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Regional Analysis |
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| April 4th 2007 |
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| South Africa: The honeymoon is over |
by Michael Fridjhon
Although only five players account for 75% of total wine sales, the number of small estates has doubled over the past five years. Many were banking on further euphoric growth; others transformed from fruit-growing to winemaking only because of the collapse of the bulk market. That should have been a warning, thinks Michael Fridjhon.
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The Mandela miracle of the Cape wine industry – the extended honeymoon period that followed the first democratic elections in 1994 – is now indisputably over. At the end of 2006, the Wines of South Africa (WOSA) office finally admitted that the year-on-year export growth, which had been the trend for a little over a decade, had turned suddenly into a net volume loss. In certain key export markets the decline is nothing short of catastrophic. The UK, long the Cape wine industry’s biggest trading partner, had shed 18%, year-on-year. The Netherlands, another big, though low-priced, customer of South African wine, was down an extraordinary 31%. All that kept the total literage loss below 10% was an increase in bulk sales and significant volume growth in Germany and France. Since this sales decline comes at the same time as what is euphemistically called stagnation on the home front, in fact slightly shrinking per capita consumption, the industry has nowhere to hide. Unsurprisingly, bulk stocks have increased by more than 25%, a situation made more uncomfortable by the fact that there is now no useful surplus-removal mechanism to bail out those who grow grapes but cannot sell their produce.
In many respects, this is a new era for the Cape wine industry. Until the KWV transformed itself into a trading company, it functioned as a parastatal national co-operative with statutory powers to manage the industry – and therefore its over-production – by acting as a buyer of last resort. However, in the boom that followed Mandela’s release, the KWV negotiated with the African National Congress (ANC) government to abandon these statutory functions and to take over assets it had used to perform them. The then Minister of Agriculture Derek Hanekom had no objection to ending the quasi-socialist role played in the South African economy by the agricultural control boards. He clearly understood that the future would have to be subsidy-free. However, no one appears to have anticipated the speed with which the export boom would suddenly come to an abrupt halt.
The problem has also been exacerbated by the surprising resilience of the South African currency. The rand had been losing value since the mid-1980s, and even the rise to power of Nelson Mandela and the evidence that the ANC government was better at managing the economy than the old National Party, did little at first to stem the slide. By early 2002, £1 cost R19. Twenty-five years earlier it had cost around R1.60.
The ever-weakening currency provided a perfect safety net for grape growers and wine producers in the post KWV era – their subsidy came in the form of a currency losing value at a rate of at least 10% per year. Certain in the knowledge that the rand would weaken, they happily granted customers extended credit terms, relying on the exchange rate to pay a bonus when the funds arrived.
From the absolute trough of early 2002, the rand has clawed itself back to a position of relative stability |
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Regional Analysis |
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and to a fair reflection of its value and buying power in international terms. At the moment, slightly less than R14 buys £1, less than R10 buys €1 and just over R7 buys $1. Except for a brief blip when emerging markets took a pounding in May to September of last year, the rand has been strong or strengthening for most of the past five years. While it has not recovered its pre-May 2006 value, it is finely poised, yielding adequate income to the country’s resource producers without hammering inflation on the back of high rand-based petrol prices. In short, currency is unlikely to provide the redemption so fervently prayed for by the 4,000-plus grape farmers. The 2007 vintage is likely to be the largest harvest on record, and grape prices are presently hovering well below the cost of managing vineyards. To make matters worse, the producer and wholesaler side of the industry is characterised by some five players who account for more than 75% of the national wine sales, and about 600 whose combined efforts dispose of the rest. Since this last figure has more than doubled in the past five years, it is clear that the dearth of experience and capital that tend to go hand in hand with the majority of such start-ups will undermine the industry’s ability to buy its way out of trouble.
The prospects are therefore anything but comforting: a significant percentage of South Africa’s producers have only transformed from fruit-growing to wine-making because of the decline in the market for bulk grapes. Many have borrowed against the value of their land to build the cellars that have now re-defined their existence. They have little or no extra money with which to establish brands or to buy their way into the local or export market. All they have done is throw good money after bad, investing heavily in deferring the insolvency scenario, which inevitably overwhelms operations that can never recover their running costs from the income the market is willing to grant them. Mostly, the industry still comprises grape farmers, a breed whose objectives – maximum yield for maximum income – is inimical to the objectives of the fine wine market. The majority grew up in the KWV-dominated era when a floor price was guaranteed – and was set at a level which ensured the certain survival of the greatest number. In the boom years of the Mandela administration, sustained demand for their fruit saw prices rise in real terms by 20% to 30% annually. A shortage of premium red grapes and only adequate supplies of internationally acceptable whites created an extraordinary seller’s market. Conditional selling – premium noble cultivar reds were only traded on condition that the buyer agreed to take the almost unsaleable whites – created the illusion that there was a market for the fruit and an insatiable demand for grapes, irrespective of provenance and condition.
Plantings and the Vineyards
In the past 12 years, the Cape has seen a massive replanting programme. In the early |
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Regional Analysis |
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1990s, white varieties comprised over 60% of the national vineyard. This percentage has substantially been reversed – particularly at the premium end. A 700% increase in Shiraz in as many years is the most striking indication of the pendulum’s swing. For those who undertook the capital investment – it costs around R100,000 to replant a hectare in constant 2001 prices – borrowing was pretty much essential. At current average grape prices, assuming average yields, growers are losing R5,000 per hectare before debt service on these investments or on any other of the property’s borrowings.
