Industry Project

Economics 205 A01

Group 14 (Okanagan Wine Industry)

Darren Lishingman

Grant Mai

Russell Long

James Moss

  1. Cost Structure

Sunk costs include:

  • equipment required to produce the wine
  • Refrigeration equipment
  • Material Handling equipment
  • Fermentation & Storage
  • Market analysis and technical expertise

Fixed Costs:

  • Land required for growing grapes and building facilities. (between $50,000 and upwards of $100,000 per acre) (Vinesmart.com 2010)
  • Large amount of electricity to operate bottling and other aspects of production.
  • Property taxes can be extensive due to large portions and values of land in the Okanagan.
  • Costs associated with land and structures account for the largest percentage off all costs for wineries.
  • Loan Interest
  • Insurance

Variable Costs:

  • A large amount of labour is required to hand pick grapes from vines. Large amount of turn over due to seasonal employment.
  • Packaging costs are often amongst the highest variable costs for wineries.
  • Seeds and grapes are also a very high variable cost.
  • Insurance
  • Marketing is also a very large variable cost for some of the major producers in the Okanagan.
  • Cooperage (Barrels) on average a winery will purchase 75% of its barrels new each year.

(Ball)

  • Governement Markup and HST taxes (150% tax and markup rate) (Hicken)

Economies of Scale:

  • Important for low-priced wines
  • Lower productivity than California/Australia

Certainly the largest factor that will determine the structure of the wine market in the Okanagan is the cost of land in that region. Fixed costs, including taxes, property and utilities account for approximately 33 percent of revenue. (Adams, D. 1992) This is by far the highest percentage of all costs for wineries. Over the last ten years there has been an increase in the number of wineries in the Okanagan by 285%. (McIntyre, G. 2010) This would indicate that the demand for agricultural land in BC is rising steeply and likely so are prices of land in the region.

There are some key opportunities and threats to point out in the Okanagan wine industry. One of the biggest factors that would drive the industry would certainly be taxes and the price of land in the area. Firms who are entering the market encounter significant barriers to entry because of the large amount of equity it takes to purchase land in the Okanagan, as well as to finance construction of facilities for production. Should the price for land in the Okanagan rise at a sharp pace this threat could put a stop to new competition for current firms and be seen as an opportunity for firms who already own facilities that are producing wine to acquire more land around them to increase their yield and production. Due to the high costs associated with growing grapes, some smaller wineries may benefit from purchasing their grapes from other grape growers in order to reduce fixed costs. This may not always be the case as at some point of production this benefit will diminish. In addition to these barriers other costs associated with entering the wine market include getting licensed as a winery and obtaining a listing to distribute their wine in British Columbia.

Lastly, as in any industry operating in British Columbia firms already in the market could potentially face changes in property rates as well as income tax rates, these could be seen as opportunities or threats whether taxes are increased or decreased. Should the taxes be increased, firms may consider moving south of the border to Washington or California to reduce costs.

  1. Demand

Tourism and hospitality is a major demand driver for the Okanagan wine industry. In recent years, tourism BC has increased promotion for wine tourism. This form of tourism mainly targets the domestic market.Most domestic visitors are just looking for a short relaxation get away. They are looking to experience the culture of the region when they visit the Okanagan valley. Therefore wine tourism is tailored to suit their taste. Most trips to the Okanagan will include tours of wineries. Most wineries offer complementary wine tasting as well as golf, and other leisure activities. Visitors will get to enjoy the laid back lifestyle of the valley, and wineries will get ample opportunities to advertise and sell their products.

Due to the fact that wine is a luxury good, consumers who are interested in purchasing wine often have high incomes to finance their tastes. Therefore wine consumers are more sensitive to quality than price. In the last decade the demand for BC wines has increased by 32%. (Kane, 2010) The demand for Okanagan wine has exceeded its supply. What caused such a boom to the Okanagan wine industry? According to Carol Nelson at BC Tourism, the success of the industry is primarily due to the improved quality of wine.(Kane, 2010) Wineries noticed that quality plays a big part in buyer’s purchasing decision. To improve quality Okanagan wineries replanted their vineyards with premium viniferas grapes and adopted the VQA program to ensure the quality of their product. (Steeves, 2010) By raising production standards, the quality of BC wines rapidly improved. With improved quality, Okanagan wineries were able to win awards both in Canada and in international competitions. Nowadays, BC wines definitely have the recognition and respect of other wine makers in the world.Okanagan wineries are also able to increase their brand power and secure consumer loyalty by winning prestigious awards from the wine community.

Consumers have strong individual preferences when it comes to purchasing wine. Wineries cannot engineer their wine to suit everybody’s taste; although, most wineries will try to acquire a unique trademark taste to differentiate their products from others. Therefore, consumers will choose to buy wine that best expressed their personal preference. Wine makers have to pay close attention to any change in consumer taste because it directly affects the demand for wine. For example, baby boomers have increasing preference in red wines such as the Shiraz wine. (Adams 1992). Wineries can also cope with the constantly changing consumer preferences by offering a wide variety of products.

