The Real Problem – Part 1
(Despite advice to tart this post up with pictures and the like, its just a wall of words because the current circumstance is a convoluted and sad new low for the Australian wine industry. But, as a tragic who follows this rabble closely and naively thinks that hope is always just around the corner, I feel the need to report the how, who, where and why of this debacle. Even very informed people are asking questions about how the hell we got to here. I hope this helps. So get your stimulant of choice, prop open your eyelids and try to stay awake. – Dudley)
The recent changes made by the federal government to the Wine Equalisation Tax Rebate to be implemented over the coming budget years are a sad consequence of a failure of governance by the Winemakers Federation of Australia (WFA) – the government recognised “peak body” for the national wine industry. WFA represents some 15-20% of Australian wineries (and about 80-90% of the wine produced) as well as about one-quarter to one-third of all the wine grapes produced (grown by their winery members).
In classical tragedy, the sad ending is a result of a personal flaw (pride, ambition, vanity, greed, etc) or some built-in characteristic (like Achilles’s unprotected heel) that can’t be escaped. The recent changes made by the government are a result of at least one of each of these.
As to the former, WFA fell for a schoolboy’s two way bet “heads I win, tails you lose” made by two of its largest members – Treasury Wine Estates and Pernod Ricard – and, as a result, has ended up throwing most of the medium and small winemakers of Australia to the wolves. In the contorted process in between these two points, it has lost any legitimate claim to its peak body status.
What ostensibly started out as an effort by industry to end the massive long-term oversupply of the Australian wine grape market ended as a successful anti-competitive power grab by Australia’s largest winemakers endorsed by a government whose main objective appears to have been increasing revenues while those not directly responsible for any of it get punished pretty much exclusively.
While the current winners and losers seem obvious enough, the question of interest at this point in this slow motion play is this: did WFA Chairman Tony D’Aloisio and the largest wine companies actually work together to this end wittingly or, was D’Aloisio completely snookered by them? In short, is he an evil genius or, just not so smart?
The WET Rebate changes – which reduce the amount of rebate from $500,000 to $290,000 over the next few years and limits access to the rebate to those who own or lease a winery – comparatively benefits WFA’s largest members; Treasury Wine Estates, Accolade, Cassella, Australian Vintage Limited, Pernod Ricard, DeBortoli, Yalumba etc. by harming their smaller competitors. All wineries will each wear a $210,000 per year income hit (small beer to the large, large beer to everyone else) while their most innovative competitors, the small “virtual” winemakers who are bringing the wine world’s interest back to Australian wine – will get shoved to the wall through new rules limiting their access to the rebate.
For the sake of transparency, none of these changes affect our family grape and wine business directly. The only dog we have in this hunt is the desire to see Australia recognised as a great wine making nation worldwide. The changes recently set out by the government will not hasten this outcome unless significant changes are undertaken.
The winemaker fury unleashed by these changes is understandable as it punishes those who did not cause the current industry mess and obscures the real problem facing the industry: long term over-supply in the Australian wine grape market.
WFA has advocated over 20+ years for policies to create and sustain conditions of surplus in the grape market to provide low and stable prices for wine grapes for its winemaking members. In fact, the only time(s) that WFA advocated for a reduction in supply has been to independent wine grape growers to reduce their crops as the surplus had grown so large it was negatively impacting WFA’s member wineries.
WFA advocated accelerated depreciation for vineyard investment to support massive planting growth in the 1990’s and early 2000’s. This policy was a result of the rapid run up of grape prices as Australian wines exploded into export markets in the low value dollar environment of the early and mid-1990’s.
The strategy was to get tax breaks (this is what industry associations exist for mostly) for WFA members to expand profitable businesses by reducing the cost of fruit through supply increases. While originally envisioned as a tax break for wineries to plant more vines, it turned into a vine planting cum raid on the ATO principally organized by the wine industry’s own employees for their personal gain both inside and outside of their day jobs.
Two common examples: wineries offering long term fixed price supply contracts to managed investment schemes managed and / or owned by their own employees (and their family members) or when winery employees would buy cheap land and sell it to a buyer with the promise of long term contract if they paid dearly and / or with a contract to employ contractors controlled by the employee or family members, etc. Many of the “great” names of the wine industry profited handsomely from this trade at the taxpayers’ expense, some even collecting gongs for their “services.”
Eventually, this got too smelly even for the winemakers who realized that the wrong sort (e.g. non-winemakers, particularly grape growers) were profiting from this scam and finally asked that it be curtailed in 2004. In order to ensure the right sort (winemakers) were looked after and that the “excess” surplus went away, WFA sought and obtained the WET rebate of $290,000 (later increased to $500,000) on wine sold thinking this would create the right incentives and reward their members.
