The pricing predicament for Australian wine exporters

Perspectives

The pricing predicament for Australian wine exporters

Agribusiness Bulletin

The Australian wine industry has emerged as a major wine exporting country over the last 20 years. As such, the industry is still adjusting to the process of setting appropriate pricing structures in international markets. This Bulletin investigates the pricing predicament faced by producers.

The Australian wine industry is one of the ‘new darlings’ of the global wine export scene, with Australia’s emergence as a major wine exporting country largely occurring within the last 20 years. As such, the industry is still adjusting to the process of setting appropriate pricing structures in international markets which will guarantee the long term success of their brands in light of the varying factors incumbent with international trade, particularly foreign exchange rates.

Emergence of Australia as a major wine exporting country

According to the International Organisation of Vine and Wine, in 1995 the Australian wine industry was insignificant on the global export stage, accounting for only two percent (116 million litres) of global wine exports. During the 20 years post 1995, demand for Australian wine rapidly increased, which was satisfied by an equally sizeable (and ultimately excessive) increase in Australian wine production.

This demand surge coincided with favourable exchange rates for exporters throughout the late 1990’s and early 2000’s, forming a ripe combination which allowed Australia to emerge as a significant wine exporting nation, as demonstrated by the following statistics

  • Australia is currently the fifth largest wine exporter in the world — behind only Spain, Italy, France and Chile 
  • Australia currently exports approximately 700 million litres of wine to global markets (at a total value of c. $1.9 billion) 
  • Australia’s wine export market has now overtaken the Australian domestic market in terms of sales, with 58% of all wine produced in Australian now being exported to global markets (compared to just 23% in 1995). 

Given this relatively new emergence onto the global export scene, the Australian wine industry’s sensitivities to foreign exchange rates is a factor which industry participants are still coming to grips with, and determining how best to approach

The importance of pricing strategy and its effect on wine brand image and profitability

As the Australian dollar began to rise in 2005, the total volume of export sales plateaued as many wine exporters struggled to maintain their presence in international markets due to:

  1. Declining gross margins at the hand of the rising Australian dollar 
  2. An increasing supply from other new world exporters (particularly South America, New Zealand and South Africa).

Those wine exporters that did manage to maintain their market presence in international markets are those who took an appropriate long-term view towards market pricing and brand image and fully appreciated the effect that these factors have on long-term profitability. 

The importance of brand and price strategy for new entrants

As wine is considered to be a luxury good, its uses (primarily consumption and gift giving) are as much about status symbolism as the quality of the product itself. Price is often used, either rightly or wrongly, as a measure of the quality of the product. As such, to a greater extent than many other industries, wine exporters need to deeply consider how their brand image and marketing strategy may affect their long-term profitability when setting prices in international markets as it often becomes challenging to increase prices without sacrificing sales volume once a wine brand has established itself in a new market at a given price point. The fact that the average pounds per litre export price of Australian wine was exactly the same at £1.60 per litre in 2007 (when the AUD was weaker at £0.42) as it was in 2013 (when the AUD was much stronger at £0.61) is evidence of the difficulty wine exporters have in increasing prices in export markets even during time of diminishing margins at the hands of fluctuating exchange rates.

To solidify their presence in a new export market, wine exporters must ensure that they enter these markets at the right price points. The ‘right’ price point is one which provides an exporter with sustainable profit margins even during times of a high Australian dollar, whilst also establishing a brand image resilient enough to maintain demand in an increasingly competitive market and/or create enough brand loyalty to allow for flexibility in pricing adjustments if required.

Take for example one of Australia’s largest wine exporters, who firmly established its dominance in the low price segment of the US wine market in the early 2000s during times when the Australian dollar was low. By selling its wine at approximately USD$7-8 a bottle this exporter created a brand reputation founded upon being an affordable Australian ‘critter’ wine. Given this entry into the ‘cheap wine’ category, there was little scope for this exporter to increase the selling price of its wine (whilst still maintaining its existing level of demand) when the Australian dollar surged in the late 2000s. Accordingly, due to this pricing decision it was difficult for this brand to maintain profit margins, evidenced by a significant decline in revenue in 2011 and Business Review Weekly reporting that this brand “doesn’t make money from US sales if the Australian dollar trades above US90¢.” Notwithstanding this, the wide distribution networks established by this brand, coupled with an increased marketing drive has allowed this brand to ride out periods of a higher Australian dollar without having to significantly increase their prices, preserving its dominant presence in the market and returning to profitability now that the Australian dollar has fallen back below $0.90.

If price is important, how do I set my price point?

To assess the sensitivity of gross margin percentages derived by an integrated Australian wine producer and exporter under various foreign exchange rate environments, we have utilised Wine Australia’s Gross Margin Ready Reckoner Wine Business Benchmark Planning Tool, which was developed in conjunction with Deloitte. This tool calculates an indicative gross margin percentage achieved by a wine maker selling wine into an international market, based on a range of assumptions. For this example we have assumed the subject is a large shiraz producer based in the Barossa Valley, exporting wine to the US market via an agent.

The tool can be used in two ways – retail price breakeven analysis or profitability analysis – which are illustrated below.

Figure 2 shows the sensitivity of GM% breakeven points for the subject winemaker at various retail pricing points (USD$ per bottle). During a period with an average AUD/USD foreign exchange rate of $0.67 (reflective of the average exchange rate between 1995-2006, the time when Australia experienced significant growth in wine export volumes) this exporters GM% breakeven point was at a retail selling price of USD$11 per bottle. In contrast, if the exchange rate rose to $0.90 (as has been the average exchange rate since 2007) this same exporter would have to sell their wine for an additional USD$3 per bottle (USD$14) in order to break even.

From a different perspective, if this exporter had fixed their selling price at USD$16 per bottle, they would have achieved an average GM% of 28% in 1995 (when the average exchange rate was $0.74) and 48% in 2001 (when the average exchange rate was $0.51). Contrastingly, if this exporter maintained their selling price of USD$16 per bottle, then in 2011 when the Australian dollar peaked this producer would have been incurred a GM% loss of 19%.

These various profitability scenarios highlight the importance to wine exporters of taking a long term view when determining sales prices in new export markets, and outline the benefits of creating a strong brand image and distribution network which provides flexibility to adjust when margins are at risk due to unfavourable exchange rates.

Important lessons learnt

With the benefit of hindsight, we can see that the intrinsic characteristics of the wine industry make it more susceptible to fluctuations in foreign exchange rates than some other export dominated industries.

Even during current times of a comparatively lower Australian dollar, it is critical for wine exporters to wholly understand how fluctuations in exchange rates may impact their export strategies and ultimate their profitability. Particular emphasis should be placed upon not just how direct margins may be impacted by exchange rate movements, but how the decision to enter a new market at a particular price point impacts on the image of a luxury good such as wine. This consideration is of particular importance given the current and rapid emergence of new Asian wine export markets.

Ultimately, a wine brands ability to alter its brand image in times when external factors fluctuate as they so often do in the wine industry (e.g. at the hand of continually changing consumer taste preferences, climatic conditions and government policy) is often difficult to achieve but is a key factor in guaranteeing the long term success in new export markets. This point should not be lost even in times when international trade agreements may be helping to reduce an exporter’s sensitivity to foreign exchange movements by opening up additional new export markets and reducing tariffs and taxes.

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Authors

Stephen Harvey

Partner

Assurance & Advisory Adelaide and SA Wine Industry Group Leader

 

Jake Stacy

Senior Analyst

Financial Advisory Services Adelaide and SA Wine Industry Group Member

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