Chapter 9: The Economics of the Wine Industry
Chapter 9: The Economics of the Wine Industry
STARTING A WINERY
THE ECONOMICS OF THE WINE INDUSTRY
If you've ever taken a tour of a winery you've probably considered, like everyone else, how wonderful it would be to do this, live like this, etc. Not to dash your hopes and dreams, but let's take a hard, dollars and cents look at just what it takes to live life in Valhalla.
Being successful in any business today takes a lot of stamina, hard work, savvy, patience and intelligence, as well as money. Probably no industry requires as much of these as the wine industry. It has many of the elements of any other industry, including one that very few could list, taste. Everyone's taste is different. There is no "right" or "wrong," only yours and mine. What makes the wine business fun, exciting and rewarding are the same things that makes it illogical, annoying, arbitrary and downright frustrating. Too often, a business decision in the wine industry is based on taste instead of good, sound business sense-and tastes are known to change.
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Once you've decided that the call of the grape is to loud too ignore, you're going to have to make some very important decisions before you consider starting a winery. These decisions may take years to unfold and, if you made a goof, may take years to correct. First, you'll decide whether you're going to grow or buy the grapes for your wine. Then you'll decide what kind of wine you're going to make, how you're going to make it and, finally, how you're going to sell it. The chart below gives the average numbers for making and packaging wine. But, before we can get there, we have to build a winery. For the sake of argument, we'll have to make a few assumptions about your taste:
First, you want to make really good wine that you can be proud of and charge a lot of money for.
Second, because they are the most popular wines, you'll make Chardonnay and Cabernet Sauvignon.
Finally, you want to make a good living at it. (Make that any kind of a living!)
BUILDING A WINERY
It costs about as much to build a winery that can make 10,000 cases (each case holds 12 bottles) as it does to build one that will make 20,000 cases. We'll take the more ambitious number since we're not talking about the equipment that goes inside, where the costs can go up logarithmically, just the cost of the land, building and basics. Since you want to make good wine, you'll have to build your winery where the grapes grow best so you won't have to transport them too far. Napa, Sonoma, Mendocino, Santa Barbara, Santa Cruz, the Sierras and San Luis Obispo are all fine, grape growing counties. Unfortunately, the people selling real estate there already know it and prices are higher than other barren agricultural areas.
You'll need about 10,000 sq. ft. including winemaking area, barrel storage, tank storage and offices. This is pretty lean and basic, no fancy picnic grounds, underground caves, etc. Maybe you can do it for $1,000,000. You'll probably have to settle for some used equipment. There's a lot of it available. Some of it has hardly been used. Wonder why? Read on.
To keep it simple, we'll make 10,000 cases of Chardonnay and 10,000 cases of Cabernet. Since we're using good grapes (either our own or someone else's) we have to spend the money to make the best wine we can. That means brand new French oak barrels at a cost of $600 each. Each barrel holds about 25 cases of wine, so quick figuring says 800 barrels for a cost of $480,000-or half of what it cost to build the winery!!!
Okay, maybe they don't all have to be new. Let's say we buy some 1 and 2 year old barrels and only spend half that much (a mere $240,000). Because we have well-structured grapes, we can leave them in the barrel longer to pick up more complex nuances without getting too oaky. So the Chardonnay may stay in the barrel for 8-10 months and the Cabernet for 16-24 months.
Uh, oh. If the Cabernet has to stay in the barrel for more than a year, where do we put next year's Cabernet? We cut our costs down to $240,000 for the barrels to house 10,000 cases each of Chardonnay and Cabernet, now we'll have to add another 10,000 cases worth of barrels because we need 2 years of Cabernet in the barrel at the same time. (Add another $120,000) Fortunately, you can wait a whole year before you have to buy them. Unless, of course, there's a barrel shortage and you have to order them a year in advance and pay for them six months before you get them.
