ROBERT MONDAVI & THE WINE INDUSTRY

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THREATS OF CHANGES IN THE WINE INDUSTRY FOR ROBERT MONDAVIS COMPETITIVE POSITION

Rise in Australian imports to the States by 30% per year Industry consolidation Consolidation in the distribution channel New entrants Brand dilution

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HOW ATTRACTIVE ARE THE ECONOMICS OF OWNING AN INDEPENDENT ULTRA PREMIUM WINNERY ON A 100-ACRE 100VINEYARD IN NAPA VALLEY?

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BASIC TIMELINE?
Long time before wine is sold Land & plants vines in Year 0. Harvests the first grapes in Year 3. First aged ultra-premium wine sold in year 5 Full scale wine production occurs between year 7 & year 10

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UPFRONT EXPENSES
land acquisition: 100 acres x $100K per acre = $10 million Vines: 2,350 vines per acre x $5 per vine = $1.2 million Vineyard development: 100 acres x $32,500 per acre = $3.25 million Barrels: 1,378 barrels (i.e. 310K liters/225 liters per barrel) x $575/barrel=$792K Crushing equipment: $500 per ton x 500 tons of grapes = $250,000 Bottling equipment: $650,000 Other capital costs (tanks, pumps, etc.) = $1 m. Total up-front expenditures = $17.1 million

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WINE PRODUCTION
100 acres x tons per acre x 620 liters per ton = 310,000 liters 310,000 liters = 413,333 bottles = 34,444 cases

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CASH FLOWS
Retail for ultra-premium = $20 Winery price = $1-$12 (based on Exhibit 9 margins adjusted upward for ultra) Revenues = 413,333 bottles x $11 per bottle = 4.5 million per year We can use EBIT margins to approximate the free cash flows that will be generated by $4.5 million in Revenue. Exhibit 9 in the case shows an EBIT margin for super premium wine equal to 23%.
That exhibit includes some portion of grapes that are purchased rather than grown internally. The analysis here presumes a completely in-house supply of grapes. If we assume that one-half of the material costs in Exhibit 9 are for grapes, then we can increase the EBIT margin from 23% to 35% (i.e. $2.10/$6.00).

Therefore, free cash flows per year = $4.5million x 35% = $1.6 million. Assuming small price increases each year (perhaps 3%, these free cash flows will escalate slowly over time.
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RATE OF RETURN
The rate of return on the initial $17.1 million investment falls below 10%.
the investment does not look attractive.

The winery would only generate $4.5 million in revenue & $1.6 million in fee cash flow in Year 5.
It only would reach those levels at some point between Year 7 and Year 10. In addition, the analysis above does not take account of the substantial investments in working capital that would be required during the early years of the vineyard.

In sum, one cannot expect the investment to generate rates of return in excess of 10%.

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WHY ARE LARGE ALCOHOLIC BEVERAGE FIRMS ENTERING THE PREMIUM WINE BUSINESS? Fosters Group?
What is that group doing? Are there economies of scope across the beer & wine businesses? Would the BCG matrix apply here?

Allied Domecq & Diageo?

What is that group doing? Are there economies of scope here?
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HOW ABOUT OTHER WINE COMPANIES?

Southcorp?
Divested its non-wine assets & invested in acquisitions to expand its presence in t he premium wine market

Mondavi?
Choice: focus on organic growth rather than acquisitions. One reason: escalating acquisition premiums Another reason: control issue
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WHAT IS MONDAVI TRYING TO ACCOMPLISH WITH ITS INTERNATIONAL JOINT VENTURE STRATEGY? Aggressive international joint venture strategy. Focuses on joint ventures with highly prestigious foreign wineries Provides learning economies Critical benefit in the US market as the prestigious foreign wines enhance Mondavis position with distributors, off-premise locations, & niche retailers in the companys domestic market Joint ventures provide them with flexibility
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ALTERNATIVES FOR MONDAVI

Stay the course Acquire/merge with domestic wineries Acquire/merge with foreign wineries Sell the company

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CONCLUSION: LESSONS FROM THE CASE

Structural heterogeneity
Industries exhibit significant structural differences across geographic regions of the world

Industry consolidation
Firms create value by expanding globally if they can realize economies of scale, scope, & learning

Diversification & cross-subsidization

Common for mature industries to diversify, but crosssubsidization only enhances shareholder value if true economies of scale & scope exist among the businesses

Shaping industry structure

Firms shape industry structure through their strategic choices & they may reshape industry structure through strategic decisions that do not enhance shareholder value

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WHAT HAPPENED TO MONDAVI?

3/11/2004 Constellation Brands & The Robert Mondavi Corporation signed a definitive merger agreement
Total value of the transaction is approximately $1.36 billion

Past history: originated as a company selling cheap wine also owns Almaden Vineyards bag-in-a-box wine
Constellation is now the largest fine wine company in the States & is now the largest wine marketer in the world

Expectation is that synergy will occur:

Complementary wine assets (vineyards, production facilities & distribution capabilities) Will this be a successful merger?

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ASSIGNMENT FOR 2/10/2006

TOPIC: Creating Business Strategies Read: Carpenter & Saunders, chapter 5 Focus: Porters Generic Strategies Good preparation for Group 3 case on caffeinated beer
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