© francisco guillermo cervantes medina 1
TRANSCRIPT
© Francisco Guillermo Cervantes Medina
www.fcervantes.es
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© Francisco Guillermo Cervantes Medina
Strategic Costs as Applied to Wineries
Club de Marketing de La RiojaApril 13, 2015
© 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”?
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© 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
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© Francisco Guillermo Cervantes Medina
What is “strategy”?
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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.
© Francisco Guillermo Cervantes Medina
What is a “cost”?
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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.
© Francisco Guillermo Cervantes Medina
How do we bring “strategy” and “costs” together?
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Strategy Costs
© Francisco Guillermo Cervantes Medina
How do we bring “strategy” and “costs” together?
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Strategy Costs
© Francisco Guillermo Cervantes Medina
Strategy and costs: Putting it together – the practical perspective
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Strategy Costs
“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
© Francisco Guillermo Cervantes Medina
Why is profit so important?
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The answer involves 2 perspectives:
1st Wealth creation
2nd Business sustainability
© Francisco Guillermo Cervantes Medina
The profit equation
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𝑷𝒓𝒐𝒇𝒊𝒕=𝑹𝒆𝒗𝒆𝒏𝒖𝒆−𝑪𝒐𝒔𝒕𝒔
Managing profit boils down to managing 2 key variables: Price and Costs
But it gets a little more complicated than that…
© Francisco Guillermo Cervantes Medina
The profit equation
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𝑷𝒓𝒐𝒇𝒊𝒕=𝑹𝒆𝒗𝒆𝒏𝒖𝒆−𝑪𝒐𝒔𝒕𝒔
Quantity sold = QSelling Price = P
What we doHow we do it
Raw materialsLabor and capital intensity
OPERATIONS
Demand Competition
Product design & development
Internal logistics:Procurement
Manufacturing Selling External logistics:Distribution
Caring for the vinesGrape selection & pickingWine conceptLabel design
Grape testing & weightingWine storage
DestemmingPressingFermentingAgeing
Function
of
National: Distributor ConsumerExport: Importer Distributor
Freight forwarderCarrierTransportation agency
© Francisco Guillermo Cervantes Medina
The profit equation: where do we see strategy?
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𝑷𝒓𝒐𝒇𝒊𝒕=𝑹𝒆𝒗𝒆𝒏𝒖𝒆−𝑪𝒐𝒔𝒕𝒔
Quantity sold = QSelling Price = P
What we doHow we do it
Raw materialsLabor and capital intensity
OPERATIONS
Demand Competition
Product design & development
Internal logistics:Procurement
Manufacturing Selling External logistics:Distribution
Caring for the vinesGrape selection & pickingWine conceptLabel design
Grape testing & weightingWine storage
DestemmingPressingFermentingAgeing
Function
of
National: Distributor ConsumerExport: Importer Distributor
Freight forwarderCarrierTransportation agency
Value chain (“Cadena de valor”)
Strategy
Strategy
Strategy
Strategy
© Francisco Guillermo Cervantes Medina
The profit equation: How do we account for it?
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𝑷𝒓𝒐𝒇𝒊𝒕=𝑹𝒆𝒗𝒆𝒏𝒖𝒆−𝑪𝒐𝒔𝒕𝒔
Quantity sold = QSelling Price = P
What we doHow we do it
Raw materialsLabor and capital intensity
OPERATIONS
Demand Competition
Product design & development
Internal logistics:Procurement
Manufacturing Selling External logistics:Distribution
Caring for the vinesGrape selection & pickingWine conceptLabel design
Grape testing & weightingWine storage
DestemmingPressingFermentingAgeing
Function
of
National: Distributor ConsumerExport: Importer Distributor
Freight forwarderCarrierTransportation agency
Value chain (“Cadena de valor”)
Trac
e ba
ck to
Thro
ugh
acco
unti
ng g
roup
6
Trace back to
Through accounting group 7
© Francisco Guillermo Cervantes Medina
Monetary value of the resources consumed by a business during an accounting period
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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.
© Francisco Guillermo Cervantes Medina
Strategy and costs: Putting it together – the technical perspective
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Period 1Accounting
Period 2Accounting
Cost Analysis
Management = strategy implementation
Results
Reconcilement
A business accounting is, at the same time, the starting and ending point for a cost analysis:
© Francisco Guillermo Cervantes Medina
Michael Porter’s Value Chain
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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
Operations External Logistics
Marketing & Sales
Post-sale Servicing
Business Infrastructure
Human Resources
Research & Development
Procurement
© Francisco Guillermo Cervantes Medina
How do we bring Value Chain and Accounting together?
