Show me the money! Better understanding winery costs and efficiencies

By Mark O’Callaghan

Managing Director, Wine Network Consulting, Healesville, Victoria. Email: mocallaghan@winenet.com.au

Winery operators rarely understand the costs associated with their wine businesses and the efficiencies that can be achieved like those in other industries. Mark spoke with operational managers from other industries to uncover what the wine industry can learn to thrive and survive in the current climate.

As the world still grapples with the COVID-19 pandemic, one is tempted to hope that — in the West, at least — we may just be seeing the end of the beginning. With respect to the Australian wine industry, however, we are not even at that point yet as we grind through another macro-level upheaval. With trade tariffs, travel restrictions, equipment and staff shortages, anti-alcohol lobbyists, a retail duopoly, drought, fire and smoke challenges — to name a few — it is essential to understand your business from end-to-end. This is the starting point for making your own choices about how to thrive or even survive. Otherwise, someone else will eventually be sent in to make them for you.

The last boom in our industry was almost 20 years ago now and waiting for another one is not planning. These two decades of pressure are now manifest in hyper competition, unsustainable grape prices and the inability to re-invest, leaving tired assets that were designed and built for another era.

Despairing is not planning either and there are always options. It has never been more important to review the operations of your business with objectivity and adapt. The focus of this piece emerged from a conversation with a friend who is new to the wine business and observed that, too often, winemakers poorly understand costs and efficiency — certainly not to the level of successful managers in manufacturing. I have, therefore, interviewed no winemakers but astute operational managers from totally different industries and one of the best senior accountants who works with many wine businesses. This is not about cutting or sweating harder but how efficiency and workflow changes can improve costs and quality simultaneously. Imagine if you could improve your return on investment from 15% to 20% without lifting prices.

WHAT IS WASTE?

Waste takes many forms but, in the end, it all costs money and it is everywhere. Management consultants have different jargon for the categories, but at least in Lean Manufacturing circles they are described as time (waiting), excess processing, defects, overproduction, inventory, transport, motion and under-utilised talent.

For his take on a general approach to efficiency and management, I spoke to Panos Miltiadou, general manager of the Lucent Group — a high-end real estate developer — reflecting on his time as a plant manager with Visy Industries.

“If you’re not looking to improve, then you’re going backwards. It’s that simple,” Miltiadou said. The key element is recording and measuring so that activities are understood and quantified, he added. “When I visited some wineries, they might only know the speed of the filling head of the bottling line but couldn’t really quantify the real costs of any down-time.

“There are great principles like Kanban management and 5S consultants out there but we used a management software company who helped us record everything,” Miltiadou continued. “The understanding that came from that fed into continuous improvement, like reduced breakdowns and WIP [workin progress] but also some really excellent quality improvements. Sure, some parts were sophisticated but sometimes it was nothing more than a counter connected to a solenoid, so for a simple activity it’s relatively cheap. Whether it’s quality, safety, productivity, small or large, this sort of information educates the owners or managers about what’s going well and what’s not. That’s where the opportunity is.”

Another great non-vinous perspective on efficiency and quality came from discussion with Daniel Auld, from the Eric Jones Stairbuilding Group — one of the best specialist stair manufacturing businesses in Melbourne’s construction industry. Not an obvious choice for a wine journal, but Auld has modernised and grown the firm to make it one of the most trusted suppliers and doesn’t see efficiency and quality as trade-offs.

“It’s really more about reliability and quality than price,” Auld said. “We’re always looking to be more efficient but I’m dead set against anything that reduces quality, even 1%. The key to competing on price is the automation: the CNC [computer numerically controlled] kit. It frees us up to focus on what’s important and get better because most of what we do is customised. I don’t want a repetitive production line — even if that’s theoretically more profitable — because my best guys wouldn’t stay anyway.”

Keeping the simple things simple and having routine tasks automated is one of the most straightforward and effective ways to release the potential and talent in any winery or vineyard team.

WASTE NOT

Unfortunately, the various waste categories are visible everywhere in our industry but a more optimistic perspective is to see these as opportunities to thrive into the future.

Waiting, or wasting time, is everywhere and if time is money (and it is) it only becomes more important under pressure. It is usually a result of poor planning, scheduling or workflow design and while most visible in repetitive environments such as bottling lines, it is common in vineyards, laboratories, cellars, offices, meetings and order processing. Furthermore, the price of time is not just money: it is quality. Improvement needs brain power and when we are bogged down in the mundane, this just gets harder.

It has never been more important to review the operations of your business with objectivity and adapt.

Excess processing is simply using too many steps to get the result. Wine industry examples can be obvious, such as bottling schedule changes because a wine or dry goods were not prepared properly, or less visible, such as winemakers requesting redundant analysis. Once again, these sorts of wastes are often caused by poor communication, systems or both. The costs, however, can be more than just time. Excess work in the cellar burns more energy, sends more to landfill, wastes more water and puts more pressure on the effluent system.

In a vertically integrated industry like ours, defects can occur across countless steps, but the common drivers behind them all are flawed systems in design and oversight. In the vineyard, losses to disease, pests or dehydration are the most visible but some of the more insidious losses are in poor establishment practices which don’t address salt, viruses or trunk diseases.

In a nutshell, overproduction is simply preparing things before they are needed. To a large extent we cannot avoid it with the seasonal nature of the grape harvest (compared to brewing, for example) but we have all seen too many wasteful examples. The costliest in our world is usually excess stock (WIP) from inaccurate forecasts. There is no foolproof system for that, of course, but improved processes and information flows are critical.