To recap your investment:
Winery Cost — $1,000,000
—$360,000 ($240,000 for the first year and an additional $120,000 to hold the next year's Cabernet Sauvignon.)
Afterwards, you'll go on a 30% to 40% barrel rotation program which means that you will buy about 300 new barrels each year and sell off 300 of your oldest ones. You will pay $180,000 for those new barrels and sell your old ones for about $60,000. This means that every year you'll need at least $120,000 for new barrels sometime between 1 and 2 years before you can sell the wine.
The first part of this book started with how important the grapes are in the making of great wine. Can you put your trust in someone else to deliver those perfect grapes? Shouldn't you exercise total control over those grapes to insure their perfection? Maybe.
Unless you own suitable grape growing land, you'll have to go buy it. The chart below illustrates typical costs of buying land plus planting and maintenance of the grapes. If you finance the project at low finance rates, your payments will be about $350 per month for each acre plus maintenance. A fully mature vineyard of Chardonnay will produce about 3 tons per acre of excellent wine. Each ton will yield about 60 cases, each acre about 180 cases. That means we need 55 acres. After planting, our Chardonnay vineyard will have cost $1,900,000 ($35,000 land and planting costs x 55 acres). If we finance it (assuming you can find a bank to finance the entire amount with no down), we'll be paying about $18,000 per month on the 15-year note at 8% interest. Did you say you had equity somewhere?
Our Cabernet gets better yields (4 tons to the acre yields 240 cases instead of Chardonnay's 3 tons and 180 cases). We could get away with only 45 acres to make 10,000 cases. That will cost roughly $1,600,000 or another $15,000 per month with the same terms as the Chardonnay vineyard. By the way, you should find yourself something to do for the first 3 years since the vines won't be producing any grapes worth harvesting in that time. While you're paying out that $33,000 a month for your 100 acres of non-producing vineyard, you'll probably have to go out and buy some grapes in order to have something to sell.
Since we've already decided to make great wine, we have to start with great grapes. Most likely we'll be paying top dollar for our Chardonnay; ($1,500/ton) and Cabernet ($1,200/ton). That means we'll pay $250,000 for our 166 tons of Chardonnay; grapes and $200,000 for our 166 tons of Cabernet to make 10,000 12 bottle cases of each. That's $450,000 for grapes picked in September which you'll have to pay for by March of the following year and you may be able to start selling the Chardonnay a month or so after that.
IF YOU GROW YOUR GRAPES
|TYPICAL PER ACRE COST ||Initial Cost ||Yearly Payments per Acre |
|Land ||$20,000 ||$2,200 |
|Planting ||$15,000 ||$1,800 |
|Upkeep per Acre || ||$1,500 |
|Total || ||$5,500 x 100 acres = $550,000/yr. or about $46,000/month. |
| || || |
You will need to hire someone to prune, weed, fertilize, etc. With 100 acres you'll get a better deal for maintenance per acre than if you only had 10.
Cabernet Sauvignon Chardonnay
Tons per Acre................................................... 4.......................................... 3
Cases per Acre............................................. 240...................................... 180
Upkeep Cost per Acre.............................. $1,500................................. $1,500
Debt Payment per Year per acre............... $5,500................................. $5,500
*Barrel Costs per acre.............................. $1,200................................. $1,200
Totals...................................................... $8,200................................ $8,200
*For ease of figuring we're just assuming you'll split that new barrel cost between the two wines in the same ratio that they contribute to the entire amount. If each acre represents 1% of the total, then it will receive a proportionate share of the expense. Since the total barrel cost of the 100 acres (after your initial barrel investment of $360,000) is $120,000, each acre uses 1% of its cost in barrels, or $1,200. (Cabernet will technically use less because the barrels are purchased every other year instead each year with the Chardonnay, but we'll assume that the percentage of new barrels will be higher thus evening out the cost against Chardonnay.)
