The following individual case analysis provides a thorough analysis for William Jaeger, a member of the partnership that owns the Freemark Abbey Winery. Recent weather forecasts show that a storm has targeted the Napa Valley area and the results could be positive or negative. This document will provide the best decision alternative in terms of harvesting the Riesling grapes prior to or in the wake of the storm and project outcomes of each option. Next the document focuses on the internal and external forces that could affect Mr. Jaeger’s decision by applying Porter’s five forces of competitive pressures to investigate the status of competition in the wine industry in U.S. and California as well as their implications. The quantitative analysis will demonstrate how investments can produce specific returns in increased revenues, improved profits, and deliver a better understanding of the decision at hand. The analysis will use the data provided and deliver profitable decision-making tools and techniques. Next the qualitative analysis will complete an examination of non-measurable data such as the winery’s reputation, a brand image and potential customer’s feelings about a product. Finally, the last section will provide recommendations for William Jaeger as to whether or not he should harvest the Riesling grapes immediately or leave them on the vines despite the approaching storm as well as possible future expansion strategies.
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Several different styles of the Johannisberg Riesling’s are on the wine market. As apart of the Freemark Abbey’s long-term strategy, Mr. Jaeger has to make a decision associated with expanding their product line with Rieslings. There is a storm forecast to hit the Napa Valley area and Mr. Jaeger needs to consider the risk and expected revenue associated with each alternative for harvesting the Riesling grapes now or waiting. If the storm hit the valley, the grapes would absorb the rainwater and swell the berries and reduce their concentration. “This would result in a thin wine and the selling price of the wine would decrease by $.85 per bottle.” (Bodily, Pg. 476) The case also states that here is also possibility that the storm results could cause the botrytis to develop on the skins of the grapes. “If the botrytis forms, the wine would be highly valued by customers who prefer high-quality wines and which would position the winery to sell the botrytised Riesling for about $8 per bottle.” (Bodily, Pg. 476) The increase price, however, would be partially offset by a decrease in the quantity sold. There are associated potential revenue gains and risk management issues based on the provided decision alternatives.
Should Freemark Abbey Winery harvest the Riesling grapes immediately or leave them on the vines despite the approaching storm?
In the last few decades, the wine market in the United States has gone through a dramatic transformation. Since the boom years of 1968 to 1972 the per capita demand for wine has increased significantly. In 1986 per capita wine consumption reached 9.2 liters, which was an increase of 82.9% compared to 1972. Population growth led to a total increase in wine consumption of 114.7 % 1968 to 2000 (Folwell, R. J.; Volanti, M. (2003), p.25f.). The wine industry has created an important segment in the American economy, worth $45 billion and creating almost half a million jobs. Due to geographical circumstances and associated weather, the wine industry is concentrated in California, with a 90% of U.S. wine production. (Nickening, R. (2004), p.16.) The Journal of Wine Research states “In 1990, the largest four wineries accounted for 49.2% of the entire wine storage capacity in the USA. The situation changed very little in 2001, with the largest four wineries accounting for 48% of the storage capacity even though there were a significant number of new wineries (Folwell, R. J.; Volanti, M. (2003)). The article also states that “the premium table wine market segment in the United States has been the only market segment with sustained demand growth.”
According to the Agricultural Innovation & Commercialization Center, wine production in California is concentrated in Northern California. (www.extension.purdue.edu/) The map above reflects that the largest numbers of wineries are located in the Napa and Sonoma regions. During the recessionary 2009 economy, California vintners shipped 467.7 million gallons (196.7 million cases) of California wine to the U.S. wine market in 2009, up a modest 0.2% compared to the previous year’s volume (The Wine Institute). In California, there are a very large number of small wineries that produce approximately 20,000 cases per year, while there are few wineries that produce over 1 Million cases per year. The difference in distribution of wineries and capacity is illustrated by the differences in the distribution of share of grapes crushed and that of wineries. Higher priced wines also grew in volume: $7-$10 wines were up 3%; $10-$14, up 7%; and $14 and over wines increased 2% by volume (The Wine Institute). In the Central Valley 76% of all grapes are crushed, but only 5% of the wineries are located in the region (The Wine Institute).