Inventory problems (similar to overproduction) are wasteful due to things such as storage costs and blowing out working capital. The wine industry is notorious for this sort of waste and it is one of the worst things for eroding return on capital if it is not managed properly. During a financial health check of any wine business, excess inventory in terms of  bottled and bulk wine is an obvious checklist item but dry goods can be a drain too.

Transport is usually managed reasonably well by the large firms because the numbers and scale are easily understood but empty trucks are financial poison. At smaller scales, there will be opportunities with things like distribution and logistics cooperation as part of the broader shift to e-commerce. At the time of writing, the COVID-related interruptions to international supply chains are dreadful but (hopefully) temporary. However, as businesses everywhere re-tool in response, one hopes that the new normal is better than that old one.

Overlapping with transport is the more general concept of motion and its associated costs. Moving things — people, plant, equipment, consumables — all takes time, which can waste money and trim wine quality. Winemakers are notoriously bad at valuing their own time and this plays out too often in horribly inefficient winery layouts and workflows, especially those built hastily during the boom or those that have expanded with no concept of a masterplan.

In some ways, underutilised talent is one of the saddest forms of waste and bad ideas can certainly lose money faster than good ones can make it. We’ve all suffered from it, we’re all guilty of it and given that it is really cultural, not physical, it should be one of the cheapest to address. The reality, however, is that addressing the human issues is usually the toughest part of business management and changes can still be expensive. Without exception, all wine businesses — mine included — can do better.

Wine businesses are awash with waste and inefficiencies in all of these categories and taking the time to work through them with your team is not about creating dreary production lines or heartless gulags — quite the opposite. This should be about maximising value, unleashing the potential of your team, your vineyards and freeing up the time and headspace to make your wines better, even if volatile, bretty pet-nats are your thing.

MAKE IT COUNT

The complexity of the vertically integrated business model that many wine businesses use is still grossly underestimated. I sometimes make the comparison with a business selling luxury handbags except that we wine people would run our own cattle stations — complete with pasture improvement and stock breeding programs — abattoir, tannery, design studios, production factories, sales and marketing departments, retail and online stores, distribution, celebrity endorsements and Instagram accounts. Who has the skill set to do all of that?

This same complexity can make understanding the financial metrics difficult and when the pressure is on, this stuff matters. I was lucky enough to interview Shaun Allan, partner at Tilbrook Rasheed, a chartered accounting firm in Adelaide, who does a great deal of advisory work for wine businesses and has seen it all.

“Across Australia, there is a paradigm shift going on and you’ve really got to know your stuff at the moment,” Allan told me. “I’ve got itchy bankers at the moment regarding profitability and they won’t necessarily understand winery operations. You simply must know what’s going on.”

The best approach is, conceptually, really quite simple: to break the business down into its component business or activity units to understand and quantify their contribution to return on invested capital (ROIC).

“We see our role as advisory — the old ‘helicopter view’ approach,” Allan continued. “It’s very easy to lose perspective when you’re immersed in it, so we try to dissect it so you can see where the profitability is coming from. If not, it’s only a matter of time. No business — not even the family legacy ones — can sustain a loss for a considerable amount of time.

“Our models, looking at normalised profit and maintainable earnings for example, are about understanding what’s really going on. Remember, our modern financial statements have evolved over hundreds of years but they haven’t necessarily been targeted at operational managers. People that don’t understand their business can make bad decisions and that goes for owners and financiers too.”

One of Allan’s great contemporary examples is how today’s P&L might reflect high cost of goods (COGS) passing through from two very expensive, low-yielding vintages (in South Australia, at least) of 2018 and 2019. One risk could be that banks make a decision based on this, not understanding that fruit prices are likely to drop in many regions (another problem) which may very well improve winery COGS over the next two to three years.

“Without that understanding, it’s hard to know which way to turn or what levers to pull,” Allan said. “You wouldn’t believe — or maybe you would — how many times I’ve heard wine company executives order a cut to the vineyard budget when, in my view, they should do the opposite. There are so many vineyards out there with depleted soils and run-down irrigation systems. How is anyone supposed to get yields up and fruit costs down when it’s like that?”

CUT THE FAT, NOT THE MUSCLE

If a business’ review of process, costs, margins and returns is to be a genuine project about renewal and re-energising rather than a race to the bottom, the decision making needs to be spot-on and this needs information, not guesses. For some businesses it might even be worth investing in formal process mapping or time and motion studies from external advisors. There are many companies out there that specialise in this sort of analysis and an outsider’s view can be refreshing. In a field as conservative as ours, there will be resistance to this sort of thinking — just as there is to any change — but it simply goes back to ‘what gets measured gets managed’. Over the years I’ve seen far too many winery environments just like one of the best moments from the 1997 movie The Castle:

“Could you move the Camira? I need to get the Torana out so I can get to the Commodore.”
“I’ll have to get the keys to the Cortina if I’m gonna move that Camira.”
“Yeah. Watch the boat, mate.”

Shaun Allan’s advice is similar.
“Pick up the phone and talk to someone to get perspective and clarity,” he said. “Don’t make knee-jerk decisions that aren’t right for the business. Talk to someone who can dissect the business, find out what’s working and what’s not. What do the P&Ls look like? What are the bankers saying? Don’t let them reach the wrong conclusions and be prepared for those meetings. The strategy review is really about where you are, where you want to be and then the pathway. It’s astounding how many people don’t know where they are.”

Financial advisors are often not the right people for operational advice — they might just order another cut to the vineyard budget — but measuring, benchmarking and understanding the business metrics can tell you where to start looking. When the simple things are simple and the business is successful, one can get back to focussing on making better wines or just enjoying life. So much serenity.