Predictably, grape growers (and other sorts of rent seekers including retailers like Coles and Woolies) then became “winemakers” to obtain $500,000 per year in tax rebates. Winemakers of all sorts would blend and buy and sell and buy and sell the same wine multiple times to get multiple rebates. Even employees of wine makers got in on the scam by “making” and “selling” wine to their employers to get the rebate as part of their compensation package.
Another unintended consequence of long term oversupply and low prices was that a new generation of winemakers was able to start making very innovative wines with very little investment and collect rebates on their sales. Some of these wines have started to capture the world’s attention for Australian wine after a decade in the wilderness.
While legal at the time, all of this behavior reflects the questionable logic of governments endorsing peak bodies and accepting their guidance in the management of sectors of our economy. While a peak body satisfies government’s seemingly sensible request to industry to speak with “one voice,” governments are absolved from making the hard decisions between competing views of the future within an industry. When things go right, it is the politicians’ success. When it goes wrong, governments have industry to blame.
As to the latter type of tragic flaw, WFA is composed of three “colleges” (Large, Medium and Small winemakers) of which four representatives of each are represented on the Board. In turn, the WFA constitution requires the assent of 80% of the votes cast to enact policy. 80% of 12 equals 9.6 votes. Assuming that the law of rounding is applied, ten votes are required to approve smoke-o.
The tragedy is that in preventing any two colleges from running roughshod over the third, the entire body can do very little that is progressive or collective as would befit a body of governance such as WFA. This structure tends to benefit large incumbents because incumbents prefer that progress be profited from and not shared with others while the smallest fear the economic power and influence of the largest. And, it can permanently stall necessary step-change recommendations like volumetric tax that might get over the line with a simple majority.
The crux of the problem is not that WFA Board are bad or dumb, it is that the WFA Constitution is a formula for deadlock, not governance. While they can generally agree on the need for more tax breaks, less competition and that independent growers should pull out their vines, they lack a structure for fair and reasonable strategy and policy to evolve over time as industry needs change.
Keep in mind that the WFA only represent their member companies. Not the 80% of wineries who do not belong, nor the businesses of 70% of the wine grapes grown (that’s the role of the underfunded, dysfunctional and ineffective WGGA), nor the regions where grapes are grown and made into wine. Taken together, these deficiencies render WFA’s current claim to industry governance inadequate.
One of the foundational crimes of the WFA was the negotiation of a 26% “ad valorem” wholesale sales tax (WET) on wine in the 1990’s along with the depreceation scheme. At the time, the reigning companies (Penfolds, Lindemans and Orlando, or, the “PLO”) all had large, low value (bag in a box) wine businesses and supported this method.
Then WFA President Brian Croser’s recollection is this:
“On the tax issue the original 1993 Dawkins proposal was to instantly increase the sales tax on wine from 20% to 31%, which could have had dire consequences and we fought that back to a staged implementation to 26%. The large companies negotiated the vineyard depreciation offset.”
There is no record of Croser or WFA arguing against the depreceation offset publicly as far as I can find. That he was totally unaware of this side deal seems improbable, but there you are. The parallels to Tony D’Aloisio and 2016 could not be clearer.
What the poorly conducted debate over the last year has made plain is that all sectors of the wine industry have cause for complaint and that no one set of policies will satisfy any one sector. The scenario of “why try to please everyone when everyone can’t be happy?” has opened the door to these new rules for the government.
How the present government landed on the present solution is pretty simple; the need to appear to be “doing something” expedient (e.g. before an election) that appeased those with the most access to government while the prospect of additional tax revenues trumped solving the hard (but solvable and controversial) problem of oversupply that they were meant to be solving with industry. How the problem being solved morphed from oversupply into too much competition bears recounting.
In September 2011, Treasury Wine Estates went “rogue” and announced it desire to see major tax changes. These calls went nowhere until May 2015, when TWE (Penfolds, Wolf Blass, Wynns, et al) and Pernod Ricard (Jacobs Creek) went outside the WFA tent together and announced that they would campaign with their own money to 1) get the ad valorem tax changed to a “volumetric” tax (a tax on the amount of alcohol in a bottle rather than the value of its contents) and 2) to eliminate the WET rebate altogether to get rid of distortions caused by virtual winemakers, retailers and rent seekers. Interestingly, in June 2015, Pernod publicly defended this approach by saying that “The single biggest challenge facing the Australian wine industry is the ongoing, unsustainable oversupply of lower-quality grapes and wines, which harms both its image and financial performance.”
