© Francisco Guillermo Cervantes Medina 1.

© Francisco Guillermo Cervantes Medina

www.fcervantes.es

1


Strategic Costs as Applied to Wineries

Club de Marketing de La RiojaApril 13, 2015


Basic questions & Concepts

• Why are you here?• Why do ALL companies exist? i.e. What is the one

sole purpose that ALL businesses share?• What is “business strategy”?• What is a “cost”?

3


Basic questions & Concepts

• Why are you here?• Why do all companies exist? i.e. What is the one

sole purpose that all businesses share?

PROFIT

4


What is “strategy”?

5

It’s a plan; an ‘elaborate and systematic’ plan.

A plan to do what?

To sell a product or service and not die doing it.

In other words…

Business strategy is an elaborate and systematic plan to sell a product or service at a profit.

La estrategia empresarial es un plan elaborado y sistemático para vender un producto o servicio a un precio tal que me permita ser rentable.


What is a “cost”?

6

Cost is a consumption of resources to carry out an activity (eg. To produce and sell a good or service).

Coste es el consumo de recursos para llevar a cabo una actividad (ej. producir, vender un bien o servicio).

And by extension…

Cost analysis is a business exercise that apportions a company’s costs to its various products and activities.

El Análisis de Costes es un ejercicio que consiste en asignar los costes totales de una empresa a sus distintos productos y actividades; es decir, en “repartir la tarta” de los costes.


How do we bring “strategy” and “costs” together?

7

Strategy Costs


How do we bring “strategy” and “costs” together?

8

Strategy Costs


Strategy and costs: Putting it together – the practical perspective

9

Strategy Costs

“Strategic Costs” I literal understanding: activities/expenses that are part of our core business strategy

− Exporting

− Marketing

Purpose: branding, profit, first-mover advantage, etc.

“Costly strategies”: Turning our strategy into a cost

− “Gain market share” strategies

Price wars

Dumping

Exporting ?

“Strategic Costs” II

− Costs are a basic tool for managing profit Cost Analysis


Why is profit so important?

10

The answer involves 2 perspectives:

1st Wealth creation

2nd Business sustainability


The profit equation

11

𝑷𝒓𝒐𝒇𝒊𝒕=𝑹𝒆𝒗𝒆𝒏𝒖𝒆−𝑪𝒐𝒔𝒕𝒔

Managing profit boils down to managing 2 key variables: Price and Costs

But it gets a little more complicated than that…


The profit equation

12


Quantity sold = QSelling Price = P

What we doHow we do it

Raw materialsLabor and capital intensity

OPERATIONS

Demand Competition

Product design & development

Internal logistics:Procurement

Manufacturing Selling External logistics:Distribution

Caring for the vinesGrape selection & pickingWine conceptLabel design

Grape testing & weightingWine storage

DestemmingPressingFermentingAgeing

Function

of

National: Distributor ConsumerExport: Importer Distributor

Freight forwarderCarrierTransportation agency


The profit equation: where do we see strategy?

13





OPERATIONS

Demand Competition







Function

of



Value chain (“Cadena de valor”)

Strategy

Strategy

Strategy

Strategy


The profit equation: How do we account for it?

14





OPERATIONS

Demand Competition







Function

of



Value chain (“Cadena de valor”)

Trac

e ba

ck to

Thro

ugh

acco

unti

ng g

roup

6

Trace back to

Through accounting group 7


Monetary value of the resources consumed by a business during an accounting period

15

This is our co.’s Group 6 of accounting

The goal of a cost system/analysis:

i.e. this is our company’s cost base.

To apportion these costs to the different business activities of the company and ultimately, to its products, services and clients.

To distribute this whole amongst the company’s products, services and clients.


Strategy and costs: Putting it together – the technical perspective

16

Period 1Accounting

Period 2Accounting

Cost Analysis

Management = strategy implementation

Results

Reconcilement

A business accounting is, at the same time, the starting and ending point for a cost analysis:


Michael Porter’s Value Chain

17

Succession of business activities, each of which adds value to the preceding step of a company’s productive and/or sales processes.

Primary or Main Activities

Support Activities

Sucesión de actividades, cada una de las cuales aporta un valor a la anterior en los procesos de producción y ventas de una empresa.

Internal Logistics

Operations External Logistics

Marketing & Sales

Post-sale Servicing

Business Infrastructure

Human Resources

Research & Development

Procurement


How do we bring Value Chain and Accounting together?

