Business final?
Group 1 Final Case Project
Societal Environment Analysis:
Political and legal forces impacting the wine industry include intense taxation and regulation from both the state and federal governments. Labels must be preapproved by the Alcohol and Tobacco Tax and Trade Bureau and must contain at least 9 items including the brand name, wine name, and alcohol content. Wine companies incur additional costs to comply with regulatory requirements in addition to tax expenses. Zoning and environmental regulations also make it difficult to acquire new land for vineyards, and contribute to the rising cost of such land.
Following Prohibition, many states imposed a 3-tiered distribution system for alcohol, requiring producers to sell to distributors, who would then sell to retailers, who would sell to consumers. A legal change benefiting the wine industry came with a Supreme Court decision in 2005 that allowed wine producers to sell to consumers and retailers directly. Margins are higher when producers sell to retailers rather than distributors, and even higher when selling direct-to-consumers. However, selling to distributors reduces selling expenses, while selling direct-to-consumers requires increases marketing, selling, and overhead expenses.
In terms of economic forces, the wine industry consists of the value segment, offering wine with prices under $10 per bottle, and the premium segment, offering wine costing more than $10 per bottle. The target retail price for Sandlands’ wine is between $24 and $28 per bottle, placing the company in the premium segment. Premium wine is considered a non-essential luxury good, meaning consumers can defer purchases and tend to buy more as their income increases. Premium wine sales are subject to variation based on the state of the economy. Rising wages, low unemployment, and increase in discretionary income would all lead to an increase in sales of premium wine.
In terms of sociocultural forces, a survey of people over legal drinking age in the U.S. revealed that 36% do not drink alcohol, 24% drink alcohol but not wine, and 40% drink wine.
Of wine drinkers, two thirds drink wine less than once per week, and one third drink wine more frequently. Wine stands behind beer and distilled spirits, accounting for only 15% of sales dollars in the alcoholic beverage industry in the U.S. However, wine consumption per capita has been increasing for decades, reaching nearly 3 gallons by 2016. Increased concerns of consumers about maintaining a healthy lifestyle and environmental sustainability may generate more interest in wines made from organically farmed grapes.
Technological forces impacting the wine industry include advances in farming equipment that help vineyards save on growing and harvesting costs. However, “old vines,” such as those used by Sandlands for its wine, are not suited for modern farming equipment, putting those vineyards at a technological disadvantage. Technological advances have also helped wine producers market their wines and sell directly to consumers. Producers can sell through the internet, promote their products through social media, and market and distribute through apps such as VineSpring.
Industry Analysis:
Looking at the threat of rivalry, there are many competitors in the wine production industry, with more than 4,000 wineries in California and more than 9,000 in the U.S. in 2017. The overall winemaking industry has medium concentration, with the top three firms producing 60% of the wine. However, these firms are primarily focused on the value segment, although some have a few premium brands. The premium segment, consisting primarily of smaller wineries, has much lower concentration, with over 80% of wineries producing less than 5,000 cases per year. There is significant product differentiation, with thousands of types of wine to produce. Type and quality of grapes used as well as various decisions throughout the winemaking process impact the final product. The majority of costs in winemaking are fixed costs such as labor, grapes, barrels, and packaging. However, capital investment needed for winemaking facilities and equipment is very high with limited returns. It is expensive to expand capacity. Overall, competition is fierce in the winemaking industry.
Looking at the threat of new entrants, there are minimal benefits from economies of scale for the majority of small competitors in the premium winemaking industry that would give an advantage over newcomers. Capital investment requirement is substantial, with limited returns, due to high equipment prices. Substantial product differentiation in the wine industry could help build customer loyalty, preventing consumers from switching to newcomers. Behind price, brand was considered the second most important factor when buying wine in a survey of high frequency wine drinkers, who account for over 80% of U.S. wine consumption. Access to distributors is a challenge for both existing small competitors and new entrants.
Potential substitute products for wine include beer and distilled spirits. Of the six customer segments in the wine industry, Price Driven consumers, accounting for 21% of consumers, and Overwhelmed consumers (19%), are most likely to switch to a substitute. Everyday Loyals (20%) and Image Seekers (18%) are potential threats to switch as well. Engaged Newcomers (12%) and Enthusiasts (10%) are most likely to stick with wine regardless of rising prices or other issues.
