BY Deborah Steinthal,
Scion Advisors

Your winery costs are ever growing: labor expenses, worker’s compensation, and the cost of selling in a crowded marketplace. Meanwhile, your revenue growth is less vibrant than before. With these pressures, how do you beat margin erosion? Your choices: you can improve performance by applying better management practices and/or you can adopt a different business strategy.

“You cannot cut, outsource, or downsize your way to economic success — you have to grow. Growth, very simply, is the one business imperative,” stipulates an April 2003 article in Fast Company. This is a very provocative position, especially if you check out businesses that actually grow during tough times in an industry or an economy, businesses such as Honda’s Pilot SUV; John Deere Landscaping; Cardinal Health; and Joseph Phelps Vineyards (St. Helena, CA).

These businesses have at least one thing in common: they carefully developed and implemented innovative strategies with the intention of growing when other companies were cutting and downsizing their organizations.
Some of these companies may not be familiar, but they are all focused on creating revenue, profits, and shareholder value by mobilizing assets that reflect their history and experience to make a compelling product offering and direct it toward a unique customer segment or market niche. Joseph Phelps Vineyards’ example demonstrates what it takes to embrace an approach to growing your winery more profitably in today’s marketplace.

What constitutes growth and why grow?
Fourteen winery participants recently pondered this question in a quarterly CEO Forum led by Scion Advisors (Napa, CA) and MKF Group, LLP (St. Helena, CA). These CEOs represent a cross-section of wineries in Napa, Sonoma, and Monterey counties. Their conclusions tell an interesting story that is pretty much in agreement with the Fast Company article.

“Growth is the process of expansion or evolution. Growth produces a different mindset — consider how hard it is to manage ‘stability.’ Forward momentum can absorb market setbacks more readily, keep core brands vital, stimulate high performers in organizations, increase profits so you can ‘become who you are,’ and force you to properly manage your wine product through its product lifecycle.”

Traditionally, wine industry growth strategy has been production-driven and focused on volume growth dictated by availability of grapes. Production-driven strategies are no longer working successfully for many wineries.

The combined dynamics of channel consolidation and increasing competition (characterized by severely declining numbers of wine distributors and by an escalating number of wine SKUs on the U.S. market) have made it much harder for wine businesses to market and sell wine. Eating into winery profits, sales and marketing costs are escalating by 20% to 30% annually, and each year wine inventories require considerable pushing through the wholesale system.

Distributors and retailers are exacting costly “favors.” Marketing directors invest larger and larger sales allowances into sales programming, distributor management, and bonusing, and sales teams direct an ever more significant effort into building key account relationships. This environment is particularly detrimental to smaller wineries that have very little muscle with three-tier distribution channels.

How best to grow profits — Do you underscore volume or price?
Volume growth, the preferred choice for fueling winery profits for many brands, is haunting countless winery owners who have underestimated the cost of higher volume production and especially the expense of higher volume sales and marketing. The highest quality, highest-priced producers appear most impacted.

Business simply has become overly complex for the (typically) smaller producers to successfully sell increasingly higher volumes of wine through a three-tier system already overburdened by brand proliferation and distributor consolidation.

This distribution bottleneck is placing unbelievable pressure on wine industry leadership to become more professional in how they compete in the marketplace, more disciplined in managing costs and pricing, and to seek out innovative business strategies focused on what they do best. Some winery CEOs, adopting new options for growth, are showing signs of being well ahead of their competition.

In response to this more complex environment, a few wineries are growing profits by actually getting smaller in volume. One of the most visible of these is Joseph Phelps Vineyards. In 1991, the winery was annually producing in excess of 120,000 cases of wine and had 26 products in its portfolio.

Today, production is slightly under 90,000 cases and more than 80% is in three wines that are sold only through the three-tier channels. The three wines are Le Mistral ($25 retail), a Syrah/Grenache blend from Monterey County; Napa Valley Cabernet Sauvignon ($45); and Insignia ($125), a Bordeaux blend. But because of a strategy extremely focused on advancing quality, dollar sales have more than tripled and profits have soared — an unusual result among today’s marketing schemes.

“We were very sure that, in order to remain both very independent and very successful, we had to find a distinctive niche,” explains Shelton. “We all agreed that our niche would be at the top of the luxury wine segment, and that we would be the benchmark winery in that rarified niche. Once we determined that was to be our goal, then we could focus on every effort it would take to get there and stay there.”

This winery case study is fascinating in that the winery leadership team made classic decisions about strategy and stuck to its plan through implementation — the trademark of successful companies in just about any industry. This team also demonstrates an uncanny ability to recognize its mistakes, learn from them, and relentlessly correct them. The following documents Joseph Phelps Vineyards master plan and its successful implementation.

