1. Objective. 1. Literature. Outline OENOMETRICS XVI - VDQS Co-ops processing Champagne: typology and determinants of performance

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1 1. Objective OENOMETRICS XVI - VDQS 2009 Co-ops processing Champagne: typology and determinants of performance Francis Declerck declerck@essec.fr 1 Houses of Champagne started in the 1700s while co-ops have processed bottles since 1960s Often rumors state that co-ops could acquire a well established international brand to enlarge their business on the most profitable markets outside EU => Objective: to identify the strategy and performance of co-ops processing Champagne 2 Outline Vertical coordination 1. Literature To reach the objective: 1. Literature review 2. Champagne industry Context 3. Method and data 4. Results 5. Conclusions Vertical coordination continuum (Williamson, 1973) New institutional economics: transaction costs and institutional environment (Ménard & Shirley, a) French school filières (food chain): power as a key driver of leadership and management (Malassis, 1973) Dutch school: co-ordination about information exchange and logistics in chains and networks (Trienekens & Zuurbier, ), Omta, Trienekens & Beers () 3 4

2 1. Literature Quality incentives and supply contracts in the wine chains (Gaucher, Soler and Tanguy, ) Optimal procurement, inventory policies, chain profits according to various levels of coordination (Gaucher, Hovelaque and Soler,) Cobweb phenomena Cycles: in a cobweb phenomena, economic agents have adaptive expectations through time (Chiarella, ) It takes 3 years to turn grapes into Champagne => Delays in supply adjustment to demand => jumps/drops in retail prices in economic booms/recession => cycles (Declerck, ) Managing price cycles in the Champagne industry and System Dynamics modeling (Declerck & Cloutier, ) 5 2. Champagne industry context 1911: Houses of Champagne bought grapes outside Champagne; Vine growers could not sell grapes 1927: PDO rule : Champagne made with grapes from an appellation of 35,355 ha 1920 s: Establishment of the first co-ops to collect grapes to avoid strong price pressure from Houses to press grapes, make bottles for vine growers who may sell bottles But, vine growers think they can be freer if they sell bottles. Since 1960s, co-ops have developed the processing of bottles 6 In sales = 323 million bottles, 4.4 billion (historical record in : 339 mn bottles, 4.6 bn) 4-year contracts on the Champagne grape market: Houses must buy grapes from growers and co-ops Vine growers and co-ops sell grapes to houses 16,000 vine growers own 90% of vineyard Champagne makers: 297 Houses of Champagne sell 66% of bottles, but only own 10% of Champagne vineyard 65 Co-ops with 13,000 vine growers 4,729 vine growers sell bottles 7 Champagne wine is made with a blend grapes coming from - any of the 319 crus (villages) - any harvest year - any of the 3 grape varieties: Chardonnay, Pinot noir, Pinot Meunier Two PDO legal factors limiting supply: Yield: 13,000 to 15,500 kg/ha Production area of 32,900 ha reached the size limit (extension by about 6,00 ha within a decade) 8

3 Figure 1: Champagne vineyard in production, - Figure 2: Average yield of Champagne grapes in kg/ha, - Vineyard in ha Year The Appellation size limit is reached: Within 10 years, it will be enlarged 9 yield in kg/ ha Year Figure 3: Current price of Champagne grapes from to (in /kg) Figure 4: Price of Champagne grapes from to, expressed in constant terms (base:, ) 6,00 9,00 8,76 Price in euros/kg 5,00 4,00 3,00 2,00 1,00 0,00 1,43 1,76 3,58 3,05 2,90 2,37 2,75 3,51 3,38 3,32 3,60 4,08 4,88 4,57 Years 3,66 4,80 4,60 4,40 4,25 4,10 4,00 4,00 3,81 3,89 3,66 3,66 3,39 3,24 3,13 11 Price 8,00 7,00 6,00 5,00 4,00 3,00 4,45 4,89 6,54 5,67 4,23 4,62 5,62 5,30 5,32 5,05 5,81 6,72 6,11 4,79 Year 4,97 4,45 4,40 4,57 4,60 4,67 4,85 5,055,25 4,59 4,60 4,65 4,71 4,19 4,01 4,09 12

4 Figure 5: World shipments of Champagne from to (in million bottles) Figure 6: International versus domestic price of a bottle of Champagne expressed in constant terms (base:, ) Champagne shipments (in million bottles) Years Price in constant euros of 18,00 17,00 16,00 15,00 14,00 13,00 12,00 11,00 10,00 9,00 8,00 Year Price per bottle outside France Average price per bottle weigthed by sales Price per bottle in France 14 Per unit price peaks in,,, and followed by a price low within a 3 year delay Figure 6: Price of a bottle of Champagne and price of grapes harvested 3 years earlier 16,00 14,00 Vertical coordination mechanisms limited the ability of Houses of Champagne to respond to financial risks due to severe short-term reduction in demand Average per bottle price stable between (inflation factored in) 15 Price (in euros) 12,00 10,00 8,00 6,00 4,00 2,00 0,00 Price of grapes harvested in year-3 in a bottle of Champagne wine Price of a bottle of Champagne wine 16