18

1,767,751 €

Red Grape Purchase - Raw Mat. 612,084 € White wine purchase - Raw Mat. 82,500 € Rosé wine purchase - Raw Mat. 82,500 € Bottling (bottles, corks, capsules, labels)

990,667 €

ProcurementCurrent

ExpensesDepreciation Total

1,489,818 €

Red Grape Production 241,494 € 303,569 € 545,063 € Destemming and 160,004 € 10,425 € 170,429 € Fermenting 277,740 € 94,979 € 372,719 €

Ageing 148,250 € 206,892 € 355,142 €

ProductionCurrent

ExpensesDepreciation Total

1,161,276 €

National Transport 215,240 € 7,250 € 222,490 € Overseas Transport 230,400 € 0 € 230,400 € Salespeople 212,829 € 760 € 213,589 €

Marketing 415,497 € 0 € 415,497 €

Sales

"Structure" (Support Activities) 462,007 € 146,242 € 315,765 €

Internal Logistics


Marketing & Sales

Post-sale Servicing


Human Resources

Tech. Development (Research & Development)

Procurement


How does this turn into a cost system/analysis?

19

Co.’s Cost Base

Process I call “Cost Mapping” (“Mapa de costes”)

Activities & Processes

Grape Production

Purchases of Raw Materials

Production• Destemming

and Press• Fermenting• Ageing

Sales• Bottling• Nat. Transport.• Int’l. Transport.• Salespeople• Marketing• Financing

“Structure” Co.’s Final Products

AccountingCompany’s main activities

Products or “cost objects” of those activities

Company’s final products

Activity-Based Costing (ABC) method


Strategy and costs: Putting it together – the technical perspective

20

Co.’s Cost Base

Activities & Processes

Grape Production

Purchases of Raw Materials

Production• Destemming

and Press• Fermenting• Ageing

Sales• Bottling• Nat. Transport.• Int’l. Transport.• Salespeople• Marketing• Financing

“Structure” Co.’s Final Products

Internal Logistics


Marketing & Sales

Post-sale Servicing


Human Resources

Research & Development

Procurement

Accounting+

Value Chain ABC=


Where does this take us?

21

Knowing the costs of our business’ processes & Activities

Processes Optimization Profit management

Management

Knowing the costs and cost structure of your business’ final product

Pricing and sales strategies

This is what will most directly affect you


Unit costs for Demvrek

22

Raw Materials0,62 € 32%

Production0,29 € 15%

Sales0,88 € 45%

0,16 € 8%

1,95 € 100%



0,16 € 8%

Sales1,03 € 49%

2,10 € 100% Tinto Joven - Export


Unit costs

23



Sales1,23 € 45%

0,16 € 6%

2,71 € 100%



0,16 € 6%

Sales1,38 € 48%

2,86 € 100% Crianza - Export


Cost structure of each product

24

VD, 0.93 €

VI, 0.48 €

FD, 0.37 €

FI, 0.18 €

0%10%20%30%40%50%60%70%80%90%

100%

Estructura de Costes

Joven Nacional

VD, 0.86 €

VI, 0.48 €

FD, 1.21 €

FI, 0.18 €

0%10%20%30%40%50%60%70%80%90%

100%


Crianza Nacional

VD, 0.92 €

VI, 0.64 €

FD, 0.37 €

FI, 0.18 €

0%10%20%30%40%50%60%70%80%90%

100%

Estructura de costes

Joven Export

VD, 0.85 €

VI, 0.64 €

FD, 1.20 €

FI, 0.18 €

0%10%20%30%40%50%60%70%80%90%

100%


Crianza Export


How low can you go? “The 10% syndrome”

25

“If I could only lower my price by 10%, I could sell a lot of wine.”

Base Case

Sales (Q x P) 3.000 €1.000 bottles x 3,00 € per bottle

Variable Costs (Q x V) (1.560 €)1.000 bottles x 1,56 € per bottle

Fixed Costs (F) (540 €)540 € / 1.000 bottles = 0,54 € per bottle

Profit 900 €

% of sales 30%

10% Discount

Sales (Q x P) 2.700 €1.000 bottles x 2,70 € per bottle



Profit 600 €

% of sales 22%

Profit Reduction (33%)


“A lot”: Enough to recover the lost margin?

26

Base CaseSales (Q x P) 3.000 €1.000 bottles x 3,00 € per bottle



Profit 900 €

% of sales 30%

10% DiscountSales (Q x P) 3.411 €1.263 bottles x 2,70 € per bottle



Profit 900 €

% of sales 26%

Profit Reduction 0%

Sales would have to increase by 26% only to go back to our before-discount

Multiplier effect of price on earnings.level of earnings


The “need” for discounts

27

Different international markets give different weights to Designations of Origin (D.O.’s).