Owners’ culture, vision — Assess your environment realistically
In early 1994, the Joseph Phelps ownership team (comprised of Joe Phelps, company president Tom Shelton, and winemaker Craig Williams) took a long hard look at the strengths and weaknesses of the winery’s operations, wines, and market position. When the ownership team committed to changing its business strategy to grow profits, team members also factored in personal goals. They had neither the desire nor the expertise to become higher volume producers and marketers.

“We are not in the same business as Kendall-Jackson, Beringer Blass, and Robert Mondavi Winery,” reflects Shelton. These other wineries have totally different business models and are extremely efficient at the higher volume, mid-price tiers. Focused on lower volume, Joseph Phelps Vineyards has a huge investment in the highest-quality vineyards and production.

Innovative business strategy — Build on history and expertise
Figure I illustrates succinctly how the owners of Joseph Phelps Vineyards approach their challenge. They articulate long-term profitability goals, design business strategies to match real market opportunity, and then carefully align the right people, structures, and systems to support proper execution.

“We realized fairly quickly that the only place we could be competitive and make money was at the top of the luxury wine segment,” notes Shelton. “We also realized that our expertise is our unique ability to build-out the quality of our wines. This absolutely is our core capability.”

The Joseph Phelps Vineyards plan to grow smaller in product mix and total production and larger in revenues incorporates three unassailable strategies. These strategies are inextricably linked. Constrained by a nominal marketing budget, Shelton understands that all three have to be in place for the growth plan to be successful. If one of these strategies does not work, profitability goals will not be met.

1. A total commitment to quality reflected in product price.
2. Product positioned for leadership in a distinct market niche.
3. Product identity that is differentiated by wine style and brand.

Very simply, in order to be profitable in a business that incurs very high product, sales, and marketing costs, the Joseph Phelps pricing strategy needs to target the highest price tier in the luxury category.

Execution excellence — The right decisions surface
What is interesting about this winery’s story is that Joseph Phelps Vineyards has been successful in execution. All too often, a business starts out with a compelling plan and good intentions, but at the first bump in the road or at the first opportunity; the leadership team changes strategy and later wonders why it never achieved its objectives. In fact, research shows that most successful companies have two things in common: a strong leadership team and an unwavering commitment to implementing their core business strategy.

For a leadership team to succeed at least two criteria have to be met: it must have the right skills and a process that yields good decisions. Internally, the Joseph Phelps Vineyards team came together as a strong group, capable of making tough decisions that were aligned with its goals.

Fortunately in the early 1990s, with Shelton’s arrival, the Joseph Phelps leadership team was extremely strong in each functional area of the business; Craig Williams in winemaking, Damian Parker in wine production, Dave Lockwood in financial operations and planning, and Shelton in marketing, sales, and general management. And, they each realized that mutual respect and trust for each other’s abilities in his area of expertise was at the core of their ability to demonstrate balanced decision-making. This balancing act was soon put to the test.

First, they gave up some sacred cows and seriously pruned their wine portfolio. Joseph Phelps Vineyards had built a reputation on product innovation. In the early days, the winery had established a market position around Chardonnay, Riesling, and Sauvignon Blanc. Over 30 years, it had expanded into the Rhône category, building out a portfolio of 26 wines.

In the 1980s, the Joseph Phelps Vineyards foray into fighting varietals almost brought the whole ship down. But in the 1990s, the winery was at the end of its innovation cycle, and the team soon became concerned about how to maintain category leadership as a mature brand while demonstrating margin growth.

“The wine market does not reward innovation, and we were finding it difficult to be a leader in this industry with innovative wines,” says Shelton. “We were ever so aware of our weaknesses surfacing around underperforming vineyards and brands. Decisions we made years ago were extremely costly to get out of, but I am utterly convinced we’d be in a very different position today if we had focused all of our energy years ago on what is now our core business.”

Shelton describes a phenomenon that is not unusual in this asset-intensive industry, where winery owners, faced with costly decisions, must make hard choices that inevitably commit them to an unalterable path.

Sometimes a decision yields long-term gains and sometimes it becomes an asset trap and straps profitability. This asset trap is illustrated by an all-too-familiar story. A small family estate vineyard owned 700 acres planted to seven different varietals and supplied grapes for wines mostly in the $7 to $12 category and some in the $15 to $20 category.

A glut undermined their grape sales, and the family decided to diversify into winemaking, eventually producing 15,000 cases of wine with a portfolio of 22 wines in the same price categories. Their objective was to grow to 100,000 cases and reduce their dependency on grape sales, a much less profitable and predictable business. However, they soon realized that they were actually losing money on their lower priced wines, which represented 80% of their volume. They were faced with the recurrence of their original problem: no profits.

