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© Francisco Guillermo Cervantes Medina www.fcervantes.es 1.

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Presentation on theme: "© Francisco Guillermo Cervantes Medina www.fcervantes.es 1."— Presentation transcript:

1 © Francisco Guillermo Cervantes Medina www.fcervantes.es 1

2 © Francisco Guillermo Cervantes Medina Strategic Costs as Applied to Wineries Club de Marketing de La Rioja April 13, 2015

3 © Francisco Guillermo Cervantes Medina Basic questions & Concepts Why are you here? Why do ALL companies exist? i.e. What is the one sole purpose that ALL businesses share? What is “business strategy”? What is a “cost”? 3

4 © Francisco Guillermo Cervantes Medina Basic questions & Concepts Why are you here? Why do all companies exist? i.e. What is the one sole purpose that all businesses share? PROFIT 4

5 © Francisco Guillermo Cervantes Medina What is “strategy”? 5 It’s a plan; an ‘elaborate and systematic’ plan. A plan to do what? To sell a product or service and not die doing it. In other words… Business strategy is an elaborate and systematic plan to sell a product or service at a profit. La estrategia empresarial es un plan elaborado y sistemático para vender un producto o servicio a un precio tal que me permita ser rentable.

6 © Francisco Guillermo Cervantes Medina What is a “cost”? 6 Cost is a consumption of resources to carry out an activity (eg. To produce and sell a good or service). Coste es el consumo de recursos para llevar a cabo una actividad (ej. producir, vender un bien o servicio). And by extension… Cost analysis is a business exercise that apportions a company’s costs to its various products and activities. El Análisis de Costes es un ejercicio que consiste en asignar los costes totales de una empresa a sus distintos productos y actividades; es decir, en “repartir la tarta” de los costes.

7 © Francisco Guillermo Cervantes Medina How do we bring “strategy” and “costs” together? 7 StrategyCosts

8 © Francisco Guillermo Cervantes Medina How do we bring “strategy” and “costs” together? 8 StrategyCosts

9 © Francisco Guillermo Cervantes Medina Strategy and costs: Putting it together – the practical perspective 9 StrategyCosts “Strategic Costs” I  literal understanding: activities/expenses that are part of our core business strategy −Exporting −Marketing Purpose: branding, profit, first-mover advantage, etc. “Costly strategies”: Turning our strategy into a cost −“Gain market share” strategies  Price wars  Dumping  Exporting ? “Strategic Costs” II −Costs are a basic tool for managing profit  Cost Analysis

10 © Francisco Guillermo Cervantes Medina Why is profit so important? 10 The answer involves 2 perspectives: 1 st Wealth creation 2 nd Business sustainability

11 © Francisco Guillermo Cervantes Medina The profit equation 11 Managing profit boils down to managing 2 key variables: Price and Costs But it gets a little more complicated than that…

12 © Francisco Guillermo Cervantes Medina The profit equation 12 Quantity sold = Q Selling Price = P What we do How we do it Raw materials Labor and capital intensity OPERATIONS Demand Competition Product design & development Internal logistics: Procurement ManufacturingSellingExternal logistics: Distribution Caring for the vines Grape selection & picking Wine concept Label design Grape testing & weighting Wine storage Destemming Pressing Fermenting Ageing Function of National: Distributor Consumer Export: Importer Distributor Freight forwarder Carrier Transportation agency

13 © Francisco Guillermo Cervantes Medina The profit equation: where do we see strategy? 13 Quantity sold = Q Selling Price = P What we do How we do it Raw materials Labor and capital intensity OPERATIONS Demand Competition Product design & development Internal logistics: Procurement ManufacturingSellingExternal logistics: Distribution Caring for the vines Grape selection & picking Wine concept Label design Grape testing & weighting Wine storage Destemming Pressing Fermenting Ageing Function of National: Distributor Consumer Export: Importer Distributor Freight forwarder Carrier Transportation agency Value chain (“Cadena de valor”) Strategy

