The Chalice Wines
The Chalice Wines
Chalice Wine Group structure
The Chalice Wine Group (CWG) cont’ Chalice is the flagship for CWG, Chalice
winery was founded in 1969 and went to public in May 1984. Until June, 1993 with the initial public offering for Robert Mondavi Winery, Chalice was the only publicly-held company in the United States whose principle business is the production and sale of premium wines.
The Project was coming up!
Bill Evanson, President and CEO of Chalice was thinking; What does it cost them to make wines the way they do? Many of their specific costs seem to get lost within their accounting system. He suspect they understate some and overstate others. Who making money in this industry, and how do they do it? But this is a complex industry because every winery has a unique approach, and every wines in different. And Chalice is a particularly complicated company. Would a VALUE CHAIN ANALYSIS be meaningful, or even possible for this company in this industry?
CWG Distribution Channel
Each of its four California wineries is located in a different legally area.
Each one is a separate profit center with its own president.
The company’s wines are sold in specialty wine shops and grocery stores, selected restaurants, hotels and private clubs.
They even distributed via direct mail in those state where it is legal.
Out if the USA, the company sells through the traditional 3-tier system; maker, distributor, retailer.
In Northern California, a wine distributor is used as a broker. In Southern California, CWG own distribution network.
Exhibit 1:California Winery Shipments
(000 Cases)*
Exhibit 2:Wine Production in Case
Equivalents
Exhibit 3: Consolidated Balance Sheets, The Chalice Wine Group, Ltd. (Thousand)
The Winery
Complex production process Wine isn’t produced in a day/month but years Periodic production costs must be allocated
among many different wines CWG’s method was as straightforward as
possible. All costs were considered product costs and
wound up as Costs of Good Sold for some particular wine
Grape costs were easy to assign directly to particular wines
Only the wines bottled in a year absorbed the bottling costs for that year.
All wines held in bulk inventory absorbed their relative proportions of winemaking costs for that period.
All wines held in bottled inventory absorbed bottle aging costs
Exhibit 4 shows the yields and the product cost breakdown for 1991 Meritage White.
The Winery
Exhibit 4
1991 Meritage White Product Costs
Tons Crushed 89.17
Gallons of Juice Fermented
14,713
Gallons Aged13,98
4
Gallons of Wine Produced
13,255
Cases Bottled 5,575
Production Cost TotalPer
Case
Grapes $73,901 $13.26
Winemaking 117,486 21.07
Bottling 93,657 16.80
Bottle Aging 8,937 1.60
Total$293,9
81 $52.73
The task now is to derive per case operating profit for this wine, and the per case Return on Assets (ROA).
The profitability analysis for one case of 1991 Cimarron Meritage White demonstrated the contribution of that wine to the overall financial performance of the Chalice Group.
Cimaron winery sold 37,205 casesTotal Revenue $2.7 millionDepreciable 4.9 million
The Winery
The Vineyard
Cimarron Meritage White is a blend of Sauvigon Blanc and Semillion grapes, neither of which is grown at Cimarron Vineyard.
All the grapes for this wine are purchased from Pinnacle Vineyards, CWG’s partner in the Opera Valley Joint Venture.
Grape cost = $13.26 per case Exhibition 5 and 6 describe the costs and
assets involved in establishment and operation of 30 acre vineyard in Sonoma Country as of the end in 1992.
