The Chalice Wines

Chalice Wine Group structure

The Chalice Wine Group (CWG) cont’

 Chalice is the flagship for CWG, Chalice winery was

founded in 1969 and went to public in May 1984.
Until June, 1993 with the initial public offering for
Robert Mondavi Winery, Chalice was the only
publicly-held company in the United States whose
principle business is the production and sale of
premium wines.
The Project was coming up!

 Bill Evanson, President and CEO of Chalice was

thinking; What does it cost them to make wines the way
they do? Many of their specific costs seem to get lost
within their accounting system. He suspect they
understate some and overstate others. Who making
money in this industry, and how do they do it? But this is
a complex industry because every winery has a unique
approach, and every wines in different. And Chalice is a
particularly complicated company. Would a VALUE
CHAIN ANALYSIS be meaningful, or even possible for
this company in this industry?
CWG Distribution Channel
 Each of its four California wineries is located in a different
legally area.
 Each one is a separate profit center with its own president.
 The company’s wines are sold in specialty wine shops and
grocery stores, selected restaurants, hotels and private clubs.
 They even distributed via direct mail in those state where it
is legal.
 Out if the USA, the company sells through the traditional 3-
tier system; maker, distributor, retailer.
 In Northern California, a wine distributor is used as a broker.
In Southern California, CWG own distribution network.
 Exhibit 1:
California Winery Shipments (000
Cases)*
 Exhibit 2:
Wine Production in Case Equivalents
Exhibit 3: Consolidated Balance Sheets, The Chalice Wine Group, Ltd.
(Thousand)
The Winery

 Complex production process

 Wine isn’t produced in a day/month but years
 Periodic production costs must be allocated among many
different wines
 CWG’s method was as straightforward as possible.
 All costs were considered product costs and wound up as
Costs of Good Sold for some particular wine
 Grape costs were easy to assign directly to particular
wines
The Winery
 Only the wines bottled in a year absorbed the bottling
costs for that year.
 All wines held in bulk inventory absorbed their relative
proportions of winemaking costs for that period.
 All wines held in bottled inventory absorbed bottle
aging costs
 Exhibit 4 shows the yields and the product cost
breakdown for 1991 Meritage White.
 Exhibit 4
1991 Meritage White Product Costs
Tons Crushed 89.17
Gallons of Juice Fermented 14,713
Gallons Aged 13,984
Gallons of Wine Produced 13,255
Cases Bottled 5,575
Production Cost Total Per Case
Grapes $73,901 $13.26
Winemaking 117,486 21.07
Bottling 93,657 16.80
Bottle Aging 8,937 1.60
Total $293,981 $52.73
The Winery
 The task now is to derive per case operating profit for
this wine, and the per case Return on Assets (ROA).
 The profitability analysis for one case of 1991
Cimarron Meritage White demonstrated the
contribution of that wine to the overall financial
performance of the Chalice Group.
Cimaron winery sold 37,205 cases
Total Revenue $2.7 million
Depreciable 4.9 million
The Vineyard
 Cimarron Meritage White is a blend of Sauvigon Blanc
and Semillion grapes, neither of which is grown at
Cimarron Vineyard.
 All the grapes for this wine are purchased from
Pinnacle Vineyards, CWG’s partner in the Opera
Valley Joint Venture.
 Grape cost = $13.26 per case
 Exhibition 5 and 6 describe the costs and assets
involved in establishment and operation of 30 acre
vineyard in Sonoma Country as of the end in 1992.
 Exhibit 5
Cost per Acre to Establish and Operate a Vineyard
Year
5&
1 2 3 4 Forward
Yield (tons/acre) 1.5 3.5 6
5,13
Total Planting Costs 8 2,440
Total Cultural Costs 609 1,062 1,216 1,317 1,317
Total Harvest Costs@$120/ton 180 420 720
Total Overhead Costs 622 622 642 698 718
636
Total Cash Costs 9 4,124 2,038 2,435 2,755
Depreciation (see Exhibit6) 843 843
Total 3,278 $3,598*
*$3,598/Acre = $600/T = $9.59/case [62.5 cases per ton]
 Exhibit 6:
Assets Required to Establish and Operate a 30 Acre Vineyard
Purchase Useful Salvage Annual
Investment   Price (new) Life Value Depreciation
Land (30 plantable acres) 525,000
Vineyard Establishment[A] 339,374 22 0% 15,426
Reservior 30,000 30 0% 1,000
Buildings 15,750 30 10% 473
Drip Irrigation System 52,400 25 10% 1,886
Frost Protection System 40,300 25 10% 1,451
Shop Tools 10,000 15 10% 600
Pruning Equipment 1,200 10 10% 108
ATV, 4WD 6,500 5 10% 1,170
Tractor   29,900 15 10% 1,794
Duster   3,035 10 10% 273
Mower [B] 5,500 10 10% 495
Orchard Sprayer   4,560 10 10% 410
Weed Sprayer   2,000 10 10% 180
Pickup Truck   16,500 7 10% 2,121
Total Investment,with new Equip.   1,082,019     27,388
*Allowance for Used Equipment   -24,598     -2,110
Total Investment,30 Acre Vineyard   $1,057,421     $25,278
A) "Vineyard Establishment" is the accumulated cash costs for 1st 3 years,net of revenue earned in
year 3 using the price paid by Cimaron in 1991 as a proxy value for each tone produced.  

