups.  

See my Liquor Changes (2015) Chart for a first attempt at creating comparison pricing between the old system and new system.

The full text of the Canada-EU Trade Deal (usually known as CETA) has now been released. As reported earlier (CETA Not Likely to Affect BC Wine Industry), it appears that the deal will have little consequence for the BC wine industry. Generally, existing distribution and pricing practices for BC wine are continued under the deal. Earlier leaked text indicated that BC would be allowed to operate up to 60 private retail wine stores that provided preferential treatment for BC wine (these are the current VQA stores and tourist wine stores). The leaked text was accurate and the final text provides the same thing. The limit does not apply to the vast majority of BC\’s private liquor stores which sell a range of products from various countries. The limit of 60 is, in fact, greater than the number of such stores that are currently operating (which is about 20). As such, CETA preserves the existing exclusive distribution channels for domestic wine in these private retail stores and it also preserves the ability of wineries to sell from their own tasting rooms (direct delivery). The agreement does contain an agreed objective of eliminating the \”differentiation of provincial mark-ups applied on domestic wines and wines bottled in Canada in private wine outlets\” … however, this objective was contained in earlier agreements with the EU and contains no concrete implementation targets other than a review in 5 years time.