Exhibit 5
Cost per Acre to Establish and Operate a Vineyard
Year
1 2 3 4 5 & Forward
Yield (tons/acre) 1.5 3.5 6
Total Planting Costs5,138 2,440
Total Cultural Costs60
9 1,062 1,216 1,317 1,317
Total Harvest Costs@$120/ton 180 420 720
Total Overhead Costs62
2 622 642 698 718
Total Cash Costs6369 4,124 2,038 2,435 2,755
Depreciation (see Exhibit6) 843 843
Total 3,278 $3,598*
* $3,598/Acre = $600/T = $9.59/case [62.5 cases per ton]
Exhibit 6:
Assets Required to Establish and Operate a 30 Acre Vineyard
Purchase Useful Salvage Annual
Investment Price (new) Life Value Depreciation
Land (30 plantable acres) 525,000
Vineyard Establishment[A] 339,374 22 0% 15,426
Reservior 30,000 30 0% 1,000
Buildings 15,750 30 10% 473
Drip Irrigation System 52,400 25 10% 1,886
Frost Protection System 40,300 25 10% 1,451
Shop Tools 10,000 15 10% 600
Pruning Equipment 1,200 10 10% 108
ATV, 4WD 6,500 5 10% 1,170
Tractor 29,900 15 10% 1,794
Duster 3,035 10 10% 273
Mower [B] 5,500 10 10% 495
Orchard Sprayer 4,560 10 10% 410
Weed Sprayer 2,000 10 10% 180
Pickup Truck 16,500 7 10% 2,121
Total Investment,with new Equip. 1,082,019 27,388
*Allowance for Used Equipment -24,598 -2,110
Total Investment,30 Acre Vineyard $1,057,421 $25,278
A) "Vineyard Establishment" is the accumulated cash costs for 1st 3 years,net of revenue earned in
year 3 using the price paid by Cimaron in 1991 as a proxy value for each tone produced.
B) Last 6 items can be purchased uesd @ an average og 60% of new costs. Allowance is made above (*).
Exhibit 7
History of California Grape Prices Per Ton
Variety (*)198
3198
4198
5198
6198
71988 1989 1990 1991 1992
Chardonnay (18%)
$980
$998
$904
$856
$922
$1,122
$1,225
$1,128
$1,122
$1,038
Cabernet (32%)
$467
$527
$533
$550
$631 $822
$1,032 $977 $918 $872
Zinfandel (56%)
$269
$253
$269
$340
$480 $817 $546 $391 $363 $434
Sauvignon Blanc (35%)
$487
$486
$441
$401
$414 $474 $571 $518 $541 $552
Semillon (73%)$21
5$26
0$21
0$24
5$25
4 $289 $311 $310 $328 $360
TTT TTTTTTTTTTT TT TTTTTTTTTTT TTTTTTTTT TTT TTTT TTT T TTTT TT TTTTT T TTT*
TTTTTTTT TT T T T T T1 9 9 2 .
Sam assumed revenue for vineyard would be $812.36/ton
Although grape cost of $9.59 per case for this vineyard represented an improvement over the $12.99 the winery was paying now
Should they change it’s make/buy policy on grapes for this wine?
The Vineyard
The Distributor Stellar wines is a typical East Coast wine
distributor. In 1992 the company sold 225,000 cases of
wine, roughly 50% imported and 50% domestic. Stellar’s product cost for Cimaron Meritage
White includes $2.25/case to cover freight from California and state tax of $1.56/case.
A wine distributor sells wine to both “on-premise” accounts and “off-premise” accounts.
Since most of CWG’s off-premise wine sales occur in a relatively small premium wine shops, it was decided that this type of business should provide the final piece of the value chain
Exhibit 8
Stellar Wines Financial Statements
(in Thousands)
Balance Sheets
December 31,
1992 1991
Assets
Cash $ 24 $ 9
Accounts Receivable 2,273 1,806
Inventory 6,500 6,592
Equipment (net) 108 105
Other 333 312
Total $9,238 $8,824
Liabilities
Note Payable, Bank $4,953 $4,794
Accounts Payable & Accruals 1,735 1,544
Stockholders' Equity
Common Stock 10 9
Retained Earnings 2,540 2,477
2,550 2,486
Total $9,238 $8,824
Income Statements
Year Ended December 31,
1992 1991
Sales $17,078 $15,389
Cost of Goods Sold 12,771 11,313
Operating Expenses 3,394 3,187
Interest Expense 425 507
Net Income Before Tax $488 $381
Exhibit 8 (cont.)
