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ROBERT MONDAVI & THE ROBERT MONDAVI & THE WINE INDUSTRYWINE INDUSTRY

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THREATS OF CHANGES IN THE WINE THREATS OF CHANGES IN THE WINE INDUSTRY FOR ROBERT MONDAVI’S INDUSTRY FOR ROBERT MONDAVI’S

COMPETITIVE POSITIONCOMPETITIVE POSITION

• Rise in Australian imports to the States by 30% per year

• Industry consolidation

• Consolidation in the distribution channel

• New entrants

• Brand dilution

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HOW ATTRACTIVE ARE THE HOW ATTRACTIVE ARE THE ECONOMICS OF OWNING AN ECONOMICS OF OWNING AN

INDEPENDENT ULTRA PREMIUM INDEPENDENT ULTRA PREMIUM WINNERY ON A 100-ACRE WINNERY ON A 100-ACRE

VINEYARD IN NAPA VALLEY?VINEYARD IN NAPA VALLEY?

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BASIC TIMELINE?BASIC TIMELINE?

• Long time before wine is sold

• Land & plants vines in Year 0.

• Harvests the first grapes in Year 3.

• First aged ultra-premium wine sold in year 5

• Full scale wine production occurs between year 7 & year 10

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UPFRONT EXPENSESUPFRONT EXPENSES

• land acquisition: 100 acres x $100K per acre = $10 million

• Vines: 2,350 vines per acre x $5 per vine = $1.2 million• Vineyard development: 100 acres x $32,500 per acre =

$3.25 million• Barrels: 1,378 barrels (i.e. 310K liters/225 liters per

barrel) x $575/barrel=$792K• Crushing equipment: $500 per ton x 500 tons of

grapes = $250,000• Bottling equipment: $650,000• Other capital costs (tanks, pumps, etc.) = $1 m.• Total up-front expenditures = $17.1 million

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WINE PRODUCTIONWINE PRODUCTION

• 100 acres x tons per acre x 620 liters per ton = 310,000 liters

• 310,000 liters = 413,333 bottles = 34,444 cases

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CASH FLOWSCASH FLOWS

• Retail for ultra-premium = $20• Winery price = $1-$12 (based on Exhibit 9 margins adjusted

upward for ultra)• Revenues = 413,333 bottles x $11 per bottle = 4.5 million per year• We can use EBIT margins to approximate the free cash flows that

will be generated by $4.5 million in Revenue. Exhibit 9 in the case shows an EBIT margin for super premium wine equal to 23%.

– That exhibit includes some portion of grapes that are purchased rather than grown internally.

– The analysis here presumes a completely in-house supply of grapes. If we assume that one-half of the material costs in Exhibit 9 are for grapes, then we can increase the EBIT margin from 23% to 35% (i.e. $2.10/$6.00).

• Therefore, free cash flows per year = $4.5million x 35% = $1.6 million. Assuming small price increases each year (perhaps 3%, these free cash flows will escalate slowly over time.

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RATE OF RETURNRATE OF RETURN

• The rate of return on the initial $17.1 million investment falls below 10%. – the investment does not look attractive.

• The winery would only generate $4.5 million in revenue & $1.6 million in fee cash flow in Year 5. – It only would reach those levels at some point between Year 7

and Year 10. – In addition, the analysis above does not take account of the

substantial investments in working capital that would be required during the early years of the vineyard.

• In sum, one cannot expect the investment to generate rates of return in excess of 10%.

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WHY ARE LARGE ALCOHOLIC WHY ARE LARGE ALCOHOLIC BEVERAGE FIRMS ENTERING THE BEVERAGE FIRMS ENTERING THE

PREMIUM WINE BUSINESS?PREMIUM WINE BUSINESS?

• Foster’s Group?– What is that group doing?– Are there economies of scope across the beer

& wine businesses?– Would the BCG matrix apply here?

• Allied Domecq & Diageo?– What is that group doing?– Are there economies of scope here?

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HOW ABOUT OTHER WINE HOW ABOUT OTHER WINE COMPANIES?COMPANIES?

• Southcorp?– Divested its non-wine assets & invested in

acquisitions to expand its presence in t he premium wine market

• Mondavi?– Choice: focus on organic growth rather than

acquisitions. – One reason: escalating acquisition premiums– Another reason: control issue

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WHAT IS MONDAVI TRYING TO ACCOMPLISH WHAT IS MONDAVI TRYING TO ACCOMPLISH WITH ITS INTERNATIONAL JOINT VENTURE WITH ITS INTERNATIONAL JOINT VENTURE

STRATEGY?STRATEGY?

• Aggressive international joint venture strategy. • Focuses on joint ventures with highly prestigious

foreign wineries• Provides learning economies• Critical benefit in the US market as the

prestigious foreign wines enhance Mondavi’s position with distributors, off-premise locations, & niche retailers in the company’s domestic market

• Joint ventures provide them with flexibility

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ALTERNATIVES FOR MONDAVIALTERNATIVES FOR MONDAVI

• Stay the course• Acquire/merge with

domestic wineries • Acquire/merge with

foreign wineries• Sell the company

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CONCLUSION: LESSONS FROM CONCLUSION: LESSONS FROM THE CASETHE CASE

• Structural heterogeneity– Industries exhibit significant structural differences across

geographic regions of the world• Industry consolidation

– Firms create value by expanding globally if they can realize economies of scale, scope, & learning

• Diversification & cross-subsidization– Common for mature industries to diversify, but cross-

subsidization only enhances shareholder value if true economies of scale & scope exist among the businesses

• Shaping industry structure– Firms shape industry structure through their strategic choices &

they may reshape industry structure through strategic decisions that do not enhance shareholder value

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WHAT HAPPENED TO WHAT HAPPENED TO MONDAVI?MONDAVI?

• 3/11/2004 – Constellation Brands & The Robert Mondavi Corporation signed a definitive merger agreement – Total value of the transaction is approximately $1.36 billion

• Past history: originated as a company selling cheap wine – also owns Almaden Vineyard’s bag-in-a-box wine– Constellation is now the largest fine wine company in the States &

is now the largest wine marketer in the world• Expectation is that synergy will occur:

– Complementary wine assets (vineyards, production facilities & distribution capabilities)

– Will this be a successful merger?

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ASSIGNMENT FOR 2/10/2006ASSIGNMENT FOR 2/10/2006

• TOPIC: Creating Business Strategies

• Read: Carpenter & Saunders, chapter 5

• Focus: Porter’s Generic Strategies

• Good preparation for Group 3 case on caffeinated beer