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Published 07 February 2013 01:09, Updated 26 November 2013 18:35
Casella can find salvation in export markets if it gives up underpricing its Yellow Tail wine and accepts lower volumes. Photo: Getty Images
The shockwaves from news that Casella Wines lost $30 million last year are still reverberating around the wine sector, with several wine publications openly questioning the company’s long-term viability. Managing director John Casella was quick to calm the speculation but there was no hiding even his concern: “It is very, very tough,” Casella said. “We are working out how we go forward. Provided we have the support of our financiers, we can make little or no money for a year or two.”
How is it possible for a company that successfully sells 150 million bottles of wine a year to lose so much money? To be fair, most of that $30 million loss can be explained by a major loan write-down. But that still leaves the uncomfortable question of how Casella’s $335 million revenue last year failed to generate any profit. If we listen to John Casella there is only one explanation: the prohibitive strength of the Australian dollar. In 2001 when the company began its assault on North America, which still accounts for three quarters of sales, the strong US dollar was worth almost double its Aussie equivalent.
Casella was able, at that exchange rate, to go into the market with a lower price than originally envisaged and Yellowtail sales rocketed beyond even the Casella family’s wildest expectations.The company’s prescribed solution to their current malaise is to tough it out and wait for Aussie dollar to weaken again.
“You need a lot of courage in the tough times. I don’t think the dollar can stay where it is,” Casella told The Australian Financial Review in January. “We want to be strong for the long term and make sure we don’t overreact to the short term.”
Unfortunately he is missing the point. Casella’s real problem isn’t global exchange rates. It’s the fact that his wine is underpriced. Underpricing is rarely discussed in Australia. If our domestic brands are going to do anything with prices it invariably results in further reductions or ridiculous sales promotions. The suggestion that, in many instances, they should be doing exactly the opposite and raising prices usually escapes most Australian executives completely.
This is unfortunate because, as global consulting firm Mckinsey observe, 80 to 90 per cent of the pricing errors made by companies are caused by underpricing. Every brand has an elasticity of demand that straddles two extreme points. At one end, overpricing attempts to generate huge margins but falls foul of the lack of demand and excess capacity that inevitably occur.
At the other extreme, underpricing achieves enormous volumes at the expense of profitability. It is that latter sin to which Casella, like most Australian brands, is guilty. If you need evidence of Casella’s imbalanced attraction to volumes over value you need only visit the company’s webpage. The site variously informs us that Casella is the largest family owned winery, responsible for 10 per cent of the country’s total grape crush, stored in million litre tanks and bottled on the world’s fastest moving production line, which can knock out 36,000 bottles every hour. We learn that one wine bottle in every five leaving Australian shores carries the Yellow Tail logo and that the brand accounts for 40 per cent of all Australian wine sales in America.
All very impressive statistics, until you add a single, damning caveat: none of this made Casella any money last year. There is further evidence of Yellow Tail’s underpricing to be found in John Casella’s own account of how his initial pricing was devised back in 2001.
Originally Casella had planned to launch Yellow Tail at $8.99. But when he looked at the $5.99 price point he saw double the potential sales. “I did the sums,” Casella explains, “and I thought at this exchange rate [then about $A0.57], it would be a great return for us and that’s where the price point for Yellow Tail came from. It wasn’t the result from any great study; it was more intuition”.
Twelve years ago Casella underpriced his wine and fell in love with volume. The salvation of his winery lies not in a stronger Australian dollar but rather in the acceptance that his wine is too cheap and the realisation that he must now sacrifice some of those enormous volumes in order to sell less, at a higher price.
Unfortunately, raising prices after you have underpriced for so long is no easy feat. And reducing volumes after 10 years of building your whole business model on growing them is equally tricky. But that, unfortunately, is the price Casella must now pay for relying on “intuition” over analysis all those years ago.
Mark Ritson is an associate professor at Melbourne Business School and a consultant to some of the world’s biggest brands.