B) Last 6 items can be purchased uesd @ an average og 60% of new costs. Allowance is made above (*).
 Exhibit 7
History of California Grape Prices Per Ton

Variety (*) 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992
$1,12 $1,22 $1,12 $1,12 $1,03
Chardonnay (18%) $980 $998 $904 $856 $922 2 5 8 2 8
$1,03
Cabernet (32%) $467 $527 $533 $550 $631 $822 2 $977 $918 $872
Zinfandel (56%) $269 $253 $269 $340 $480 $817 $546 $391 $363 $434
Sauvignon Blanc
(35%) $487 $486 $441 $401 $414 $474 $571 $518 $541 $552
Semillon (73%) $215 $260 $210 $245 $254 $289 $311 $310 $328 $360
* The percentages in parentheses represent the premiums paid to Sonoma County growers ove
r the state averages in 1992.
The Vineyard
 Sam assumed revenue for vineyard would be
$812.36/ton
 Although grape cost of $9.59 per case for this
vineyard represented an improvement over the $12.99
the winery was paying now
 Should they change it’s make/buy policy on grapes
for this wine?
The Distributor
 Stellar wines is a typical East Coast wine distributor.
 In 1992 the company sold 225,000 cases of wine,
roughly 50% imported and 50% domestic.
 Stellar’s product cost for Cimaron Meritage White
includes $2.25/case to cover freight from California
and state tax of $1.56/case.
 A wine distributor sells wine to both “on-premise”
accounts and “off-premise” accounts.
 Since most of CWG’s off-premise wine sales occur in
a relatively small premium wine shops, it was decided
that this type of business should provide the final
piece of the value chain
 Exhibit 8
Stellar Wines Financial Statements
(in Thousands)
Balance Sheets
December 31,
1992 1991
Assets
Cash $ 24 $ 9
Accounts Receivable 2,273 1,806
Inventory 6,500 6,592
Equipment (net) 108 105
Other 333 312
Total $9,238 $8,824
Liabilities
Note Payable, Bank $4,953 $4,794
Accounts Payable & Accruals 1,735 1,544

Stockholders' Equity
Common Stock 10 9
Retained Earnings 2,540 2,477
2,550 2,486
Total $9,238 $8,824
 Exhibit 8 (cont.)
Stellar Wines Financial Statement
(in Thousands)

Income Statements
Year Ended December 31,
1992 1991
Sales $17,078 $15,389
Cost of Goods Sold 12,771 11,313
Operating Expenses 3,394 3,187
Interest Expense 425 507
Net Income Before Tax $488 $381
The Retailer