Cabernet Sauvignon Chardonnay
Cost per Case w/Debt Payment........... $34.17 ................................ $45.55
By dividing the total cost by the number of cases produced we can project a cost per case. The Cabernet costs $34.17 because, due to the higher yield, you get more cases per acre ($8,200/240). The Chardonnay costs more because it produces less cases per acre ($8,200/180). Once you pay off the debt, if you're still in business, your costs will drop by more than 80% in terms of upkeep. But, don't hold your breath. We haven't made any money, yet.
Cabernet Sauvignon Chardonnay
Cost of Grapes/Ton................................. $1,200 ................................ $1,500
Barrel cost/Ton........................................ $ 723................................. $ 723
Total Cost/Ton....................................... $1,923............................... $2,223
Cost of Grapes per Case............................ $32 ..................................... $37
We need to buy 166 tons of each grape to make 10,000 cases. Our total new barrel cost is $120,000. We divide this cost by the 166 tons to arrive at the cost of barrels per ton ($723). Each ton produces 60 cases of wine. You buy the Cabernet grapes ($1,200/ton), add the barrels ($723/ton) and divide the total ($1,923) by the number of cases (60) to arrive at a cost per case ($32).
PACKAGING COSTS PER CASE
Cabernet Sauvignon Chardonnay
Corks/Foils/Labels/Bottles/Boxes.................. $10...................................... $10
Labor.............................................................. $8 ....................................... $8
Packaging Costs per Case.......................... $18..................................... $18
TYPICAL COST PER CASE OF BOUGHT GRAPES WITH PACKAGING COSTS
Cabernet Sauvignon Chardonnay
Cabernet Sauvignon.................................. $50...................................... $55
TYPICAL COST PER CASE OF GROWN GRAPES WITH DEBT SERVICE AND PACKAGING COSTS
Cabernet Sauvignon Chardonnay
Cabernet Sauvignon............................. $52.17................................. $63.55
These are "raw" costs for material and immediate labor only. Suffice to say that our wonderful Cabernet costs between $4.25 and $4.40 a bottle and our Chardonnay between $4.50 and $5.40 per bottle depending on whether we've supplied our own grapes or bought them. And, we've not paid for a few other incidentals.
These figures are on top of the initial cost of $1,360,000 to build the winery and buy the first round of barrels. If this amount were financed at the same attractive rate of 8% for 15 years, you would make payments of $156,000 per year. This would add another $7.80 per case of direct cost ($156,000/20,000 cases) until the loan was paid off 15 years later.
IS THERE MORE?
As you probably know, even if you've never been in business before, there are lots of costs one must incur that aren't on the tip of everyone's tongue until they start getting the bills. For the sake of keeping this book shorter than the Koran, we'll just list a few things and do a rough and dirty composite total.
Licensing, taxes, state duties (unless you plan on selling it all in your own state), insurance, utilities ($2,000 a month is average), trucks, office and winery supplies, etc. could easily add up to $250,000 a year for your 20,000 case operation or another $12.50 per 12 bottle case.
Almost forgot. Just because the wine is finished fermenting doesn't mean that you can go out and sell it. Chardonnay, especially a premium one, can't be released for one and sometimes two years after the harvest, Cabernet at least 2 and sometimes 3 or more years after harvest. Who's paying for the storage (all temperature-controlled) during that period? You have incurred debt from day one of the winery being built, and expenses from the time the grapes are planted (or purchased) to the time the wine is packaged, and you will not see a dime for at least a year after the harvest!
Unless you're going to do everything yourself from deciding when to pick the grapes, inoculate for malolactic, clean the toilet and buy paper for the copy machine, you'll have to hire a few people. Totaling up a meager wage (of course they'll work cheap, they get to be in the wine business!), workers compensation, liability insurance, social security, payroll taxes and such, you can figure for at least 2 workers and another $100,000 a year or $10 per case.
ARE WE DONE YET?