Bargaining power of suppliers is a minimal threat to the winemaking industry. Suppliers for the wine production industry include grape growers, who have high competition in their own industry and hold limited power. Some winemakers may grow their own grapes as well. Other inputs such as barrels, bottles, labels, and shipping materials are available from multiple suppliers and priced competitively.
Bargaining power of buyers varies based on the winemaker’s distribution channel. One method of selling wine is to sell to a distributor. The wine distributor industry is competitive and is experiencing increasing concentration. It is difficult for small wineries to do business with large distributors, and these distributors hold great power over the small wineries that they do deal with. Small distributors specializing in premium wines also need volume in order to make a profit, so small wineries have a difficult time selling even to them. Another option is to sell direct-to-consumers. Wineries can charge higher prices to consumers, who do not hold the power of distributors. If a winery is popular and has limited production, consumers may even be willing to buy their wine for higher prices on the secondary market. For example, Sandlands wine retails for $24-$28 per bottle, but has sold for $39-$79 per bottle on the secondary market.
Internal Analysis:
One important resource possessed by Sandlands is owner Tegan Passalacqua’s ownership of a 20-acre old vine vineyard for grape growing. Old vine vineyards are defined by the Historical Vineyard Society as being over 50 years old. Additionally, Passalacqua has built strong relationships with other old vine growers for purchase of additional grapes, largely established through his experience as a winemaker at Turley Wine Cellars, a wine production company making between 35,000 and 60,000 cases of premium and luxury wines per year. Access to old vines is a valuable resource. Old vines have much deeper roots than new vines, which come in contact with unique soil elements, giving wines produced from old vine grapes unique and balanced flavors. Ownership and access to old vine vineyards is also a rare resource. Of the over 600,000 acres of vineyards in California, only 6,000 are old vine vineyards. Old vines have lower yields and cost more to grow and harvest than new vines because modern farming equipment cannot be used on them. This is leading some farmers to replace old vines with newer vines. As a result, the rareness of old vines is increasing, and will likely continue to increase. It would be very challenging to imitate Passalacqua’s access to old vine vineyards, which allows for production of unique wines. He has gained connections with growers through years of working in the wine making industry, in addition to owning an old vine vineyard.
Another important resource is Passalacqua’s experience as a skilled winemaker, gained through education and work experience at Turley. This experience is valuable because it allows Passalacqua to make the Sandlands wine himself rather than hiring a winemaker. This saves Sandlands an estimated $50 per case, or $60,000 per year at his current production rate of 1,200 cases. This resource is not extremely rare. Although Passalacqua is a highly experienced winemaker, with over 9,000 wineries in the U.S. and over 4,000 in California, it is likely that many others are owned by skilled winemakers or able to hire one. For vineyards not owned by a skilled winemaker, this resource could be imitated by hiring a skilled winemaker, although profits would be impacted.
Sandlands also has access to three distributors, including one in California and one in New York, the two largest wine markets. Distribution access is a valuable resource, despite lower profit margins when selling to distributors, because they have access to influential wine buyers and help to market the products. Access to distribution is also a rare resource for small wineries. Distributors have low margins and depend on volume, so small wineries have trouble gaining access even to smaller specialty-oriented distributors. Distribution access would be a difficult resource for small competitors to imitate.
Passalacqua also has access to Turley’s facilities for production, which helps lower fixed costs. Access to Turley’s facilities is a rare advantage and difficult to imitate, although Passalacqua has been purchasing more of his own equipment and is considering investing in his own building for increased production and possibly a tasting room. He aims to increase production to around 5,000 cases per year.
Passalacqua has successfully bundled his resources of access to old vine grapes, access to distributors, and skill as a winemaker. His wines have been received very well by critics, and he has more demand than supply. His wines sell for much higher prices on the secondary market due to excess demand. Passalacqua has largely been managing his own old vine vineyard and Sandlands as independent operations. His idea of potentially buying a building near the vineyard for wine production could improve his ability to exploit his resources. Although fixed costs would go up by moving out of Turley’s facilities, costs of grapes would go down if he used some of his own grapes and production capacity would increase, improving total sales.