Distribution of Wineries in California and of Share of Grapes Crushed
Benchmarking and Self-Assessment in the Wine Industry Available at http://ies.lbl.gov/iespubs/59957.pdf (November 1, 2010)
The Porters five forces graph below demonstrates the competition within the U.S. wine industry.
Porter’s Five Forces Analysis
Bargaining Power of Suppliers
The highest concentration of grapes within the U.S. wine industry is in Napa and Sonoma Valley area of California. (www.extension.purdue.edu/) Situations similar to this can lead to a winery requires specific grape varieties for specific wine products, then the concern focuses on supply and demand for particular wine products. If demand decreases the supply, suppliers will demonstrate to wineries that the increased bargaining power. The raw materials required for wine production are usually cyclical in price, availability and quality. (www.extension.purdue.edu/) When demand decreases or if there is increased supply, high-demand grapes can be purchased for lower prices as well as when particular grape varieties are difficult to find. Supply conditions can create production issues for winery operations and increases the force of suppliers on a small winery operation. Service level agreements with clients, vendor management strategies with suppliers and producers are additional tools and techniques a small winery can utilize to manage the uncertainty and power of suppliers. It is vital for winery’s to understand the influence of suppliers and outside factors as a strategic consideration.
Bargaining Power of Buyers – Moderate to High
The wine market offers an extensive selection of products across a wide range of price-points to satisfy a wide range of customer preferences and budgets needs. Freemark established a local presence by primarily selling wines in San Francisco retail stores. (freemarkabbey.com/) This strategy can enable the winery to developed a longstanding presence and create a market share for the Freemark Abbey label in the retail sector. Freemark is not the only winery in a position to offer value wines; competitor product offerings are the main contribution to the moderate-high buyer bargaining power of buyers. (www.extension.purdue.edu/) Wine prices are competitive among lower priced wines and customers have the option to select a particular what they want to drink based on a narrow price difference. Freemark Abbey winery can reduce their exposure to the bargaining power of buyers through offering unique products and services as well as wine tasting events that increase the perceived value to the customer.
The repeal of national prohibition, created a situation where states needed to create laws to regulate alcohol sales and distribution within their states. Wholesalers have a significant amount of bargaining power because some states developed a “three-tier” system of distribution, in which a winery must sell to a distributor, which must sell to a retailer, which then sells to customers.(http://www.betanews.com/) The bargaining power of small wineries can be weak when compared to the wholesalers.
Threat of New Entrants – Weak
The threat of new entrants is complicated as it relates to the wine industry. A winery requires a substantial large capital cost coupled with the fact that market entry can take years for vineyard and wine production and licensing requirements. There is also time need to build a strong knowledge base and time for the learning curve. The threat of new entrants is tightly linked to the barriers to entry. Barriers to entry in the local wine market are high due to capital investments, licensing, and knowledge requirements.
Threat of Substitutes – High
With the countless number of beverage substitutes on the market, consumers easily assume that beer is the traditional substitute for wine. Other substitutes include but are not limited to other expensive wines, inexpensive alcoholic beverages, mixed drinks, soft drinks, juices and milk. In addition to selling different wine selections, wineries have evolved into a vacation destination. “Competing against the other travel destinations for limited customer leisure time is one of the biggest challenges.” (www.extension.purdue.edu/) Some wineries now provide entertainment, historical and educational information to existing and potential customers as a way to increase the perceived product value. Based on customer needs and expectations, products with similar price points and with similar taste are available. Freemark Abbey’s strong and long time presence in the industry allows the winery to focus on the premium wine segment. Just increasing the scope and breadth of their product lines will not enough to decrease the threat of substitutes. Freemark Abbey can reduce the threat of substitutes by listening and measuring customer preferences to differentiate their wine products by an expanded branding.