Growers are compelled to continue their plantings, mainly because South Africa suffers from a world-class collection of vineyard viruses. Even material supplied by the nurseries as ‘virus-free’ often show – within five years of the vineyard brand building and the right commercial partnerships will see volume gains (albeit sometimes only modest) but, more importantly, significant value enhancement. In the past year, DGB has increased its listings in the above-£5 category and sold over 100,000 cases in the on-trade. It has become Waitrose’s eighth largest wine supplier, delivering more Cape wine to the upmarket chain than any other distributor. Charles Back – regarded as the most entrepreneurial of the Cape’s producers – has had an almost identical experience. In a decision that initially cost him a measurable drop in volumes five years ago, Back shifted the focus of his business from multiples to specialist retailers and the ontrade. The strategy appears to have worked for him: while the Cape was losing literage in the UK in 2006, Back saw a 20% growth in his Fairview and Goats du Roam brands.
Germany: South Africa’s number two export slot has changed in the past year, with Germany supplanting the Netherlands as the Cape’s second most-important market. Between 2005 and 2006, exports to Germany increased from 36 million to 41.6 million litres. A significant amount of this growth comes from the KWV’s joint venture brand with Racke: Golden Kaan appears to be doing for South African wine in Germany what Kumala achieved in the UK. KWV’s newly appointed CEO Thys Loubser is upbeat and predicts growth and consolidation with this front-running brand. ‘Good market penetration has been achieved globally,’ he says. ‘Golden Kaan is the category opener for the South African segment in Germany, with now more than one million bottles sold.’ Holland: The dramatic drop in exports to the Netherlands – from 47 million litres in 2005 to 37 million in 2006 – has caused more than its fair share of anguish in the Cape. No one doubts that the bulk of what has been lost is at the most discounted end of the trade. It is probable that Scannell’s analysis of the volume losses in the UK applies equally well to the Netherlands, a market that has always been under price pressure from the brokers and their retail clients, |
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Regional Analysis |
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who drive much of this trade. Hermann Böhmer, CEO of The Company of Wine People, which does a lot of its business in Holland, claims that its volumes actually increased in 2006. ‘We have achieved very significant volume growth – particularly for Welmoed off an already high base – but there has been listings growth for new SKUs too,’ says Böhmer. ‘We ascribe this to brands which are correctly positioned, but very importantly to a great partnership we have with our Dutch partners. They clearly see that the promotional tool kit consists of more than deep discounts.’ Sweden: Sweden continues to be South Africa’s fourthbiggest market, growing by 15% in 2006 from 20 to 23 million litres. More importantly, it is in the higher value segments that much of this increment is being recorded. DGB’s Hutchinson points out that the new Bellingham Shiraz listing – on an international not a South Africa tender – has added 600,000 litres at the price point equivalent of £6.99. As one of the top exporters to the Swedish liquor monopoly, South Africa is well positioned to consolidate both volume and value in this market.
Canada: Canada remains the fifth-biggest market for Cape wine – though literage actually declined in 2006 from 12.7 million to 12.1 million litres. Historically the US’s northern neighbour used to be a very important destination for Cape wine and brandy. While much of this volume was lost during the sanctions era, it has slowly been coming back. A strong expatriate South African population in Canada no doubt contributes to this growth. In addition, until Constellation took control of Western Wines, Kumala was owned by Canadian-based Vincor, and this too must have played a role. Scannell believes that there is still substantial potential in Canada. Accordingly, the company’s North American office is working now at building brands – rather than volumes – in both the US and the Canadian markets.
The Best of the Rest – and an Outside Chance
The US, Denmark, Belgium and France each import between 8 and 12 million litres per year of South African wine. France has shown the greatest growth – from 5.4 million to 8.5 million litres in 2006. This dramatic increase – off a reasonable base and in one of the most patriotic of winedrinking markets – suggests that South Africa should be focusing its marketing efforts in the heart of the Old World. So it may come as something of a surprise to discover that WOSA, and several of the bigger producers, are investing time and effort in the Far East. DGB has already entered into a joint venture with Chateau Indage that will see Boschendal, Bellingham and Douglas Green represented on the Indian market. Distell has an office in Singapore, while WOSA is working to grow trade between South Africa and India. At this stage, the actual sales don’t make it onto the radar screen but, with strong social, political and emotional connections between |
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Regional Analysis |
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South Africa and the Indian subcontinent, and trade barriers falling away, this could become one of the bigger markets for Cape wine by the end of this decade.
How does South Africa go forward?
It has often been said that South Africans are a nation of incurable optimists. In the presence of the 2006 decline in exports, WOSA CEO Su Birch is resolute and calm. For a start, she points out, figures for the most recent three-month period suggest that there is a significant turnaround – which would make the dip no more than a blip. She also cites the ongoing success of relative newcomer First Cape and the work being done by Constellation on Kumala in the UK.
However she sees the Cape’s biodiversity positioning statement – a campaign launched in 2006 – as the basis for a long-term and unreproducible USP. ‘Variety is in our Nature’ is catching the increasingly eco-sensitive mood of the world and gaining massive and valuable editorial space. ‘It’s a winner,’ she says, ‘but it’s not going to change our wine world tomorrow.’ With 50,000 hectares conserved on farms in under two years, it is clear that the industry is doing more than merely paying lip-service to a marketing exercise. ‘I am convinced,’ she says, ‘that as a long-term positioning this clearly differentiates our wine industry, underpins authenticity, and builds the quality image we need to trade up. It also helps grow our wine tourism industry, taking it into the whole world of eco-tourism and protecting the values for future generations.’
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