Strategic Options:
Sandlands produces wine using grapes from old vine vineyards, which provide the wine with unique and balanced flavors. Sandlands currently has a strength in its access to rare old vine grapes, which make up less than 1% of the vineyards in California by acre. Passalacqua owns a 20-acre old vine vineyard and also buys grapes from other growers who he has a relationship with from his job as winemaker at Turley Wine Cellars. Passalacqua also has experience in growing the grapes, and is knowledgeable in his operation of his own vineyard. Sandlands faces a threat because the availability of old vines is decreasing. Old vines have a low yield of grapes compared to new vines, and cannot be grown or harvested using modern farming equipment, so some farmers are replacing old vines with new vines. Sandlands’ pool of suppliers is decreasing, while old vine vineyards have been generating increasing interest from winemakers. Old vine growers may begin to charge higher prices as supply decreases and demand increases for old vine grapes, impacting Sandlands’ profit margin. Sandlands’ also uses various types of grapes grown with varying farming methods, all from old vines, to make the different types of wines it offers. The selection of different grapes and farming methods may decline as well as vines are replaced, limiting Sandlands’ product selection.
To mitigate this threat, while taking advantage of Passalacqua’s strengths of vineyard ownership and knowledge of grape growing, Sandlands could utilize the corporate directional strategy of backward vertical integration. Passalacqua likely only has the funds for one major investment in the business in the next five years and is considering buying a building to make into a winery, or saving for another vineyard. Purchase of another vineyard would help mitigate the threat of increasing supplier power in the old vine market and potential lack of control over types of grapes and farming methods. Additionally, Passalacqua can utilize his current vineyard to produce grapes from Sandlands wine rather than operating the businesses independently as he currently does. Passalacqua has a goal of increasing his production from the current 1,200 cases per year to 5,000 cases per year. Having more land for grape growing would provide more supply for his planned production increase, as well as provide more area for him to grow different types of grapes and try different farming techniques to create different types of wine.
An old vine vineyard yields between one and two tons of grapes per acre, with each ton producing approximately 65 cases of wine. Assuming an average of 1.5 tons per acre, Passalacqua’s current vineyard can yield grapes for 1,950 cases of wine, enough for his current production, but not his planned production. The weighted average price per bottle for Sandlands wine is currently $22.75, or $273 per case. Following the costs laid out in the case, and removing the labor cost as Passalacqua does the work himself, Sandlands makes a profit of $122 per case. Annual profit is $146,400 at the current production rate of 1,200 cases. By using backward integration and using his own grapes, Sandlands will save $35 per case, for a total profit of $188,400 per year at the current production rate. Purchase of an additional vineyard may be needed to provide the range of grape types and farming options that Sandlands works with, and will definitely be necessary to increase production to the goal of 5,000 cases per year with its own grapes. At an average yield of 1.5 tons of grapes per acre, Passalacqua will need an additional 31.3 acres of old vine vineyards to meet his production goal. Prices vary and old vine vineyards are sold infrequently, but the lowest priced vineyard Passalacqua knew of was a 15-acre vineyard expected to go on the market for $1.0 million. Passalacqua could expect to spend over $2.0 million on vineyards to produce all of his own grapes, and potentially much more. Investment in a vineyard would also prevent Passalacqua from purchasing the Eastside Meats building. He would be unable to increase production by moving into his own facility until more funds were raised.
A weakness of Sandlands is its limited production capacity. Sandlands wines are made using the facilities of Passalacqua’s employer Turley Wine Cellars. Although access to the Turley facilities benefits Sandlands by reducing fixed costs by $22 per case, it also limits the amount of wine that can be produced. Sandlands has an opportunity due to the growing demand for wine in the U.S., with per capita consumption of wine steadily rising for decades. Sandlands currently has excess demand, with Passalacqua having to make tough decisions on which customers’ orders to fill. Sandlands could follow the corporate directional strategy of horizontal growth by expanding wine production through the purchase of the Eastside Meats building to convert into a winery.
The building is close to Passalacqua’s vineyard, which he had been operating independently from Sandlands. Moving production near the vineyard would help realize synergy between the vineyard and winery businesses. However, Passalacqua would still need to purchase grapes from outside growers once production was increased beyond 1,950 cases as well to gain access to a variety of grapes and farming methods. Purchase of the Eastside Meats building requires a capital investment of $500,000. Although this is far lower than the price of a vineyard, the purchase would still prevent Passalacqua from purchasing another vineyard until more funds were raised. Prices of old vine vineyards are rising as they are increasingly rare and have been generating interest from winemakers. However, increasing production to the goal of 5,000 cases per year at the new facility brings significant increases in profit, despite the increase in fixed costs. Assuming that Passalacqua uses the grapes from his current vineyard in 1,950 cases, those cases have a profit of $135 per case. Grapes for the remaining 3,050 cases must be purchased from other growers and would have a profit of $100 per case. Total annual profits would be $568,250. The investment in the building would pay for itself in increased profits in just over a year.