Around that time, Australian Vintage put its membership “on hold” with WFA in order to represent its own (presumably differing) views to government. In any scenario, if the WFA lost two of its largest members, it financial capacity to continue and its claim to represent most of the industry would be wrecked. Having temporarily lost one of the largest, it appeared to believe that it was doomed to sue for peace with the other two if it was to continue as an organisation. Ever the corporate lawyer, President Tony D’Aloisio started imagining ways to paper over the differences.
What was not inevitable was what the terms of the peace would be. Would TWE and PR be happy winning just one side of the two way bet or would they demand the whole enchilada? Or, was the terror of volumetric tax only a cudgel used to obtain wider rebate reforms than WFA would agree to in order to comparatively benefit large companies at the expense of everyone else? Or, were they bluffing?
Without bluffing in response, D’Aloisio had the choice to publicly say that if TWE and PR wished to go rogue on these issues, they did so without the support of the WFA Board and that WFA would oppose these efforts. Strategically, TWE and PR only really need WFA 1) for the base of political and multi-state / community support (e.g. voters) that its other 400 members provide and 2) to make sure the industry does not cooperate in ways harmful to them. What happened instead was pathetic – D’Aloisio blinked.
Oddly, the most economically sensible (and politically difficult) solution for the entire industry was the proposal to change the taxation method to volumetric. Given that two-thirds of Australian production is for export, the taxation method is of no consequence to this portion of the market.
To the exposed one third of the industry remaining, it is clear from the research that high value grapes and regions create jobs at a rate of about 4 times per tonne to that of low value regions while employing as little as one-eighth of the water for the same value of grape output. The University of Adelaide’s Kym Anderson’s encyclopedic research on this topic “Economic Contributions and Characteristics of Grapes and Wine in Australia’s Wine Regions ” from April 2009 is unequivocal. As this research was partially underwritten by WFA, they can’t claim to not know this.
For those who claim that a volumetric tax would wreck inland communities etc, it just isn’t so. Some grape growers would exit grapes and enter another agricultural sector, some would shift to a different level of value production by changing to less water intensive and climatically appropriate varieties or quality grades, some would carry on as they have, many would add value by making wine, building cellar doors etc. and some would leave the business.
Given that these regions are currently poorly differentiated and being financially bled to death en masse, a phased in volumetric tax actually presents real opportunities for change. However, to erect new barriers to these businesses evolving and entering the value added branded wine sector would be doubly cruel policy. As to what an alternative and prosperous future looks like, The Ricca Terra Farms and Chalmers businesses are great inland success stories that should be studied and emulated. You can make money there in this business environment.
To the extent that there would be low value grape growing and winery job losses, they would be replaced by those generated from additional plantings of just one fourth of as much grape volume using one eighth of the water in high value regions. Moreover, the enormous quantities of irrigation water saved could be used to grow food, jobs and economic diversity in inland regions instead of surplus wine grapes that sell as wine for less than bottled water as at present.
By way of example, McLaren Vale has cut nearly half its grape production in the last ten years but emerged with a stronger and more successful industry by focusing on higher quality and greater diversity of grape, wine and tourism experiences. This, in turn, is attracting world-class investors who are buying and planting vineyards again. We’ve slowly learned that the only way forward is to grasp the nettle of change, not avoid it.
On the consumer side, a volumetric tax would spur demand for higher value wines (e,g. over $15 p/b) as their retail prices tumbled due to reduced taxes per bottle. Higher value wine would steal share from other drinks sectors as taste became the basis for consumption. Competition and investment in this sector would increase significantly. There is already a looming shortage of high quality fruit that is causing smart wineries (Casella (Yellow Tail), Jackson Family Estate, (USA), Delegat (NZ), Seppeltsfield (Barossa) and others) to purchase large vineyards in high value Australian regions to guarantee future supply.
On the other hand, goon bag wine would increase in price and cause consumers to contemplate which form of alcohol they preferred based on taste rather than price. But goon bags will not disappear. Not ever. Lots of people like the flavor and convenience of bag in a box wine and will pay more for it.
Numerous reviews, including the Henry Tax Review, have suggested ad valorem be changed to volumetric for many economically efficient and sensible reasons only to be ignored because of some large companies and WFA’s lobbying to maintain ad valorem. Code words used like “caring for regional Australia and inland communities” unfortunately mean “keep the surplus”, “keep the wine industry’s monopoly on low priced alcohol” and “don’t make us change.”
Most importantly, the health lobby has made legitimate points in its campaign to change tax on wine in Australia. It is a well-funded lobby that will not quit. As with the tobacco industry, what will bring them eventual victory will be the toxic equivocations of the wine industry’s leaders, not the toxicity of the wine industry’s products.
To fight to maintain a permanent large price advantage to sell alcohol in large (millions of units of 3-5 litre boxes) formats to the most vulnerable in society is to abandon the moral high ground to those who might do our industry much more serious harm than sensible self reform would entail.