Rivalry among Competitors – High
The Wine Institute, Number of California Wineries chart demonstrates that the number of competitors within the wine industry is increasing every year. Also, the wine institute research shows “Wine sales to the U.S. from all production sources-California, other states and foreign producers-grew 2% to 767.4 million gallons (322.8 million cases) in 2009, according to Gomberg-Fredrikson”(The Wine Institute). These statistics also reflect that the overall quality offered to customers is very important. The first purchase is based on the look of the wine bottle and label and service received at the point of sale. To develop and acquire customer loyalty, the quality of the product is critical in not only the basic winery strategy. Future purchases are based on the customer perception of the taste, not just the bottle presentation. Ultimately, the winery manager should focus on the total customer experience that increases the value of the product past that of the competition.
The Freemark Abbey Winery “About Us” website states “In 1939, three businessmen from Southern California, Albert “Abbey” Ahern, Charles Freeman and Markquand Foster purchased Lombarda Cellars. The new created partnership reopened the winery and renamed it Freemark Abbey. (freemarkabbey.com) After the reopening, the new winery primarily sold its wines in San Francisco retail stores and developed a longstanding presence to create a market share for the Freemark Abbey label. The winery in the years that followed, Freemark Abbey went through different owners and in 1966 a group of partners purchased Freemark Abbey.
Freemark Abbey Winery is a leading producer and marketer of table wines, located in St. Helena, California, in the northern Napa Valley. Freemark Abbey currently manufactures approximately 25,000 cases of wine each year. Freemark Abbey produces three Cabernets, a Napa Valley Cabernet, and the vineyard designated Bosche and Sycamore Cabernets. (freemarkabbey.com) “Of the 25,000 cases of wine bottled each year, most were Cabernet Sauvignon and Chardonnay. About 1,000 cases of Riesling and 500 cases of Petite Syrah are also bottled.” (Bodily, Pg. 475) The Table Wine Volume Share by Color shows that whites and reds command the market share as it relates to color. Freemark also produces Merlot, Chardonnay, and Riesling, as well as very limited production wines, such as Viognier, Petite Sirah, Sangiovese, and Cabernet Franc (freemarkabbey.com). Once the right climate and harvesting conditions exists, the winery can also make a late harvest Riesling known as “Edelwein Gold”. Freemark Abbey was originally founded as Tychson Cellars in 1886 by Josephine Marlin Tychson. Josephine was the first woman to develop and operate a winery in California.
Map of St. Helena
California Wine Mall, Map of Napa Valley Available at http://www.cawinemall.com/local.html (October 25, 2010)
Possible Decision Alternatives
The wine making production process that determines the sugar content for Riesling product can also reduce the volume of wine juice. If the storm hits and the botrytis does not form, the rainwater will be absorbed by the vines and causing the grapes to swell. The resulting product will be a thin wine that could be sold as a low-cost wine. The issue related to branding a thin wine under a label known for high-quality wines, is heavily associated with damaging the Freemark Abbey reputation. A brand management strategy would be to sell the Riesling grapes in bulk to another winery and avoid damaging the winery’s quality reputation.
If Mr. Jaeger goes with not harvesting the grapes now and the storm does not strike, the grapes would ripen more fully. “Fermentation is an extremely important step in winemaking, determining taste and quality. In fermentation, yeasts convert the sugars to alcohol and carbon dioxide. The alcohol is the wine’s major flavor component, affects the solubility of many wine constituents and enhances the wine’s resistance to spoilage.” (http://ies.lbl.gov/iespubs/59957.pdf) During the ripening process, the sugar and acidity levels rise and the grapes must be closely monitored. If the acidity falls below an unfavorable level, the grapes must be immediately harvested regardless of the sugar content level. The associated costs to the winery are approximately the same for each wine style and are minimal relative to the wholesale price. The forecasted storm could produce either a light, want rain or no rain.