Unfortunately, the potential solution was severe. They needed to transition their winemaking operations away from the low-end to higher priced wine production by replanting a significant portion of their vineyard to their best-selling, highest-priced varietal, to reduce their portfolio to two or three wines, to shift their growth strategy to emphasize profits not volume, and perhaps even to sell off non-strategic land assets to properly capitalize the business.

These are difficult, costly choices of the sort that Shelton recognizes all too well. As a result of such painful lessons and mindful of what it takes to get out of a bad decision, his team is more cautious in its choices and decisions and spends much more time weighing the outcomes and understanding how and where the winery can be successful.

Distribution channels — Never rest on your laurels
Shelton readily admits wineries large and small in this industry have been forced to share the same, mandatory three-tier distribution infrastructure, which is proving to be quite dysfunctional for smaller brands. Shelton has faced a considerable challenge in communicating the Joseph Phelps Vineyards strategy to distributors.

The issue is one of differing objectives. Distributors are incentivized by consistent volume box sales, and by necessity, the strategy forced on many luxury producers is an allocation model constrained by production variability. This lack of predictability in availability of their wines has made it tough on their distributor relationships.

Every winery experiences challenges during plan execution. For Joseph Phelps Vineyards, the 2000 vintage was such a challenge. The Insignia brand was built for the wine collector market, which is greatly influenced by gatekeepers Robert Parker and the Wine Spectator. Though Insignia received a 91 rating from Parker, the 2000 vintage overall was panned, and the impact on the Meritage luxury category was unfortunate. Sales slowed considerably.

Shelton’s team, relying too heavily on the wine collector market, had not built out additional channels to broaden the wine’s exposure across the market. In response to this oversight, the team has since made a major push into the on-premise market.

“In late 1990s and early 2000s, it was easy to be seduced by multiple years of easy markets,” recalls Shelton. “We were focused on too many things and not paying attention to our knitting.”

Fortunately, the winery’s strategy focused on profitability provides them with margin for error, so they are able to sustain such bumps in the road with a certain degree of elegance.

Good plans take time — Plan during an up-cycle
“When we started working on the plan in 1994, we could have easily rested on our laurels, since the winery was doing so well,” remembers Shelton. Demonstrating foresight, the team started implementing the plan, bought land in Sonoma County and started planting 100 acres five years ago — 80 acres in Pinot Noir and 20 in Chardonnay — with the same commitment to quality and the luxury wine segment now demonstrated in Napa.

Half-way through 2004, Joseph Phelps Vineyards, on the cusp of taking its 1994 plan to market, continues to build brand equity through product quality and telling its story. Through commitment to its long-term strategy, this privately held winery expects to maintain sustainable profitability and a highly differentiated position at the top of the luxury segment.

When queried about his concerns vis-a-vis the overnight arrivists in the luxury category, Shelton responds: “The wine market values and rewards newcomers. In fact, the barriers to entry are very low. But the honeymoon tends to be short. These newcomers don’t typically exhibit staying power. The long haul takes commitment and single-minded focus on quality.”

In fact, Robert Parker in his recent newsletter paid homage to the venerable estates of Joseph Phelps Vineyards, Chateau Montelena, and Shafer Vineyards, all of which have clearly risen above the heap and continue to successfully demonstrate staying power — consistently building product quality and brand equity.

Lessons learned from Joseph Phelps Vineyards case study

Does one strategy fit all?
Do not try this without adult supervision!

Imagine going to your doctor, and before you’ve had a chance to describe your symptoms, the doctor writes out a prescription and says, “Take four of these two times each day, and call me in 10 days.” “But — I haven’t told you what is wrong,” you say. “How do I know this will help me?” “Why wouldn’t it?” replies the doctor, “It worked for my last two patients.”

No competent doctor ever practices medicine like this, nor does any sane patient accept such treatment. Yet some consultants routinely prescribe such generic advice, and some managers routinely accept such therapy in the belief that, if a particular course of action helped other companies succeed, it ought to help theirs too.

Not all wineries have the appetite or the ability to follow the Joseph Phelps Vineyards’ strategy. Only a blessed few have the capacity to become the category leader, command top prices, and maintain this position over the long run.

However, a number of wineries are adopting a similar strategy, growing average revenue per case by reducing overall volume and actually shifting emphasis from growing their wholesale channels to committing significant resources to developing their more profitable consumer-direct channels.

