Economies of Scale Are Not Always All They Are Cracked Up To Be

In the wine business many people may think the large companies have economies of scale which allow them to deliver wine with better value, but in reality that may well not always be the end result for the consumer.

At the low cost end where every cent counts economies are important but that does not mean that the biggest companies are able to produce the lowest cost wines. Let’s compare a few situations to see why.

When making a bottle of wine the grapes have got to be paid for one way or another. Very few large concerns (who would be capable of using economies of scale) own all their own vineyards so much of the grapes have to be purchased either by contract or on the open market. At a particular quality level these grapes cost the same if a large or small producer is buying them, so there are no real economies of scale saving to be made here.

The “manufacturing” component incurs a cost as there must be a winery involved in making the wine. It costs just as much for a company like Southcorp to build a large processing facility as it would cost a medium sized operation like say Grant Burge or a small producer so there is unlikely to be much in the way of saving in facilities manufacturing costs.

Cost of oak barrels, oak chips, tartaric acid, powdered tannins, bottles and corks etc. may vary with quantities purchased so there may be some savings here but how much would that saving be in a low cost bottle of wine? Not much!

Owning your own bottling line that is going twenty four hours a day seven days a week would provide some small savings over a smaller producer that does not have their line going all the time or uses a commercial bottling set up, but how much would that represent on a low cost bottle of wine? Once again, not much! So whilst there are some saving for the likes of say Southcorp who can operate lines continually over say Grant Burge or a mom and dad operation they would not represent a large absolute dollar saving.

It has been said that a saving of a few cents per vehicle in the manufacturing costs adds millions to the bottom line for the car company so I guess that has to be true for the wine industry as well.

But then we have to look at the other side of this coin. The Southcorp used in this story has large corporate offices, a marketing department and a large staff that has to be paid. On top of that there are all the costs associated with running a public company including compliance costs and the salary of the board members. These costs are not there in the mom and pop operation that make strategic decisions over the dinner table and only partially there for the Grant Burge size operation.

So the end result is to be able to take advantage of the large economies of scale in wine production, generally speaking the larger the company and the larger the associated overheads. (The one exception to this may be the occasional company like Casella/Yellowtail.) In most cases there are no big savings to be made in producing low cost wines by being a large producer unless you are a huge producer!

World wide success stories or brands like Jacobs Creek where they are making millions of bottles a year with a very high number of stock turns which also leverage reputation and effective advertising fit the mould. The brands that fall into this category can probably be counted on one hand but they often represent excellent value for money. That may go a long way to explain why so few small wineries have inexpensive brands.

As to the rest of the wine industry most of the time the cost of the wine to the consumer has little to do with what it costs to produce; its all about how much the market will pay for it. It doesn’t cost forty times as much to produce Grange as it does Jacobs Creek now does it?

And that’s why economies of scale have little to do with the cost of a bottle of wine unless it’s at the very low cost end of the spectrum.