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Operating Lean in the Wine Industry

16/02/2012


Traditionally, businesses set their selling prices like this

Cost to produce + Desired profit = Selling price

For most industries, production costs are the starting point in the determination of prices. If you want to increase profit, you can increase you prices, sell more units, reduce you cost per unit, or some combination of all three strategies.

However, in the wine industry, where image and perception are everything, winery owners tend to think like this:

Desired selling price - Desired profit = Cost

Most owners tend to start with a very specific idea about how much they are going to charge for their wine. Some will also have a good idea of the profit they want to make on each sale. But very few consciously follow through the equation to say “if I am going to sell my wine for x, and I want to make a profit of y, then my cost of production needs to be z”.

To complicate matters, there are different channels through which you can sell your wine, and each channel provides a significantly different profit margin. If you are not certain what it costs you to produce a bottle of wine, you are in danger of making ineffective decisions about how to price and where to sell that wine.

I sympathize with the owner managers of smaller wineries, where they often wear many hats. Cost accounting is complicated. Even many accountants find this area challenging. To help “demystify” cost accounting,here are a few key concepts to keep in mind:

Your cost accounting calculations can exist separately from your accounting system.

You may want to track your cost of production differently or in more detail than the way your accounting system tracks information for tax and external reporting. Remember, cost accounting is a management tool and the goal is to capture the information you need to make key decisions.

What should you include in your calculation of unit cost?

At a minimum, you need to consider all the variable costs associated with producing a particular wine. Consider whether the cost “disappears” if you do not produce that wine. If it does, then it is likely a variable cost and should be included in your unit cost calculations. For example, your cost of buying bottles would “disappear” if you did not produce wine, and the more wine you produce, the more bottles you need. Bottles are a variable cost. Conversely, costs like property taxes and insurance remain constant no matter how much wine you choose to produce in a given year. We tend to consider these fixed costs and we do not usually include them in our unit cost calculations.

Allocating costs to a particular wine

Some costs are easy to trace to particular wines. Grapes are a good example. If we can assign a cost directly to a particular product, we call this direct costing. But wine making is a process, and although there are some unique differences (aging in barrels, for example), the process tends to involve many of the same input costs no matter what type of wine is being produced. For instance, consider the winemaker’s salary. If we didn’t make wine, we wouldn’t need a winemaker, so we might consider the salary to be a variable cost. But how much of the salary should be allocated to each type of wine? To allocate the cost, we must first decide on an appropriate allocation base. If we wanted to be very precise, we might ask the winemaker to keep a record of how much time he or she spends on each wine and use this as a basis for allocating the salary. Alternatively, we might choose a more simple allocation base, like volume of wine and allocate the salary to each wine based on the number of litres produced.

Cost accounting can consider many of these types of cost/benefit trade-offs. Always keep in mind that the time and effort expended to make your information more precise should never exceed the incremental benefit of doing so.

Budgeted versus actual costs

For budgeting purposes, we would usually use actual unit costs from past production, or estimates if it is a new wine being produced. Once bottled, we can adjust these budgeted unit costs to actual for purposes of making pricing and sales allocation decisions.

The process of reviewing in detail the variances between budgeted costs and actual costs is critical to profitability. It introduces a “lean” mentality in your business - production costs matter. It shines a spotlight on those areas of your operation that are inefficient, stealing dollars from your bottom line. It arms you with the data you need to make key decisions:

  • What wines should be focus on?
  • How much should we produce?
  • Where should we sell it and how much should we charge to reach our target profitability?
  • What can we afford to pay our cellar hands?
  • How much can we spend on bottling and packaging?

With a little help from your accountant or advisor, you can set up some basic spreadsheets that will get you started in the right direction. It’s well worth the effort. Operating in the dark when it comes to your cost of production could be costing you more than you think.

Geoff McIntyre, CA, is the Food & Ag Processing Leader for MNP’s Okanagan Region. To find out what Geoff can do for you, contact him at 250.763.8919 or [email protected]

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