Vina San Pedro

1. How would You describe the key business characteristics of the Chilean wine industry?

Wine production in Chile dates back more than 400 years. Its South American climate provides ideal conditions for growing rootstock (Chilean vineyards yield twice as much grapes per hectare than European vineyards do.) This expertise formed a brand name, which still today makes this wine best known for finest quality. European vineyards were affected by a plague, which left Chile untouched. This makes it the only country in the world to produce from original rootstock. This uniqueness is an additional cornerstone in forming the brand of Chilean wine. The production got influenced by political sanctions . Therefore, consumption dropped in 1985 to 400 million liters (36,9 l per capita) and in 1997 to 211 million l (14,4 l per capita). It is expected for the market to recover and to grow by about 4% annually to 239 million l by 2001. Consequently, the growth potential is very limited.

The consumers are very price-sensitive, which makes the price-leadership strategy the only one reasonable. Only big wineries with a great economies of scale had a chance to survive in this highly competitive market. This lead to only three dominant firms: Concha y Toro (24% market share), Santa Rita (21.1% market share) and Vina San Pedro (VSP) having 10,7% market share. The remaining 54,2% are represented by a number of small wineries, the so-called “informal market”. These producers avoid paying the 18% value-added tax and 15% alcohol excise tax, which is a good opportunity for the formal market in order to get additional market share by trying to force them to obey state regulations.

Chilean consumers are only little quality-conscious compared to consumers from importing countries like the US and Germany. Grapes of lower quality can be used. Packaging is another important business. Cheap and low quality wine, like Gato, come in cardboard containers, which dominate 70% of packaging, whereas 20% come in five-liter jugs or plastic/cardboard containers and only 10 in bottles. Packaging is an important part in the value chain. Cardboard container packed wine are the best sold product, covering 87,7% of all domestic sales. Only 4,5% of all sales are bottled, 5,5 % in jugs and only 2,3% in plastic/cardboard containers. VSP wine sells in average 5% below the price of its competitors. However, consumers perceive the quality worse than the wine of the competitors.

Marketing expenses vary a lot among the big three: Santa Rita spends about 46% of total Chilean wine marketing expenses on marketing, Concha y Toro 29% and VSP only 3%. This seems to be one reason for the fact that consumers consider its wine quality worse than others. The marketing channels are very limited and not used completely.

Distribution of VSP is a success story. By using the CCU distribution network, they managed to expand its customers from 6000 to 30000. Out of these, 37% go to retailers, 23% to wholesalers and another 23% go to supermarkets. Only 12% are shipped to bars and restaurants. In order to add value to the low quality products, VSP got an exclusive agreement on a machine from a German manufacturer in order to vary the size and shape of cardboards to make it more attractive to customers.

Chiles labor laws are very relaxed compared to those in countries like Germany or the US. There is almost no union existing. State regulations make temporary workforce easily available. Furthermore, seasonal differences make it possible to market seasonal wine. Chile started in 1987 to gain an expertise in making premium quality wine on the international market. This opened up fast growing markets and huge opportunities.

The scope of competitive rivalry is still primary domestic, but is about to be international in the future. The growth rate however annually about 4% until 5%. The stage in life cycle is mature. There is almost no backward integration, because there is the basic product for the process produced.

The barriers to entry are very low. There is just land needed and skills, which are present in this area, where people look back on a success story concerning winery. Furthermore, only little machinery is needed. Most of the work is made by hand. Packaging needs some minor machinery.

The product characteristics are standardized. However, there are significant differences in the quality and price of the products.

How do the characteristics of the global wine industry vary from that in Chile?

Wine sales in major markets have grown between 1992-1996 it all countries, except Chile (minus 0,5%) and Portugal (minus 2,9%). The highest increase in sales was in Russia, Poland, Greece and the UK. Consequently, the international market promises higher profits than the domestic market.