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Qualitative Evaluation of Alternatives
Mr. Jaeger has two possible decision alternatives: Option (a) is to harvest the Riesling grapes now or option (b) wait for the storm to make land fall based on the weather forecast. If he waits, the storm may or may not hit the Napa Valley area and the storm hits, the botrytis may or may not develop. The results of both could have a positive or negative effect on winery’s revenue and profit margins. If the storm hits and no botrytis develops the resulting grape product could have a diluted concentration of sugars, fruit acids and minerals level. The concentrations levels establish the quality of the wine and the uncertainty about the concentration of final product causes concern about possible revenue. Also, the doubt concerning the mold is vital in determining the difference between a premium wine and a low-cost wine.
Mr. Jaeger may be reluctant to risk the Freemark Abbey brand reputation by marketing and selling a low-cost wine. Selling a low-cost wine could also increase Freemark Abbey’s market share by entering the low-cost wine market. If Jaeger executed this strategy and the thin wine sold for $2.00 per bottle, the EMV would be $39,240 which would be 10.1% higher. Finally, protecting Freemark’s reputation creates another decision alternative, Jaeger could sell the grapes in bulk or produce a low-cost wine to market under an expanded Freemark Abbey brand.
Quantitative Evaluation of Alternatives
The decision tree provides an effective framework within which Mr. Jaeger can explore options, and investigate the possible outcomes of choosing the two options. The harvesting now option will bring $2.85 per bottle per case of revenue for the Riesling product line. Waiting for the forecasted storm, complicates the decision process and requires Mr. Jaeger to consider additional alternatives with multiple outcomes. He has to consider the possibility of a forecasted storm hitting the Napa Valley area or not. The comparison of option (a) and (b) shows the EMV is calculated to determine the expected monetary values of the identified scenarios. There are two scenarios in option (b), storm or no storm. The information states there is a 0.4 probability to get the grapes botrytis and positive results and there is a .60 probability to get no botrytis. If there is no botrytis happens, Freemark can sell the wine at $1.00 per bottle and accepts a 50% reduction in per bottle revenue to protect the winery’s reputation. For the no storm option, Mr. Jaeger has a .50 probability of getting a selling price of $3.50, a .50 probability to be in a position to sell at $3.00 per bottle and a .20 probability to get $2.50 per bottle.
Freemark Abbey Decision Tree
EMV = $2.85 x 12,000 = $34,200
EMV (No Storm) = ($3.50 x .40 + $3.00 x .40 + $2.50 x .20) x 0.50 + ($8.00 x .40 x .70 + $2.00 x .60 x .50 x .50 = $2.97 x 12,000 = $35,640
EMV (Sold per Bottle) = ($3.50 x .40 + $3.00 x .40 + $2.50 x .20) x 0.50 + ($8.00 x .40 x .70 + $2.00 x .60) x .50 = $3.27 x 12,000 = $39,240
EMV (Storm) = $67,200 x .40 + $12,000 x .60 = $34,080
EMV (Botrytis) = 12,000 x .70 = 8,400 x $8.00 = $67,200
EMV (Sold in Bulk) = 1,000 x 12,000 = 12,000 x $1.00 = $12,000
EMV (Below Standard) = $2.50 x 12,000 = $30,000
EMV (.25 Sugar) = $3.50 x 12,000 = $42,000
EMV (.20 Sugar) = $3.00 x 12,000 = $36,000
EMV (Wait no Storm) = $42,000 x .40 + $36,000 x .40 + $30,000 x .20 = $37,200
In conclusion, Mr. Jaeger should choose the option of waiting for the storm and harvesting later. Mr. Jaeger can decide whether bottling a wine that was not up to standards, or selling the grapes at 50% lower price to protect company’s reputation. Either way, he can anticipate the higher revenue than harvesting the Riesling grapes immediately. Riesling contributes 1,000 cases of wine out of the annual 25,000 cases Freemark bottles. Since the decision analysis only affects approximately 4% of Freemark Abbey’s total production an EMV approach is appropriate. If the decision involved a larger percentage of production and the firm was not well-established, a near risk-averse approach might make sense. Finally, Freemark Abbey could put a strategy in place to possibly expand into the destination and vacation market by partnering with hotels and cruise lines in San Francisco. Excursions enhance each vacation and port visit and increase profits for the travel industry.
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