 Riverside Wide Company is one of Stellar’s best

customers.
 As grocery chains and discount clubs have gained
market share,
 Many small premium wine shop have been driven out
of business.
 However, at the top end of the business there remains
a demand for service and selection that is difficult to
provide in a high volume setting.
The Retailer (cont.)
 Exhibit 9 contains selected financial information for
Riverside for 1992.
 As with the distributor, a case is a case.
 So one way of assigning operating expenses and
assets among the cases sold is equal weight.
The Retailer (cont.)
Exhibit 9
Riverside Wine Company, 1992

Total Sales $1,889,916

Cost of Goods Sold $1,412,000
Operating Costs $438,134
Profit (before tax) $39,782
Cases Sold 14,776
Total Assets $719,261
($235,333 of inventory)
Overall Value Chain

 Sam and Bill stepped back to consider what the

numbers meant, and what were the strategic
implications for Chalice.
 Sam put the profitability for the four participants in
this value chain together to determine the overall
profit margin and the overall return on assets for the
industry on every case of 1991 Cimarron Meritage
White sold to consumers in retail wine shops.
Winery Costs Revisited
 Sam knew the production cost of $52.73/case from
Exhibit 4 was a very crude aggregate average cost.
 Upon careful reflection, he concluded that the
winemaking process can be viewed as involving three
distinct stages:
 Stage 1 (crushing, pressing and fermenting)

 Stage 2 (fining, filtering, bulk aging)

 Stage 3 (preparation for bottling)

Winery Costs Revisited (cont.)
Exhibit 10
Winemaking Cost-ABC Approach
1991 1992
Stage 1 $285,000 (1) $268,000
Stage 2 571,000 559,000 (2)
Stage 3 57,000 56,000
TOTAL $913,000 $883,000

*The 1991 Meritage White vintage represented 18% of the wine made in 1991, 15% of
stage 2 costs in 1992, and 28% of the wine prepared for bottling in 1992

(1) Including $12,700 of barrel depreciation, because some white wines are barrel
fermented
(2) Including $154,900 of barrel depreciation
 Sam also discovered that the $16.80 per case for bottling was a very simple overall
average allocation.
 Exhibit 11 shows a comparison of the average approach and the ABC approach to
bottling cost.

Exhibit 11
Bottling Cost--Per Case

Cost Category Average Cost ABC Cost for Meritage White

Labor 1.16 .75

Supplies .07 .07
Bottles 6.43 5.00
Corks 2.39 2.39
Capsules 1.19 1.19
Labels 1.99 1.50
Wooden Boxes .55 0
Taxes 3.02 3.02
TOTAL 16.80 13.92
 Third, Sam discovered that barrel depreciation was a
very complex issue, involving French oak barrels that
had risen in cost from $362 in 1988 to $650 in 1993.
 White wines are both fermented (3 months) and aged
in barrels whereas red wines are fermented in tanks.
 But, red wines are aged 2 years in the barrels versus
only 9 months for white whites.
 Yet all barrels at the Cimarron winery are just
depreciated, straight-line, over 4 years, with barrel
depreciation as 1 line item in winemaking cost.
 Of the $21.07 winemaking cost for the 1991 Meritage
White, $4.03 (19%) was for barrel depreciation.
 Sam had no intuition about how a more accurate
ABC assignment of barrel depreciation would affect
the $4.03 number.
 Exhibit 12 was constructed to estimate actual
consumption of barrel cost, using estimated market
values and the actual barrel usage plan for the 1991
Meritage White
Lyford Winery

 Sam was aware of Lyford Winery which had been

founded in Sonoma County in 1981.
 It was constructed as a state of the art winemaking
showplace with no expense spared in either the
production of the wines or in the effort to build the
brand in the marketplace.
 The brand name was sold to a French company.
 Wine for the brand was sourced from the bulk wine
market.
 Exhibit 13 gives the per case cost structure for one of Lyford’s more recent
releases, a 1991 Meritage White.
 The final blend was 85% Sauvignon Blanc, 13% Semillon, and 2% White
Muscat.
Exhibit 13:
1991 Lyford Meritage White
Product Costs per Case