Some of these same wineries have succeeded in doubling and tripling operating income within three to five years. These strategies are also about growing profitability, but these wineries are emphasizing channel-mix over pricing. They are shifting more products to more profitable distribution channels, rather than claiming prices in the top rank of the luxury category.

What Joseph Phelps Vineyards and these wineries are learning is that you can show improved performance by growing smaller and more focused in product mix (see PWV September/October 2004, “Prune Your Portfolio”). You can use the resources you’ve freed up to make your brand stronger in all channels and more attractive to customers. Thus, a growth-strategy focused on margin-growth and not volume is potentially within reach of many smaller wineries.

When clients of Scion Advisors are contemplating a change in business strategy, we advise them to consider at least four critical steps. These steps parallel the ones embraced by Joseph Phelps Vineyards.

Get clear on your family/ownership goals and values.
Business owners need to define business goals that specifically support their personal needs. The process of scrutinizing goals is particularly important for families in transition, principally, when a new generation decides to participate in the family business. Family goals can include the explicit need to take profit out of the business to fund education or pay down the purchase of the business from elders. They may include the assessed investment requirements for funding future growth in shareholder value.

The wisdom behind goal-setting is simple: “If you aim for the tree, there is a good chance you will hit the tree. But, did you really want to aim for the tree?” A well-defined set of goals gives your strategic plan integrity and is the basis for evaluating performance and making decisions about the future.

For example, if you are looking to grow profitability and brand equity by emphasizing upwardly mobile pricing, your goals might be stated as: grow to $270 average price/case at a volume of 75,000 cases, yielding an operating income of $3 million in 2008. An important component of goal setting is a well-articulated vision that focuses the business on something family and business participants are motivated to be part of, is everlasting, and helps the organization survive change to endure beyond the bumps in the road.

Conduct a reality check and assess your current situation.
You may need to appraise the strength of your winery’s operations, wines, and position in the marketplace by seeking to understand the essential building blocks of the business: what are the style and quality of the wines and what is the potential for product improvement, at what cost; what is the value proposition to each customer tier and how should this change in the future; and what are your competitive position and points of differentiation and how can these be more effective?

Third party assessments of your operations, your position in your market, and your wine style can help you gain a more balanced perspective of the health of your business. By assessing your business performance against other “like-businesses,” you may discover your strong margin growth is not as strong as you thought.

“Corporate-speak” from your distributor may lead you to reduce your prices, but a robust survey of your retail and restaurant accounts and consumers helps you understand who your competitive set actually is.

Your “house-palate” may lead you to believe your wine is of the right quality to compete in the $30 Cabernet category, but an invited group of “outside” tasters reveals you have overestimated its quality at that price point.

If your winery has the right building blocks in place, you have increased opportunity to implement more innovative strategies. If not, your business may not be strong enough to successfully absorb an aggressive growth plan.

Set in place your core business strategy.
The plan you develop must be geared toward achieving your stated family and business goals. At a minimum, your plan must identify strategic goals against a timeline and address the key ingredients that are necessary to achieve these.

Consider answers to these essential questions: What can you leverage from your past to achieve your goals? What existing core strengths can you leverage into a competitive position in the future? How will you compete in your target market? What are your cornerstone strategies to developing the future business?

Execute with excellent people, processes, and systems.
Before you are ready to move out with your plan, you will need to consider your enterprise’s ability to support its execution and to identify important organizational gaps. Companies that over-estimate leadership, organization, and process/system readiness are frequently off dramatically from plan projections by years and by millions of dollars in revenues and expenses.

Leadership readiness, a large component of organization readiness, has been dramatically under-valued by many CEOs in the wine industry. Many a winery struggles with the issues around hiring new, more professional staff, or showing loyalty to past employees through investing in their development needs. The cold reality is that some of these employees may take years to develop. The winery ends up missing a critical window of opportunity and spending much more in soft and hard development dollars than if it had hired higher priced, qualified leadership.

A gap analysis conducted at three levels helps you assess the cost and timing of implementing the proper delivery infrastructure. Assess:

1. Leadership team skill set and know-how,
2. Organization strategy and structure,
3. An appropriate underpinning of reporting, planning, and employee development processes and systems.

By characterizing enterprise-readiness to execute the plan, you increase your probability of achieving your profit goals on time.

Scion Advisors founding partner Deborah Steinthal, a professional advisor, helps family-owned wine businesses prosper in an increasingly crowded and complex marketplace by improving management and leadership practices. In partnership with MKF, Deborah also leads the Winery CEO Forum, an executive program for an exclusive group of winery CEOs who seek stimulating discussion focused on critical leadership challenges. Deborah can be reached at deborah@scionadvisors.com or by calling 707/258-9130.