14 © Francisco Guillermo Cervantes Medina The profit equation: How do we account for it? 14 Quantity sold = Q Selling Price = P What we do How we do it Raw materials Labor and capital intensity OPERATIONS Demand Competition Product design & development Internal logistics: Procurement ManufacturingSellingExternal logistics: Distribution Caring for the vines Grape selection & picking Wine concept Label design Grape testing & weighting Wine storage Destemming Pressing Fermenting Ageing Function of National: Distributor Consumer Export: Importer Distributor Freight forwarder Carrier Transportation agency Value chain (“Cadena de valor”) Trace back to Through accounting group 6 Trace back to Through accounting group 7

15 © Francisco Guillermo Cervantes Medina Monetary value of the resources consumed by a business during an accounting period 15 This is our co.’s Group 6 of accounting The goal of a cost system/analysis: i.e. this is our company’s cost base. To apportion these costs to the different business activities of the company and ultimately, to its products, services and clients. To distribute this whole amongst the company’s products, services and clients.

16 © Francisco Guillermo Cervantes Medina Strategy and costs: Putting it together – the technical perspective 16 Period 1 Accounting Period 2 Accounting Cost Analysis Management = strategy implementation Results Reconcilement A business accounting is, at the same time, the starting and ending point for a cost analysis:

17 © Francisco Guillermo Cervantes Medina Michael Porter’s Value Chain 17 Succession of business activities, each of which adds value to the preceding step of a company’s productive and/or sales processes. Primary or Main Activities Support Activities Sucesión de actividades, cada una de las cuales aporta un valor a la anterior en los procesos de producción y ventas de una empresa. Internal Logistics OperationsExternal Logistics Marketing & Sales Post-sale Servicing Business Infrastructure Human Resources Research & Development Procurement

18 © Francisco Guillermo Cervantes Medina How do we bring Value Chain and Accounting together? 18 Internal Logistics OperationsExternal Logistics Marketing & Sales Post-sale Servicing Business Infrastructure Human Resources Tech. Development (Research & Development) Procurement

19 © Francisco Guillermo Cervantes Medina How does this turn into a cost system/analysis? 19 Co.’s Cost Base Process I call “Cost Mapping” (“Mapa de costes”) Activities & Processes Grape Production Purchases of Raw Materials Production Destemming and Press Fermenting Ageing Sales Bottling Nat. Transport. Int’l. Transport. Salespeople Marketing Financing “Structure” Co.’s Final Products Accounting Company’s main activities Products or “cost objects” of those activities Company’s final products Activity-Based Costing (ABC) method

20 © Francisco Guillermo Cervantes Medina Strategy and costs: Putting it together – the technical perspective 20 Co.’s Cost Base Activities & Processes Grape Production Purchases of Raw Materials Production Destemming and Press Fermenting Ageing Sales Bottling Nat. Transport. Int’l. Transport. Salespeople Marketing Financing “Structure” Co.’s Final Products Internal Logistics Operations External Logistics Marketing & Sales Post-sale Servicing Business Infrastructure Human Resources Research & Development Procurement Accounting + Value Chain ABC=

21 © Francisco Guillermo Cervantes Medina Where does this take us? 21 Knowing the costs of our business’ processes & Activities Processes Optimization  Profit management Management Knowing the costs and cost structure of your business’ final product Pricing and sales strategies This is what will most directly affect you

22 © Francisco Guillermo Cervantes Medina Unit costs for Demvrek 22 Raw Materials 0,62 € 32% Production 0,29 € 15% Sales 0,88 € 45% 0,16 € 8% 1,95 € 100% Raw Materials 0,62 € 29% Production 0,29 € 14% 0,16 € 8% Sales 1,03 € 49% 2,10 € 100% Tinto Joven - Export