All wine producing counties suffered from a plague except Chile. This makes it a premium product out of premium rootstock, more than 400 years old.

On other than the Chilean market, customers value high quality. These markets are already flooded with all brands of wine and barriers to entry are high and so are financial requirements in case of an entry.

The domestic market is compared to different markets small. Extensions in the beer industry to neighbouring country was not a success in terms of sales.

The domestic market demands high marketing expenditures, because of the strong competition. International markets need only little marketing efforts. Therefore, there are higher margins expected, if the producers manage to cut trades out of the value chain.

2. How does VSP choose to compete in the industry? What are the key elements of its business strategy?

VSP did choose to compete on different markets differently:

a. The domestic market

VSP was acquired by Compana Cervecerias Unidas S.A. (CCU) in 1994, a company that was the dominant player in the beer market with a 91% market share. Furthermore, it was the second largest beer seller on the Argentine beer market and the largest Chilean mineral water producer. With the acquisition of VSP it also became the third largest wine producer in the country, which was to become the diamond in the whole company. Because VSP is treated as an independent business unit, with Matias Elton as Chief Executive Officer, it has a strong financial backing. It chooses on the domestic market the overall cost leadership strategy. The consumers in the domestic market are very price-sensitive. VSP reaches for highly cost-effective operation rather than production numbers. It succeeded in opening up a sustainable cost advantage over competitors relatively to their products. However, the goal is not to gain the lowest cost, but to be lower that the competitor. The success is apparent, because VSP´s products average 5% below competitors products. Consequently, the long term strategy is to underprice the competitor.

However, VSP has to take care if it wants to remain in this position, because competitors could benchmark business behaviour and lower their prices in order to gain extra market share. One important step to fight this is the exclusive arrangement with SIG Combiblock. VSP will add value by responding to the needs of customers and will offer wine packaging in different sizes and improved look. This will help to ban the myth of bad quality. For instance, it might produce packages containing 1,1 liter and sell it for the price of one liter or offer different sizes in different areas with different incomes. 70% of its cheap wine Gato is packed in Tetra-Packs. Consequently, VSP revamps the firm’s value chain to bypass some cost-producing activities. They get the machine for free.

As CCU took VSP over , it focused on reducing costs, increasing distribution and improving quality. It reduced debt by 7,8 billion CP, invested 864 Billion CP in new capacity for aging wines, 178 Billion CP for new vineyards and intensifies cooperation with local growers. In 1997, Matias Elton was called for VSP president. He invested another CP 17,7 Billion in expanding vineyards. He also reorganized the corporation to have clear responsibilities in the workforce. From 1998 on, as Patricio Jottar became the new CEO from CCU, further synergy effects were used in order to further decrease costs. He is the one, who enforced lobbying authorities and politicians. The CEO gave the business a clear vision.

The almost absence of unions in this area are an important factor in the effort to lower the cost of key resource inputs. Furthermore, the low wage level benefit the business as well as the easy access to workforce.

Because CCU only sells beverages, activities in the firm can be coordinated and synergy effects can be used. Existing contacts to retailers, wholesalers and other customers can be used.

b. The international market

VSP chooses to compete on the international market with the best-cost strategy. People abroad focus more on quality and do not consider price the number one priority. The export numbers increased up to 1998 to 23,1 million liters, which made VSP the number two with sales, second only to Concha y Toro.

VSP big advantage is the cost/quality ratio to customers (see also core competencies above).

There is almost no advertising in other countries, which adds value to the value chain.

VSP sells via agents, which takes a 20% markup. The retailers add another 26% markup.

On the other hand, exports are risky, because of exchange rates that change often.

VSP decided to react on the different market needs and does not have an ethnocentric attitude. Consequently, the international market is very promising for VSP. The best-cost strategy is well appropriate.

Finally, the sales on both markets are strongly influenced by the step taken by the CEO to buy additional land to grow vineyards. This lowers the bargaining power of suppliers and decreases costs considerably. This adds value to the value chain.