Bulk Wine Cost $ 9.26

Bottling 2.28
Corks 2.37
Capsules 1.16
Labels 0.70
Bottles 4.60
Lyford Overhead & Supplies 2.02
Wine Tax 3.02
Total $25.41
 The product costs shown in this exhibit tell nearly the
entire story of this wine.
 The “winery” has virtually no capital assets beyond
leased office and warehouse space and working
capital (assume 30% of sales).
 An allocation of marketing expenses added only
about $1.09 to the per case cost of the wine.
 Leased space and equipment added about another $5
per case.
Lyford sold the wine to wholesale distributors for
$45.00 per case, with a target retail price of $7.50 per
bottle.

*Lyford Winery—The Value Chain

Sales 45
Costs ?
Margin ?
Assets ?
ROA ?
Price to Distributor 45.00
+ Freight & Taxes + 3.81
Delivered = 48.81

Price to Retailer (/.75) = 65.00

Price to Consumer (/.75) = 86.67

= ~7.22/Bottle
(~$7.50 with sales tax)
 Exhibit 14: The Value Chain—1991 Cimarron Meritage White
(per case)
Vineyard
Revenue 12.99 P/S = 0.26
Operating costs 9.59 S/A = 0.685
Margin 3.49 ROA = 0.184
Assets 18.97
Winery
+$2.7 handling cost
Revenue costs 72.57 P/S = (0.32)
Grapes 13.26 S/A = 0.551
Winemaking 47.33 ROA = (0.174)
Bottling 13.92
Bottle Aging 1.60
SG&A 19.32
Margin (22.86) +$2.25 handling cost
Assets 131.70
Distributor +1.56 tax
Revenue 114.32 P/S = 0.19
Wine Cost 76.38 S/A = 2.78
Operating Cost 15.08 ROA = 0.56
Margin 22.86
Assets 41.06
Retailer
Revenue 142.46 P/S = (0.016)
Wine Cost 114.32 S/A = 2.93
Operating Costs 29.65 ROA = (0.031)
Margin (1.51)
Assets 48.68
 The Overall Value Chain

 Revenue 342.34 P/S = 0.0055

 Profit 1.89 S/A = 1.424
 Assets 240.41 ROA =0.0079
Vineyard, CWG is paying way more that the industry average
price for grapes. If it paid the industry average price, there is a
potential an incremental $5.o per case profit. Should it keep on
sacrificing profit for quality?
The cost to establish and operate a vineyard is $9.59 per case,
whereas CWG is paying $12.99 per case, plus handling. It has to
decide if it will continue to buy grapes or start growing grapes.

Winery Product costs were assigned equally to various wines

when no two wines were the same. This was done based on the
average cost system. ABC analysis better reflected the
winemaking, bottling costs than average costing did.
The winery is unprofitable, losing $22.86 per case. CWG has a lot
of money tied up in inventory. The winery has 4.9 million in
depreciable assets, while Lyford winery has virtually no capital
assets.
Distributor The most profitable part of the value
chain with a margin of $22.86 per case sold. It also
has the highest ROA (56%) in the value chain.

Retailer Make a loss of $1.51 for every case sold. It

has the highest wine cost in the value chain, a big
reason why it is unprofitable.

Overall value chain The overall total profit is $1.89

per case and overall ROA is .77%. There numbers
suggest that this is not a profitable business.
The Lyford Wines Value Chain
The Lyford winery has virtually no capital assets
beyond leased offices and warehouse space and
working capital this enables it to have a high ROA of
100%. Lyford winery also purchased its processing
service from customs suppliers, and all of the services
required to bring the product form the bulk wine
market to distribution was also purchased form
custom winemaking operations. This resulted in a low
product cost of $25.41 and a margin of $18.5 per
case. Lyford winery shows an alternative, more
profitable approach towards winemaking. Lyford’s
value chain suggests that CWG might be better off
outsourcing some of its activities and reliving on
custom suppliers to keep its product cost low.
Thank you !!