Stellar Wines Financial Statement
(in Thousands)
The Retailer
Riverside Wide Company is one of Stellar’s best customers.
As grocery chains and discount clubs have gained market share,
Many small premium wine shop have been driven out of business.
However, at the top end of the business there remains a demand for service and selection that is difficult to provide in a high volume setting.
Exhibit 9 contains selected financial information for Riverside for 1992.
As with the distributor, a case is a case. So one way of assigning operating
expenses and assets among the cases sold is equal weight.
The Retailer (cont.)
Exhibit 9Riverside Wine Company, 1992
Total Sales $1,889,916Cost of Goods Sold $1,412,000Operating Costs $438,134Profit (before tax) $39,782Cases Sold 14,776Total Assets $719,261
($235,333 of inventory)
The Retailer (cont.)
Overall Value Chain
Sam and Bill stepped back to consider what the numbers meant, and what were the strategic implications for Chalice.
Sam put the profitability for the four participants in this value chain together to determine the overall profit margin and the overall return on assets for the industry on every case of 1991 Cimarron Meritage White sold to consumers in retail wine shops.
Winery Costs Revisited
Sam knew the production cost of $52.73/case from Exhibit 4 was a very crude aggregate average cost.
Upon careful reflection, he concluded that the winemaking process can be viewed as involving three distinct stages: Stage 1 (crushing, pressing and
fermenting) Stage 2 (fining, filtering, bulk aging) Stage 3 (preparation for bottling)
Exhibit 10
Winemaking Cost-ABC Approach
1991 1992
Stage 1 $285,000 (1) $268,000
Stage 2 571,000 559,000 (2)
Stage 3 57,000 56,000
TOTAL $913,000 $883,000
*The 1991 Meritage White vintage represented 18% of the wine made in 1991, 15% of stage 2 costs in 1992, and 28% of the wine prepared for bottling in 1992
(1) Including $12,700 of barrel depreciation, because some white wines are barrel fermented
(2) Including $154,900 of barrel depreciation
Winery Costs Revisited (cont.)
Sam also discovered that the $16.80 per case for bottling was a very simple overall average allocation.
Exhibit 11 shows a comparison of the average approach and the ABC approach to bottling cost.
Exhibit 11Bottling Cost--Per Case
Cost Category Average Cost ABC Cost for Meritage White
Labor 1.16 .75Supplies .07 .07Bottles 6.43 5.00Corks 2.39 2.39Capsules 1.19 1.19Labels 1.99 1.50Wooden Boxes .55 0Taxes 3.02 3.02
TOTAL 16.80 13.92
Third, Sam discovered that barrel depreciation was a very complex issue, involving French oak barrels that had risen in cost from $362 in 1988 to $650 in 1993.
White wines are both fermented (3 months) and aged in barrels whereas red wines are fermented in tanks.
But, red wines are aged 2 years in the barrels versus only 9 months for white whites.
Yet all barrels at the Cimarron winery are just depreciated, straight-line, over 4 years, with barrel depreciation as 1 line item in winemaking cost.
Of the $21.07 winemaking cost for the 1991 Meritage White, $4.03 (19%) was for barrel depreciation.
Sam had no intuition about how a more accurate ABC assignment of barrel depreciation would affect the $4.03 number.
Exhibit 12 was constructed to estimate actual consumption of barrel cost, using estimated market values and the actual barrel usage plan for the 1991 Meritage White
Lyford Winery
Sam was aware of Lyford Winery which had been founded in Sonoma County in 1981.
It was constructed as a state of the art winemaking showplace with no expense spared in either the production of the wines or in the effort to build the brand in the marketplace.
The brand name was sold to a French company.
Wine for the brand was sourced from the bulk wine market.
Exhibit 13 gives the per case cost structure for one of Lyford’s more recent releases, a 1991 Meritage White.
The final blend was 85% Sauvignon Blanc, 13% Semillon, and 2% White Muscat.