5 Price/ bottle (in constant euros of ) Figure 7: World shipments of Champagne from to in function deflated price per bottle expressed in constant terms (base:, ) 15,00 14,00 13,00 12,00 3. Method & data Identification of the strategy of co-ops processing Champagne using Porter s diamond model () and SWOT analysis => A typology is set according to co-ops marketing strategy:. selling bottles as much as possible to (supermarkets). versus providing their 11,00 Financial assessment of co-ops according to their main distribution channel 10, Champagne shipments (in million bottles) Sources of data 3. Method & data Comité Interprofessionnel du vin de Champagne (CIVC) for Champagne volumes and prices Orbis data bank for financial statements Web sites of Champagne co-ops which have one Individual talks with co-op staff Due to limited information, only 13 co-ops : - 5 co-ops selling - 8 co-ops selling mainly processing their (vinegrower) who sell bottles 19 Figure 4: Competitive forces that determine the Champagne industry's profitability Threat of potential entrants Potential Entrants: ALMOST NO Legal protections and constraints Legislation provides HIGH BARRIER TO ENTRY. High barrier to entry due to high volumes. Legislation on designated areas of origin (AOC) to protect demanded by hyper and supermarkets the "Champagne" name, limiting surfaces and yields. High barrier to entry due to the supply of. Laws (e.g. Evin law in France) limiting communication grapes of particular vintages to be blended in order to guarantee quality over large volumes and advertisements on alcoholic beverages. Laws (e.g. Raffarin law in France) limiting the opening up. High barrier to entry due to the cost of an Industry competitors = of supermarkets and hypemarkets larger than 300 m 2 international commercial & logistical network Champagne makers Characteristics: Bargaining power of buyers: STRONG in EU, WEAK outside EU Bargaining power of suppliers. Strong competition between Buyers = supermarkets, cafes, restaurants, wine stores Suppliers = vine growers' POWER merchants and co-ops Super & hypermarket operators and hotel-restaurant chains:. Strong bargaining power since suppliers. Atomicity of operators - have strong bargaining power in France and Western may choose to make wine with a House and : among merchants and Europe where they are highly concentrated.. No substitute for "AOP Champagne" grapes co-ops - have the power to delist and reject large volumes of wine from. Limited area of "Champagne" vineyards. Lack of brand homogeneity store shelves, so Champagne makers may be in financial danger.. Limited grape yield across countries Independent wine stores and cafes worldwide: Threat of Substitute Products or Services Performance drivers Low bargaining power because they are not highly concentrated Substitutes = A LOT. Brand awareness Large sales force is required to reach large numbers of individual clients. Other sparkling wines. Volumes of wine from the. Other wines same blend of grapes in Bargaining power of final buyers. Spirits: whisky, rhum, Cognac, order to ensure constant taste Final clients = consumers have NO POWER vodka, gin, etc Households and business men / women have no bargaining power. All they can do is refuse to buy. 20

6 4. Results Champagne co-ops Threat of potential entrants Potential Entrants: ALMOST N O Bargaining power of suppliers Suppliers = vine growers' POWER. High barrier to entry due to high volumes demanded by hyper and supermarkets. Strong bargaining power since suppliers may choose to make wine with a House and :. No substitute to "PDO Champagne" grapes. High barrier to entry due to the supply of grapes of particular crus to be blended in order to guarantee quality for large volumes. Limited area of "Champagne" vineyard. Limited grape yield Threat of Substitute Products or S ervices Substitutes = A LOT. High barrier to entry due to the cost of an international commercial & logistical network 21. Other sparkling wines. Other wines. Spirits : whisky, rhum, Cognac, vodka, gin 22 Legal protections and constraints Legislation provides HIGH BARRIER TO EN TRY. Legislation on designated areas of origin (PDO) to protect the "Champagne" name, limiting surfaces and yields. Laws (like Evin law in France) limiting communication and advertisements on alcoholic beverages. Laws limiting the opening up store size Bargaining power of buyers: STRON G in EU, W EAK outside EU Buyers = supermarkets, cafes, restaurants, wine stores Super & hypermarket operators and hotel-restaurant chains: - have strong bargaining power in France and Western Europe where they are highly concentrated. - have the power to delist and reject large volumes of wine out of store shelves, so Champagne makers may be in financial danger. Independent wine stores and cafes world-wide: Low bargaining power because they are not very concentrated Important sales force is required to reach a lot of individual clients (for stores > 300 m2 in France, up to ) 23 Bargaining power of final buyers Final clients = consumers have NO POWER Households and business men / women do not have any bargaining power. They just can refuse to buy. 24