Which means that depending on the international market, different Designations of Origin may compete on a more level paying field than in the national market.

D.O. regulations vary, hence, the costs to make wine in different D.O.’s may not be the same

For example…


The “need” for discounts - Costs specific to the wine business in Rioja

28

Red grape yields in La Rioja are capped at 6.500 kg/hectare.

Grapes are0,62 € or 29% of total wine cost

2,10 € Tinto Joven - Export


2,86 €Crianza - Export

But that is not the case for all DO’s…


The “need” for discounts

29

This means that a winery of similar characteristics to our fictitious Demvrek could have a significantly lower unit cost per bottle of wine simply by belonging to a D.O. different than Rioja.

Let’s assume, for the sake of argument that Demvrek’s Rioja “Crianza” is competing against a decent Penedés of a winery of similar characteristics and operations.

For example:Somontano allows a yield of 8.000 kg/hectarePenedés allows a yield of 9.000 kg/hectare

Assuming everything else constant, the cost structure of the Penedés vs. the Rioja wine would be different due to the different D.O. regulation.


Rioja Penedés

30



2,86 €Crianza - Export2,69 €

Crianza - Export

6% cost advantage

Should Demvrek offer that 6% as a discount?

Does it make sense to compete on price?

Does it make sense to compete in this market?

Strategy Costs

Tinta, 0,43 €


Cash Conversion Cycle or CCC (periodo de maduración de una venta)

31

t0

15-SepGrapes delivered to winery; winemaking process begins

t1= 90 days

15-DecNew wine elaborated

t2= 93 days

18-DecFirst sale of the recently made wine

t3= 120 days

15-JanPayment to grape suppliers

t4= 190 days

25-MarClient pays

Average Production Time

Time from Inventory to Sale

Average Time to Pay

Collection Time

90 days 3 days 97 days+ + =

CCC 70 days

DOH 93 days

DSO 97 days

# Days of Payables -120 days

Days of Inventory on Hand (DOH)

Days of Sales Outstanding (DSO)

Number of Days of Payables



32

t0 t1= 90 days t3= 360 days

15-SepWine sale

t2= 120 days

15-EnePayment to grape suppliers

t4= 457 days

22-DecClient pays

Average Production Time

Time from Inventory to Sale

Average Time to Pay

Collection Time


CCC 337 days

DOH 360 days

DSO 97 days









33

t0 t1= 90 t4= 545

15-Mar + 1Sale of aged wine

t2= 120

15-JanPayment to grape suppliers

t5= 642

22-Jun + 1Client pays

Average Production Time Time from Inventory to Sale

Average Time to Pay

Collection Time


CCC 522 days

DOH 545 days

DSO 97 days


90 days

t3= 455

15-Dec + 1Aged wine elaborated






+


Expenses and Cash Flows associated with Inventory

34

CAPEX (Long Term)

Warehouse

Tanks

Barrels

Barrel supports

Cages

Forklift, etc.

Depreciation

Interest

Repayment of outstanding debt

Fiscal deduction

Expense

Expense

Less Expense

Flow

Flow

Flow

Flow

Current Expenses

Grapes, wine, bottling supplies purchases, etc.

Expense Flow

Direct Labor Expense Flow

Power & other utilities Expense Flow

Other production and ageing costs

Expense Flow


Expenses and Cash Flows associated with Inventory

35

Most of these expenses and cash flows will be disbursed in recurring installments.

All of these expenses and cash flows will need to be financed:

a) Company’s own resourcesb) Equity holders’ resourcesc) Debt holders’ resources

imply Financing Costs

All of them will be disbursed well – years – before a sale is made.

Carrying inventory costs for a winery are substantial and must never be ignored.


To recap: how do costs affect you and your business strategy?

• Negotiate the payment terms and pay attention to any “red flags” when it comes to credit risk. Crucial due to long CCC.

• The 10% syndrome How low can I go? What effect will the discount have on my winery’s profit? How much will sales increase by applying the discount? Does the discount make sense? Is it worth it?

• Bear in mind your cost structure and don’t compete solely on price!

• Remind yourself and your managers that you are there to sell for a profit, not just to sell.

36


To recap: how do costs affect you and your business strategy?

• Why do I want to be in these markets? What is my purpose? Is it to become big? Or is it to become profitable?

• Where is my export department in the grand scheme of things? Big or profitable?

37

© Francisco Guillermo Cervantes Medina38


www.fcervantes.es

39



© Francisco Guillermo Cervantes Medina 1.

Documents

strategycosts slide

profit cost analysis

profit equation

strategycosts strategic

companys costs

words business strategy

managing profit boils

costes es