Has the strategy yielded success in the Chilean and international markets?

Yes, the strategy was successful on the domestic and international market.

1. Sales increased on the domestic market from 18 million liters in 1995 to 28,7 million liters in 1998 and on the export market from 27,4 million l in 1995 to 51,8 million l.

2. Net income increased from 2,1 billion CP in 1997 to 2,4 billion CP one year later.

3. What kind of financial performance has VSP´s strategy produced?

VSP´s financial statements portrays a good overall performance. The income statement states an increase in net income of more than 10% from December 1997 untill one year later. On the other hand, costs and expenses rose as well. But, management seems to have these problem under control. The interest income decreased, which might be an indicator for the fact that available cash decreased, which gains an interest when deposited. Interest expenses increased by 50%. Consequently, VSP still invests heavily in order to get ready for future engagements and challenges.

The Cash Flow Statement reflects a severe drop in cash available. More than 11 billion CP were spent during the last year. Inflation put another heavy weight on the cash flow. Many businesses went bankrupt because of cash available shortages. Management has to take care of this problem. The balance sheet portrays an increase in shareholder value. Assets have considerably increased (by more than 40%). One can see that about two billion CP were spent on inventory and another two billion CP on land and another billion on plant and equipment. VSP is expanding heavily its

capacities. On the other hand, receivables increased by a little less than 4 billion CP. Something has to be done about it. Getting the money in might lift the shortage of cash at hand.

Long term assets even increase by almost 100%. Management is very sure about the prosperous future of the business and its long lasting success. This confidence is a good sign for shareholders. The clear vision from CCU CEOs and the skills from VSP CEOs pay off after a very short time.

This success might be of short time, because it is financed by debts payables. Because of this, management decided not to pay dividends. This is understandable at this debt rate and in the overall risky situation. Shareholders will probably accept this for a period if sufficient information are given.

Accounts payable were decreased by 100%. The CFO probably wants to put the business on a solid basis. On the other hand, VSP finances itself partly by borrowing from related businesses. Most likely, this liability is the additional grapes VSP sold from other vineyards in order to increase production.

Additionally, one should not forget that strategic changes are not visible in the short run in the first place. They help the survival of the business in the long run. The new CEO, however, did a good job.

Consequently, VSP is on the right track. It takes risks, but found a way to balance it. Even the fact that liabilities increased, business assets increase even more, which results in a higher shareholder value. CEO Elton does a good job. Strategy pays off as well as the long-term investments. VSP proofs to be the diamond in the row of CCU.

Does VSP´s financial performance compare favourable to that of other CCU business units?

The performance of other CCU businesses differ.

1. Chilean beer gains good revenue. The data are not sufficient, but one can assume that it reached a level around 117 CP billion, which is the market share it can get. However, management managed to decrease cost of goods sold constantly as well as selling, general and administrative expenses for about 7,2 CP billion. Consequently, the operating income increases.

2. Beer sold in Argentina is the absolute opposite. Even the fact that revenues increase, costs do so in a more severe manner. An revenue increase in the past two years for 12,9 CP billion faces an increase in losses of 14,8 CP billion. Argentina beer causes cost of goods sold and selling, general, and administrative expenses of 40,1 CP billion, but revenues only level 37,7 CP billion. Furthermore, costs are increasing constantly, most severe selling, general and administrative costs. Consequently, this branch should be, according to the data, closed down. There might be a number of facts that management does not. One might be that the barriers for exit are too high and a cross subsidy is more favourable.

3. Revenues for soft drinks and mineral water are declining. Maybe harder competition emerged and got some market share from CCU. However, cost of goods sold as well as selling, general and administrative cost decreased. The operating income is positive but slightly declining. It is still a profitable branch, but should be watched. If revenues continue to decrease, management has to do something about it.