FTA(free trade agreement) between the U.S. and Canada directly affects the Okanagan wine industry. (Steeves, 2010) Imported U.S. wine offer consumers substitutes from BC wine. As mentioned previously, consumer preference and quality play a big part in the demand for wine. The addition of U.S. wine will offer a wider range of variety for consumers to choose from. The availability of substitutes can reduce demand for BC wine in Canada; however, the free trade agreement also gives the Okanagan wine industry an opportunity to enter the U.S market.

Instead of competing with price, Okanagan wineries offer consumers quality and variety which diminishes the role price plays in the industry. The demand for Okanagan wine is also directly fueled by BC tourism and affected by the free trade agreement.

  1. Future Profitability and Industry Attractiveness, Price Competition/Entry, and Performance

The Okanagan wine industry is a quickly growing industry with over 182 licensed wineries, 9,100 acres of vine accounting for 84.3 percent of BC's vineyards, making it the largest distributor of wine in BC (Lawrasson and Pender). The demand for BC wine is growing faster than vineyards can supply, thanks to BC's wide consumer base (demand) and a relatively small winery industry (supply), along with government VQA regulations. All of this implies that the industry is quite attractive. However, the rising price of land in the BC Okanagan, which is among the most expensive in the world, makes it hard for vineyard owners to increase production or to even enter the market. A solution for investors looking to expand in the Okanagan wine industry would find more suitable land and climate that can accommodate vineyards for production, such as the Similkameen Valley. Also, the price of land is Similkameen is considerably lower than compared to the south near Osoyoos; however, the price of land is also rising and will continue to rise(Schreiner). Moreover, competition has increased by 285% over the last five years. Thus, investors face challenges in terms of future profitability. Still, world class wine makers are attracted to the distinctive grapes of the Okanagan, which would provide them with a distinctive product such as Icewine, and productivity is increasing at a steady rate (Canadian Wine Industry).Overall, although competition has increased significantly over the past few years along with rising land prices, the rapidly growing Okanagan wine industry should be quite profitable in the long runwith its high demand for high quality wines and niche wines, which could offset the downside of high fixed costs and increasing competition.

The Okanagan wine industry is still dominated by large wineries with similar cost structures such as Mission Hill, which would influence the market price of wine, and thus the competition of price. Low levels of price competition serve as barriers of entry into the industry, but small scale wineries are able to compete among themselves in terms of pricing, as their prices would be ignored by the larger players. Moreover, the rising demand of Okanagan wine suggests significant entry threats. However, Government regulations in terms of bottle size and number of applications for listings annually scares certain foreign wineries away from the industry. Also, there are large fixed costs such cost of land, sunk costs such as technical expertise, and competition from U-vint do-it-yourself retail wine outlets(Canadian Wine Industry). All of these factorsare significant barriers of entry, neutralizing certain entry threats. Still,there are indeed many entry threats in the form of imported wines, due in large part to high demand, the FTA agreement, and the EU intervention, which prevents imported products to be at a marketing disadvantage. (Canadian Wine Industry). This could mean lower revenue for domestic wineries as demand for Okanagan wine decrease, unless the imported wines serve as complements to Okanagan wine.

Production costs such as price of grapes and high price of land decreases the performance of the industry, turning away certain producers. Demand for high quality, unique Canadian products such as Icewine, allows Okanagan wineries to compete with foreign wineries in the domestic market. Still, imported products hold the majority of the domestic market share (67.1% in 2006). Finally, an ever increasing tourism demand, which is expected to grow by 50% between 2005 and 2015, add to the overall performance of the Okanagan wine industry (Canadian Wine Industry).

Word count: 1496

Works Cited

Adams, Derek, “The Estimation of the Degree of Pricing Competition in the British Columbia Wine Industry (1957-1986)”, UBC Retrospective Theses Digitization Project (1992): 19-38. Web. 19 Nov. 2010.

Hicken, Mark. “Time for Accountability for the BC Liquor System.” Winelaw.ca. Winelaw, 2010. Web. 21 Nov.2010

Ball, Trent, et al. “Small Winery Investment and Operating Costs.” Extension Bulletin (1996): 1-41. Web. 20 Nov. 2010.

“The B.C. Wine Industry - A Look Ahead.” MNP. N.d. Web. 18 Nov. 2010.

“Featured Properties.” Vinesmart. 2010. Web. 20 Nov. 2010.

Teeves, Judie. “Okanagan wine industry has come a long way”. Kelowna Capital News 1. Oct. 2010. Web. 20 Nov. 2010.

Kane, Mari. “Get lost and happy in Okanagan wine country.”Marikane.com. Nd. Web. 20 Nov. 2010.

“Thompson Okanagan Wineries & Vineyards.” Supernatural British Columbia, Government of Canada 2010. Web. 21 Nov. 2010.

Schreiner, John. “Are B.C. wine prices getting too high?.” Plan it British Columbia. 2007. Web. 19 Nov. 2010.

Lawrasson, David, Rhys Pender. “A Tale of Two Regions.” Wineaccess. 2008. Web. 20 Nov. 2010.

“Canadian Wine Industry.” Agriculture and Agri-food Canada. 2009. Web. 20 Nov 2010.