23 © Francisco Guillermo Cervantes Medina Unit costs 23 Raw Materials 0,60 € 22% Production 0,73 € 27% Sales 1,23 € 45% 0,16 € 6% 2,71 € 100% Raw Materials 0,60 € 21% Production 0,73 € 25% 0,16 € 6% Sales 1,38 € 48% 2,86 € 100% Crianza - Export

24 © Francisco Guillermo Cervantes Medina Cost structure of each product 24

25 © Francisco Guillermo Cervantes Medina How low can you go? “The 10% syndrome” 25 “If I could only lower my price by 10%, I could sell a lot of wine.” Base Case Sales (Q x P)3.000 € 1.000 bottles x 3,00 € per bottle Variable Costs (Q x V)(1.560 €) 1.000 bottles x 1,56 € per bottle Fixed Costs (F)(540 €) 540 € / 1.000 bottles = 0,54 € per bottle Profit900 € % of sales30% 10% Discount Sales (Q x P)2.700 € 1.000 bottles x 2,70 € per bottle Variable Costs (Q x V)(1.560 €) 1.000 bottles x 1,56 € per bottle Fixed Costs (F)(540 €) 540 € / 1.000 bottles = 0,54 € per bottle Profit600 € % of sales22% Profit Reduction(33%)

26 © Francisco Guillermo Cervantes Medina “A lot”: Enough to recover the lost margin? 26 Base Case Sales (Q x P)3.000 € 1.000 bottles x 3,00 € per bottle Variable Costs (Q x V)(1.560 €) 1.000 bottles x 1,56 € per bottle Fixed Costs (F)(540 €) 540 € / 1.000 bottles = 0,54 € per bottle Profit900 € % of sales30% 10% Discount Sales (Q x P)3.411 € 1.263 bottles x 2,70 € per bottle Variable Costs (Q x V)(1.971 €) 1.263 bottles x 1,56 € per bottle Fixed Costs (F)(540 €) 540 € / 1.263 bottles = 0,428 € per bottle Profit900 € % of sales26% Profit Reduction0% Sales would have to increase by 26% only to go back to our before-discount  Multiplier effect of price on earnings.level of earnings

27 © Francisco Guillermo Cervantes Medina The “need” for discounts 27 Different international markets give different weights to Designations of Origin (D.O.’s). Which means that depending on the international market, different Designations of Origin may compete on a more level paying field than in the national market. D.O. regulations vary, hence, the costs to make wine in different D.O.’s may not be the same For example…

28 © Francisco Guillermo Cervantes Medina The “need” for discounts - Costs specific to the wine business in Rioja 28 Red grape yields in La Rioja are capped at 6.500 kg/hectare. Grapes are 0,62 € or 29% of total wine cost 2,10 € Tinto Joven - Export Grapes are 0,60 € or 21% of total wine cost 2,86 € Crianza - Export But that is not the case for all DO’s…

29 © Francisco Guillermo Cervantes Medina The “need” for discounts 29 This means that a winery of similar characteristics to our fictitious Demvrek could have a significantly lower unit cost per bottle of wine simply by belonging to a D.O. different than Rioja. Let’s assume, for the sake of argument that Demvrek’s Rioja “Crianza” is competing against a decent Penedés of a winery of similar characteristics and operations. For example: Somontano allows a yield of 8.000 kg/hectare Penedés allows a yield of 9.000 kg/hectare Assuming everything else constant, the cost structure of the Penedés vs. the Rioja wine would be different due to the different D.O. regulation.