4. Wine is next to Chilean beer the fastest growing branch in the corporation and is the diamond in the row.

5. Overall s CCU a profitable business. Its net income rose from 20,1 CP billion in 1996 to 39,3 CP billion in 1998. Its nonoperating results turned from a negative value into a positive number during the last three years. Assets increased considerably. That is a good sign and reflects the business strength of CCU. Management should consider abandoning beer sales in Argentina and closely watch soft drinks and mineral water sales.

4. Is now the time for VSP to push into new international markets and make exporting a larger component of its business?

The Chilean market proofs to be mature. Sales of beer and soft drinks/mineral water reached its level and there is only little to do about gaining additional market share. The growth potential of 4% as stated above, further split among the various firms. VSP is only the third largest in the country. Fundamental changes in the competitive environment appear, like:

1. Increasing head-to-head competition for market share,
2. Consumers drive harder bargain on repeat purchases,
3. Consumers demand more emphasis on cost and service (e.g. packaging)
4. Extra capacity might lead easily to oversupply,
5. New product features, like new tastes, are harder to come by,
6. Seek out for sales on different markets,
7. Harder competition drives weaker firms out and consolidates the remaining businesses.

According to the given changes in a competitive environment, VSP needs to push into the international market. Even the fact that Chile is an emerging-country market itself, it needs to bundle its strength and go international.

There is only a little chance for VSP to widen the selection of its products. Gato, the best selling wine, cannot get another wine at its side in order to avoid cannibalisation. The low-price advantage VSP still has, it sells an average of 5% below competitors price, is essential for survival. Management tries to add values to the products. But, this will result only in a small marginal increase in sales. Costs are increasing less that revenues do. This is essential in order to cover the high expenditures on assets. This adds additional value for the customer. Matias Elton further decreases costs by reorganizing the business and sells machinery in order to increase efficiency. Management tries to add additional features in order to “please” the customer. It will package its products according to customers needs. Poor areas might want to buy 1,2 liter for the price of one or can only afford half a liter at a time. VSP meets this demand with the new packaging machine. This will help to increase market share on the domestic market. Consequently, the economic strength of VSP increases. But, still, it is only number three in the market. CCU still is a strong partner, but, as identified above, has also its weaknesses. Future unstable environmental conditions might be disastrous for CCU.

Consequently, VSP should go international. There is a huge growth potential. Compound average growth rate in e.g. Russia is 16,7%, in the UK 5,7% and Greece 8,9% from 1987-2001. The number of Nine-liter cases exported have constantly increases considerably. According to the data given VSP has a market share of 16,9% of Chilean wine exported to the UK. This market is very promising and export should intensified. As developing countries like Russia and Poland reach better economic environments, there is a market first of all for premium quality wines, like Cabo de Hornos or Castillo de Molina. One important step in this direction is also the acquisition of Croatian brewery stock of 43% by 1997. The brewery might serve as a distribution center for direct sales, without having interim dealers, which increase selling prices considerably. Another important fact for going international is the fact that heavy investments in rootstock and capacities increase capacity first of all for premium quality wine, which is hard to sell on the domestic market.

VSP gained additional 40 hectare land and becomes more independently from outside suppliers. It will lower costs and increase quality. It becomes more flexible to customer needs. Its core competencies discussed above are partly unique and make a push toward international markets feasible.

What valuable resources, competitive capabilities and core competencies has VSP developed that have contributed to its competitive strength in Chile?

1. The clear vision from CCU CEO Patricio Jottar is one cornerstone for the corporation. Her is to use synergy effects, existing distribution capabilities of CCU will be further leveraged, administrative expenses should be reduced and he wants to lobby and influence authorities and politicians. Finally, he installs an information system for all CCU companies to deliver and exchange business information.
2. The original rootstock, not infected by the plague (the only one in the world), is a very valuable recourse.
3. Experience, expertise and skills that date back for more than 400 years.
4. Efficient delivery system (customers increased from 6000 to 30000 on the domestic market).
5. Efficient and sufficient technology.
6. Sufficient capacities.
7. Management know-how from CEO Matias Elton.
8. Low-cost production.
9. Workforce easily available.
10. Low cost production assets.
11. New packaging opportunities, customer friendly.
12. Unique production facilities in the “wine country of Chile”.

