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The Chalice Wines

The Chalice Wines. The Chalice Wine Group (CWG). The group was owns two vineyards which is Chalice and Cimarron, and one-half of a third in Delta.

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The Chalice Wines

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  1. The Chalice Wines

  2. The Chalice Wine Group (CWG) • The group was owns two vineyards which is Chalice and Cimarron, and one-half of a third in Delta. • It owns three wineries which are Chalice, Cimarron and Alicia, and owns Opera Valley for one-half of a fourth which is operates for a distribution fee on behalf of the joint venture owners. • CWG has a cross-investment with a prominent French wine company for distribution in the US of its French and Chilean wines. • CWG also owns a one-half interest in a vineyard in eastern Washington State with plans to build a winery at this site.

  3. Chalice Wine Group structure

  4. 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.

  5. The company is somewhat less effusive in describing its financial results in the 1993 Annual Report

  6. 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?

  7. Value Chain Analysis • A value chain is a chain of activities. Products pass through all activities of the chain in order and at each activity the product gains some value. The chain of activities gives the products more added value than the sum of added values of all activities. It is important not to mix the concept of the value chain with the costs occurring throughout the activities. A diamond cutter can be used as an example of the difference. The cutting activity may have a low cost, but the activity adds much of the value to the end product, since a rough diamond is significantly less valuable than a cut diamond.

  8. Visualization of Value Chain

  9. CWG Distribution Channel • Each of its four California wineries is located in a different legally designated viticulture (grapevine growing) 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.

  10. Exhibit 1:California Winery Shipments (000 Cases)*

  11. Exhibit 2:Wine Production in Case Wquivalents

  12. Exhibit 3: Consolidated Balance Sheets, The Chalice Wine Group, Ltd. (Thousand)

  13. The Winery • Complex production process • Wine isn’t produced in a day or a month but years • Various pools of periodic production costs must be allocated among many different wines from different vintage years • CWG’s method was as straightforward as possible, given the complexity of the situation • All costs were considered product costs and wound up as Costs of Good Sols for some particular wine • Grape costs were easy to assign directly to particular wines

  14. The Winery • 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.

  15. The Winery • 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 cases Total Revenue $2.7 million Depreciable 4.9 million

  16. 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.

  17. The Vineyard • 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?

  18. 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

  19. Exhibit 8 (cont.) Stellar Wines Financial Statement (in Thousands)

  20. 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.

  21. The Retailer (cont.) • 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.

  22. The Retailer (cont.) Exhibit 9 Riverside Wine Company, 1992 Total Sales$1,889,916 Cost of Goods Sold $1,412,000 Operating Costs $438,134 Profit (before tax)$39,782 Cases Sold 14,776 Total Assets $719,261 ($235,333 of inventory)

  23. 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.

  24. 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)

  25. Winery Costs Revisited(cont.) Exhibit 10 Winemaking Cost-ABC Approach 19911992 Stage 1 $285,000 (1) $268,000 Stage 2 571,000 559,000 (2) Stage 3 57,00056,000 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 • Including $12,700 of barrel depreciation, because some white wines are barrel fermented • Including $154,900 of barrel depreciation

  26. 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 11 Bottling Cost--Per Case Cost CategoryAverage CostABC Cost for Meritage White Labor 1.16 .75 Supplies .07 .07 Bottles 6.43 5.00 Corks 2.39 2.39 Capsules 1.191.19 Labels 1.99 1.50 Wooden Boxes .55 0 Taxes 3.023.02 TOTAL 16.80 13.92

  27. 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.

  28. 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

  29. 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.

  30. 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

  31. 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.

  32. 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 Chain Sales 45 Costs ? Margin ? Assets ? ROA ?

  33. Price to Distributor 45.00 + Freight & Taxes + 3.81 Delivered = 48.81 Price to Retailer (/.75) = 65.00 Price to Consumer (/.75) = 86.67 = ~7.22/Bottle (~$7.50 with sales tax)

  34. Exhibit 14: The Value Chain—1991 Cimarron Meritage White(per case) Vineyard Revenue 12.99 P/S = 0.26 Operating costs 9.59 S/A = 0.685 Margin 3.49 ROA = 0.184 Assets 18.97 Winery Revenue 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 Distributor Revenue 114.32 P/S = 0.19 Wine Cost 76.38 S/A = 2.78 Operating Cost 15.08 ROA = 0.56 Margin 22.86 Assets 41.06 Retailer Revenue 142.46 P/S = (0.016) Wine Cost 114.32 S/A = 2.93 Operating Costs 29.65 ROA = (0.031) Margin (1.51) Assets 48.68 +$2.7 handling cost +$2.25 handling cost +1.56 tax

  35. The Overall Value Chain • Revenue 342.34 P/S = 0.0055 • Profit 1.89 S/A = 1.424 • Assets 240.41 ROA =0.0079

  36. 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.

  37. 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. RetailerMake 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.

  38. The Lyford Wines Value Chain 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.

  39. Thank you!

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