A strategy at the business level that Sandlands could utilize is to use a differentiation focus strategy, targeting the Enthusiast segment of wine consumers, by marketing itself as a unique premium wine. This strategy takes advantage of Sandlands’ unique use of old vines and Passalacqua’s skill as an experienced winemaker which allows him to produce high quality products, as well as the opportunity of steadily increasing wine demand.
Sandlands wines were regularly selling in the secondary market at prices of $39 to $79 per bottle, despite the average retail price of $26 per bottle. If Sandlands were to reprice its wines with a retail price of $39, at the low end of the secondary market prices, profits would improve significantly. Assuming that the same distribution channels are used, with 25% of wine being sold through distributors at half the retail price, and 75% being sold to directly to consumers at retail price, the weighted average cost per bottle would be $34.125. The price per case would be $409.50. If this strategy was used in conjunction with the purchase of the Eastside Meats building, with capacity increasing to 5,000 cases per year, profits would increase significantly. At 5,000 cases per year, profit per case would be $271.50 for the 1,950 cases made from grapes from Passalacqua’s vineyard, and $236.50 per case for the 3,050 cases made with purchased grapes. Annual profits using these strategies would come in at $1,250,750.
Passalacqua had expressed concerns about extra time and effort needed to sell his wines if he raised prices. At higher prices, customers tend to shop around more and like to meet the winemakers to discuss the products. In addition to making the Sandlands wines and working his job at Turley, Passalacqua did not have time for extra marketing efforts. A solution to this would be to hire another winemaker to assist in production under Passalacqua’s instructions, and in meeting with customers. Including a tasting room in the winery at the Eastside Meats building would also help in executing this strategy, by giving customers a chance to try the wines and meet the winemakers.
The cost of labor for a skilled winemaker for Sandlands was estimated at $50 per case produced. This number has been excluded from previous profit calculations due to Passalacqua performing all the work himself. After hiring an additional winemaker, profits would be $186.50 per case for the cases made with purchased grapes, and $221.50 for the cases made with Passalacqua’s grapes. This is still significantly more profitable compared to pricing the bottles at $26 per case. Profits at the new facility at 5,000 cases per year with an additional winemaker on staff would be $1,000,750 per year, compared to $568,250 per year at the new facility at the lower price with Passalacqua performing all the work.
Strategy Recommendation:
Sandlands should follow the horizontal growth strategy by purchasing the Eastside Meats building and converting it to a winery and tasting room. This would allow for expanded production capacity and help create synergy between Sandlands and Passalacqua’s vineyard. Additionally, this strategy helps Sandlands overcome its weakness of limited production capacity and resolves issues of having to choose which customer’s orders to fill. Sandlands should also increase its pricing and pursue a differentiation focus strategy, marketing itself as a unique premium wine. This would help build in a competitive advantage for Sandlands, utilizing its valuable resources of access to old vines to make unique wine, and the knowledge and experience of Passalacqua as a winemaker. Including a tasting room at the new winery and hiring a winemaker would help this strategy succeed. Purchasing additional vineyards is not as viable in terms of improving profitability. Significantly higher capital investment is required with lower returns. Purchasing another vineyard would not improve Sandlands’ production capacity and eliminating the cost of grapes would only improve profits by $42,000 per year at current production numbers. Although it would help mitigate the threat of increasing rarity of old vines, it is not the most effective strategy to utilize Sandlands strengths to improve profits. Combining the horizontal integration strategy and differentiation focus strategy, along with vertical integration exclusively from the current vineyard, would improve profits by $854,350 per year, quickly covering the $500,000 dollar investment in the building, as well as generating a lot of additional capital to purchase a vineyard in the near future if the threat of decreasing old vine grape supply becomes an issue. Purchasing a vineyard first does not provide a pathway to generate enough capital to open a winery and tasting room in the near term.