How can Matias Elton exploit the company’s strength and capabilities in the companies international expansion efforts?

If the markets, the company wants to go into, are identified, Matias Elton can use experienced CCU made with its brewery in Croatia. It can use its distribution channels and can use it as the distribution center. Being in the European market eases information exchange about trends and is closer to potential partners.

The production expertise, skills and knowledge as well as the 400-year long tradition in unique all over the world. This gives VSP a splendid issue in terms of marketing efforts. Furthermore, the original rootstock make the oenologist produce a unique product.

The business wide information system installed at CCU, gives necessary news about trends and developments within and outside of the firm. VSP can react fast on changes in the internal and external environment.

The managemnt know-how from Matias Elton helps to decrease costs. By renting harvesting machines, he saves 350 US $ per hectare per year, because labour costs 650 US $ per year per hectare, whereas renting the machine is only 300 US $ per year per hectare.

Matias Elton used to work for an fruit importing company and is a graduate from Georgetown University. Consequently, he “knows the right people”, has knowledge about the North American market and knows differences in tastes and cultural differences.

6. What international markets appear most attractive for VSP?

VSP should appear the Pacific Rim. Consumption has reached 1,4 l per person per year. An increase up to 2,2 l per person per year by 2001 is expected. Still, it is far below the tree liter annual consumption world average. Further research is necessary about the customs in this area concerning wine consumption should be done. Furthermore, low priced wines should be exported there in order to take care of the volatility of exchange rates and the buying power of the customers.

The USA and Canada is another important market. Shipping costs are lower and the currencies are relatively stable. As competition is high, VSP should gain a brand name by exporting wine in the popular price range. After gaining acknowledgement in step two it should introduce premium quality wine. Furthermore, VSP should expand on the whole market and not only cover the West coast.

On the European market England and Greece are the most favourable countries to go into. As the economics conditions in those countries are stable and wine sales increased considerably (expected: UK by 5,7% and Greece by 8,9% from 1997-2001), it seems to be worth going into.

Furthermore, sales in Poland and Russia are increasing significantly. But, inflation rate is high and so are market and diversified risk. But, because sales in Russia increased from 1992 until 2001 by 2,24 US $ billion, engagement on the Russian market should be undertaken in order to profit from future developments. Poland’s sales increased by 0,93 US $ billion, or by 12,9% from 1997- 2001. Because it is an early candidate for becoming a member of the European Union and the tough conditions the EU demands, it is a pretty stable market in terms of exchange rate and future developments.

Consequently, VSP should go into these two markets also.

Should the company pursue a multi-country or global approach to international competition?

Because there is engagement on selected countries on different continents, VSP is going to act international (or multinational).

What are the implications for production capacity, quality, and cash flow?

- Production capacity: CEO Matias Elton enlarged capacity considerably. These can be

used now. On the one hand more grapes are harvested, but also aging space was enlarged, which allows the production of higher quality wines in order to satisfy quality needs and standards abroad. Production capacity was also optimised by using cheap machinery.

- Quality: it has to put an eye on quality issues. E. g. Japanese and European markets demand high quality. There is strong competition in the markets. Chile can offer premium quality wines at a moderate price due to low labor costs, lack of unions and effective production strategies.

- Cash flow: VSP has to be able to react on short term problems quickly. They need to make more cash available. Furthermore, they need to find tools in order to reduce accounts receivable, an asset, and reduce operating costs by e.g. using synergy effects within CCU.

6. What recommendations would you make to Matias Elton concerning VSP´s immediate internationalisation plans?

- Start competing internationally by entering just a select few markets, like England, Greece and Russia. By doing so, spread the risk.