30 © Francisco Guillermo Cervantes Medina RiojaPenedés 30 Grapes are 0,43 € or 16% of total wine cost Grapes are 0,60 € or 21% of total wine cost 2,86 € Crianza - Export 2,69 € Crianza - Export 6% cost advantage Should Demvrek offer that 6% as a discount? Does it make sense to compete on price? Does it make sense to compete in this market? Strategy Costs Tinta, 0,43 €

31 © Francisco Guillermo Cervantes Medina Cash Conversion Cycle or CCC (periodo de maduración de una venta) 31 t0t0 15-Sep Grapes delivered to winery; winemaking process begins t 1 = 90 days 15-Dec New wine elaborated t 2 = 93 days 18-Dec First sale of the recently made wine t 3 = 120 days 15-Jan Payment to grape suppliers t 4 = 190 days 25-Mar Client pays Average Production Time Time from Inventory to Sale Average Time to Pay Collection Time 90 days3 days97 days + += CCC70 days DOH93 days DSO97 days # Days of Payables-120 days Days of Inventory on Hand (DOH) Days of Sales Outstanding (DSO) Number of Days of Payables

32 © Francisco Guillermo Cervantes Medina Cash Conversion Cycle or CCC (periodo de maduración de una venta) 32 t0t0 t 1 = 90 days t 3 = 360 days 15-Sep Wine sale t 2 = 120 days 15-Ene Payment to grape suppliers t 4 = 457 days 22-Dec Client pays Average Production Time Time from Inventory to Sale Average Time to Pay Collection Time 90 days270 days97 days + + = CCC337 days DOH360 days DSO97 days # Days of Payables-120 days Days of Inventory on Hand (DOH) Days of Sales Outstanding (DSO) 15-Sep Grapes delivered to winery; winemaking process begins 15-Dec New wine elaborated Number of Days of Payables

33 © Francisco Guillermo Cervantes Medina Cash Conversion Cycle or CCC (periodo de maduración de una venta) 33 t0t0 t 1 = 90 t 4 = 545 15-Mar + 1 Sale of aged wine t 2 = 120 15-Jan Payment to grape suppliers t 5 = 642 22-Jun + 1 Client pays Average Production Time Time from Inventory to Sale Average Time to Pay Collection Time 90 days365 days97 days ++= CCC522 days DOH545 days DSO97 days # Days of Payables-120 days 90 days t 3 = 455 15-Dec + 1 Aged wine elaborated 15-Sep Grapes delivered to winery; winemaking process begins 15-Dec New wine elaborated Days of Inventory on Hand (DOH) Days of Sales Outstanding (DSO) Number of Days of Payables +

34 © Francisco Guillermo Cervantes Medina Expenses and Cash Flows associated with Inventory 34 CAPEX (Long Term) Warehouse Tanks Barrels Barrel supports Cages Forklift, etc. Depreciation Interest Repayment of outstanding debt Fiscal deduction Expense Less Expense Flow Current Expenses Grapes, wine, bottling supplies purchases, etc. ExpenseFlow Direct LaborExpenseFlow Power & other utilitiesExpenseFlow Other production and ageing costs ExpenseFlow

35 © Francisco Guillermo Cervantes Medina Expenses and Cash Flows associated with Inventory 35 Most of these expenses and cash flows will be disbursed in recurring installments. All of these expenses and cash flows will need to be financed: a)Company’s own resources b)Equity holders’ resources c)Debt holders’ resources imply Financing Costs All of them will be disbursed well – years – before a sale is made. Carrying inventory costs for a winery are substantial and must never be ignored.

36 © Francisco Guillermo Cervantes Medina To recap: how do costs affect you and your business strategy? Negotiate the payment terms and pay attention to any “red flags” when it comes to credit risk. Crucial due to long CCC. The 10% syndrome  How low can I go? What effect will the discount have on my winery’s profit? How much will sales increase by applying the discount? Does the discount make sense? Is it worth it? Bear in mind your cost structure and don’t compete solely on price! Remind yourself and your managers that you are there to sell for a profit, not just to sell. 36

37 © Francisco Guillermo Cervantes Medina To recap: how do costs affect you and your business strategy? Why do I want to be in these markets? What is my purpose? Is it to become big? Or is it to become profitable? Where is my export department in the grand scheme of things? Big or profitable? 37

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39 © Francisco Guillermo Cervantes Medina www.fcervantes.es 39

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