The current leadership of the wine industry has somehow captured the triple crown of bad governance: economically non-adaptive, strategically wrong and morally odious. If the wine industry wishes to prosper over the long term as a respected industry in Australia, it needs to reverse all three of these positions at speed.
Without recounting the multiple industry and government initiatives including a Senate Inquiry, suffice it to say that WFA was in a fight for its own survival, not a fight for the best policy or for its 400 members.
When it put out a mad list of things that 80% of its board could agree to (including less competition and more tax breaks), the government implicitly rejected the WFA offering by establishing still another committee of industry folks (including TWE, Orlando, DeBortoli, Yalumba and others) to make recommendations to it via the Treasury instead of through Agriculture.
Instead of saying to government that “the WFA has made recommendations that its entire Board supports” and staying out of it, D’Aloisio joined this new committee when invited. Had he stayed out of it, he would have undermined the new group’s legitimacy and been able to make a principled case on behalf of WFA’s members against their eventual recommendations.
However, by joining, he lent WFA’s imprimatur to the new group’s authority and allowed his own small and medium members to ultimately get the shaft. While we can only speculate why he made such a poor decision for his membership, it is a reflection of his failure to play the two way bet from a position of principles or courage in the first place.
This committee’s findings, combined with the Senate Inquiry, gave the government scope to back policies preferred by the big end of town. Given that the Government’s prime short-term concern is revenue, this was a seemingly expedient and reasonable solution. However, these new rules will prove to be not only bad policy and bad politics, they will be a nightmare to enforce.
Had WFA lost on ad valorem, it would have lost its other large members – AVL, Casella and, perhaps, Accolade. Instead, it got to keep all its big members (despite the fact that they do not agree on the big issues of oversupply and taxation) while sacrificing its medium and small members interests.
All of which is to say that this convoluted saga served the biggest companies perfectly: everyone has forgotten what they were supposed to be doing – eliminating the long-term oversupply of grapes that is destroying the industry that was both caused and perpetuated by WFA over 20+ years.
Instead of a sensible policy emanating from those granted “peak” authority, the wrong issues have been now been settled by the government punishing the exact people and businesses who had little or nothing to do with causing the problem – small and medium winemakers – without solving, let alone addressing, the what needs solving – oversupply. At a minimum, government was not well informed by industry. As the “peak” body, only WFA and its president can be blamed for this.
It is cheap and stupid to characterise this as a purely political issue, or to demonise one political party or the other. Neither major party has implemented a broadly sensible set of policies with respect to alcohol and taxation. Nor have they declared what the tax and rebate is explicitly for and against; harm mitigation, general revenue raising, demand management, etc.
Governments are responsible for representing the country, not just one set of interests or to solve just the easy problems or to raise revenue. They alone have the resources and authority to do the job in full and at the pace required to achieve outcomes with positive long-term effects for the country.
I have spoken with enough people in the bureaucracy and the (present and former) government(s) to know that they know this has not been “solved” as long as oversupply remains and that there is a lot of work remaining. They also know that WFA is a shambles but are not sure what to do about it.
In classical Greek mythology and tragedy, the punishment after the downfall was often agonizing and repetitive – like Sisyphus pushing his rock or Prometheus’s eyes being continually attacked by birds. Without major reform like a volumetric tax to put the Australian wine industry on a different trajectory, the industry’s future will likely be equally awful and repetitive. Or maybe the dollar will drop to 50 cents USD and we’ll forget all about this. Again.
For what it is worth, my prediction is that as the reforms bite and the competition quickly disappears, the grape supply will not contract by much, if at all.
What will happen is that these large wine companies will renew their decades long race to the bottom of the price, margin and quality barrel (notice after years of “luxury”, “premiumisation” and “masstige” talk that TWE is introducing its Yellowtail priced Blossom Hill range to Australia right now?) and keep grape growers on the knife edge of survival. Meanwhile governments will justifiably say “how did this happen, we did what industry asked” whenthe complaining grows louder.
Oh, and where the $50 million “from the government” to be devoted to marketing Australian wine the next four years came from that no one is talking about and no one knows how it will be spent? One guess.
- Cancel your WFA membership. Now.
- Care enough to complain. Loudly.
- Its election season – call, write and post on social media to candidates and tell them these reforms harm the wrong people and don’t address the problems of over supply – you will be surprised how much they listen once every three years. WFA, Treasury and Pernod Ricard are betting you won’t. List of candidates here.
- Demand that WFA lose its federal peak body status until its current President stands down and new rules in its Constitution are put in place for 51% of its Board to make decisions and its Board members to be elected by their entire membership.
- Or, do nothing. Other professions beckon.
Part 2 to follow in the coming days.