Well, yes. And, no. If we bought our Chardonnay grapes for $37 per case, added the $25 for incidentals like labor, overhead and the debt on our original purchase of winery and barrels, we're at nearly $62 a case or $5.25 a bottle. If we planted grapes, waited 3 years and are paying off our debt, we're at nearly $100 per case or $8 per bottle (not counting the 3 years of paying off debt with no grapes to make wine from). Now, the all important question emerges: How much do we charge? After all this expense, sweat, 70 hour work weeks and time and effort, we gotta make some money. We'll double our cost.
Next question: How are we going to sell it? Do we have a mailing list of consumers who we sent an offering to asking them to purchase our wine (nothing too fancy, we don't have any money). Are they going to shell out $11 ($132/case) for a wine they've never heard of or $17 ($204/case) for the wine from our three-year-old, unproven and unpaid for, vineyard?
THE TEAR SYSTEM
Most likely we'll have to sell our precious wine to a distributor who in turn will sell it to a retailer who in turn will sell it to the consumer. We sell our bought-grape Chardonnay to them for $120 per case. The distributor sells it for $160 to the retailer who in turn sells it to the consumer for around $240. The wine that we have a direct, no profit, cost of $5.25, ends up on the shelf for $20. If we're talking about our own grapes, the costs spiral from $200 a case to the distributor (if you include debt service) to $250 to the retailer to $360 for 12 bottles to the consumer. When was the last time you spent $30.00 on a bottle of Chardonnay? If it doesn't sell, you'll have to lower the price and your profit. It's enough to make you cry.
Obviously, not everyone in the wine business just got there. Many wineries have been around for generations, have most, or all, of their winery and vineyards paid for, but many don't. Many wineries cut costs and buy good to excellent bulk wine from an open and occasionally depressed market for less than what it would cost to make. Some have enough money to look on their investment as just that, and not expect the consumer to pay for that investment. They don't factor in their initial costs for land, planting and building. They also have more spendable money than you do.
Even if you buy your grapes, rent space in a large winery with excess room to spare (they're not selling as much wine as they used to either) and keep your overhead down to almost nothing, your Chardonnay will still cost you over $3 a bottle. If you sell it for $6 to a wholesaler who sells it for $8 to a retailer you're still looking at a bottle of wine on the shelf for $10 to $12 or at least $24 on the wine list. And, we haven't even talked about marketing, wine tastings, advertising, entertainment (the press and your wholesalers like to eat a lot) or any of the other parts about running a business that even the wine industry can't escape.
There have been tremendous strides in growing superb grapes at much higher yields than our model. Even if you increased the yield, without sacrificing quality, by 50%, the reduction in cost would only be $15.00/case less for the Chardonnay and $11.00/less case for Cabernet Sauvignon. This would lower the retail price of your Chardonnay from $30.00 to about $27.00. Big deal, huh?
No matter how you slice it, this is a very expensive business. It takes a lot of time before you ever find out whether your venture is viable or not. When all is said and done, the consumer, the trade, the press and maybe even you will still have to stand back and ask: Is it worth it?
Grapes develop natural fruit acids (the most common being tartaric, malic and citric), which are needed to balance the finished wine. Acidity gives wine its relative tartness and serves as the backbone to a wine's flavor profile.
In a precise way, this refers to the odor derived from the grape or grapes used. To be distinguished from bouquet in that it is usually used to describe a young wine.
This is a tactile impression experienced on the insides of the cheeks and gums. It is a drying, puckery sensation. The degree of astringency is a factor of the tannins coming from the grapes' skins and seeds and, in some wines, also from the oak barrels used for aging.
Another tactile sensation relating to the feel or viscosity of the wine. It is appropriate for some wines to be light-bodied (Chenin Blanc, for example), and others to be full-bodied, such as Cabernet Sauvignon.
The smell of a wine that is a culmination of the soil and climate the grapes were grown in, the fermentation and the processing. Wines change in the bottle. Some wines develop "bottle bouquet" quite distinct from the grape aroma. Once all the properties of the wine have melded together, it becomes more difficult to tell what it is, where it came from or anything else about the wine because all these factors present a united whole as opposed to aroma which shows the distinctive parts such as the grape, soil, barrel treatment, etc.