Exhibit 13:
1991 Lyford Meritage White
Product Costs per Case
Bulk Wine Cost $ 9.26
Bottling 2.28
Corks 2.37
Capsules 1.16
Labels 0.70
Bottles 4.60
Lyford Overhead & Supplies 2.02
Wine Tax 3.02
Total $25.41
The product costs shown in this exhibit tell nearly the entire story of this wine.
The “winery” has virtually no capital assets beyond leased office and warehouse space and working capital (assume 30% of sales).
An allocation of marketing expenses added only about $1.09 to the per case cost of the wine.
Leased space and equipment added about another $5 per case.
Lyford sold the wine to wholesale distributors for $45.00 per case, with a target retail price of $7.50 per bottle.
*Lyford Winery—The Value ChainSales 45Costs ?Margin ?Assets ?ROA ?
Price to Distributor 45.00+ Freight & Taxes + 3.81Delivered = 48.81
Price to Retailer (/.75) = 65.00
Price to Consumer (/.75) = 86.67 = ~7.22/Bottle
(~$7.50 with sales tax)
Exhibit 14: The Value Chain—1991 Cimarron Meritage White
(per case)Vineyard
Revenue 12.99 P/S = 0.26Operating costs 9.59 S/A = 0.685Margin 3.49 ROA = 0.184Assets 18.97
WineryRevenue costs 72.57 P/S = (0.32)Grapes 13.26 S/A = 0.551 Winemaking 47.33 ROA = (0.174) Bottling 13.92 Bottle Aging 1.60 SG&A 19.32 Margin (22.86) Assets 131.70
DistributorRevenue 114.32 P/S = 0.19Wine Cost 76.38 S/A = 2.78Operating Cost 15.08 ROA = 0.56Margin 22.86Assets 41.06
Retailer Revenue 142.46 P/S = (0.016)Wine Cost 114.32 S/A = 2.93Operating Costs 29.65 ROA = (0.031)Margin (1.51)Assets 48.68
+$2.7 handling cost+$2.7 handling cost
+$2.25 handling cost+$2.25 handling cost
+1.56 tax+1.56 tax
The Overall Value Chain
Revenue 342.34 P/S = 0.0055 Profit 1.89 S/A = 1.424 Assets 240.41 ROA =0.0079
Vineyard, CWG is paying way more that the industry average price for grapes. If it paid the industry average price, there is a potential an incremental $5.o per case profit. Should it keep on sacrificing profit for quality?
The cost to establish and operate a vineyard is $9.59 per case, whereas CWG is paying $12.99 per case, plus handling. It has to decide if it will continue to buy grapes or start growing grapes.
Winery Product costs were assigned equally to various wines when no two wines were the same. This was done based on the average cost system. ABC analysis better reflected the winemaking, bottling costs than average costing did.
The winery is unprofitable, losing $22.86 per case. CWG has a lot of money tied up in inventory. The winery has 4.9 million in depreciable assets, while Lyford winery has virtually no capital assets.
Distributor The most profitable part of the value chain with a margin of $22.86 per case sold. It also has the highest ROA (56%) in the value chain.
Retailer Make a loss of $1.51 for every case sold. It has the highest wine cost in the value chain, a big reason why it is unprofitable.
Overall value chain The overall total profit is $1.89 per case and overall ROA is .77%. There numbers suggest that this is not a profitable business.
The Lyford winery has virtually no capital assets beyond leased offices and warehouse space and working capital this enables it to have a high ROA of 100%. Lyford winery also purchased its processing service from customs suppliers, and all of the services required to bring the product form the bulk wine market to distribution was also purchased form custom winemaking operations. This resulted in a low product cost of $25.41 and a margin of $18.5 per case. Lyford winery shows an alternative, more profitable approach towards winemaking. Lyford’s value chain suggests that CWG might be better off outsourcing some of its activities and reliving on custom suppliers to keep its product cost low.
The Lyford Wines Value Chain
Thank you !!