7 Industry competitors = Champagne makers Characteristics:. Strong competition among merchants and co-ops. Atomicity of operators among merchants and SWOT analysis STRENGTHS GOVERNANCE The ability to involve (vine growers) in the management: agricultural practices => desired quality WEAKNESSES GOVERNANCE lack of reactivity when there is no consensus co-ops making wine. Lack of brand homogeneity among countries The POWER OF HAVING COMMODITY (convenience yield) Grapes :90% when houses of Champagne sell 66% of bottles NO INTERNAL COST OF GRAPES Co-ops always buy grapes at market price and cannot cut costs that represent more than 60% of bottle price Factors of performance. Brand notoriety. Volumes of wine from the same blend of vintages in order to get constant taste 25 Easy TRACEABILITY LEGALLY ROOTED IN LOCAL REGION, by status: Easy partnership with regional government 26 SWOT analysis OPPORTUNITIES TO INCREASE MONOPOLISTIC POWER by grouping larger volumes of grapes TO BE CONSUMER ORRIENTED IN SELLING BOTTLES IN ORDER TO CAPTURE MORE ADDED VALUE BO BUY AN INTERNATIONAL BRAND FROM A HOUSE TO SELL BOTTLES AT HIGH PRICE THREATHS DECLINE IN CHAMPAGNE SALES DUE TO: - ECONOMIC RECESSION - SUBSTITUTES (other sparkling wines and spirits) - WINE PROBIHITION - FASHION NO RENEWING OF 4-YEAR CONTRACTS WITH MEMBERS A CO-OP MEMBER MAY: - SELL GRAPES TO HIS CO-OP - SELL GRAPES TO HOUSES OF CHAMPAGNE - SELL HIS/HER OWN BOTTLES PROCESSED BY THE CO-OP or HIMSELF CLIMATE CHANGE MAY ALTER THE CHAMPAGNE TERROIR => Risk of early hot temperatures in April and frost later when flower blossoms => Acidity of grapes and wine? 2018: EU DEREGULATION OF VINE PLANTATION RIGHTS: Vine may be planted everywhere 27 Champagne Cooperatives selling Average values Creation Number of vinegrower Number of employees Vineyard (in hectare) Million bottles produced 12 8,0 Million bottles sold 5,6 0,5 4,4 0,5 Million bottles sold under own brands 3,7 3,1 Median values % exports 54% 42% 46% 35% Consumer Price of a Brut Champagne bottle VAT included (in ) 19,43 17,68 20,00 17,35 Price of a Brut Champagne bottle without VAT (in ) 16,25 14,78 16,72 14,51 28

8 Champagne Cooperatives selling Key Results Total Sales (in k ) EBITDA (in k ) EBIT = operating income (in k ) Net Income (in k ) Financial Structure Average values Median values Equity Capital / Long Term Capital 81,2% 76,0% 97,2% 77,3% Financial Debt / Equity Shareholder's Funds 34,2% 41,6% 19,7% 41,8% Champagne Cooperatives selling Economic Performance Sales Growth w.r.t. previous year 10,3% 6,2% 9,7% 10,3% Value Added to Sales 16,3% 18,6% 14,3% 19,2% Labor Costs to Value Added 36,6% 35,6% 31,1% 34,9% Financial Expenses to Value Added 3,9% 4,2% 2,1% 2,1% EBITDA to Invested Capital 13,4% 13,7% 12,5% 13,7% EBITDA to Sales 10,5% 11,9% 8,1% 11,8% Operating margin (= EBIT) to Sales 7,9% 8,6% 6,2% 9,1% Profitability Average values Median values Profit margin on Sales 8,3% 7,8% 6,0% 7,5% Return on equity (ROE) 10,3% 10,7% 11,1% 10,6% Conclusion 1. Co-ops processing and selling Champagne have quite low debt level. So, they seem able to absorb current sales decline. 2. But trade-off between business risk and financial risk: Co-ops producing and selling (high business risk) are less leveraged (low financial debt risk) than co-ops which mainly provide their 1. Further research may be done to quantify the impact of the current decline in bottle sales on co-ops financial situation. Co-ops processing Champagne: typology and determinants of performance Thank you for your attention Francis Declerck declerck@essec.fr 31 32