A calibrated measure of the percentage of sugar in grapes and wines. Tests are taken to monitor amounts of sugar in the grapes as a guide to when harvest should begin. It is expressed in terms of percentage, i.e., 22% or 22 degrees Brix.
This term refers to any container holding and storing wine, from stainless steel tanks to large casks and small barrels.
The opposite of sweet in wine tasting. The detection of sweetness is an individual threshold experience, varying widely. Most people do not notice any sweet taste when the wine in question contains less than 1% residual sugar.
The study and science of winemaking. Winemakers are often called enologists.
A chemical reaction that occurs in the presence of sugar and yeast in which the yeast enzymes convert the sugar into roughly equal parts of alcohol and carbon dioxide.
A positive description for most table wines. It implies the wines are clean, fresh and smell as if they were made from grapes.
Used to indicate that the grapes came from a particular area that, along with the elevation of the vineyard and the angle of exposure to the sun, influences the outcome of the wine.
Refers to four grape varietals. Riesling and Chardonnay for white and Pinot Noir and Cabernet Sauvignon for red. Generally defines these grapes as special because of their natural tendency to make great wine without coaxing. Most vines, if left to grow wild, will produce more grapes than would be acceptable to make good wine. These four grapes actually resist the tendency to overproduce, inherently trying to make good wine naturally, a trait considered "noble."
An important determinant of wine quality, pH is a measure of the charged hydrogen ions in suspension. Winemakers prefer a pH factor of between 2.8 and 3.4 for table wines. The pH is inversely proportional to the total acidity. A low pH goes with high acidity, and high pH with low acid levels. Low pH wines are more resistant to bacteria and normally have better aging potential. The pH can be changed with the addition of acid, which is legal in California.
Regions I-V (Zones)
This is a rough system used in California to help classify regions for grape growing. It works by accumulating the daily mean temperatures above 50ËšF during the normal growing season between March 1 and October 31: the lower the total, expressed in degree days, the cooler the climate; the higher the total, the hotter the area. The system helps to indicate where the heat-sensitive grape varieties, such as Gewürztraminer and Riesling, would prosper over the heat-loving varieties, such as Zinfandel and Cabernet.
One of the basic tastes we all experience. In wine, the perception of sweetness depends on the degree of residual sugar left in the wine and on the other constituents, the alcohol and the acidity in particular. Most wines containing more than 2% residual sugar taste sweet to most people. It is not permissible to add sugar to wine in the US.
A compound derived from the skins, seeds and stems of grapes and, to some degree, from new oak barrels. The tannins, which make your mouth pucker, give wine longevity. Because they are fermented with the stems, seeds and skins, red wines contain higher levels of tannin than white wines.
The study and science of grape growing.
An important species of grapes numbering about 5,000, but only about 100 to 200 of these are important, and account for most of the world's fine wines. Most of the grapes in the species contain seeds, develop molds and problems under humid summer conditions, won't survive freezing winter temperatures and are not much good to eat. They exist in general to be converted into wine.
The following is a list of books, which address specific wine topics better than most.
Vintage Talk by Dennis Schaefer, 1994. A fascinating, behind the scenes look at how wine is made. Interviews with the top winemakers in California.
Plain Talk about Fine Wine by Justin Meyer, 1990. "Mr. Cabernet Sauvignon" tells us how the most sought-after red wine in California, Silver Oak Cellars, is made.
The Vintner's Art by Hugh Johnson and James Halliday, 1992. In-depth description on how the great wines of the world are made...from the vineyard to the table.
The Oxford Companion to Wine by Jancis Robinson, 1999. Probably the most comprehensive encyclopedia on wine ever written.
Vintage: The Story of Wine by Hugh Johnson, 1989. Takes a fascinating