- Engagements in Japan, USA and Canada should be intensified

- Use the best-cost strategy and take advantage of the strengths (e.g. skill, expertise, low wage) and opportunities (fast growth rates).

- Use in the phase of entering a new market only the export strategy. Use foreign distributors.

- As the US dollar is very strong, the North American market seems to be the most promising market. Strong focus should be put on this fact. Intensify export of “Gato” to make VSP a brand. Later introduce better quality brands.

- Maintain the national production base, because it is the core competency of the business.

- Export goods by using the company owned distribution channel in Croatia.

- Transfer ideas, technologies, competencies back to the home country in order to lower costs and increase quality of the vine.

- In riskier markets, like Russia, it is advisable not to invest heavily. Elton should use the local distribution facilities.

- Undergo marketing efforts in order to explore local conditions and differing buyer tastes and preferences. This will help to import the brands that are liked best by the customers.

VSP should not offer all brands.

- Keep adding value for the customer in the value chain.

- Also focus on the domestic market. If there are about 25% of the whole market produced in the informal market, something has to be done it. Lobbying politicians and authorities is just one step. These businesses on the informal market have to be forced, to pay taxes as the businesses on the formal market do. These firms would not stand competition and could be acquired by VSP or just went bankrupt. Consequently, VSP gets more market share and increases cash flow.

- Treat each new market as independent business unit.

- The popular wine, like Gato, and the varietal, like 35 Sur, found acceptance in North America. This is the first market to go into with reserve and premium reserve wines. Furthermore, it promises the highest revenues because of lowst interest rate losses.

- Varietal and reserve wines, sorts of better quality, are demanded on the Japanese and European market. They should be introduced in order to get market share and find acceptance by the customer. After having reached this, premium reserve brands can be introduced.

- Put the new vineyards in operation as soon as possible in order to lower production costs. Purchased grapes cost 1,25 US $ per liter whereas self produced cost only 0,34 US $ per liter.

- After being successful in multicountry strategy, it should consider change into a global

strategy. Hence, this is still a long way to go.

- Keep an eye on the performance within the corporation, where two branches face severe problems.

What do your projections for VSP´s operating income look like for the next three years?

Let me start with a few calculations:

1. Regression analysis on sales of VSP (volume in millions of liters)

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2. Development in sales

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3. Development in US $

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(see also the attached EXEL file for calculations)

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Total costs of goods sold will still increase, because new stockyards and other capacities (e.g. aging space) were bought and put into operation. Additional investments in expansion of vineyards of 178 CP million were done. 4,5 CP million are needed for one hectare. Consequently, 40 hectare are bought and planted.

Remember that each leased harvesting machine costs 300 US $ per hectare. Additionally, further workforce is needed to manage and supervise the fields. After having reached its paramount, I expect the cost to drop again, because clever management and the use of synergies leads the business towards economies of scale.

But, less grapes have to be bought because of the extension of the vine fields (down from 52% to expected 38% in 2003). The production costs of wine make 56% of total production costs. By putting additional own vineyards into operation, for the differing 14% production costs can be decreased by almost 73%. On the other hand, engagements in selected countries need investments and increase operation costs, like shipping costs.

The regression analysis above portrays an impressive rise in sales. One can see that export sales rise much more than domestic sales of liters. The calculated prices per liter domestically as well as in the export give an idea, at what rate sales will increase. As discussed above, export will outrun domestic sales very soon. The level in 1999, whereas the slope in domestic sales is not as strong as in export sales.

The calculation can only be seen as a trend analysis, although the statistical tool of regression analysis is very powerful. But because of the engagements in foreign markets as well as changes macroeconomic and microeconomic environments, it looses partly of it.

Finally, I expect for the next tree years the operating income to be positive. But because of the new engagements in selected countries as well as on the domestic market I expect it to be lower than portrayed in the figure and tables above.