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1,767,751 €
Red Grape Purchase - Raw Mat. 612,084 € White wine purchase - Raw Mat. 82,500 € Rosé wine purchase - Raw Mat. 82,500 € Bottling (bottles, corks, capsules, labels)
990,667 €
ProcurementCurrent
ExpensesDepreciation Total
1,489,818 €
Red Grape Production 241,494 € 303,569 € 545,063 € Destemming and 160,004 € 10,425 € 170,429 € Fermenting 277,740 € 94,979 € 372,719 €
Ageing 148,250 € 206,892 € 355,142 €
ProductionCurrent
ExpensesDepreciation Total
1,161,276 €
National Transport 215,240 € 7,250 € 222,490 € Overseas Transport 230,400 € 0 € 230,400 € Salespeople 212,829 € 760 € 213,589 €
Marketing 415,497 € 0 € 415,497 €
Sales
"Structure" (Support Activities) 462,007 € 146,242 € 315,765 €
Internal Logistics
Operations External Logistics
Marketing & Sales
Post-sale Servicing
Business Infrastructure
Human Resources
Tech. Development (Research & Development)
Procurement
© Francisco Guillermo Cervantes Medina
How does this turn into a cost system/analysis?
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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
AccountingCompany’s main activities
Products or “cost objects” of those activities
Company’s final products
Activity-Based Costing (ABC) method
© Francisco Guillermo Cervantes Medina
Strategy and costs: Putting it together – the technical perspective
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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=
© Francisco Guillermo Cervantes Medina
Where does this take us?
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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
© Francisco Guillermo Cervantes Medina
Unit costs for Demvrek
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Raw Materials0,62 € 32%
Production0,29 € 15%
Sales0,88 € 45%
0,16 € 8%
1,95 € 100%
Raw Materials0,62 € 29%
Production0,29 € 14%
0,16 € 8%
Sales1,03 € 49%
2,10 € 100% Tinto Joven - Export
© Francisco Guillermo Cervantes Medina
Unit costs
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Raw Materials0,60 € 22%
Production0,73 € 27%
Sales1,23 € 45%
0,16 € 6%
2,71 € 100%
Raw Materials0,60 € 21%
Production0,73 € 25%
0,16 € 6%
Sales1,38 € 48%
2,86 € 100% Crianza - Export
© Francisco Guillermo Cervantes Medina
Cost structure of each product
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VD, 0.93 €
VI, 0.48 €
FD, 0.37 €
FI, 0.18 €
0%10%20%30%40%50%60%70%80%90%
100%
Estructura de Costes
Joven Nacional
VD, 0.86 €
VI, 0.48 €
FD, 1.21 €
FI, 0.18 €
0%10%20%30%40%50%60%70%80%90%
100%
Estructura de Costes
Crianza Nacional
VD, 0.92 €
VI, 0.64 €
FD, 0.37 €
FI, 0.18 €
0%10%20%30%40%50%60%70%80%90%
100%
Estructura de costes
Joven Export
VD, 0.85 €
VI, 0.64 €
FD, 1.20 €
FI, 0.18 €
0%10%20%30%40%50%60%70%80%90%
100%
Estructura de Costes
Crianza Export
© Francisco Guillermo Cervantes Medina
How low can you go? “The 10% syndrome”
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“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
Profit 900 €
% of sales 30%
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
Profit 600 €
% of sales 22%
Profit Reduction (33%)
© Francisco Guillermo Cervantes Medina
“A lot”: Enough to recover the lost margin?
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Base CaseSales (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
Profit 900 €
% of sales 30%
10% DiscountSales (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
Profit 900 €
% of sales 26%
Profit Reduction 0%
Sales would have to increase by 26% only to go back to our before-discount
Multiplier effect of price on earnings.level of earnings
© Francisco Guillermo Cervantes Medina
The “need” for discounts
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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…
© Francisco Guillermo Cervantes Medina
The “need” for discounts - Costs specific to the wine business in Rioja
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Red grape yields in La Rioja are capped at 6.500 kg/hectare.
Grapes are0,62 € or 29% of total wine cost
2,10 € Tinto Joven - Export
Grapes are0,60 € or 21% of total wine cost
2,86 €Crianza - Export
But that is not the case for all DO’s…
© Francisco Guillermo Cervantes Medina
The “need” for discounts
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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/hectarePenedés 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.
© Francisco Guillermo Cervantes Medina
Rioja Penedés
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Grapes are0,43 € or 16% of total wine cost
Grapes are0,60 € or 21% of total wine cost
2,86 €Crianza - Export2,69 €
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 €
© Francisco Guillermo Cervantes Medina
Cash Conversion Cycle or CCC (periodo de maduración de una venta)
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t0
15-SepGrapes delivered to winery; winemaking process begins
t1= 90 days
15-DecNew wine elaborated
t2= 93 days
18-DecFirst sale of the recently made wine
t3= 120 days
15-JanPayment to grape suppliers
t4= 190 days
25-MarClient pays
Average Production Time
Time from Inventory to Sale
Average Time to Pay
Collection Time
90 days 3 days 97 days+ + =
CCC 70 days
DOH 93 days
DSO 97 days
# Days of Payables -120 days
Days of Inventory on Hand (DOH)
Days of Sales Outstanding (DSO)
Number of Days of Payables
© Francisco Guillermo Cervantes Medina
Cash Conversion Cycle or CCC (periodo de maduración de una venta)
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t0 t1= 90 days t3= 360 days
15-SepWine sale
t2= 120 days
15-EnePayment to grape suppliers
t4= 457 days
22-DecClient pays
Average Production Time
Time from Inventory to Sale
Average Time to Pay
Collection Time
90 days 270 days 97 days+ + =
CCC 337 days
DOH 360 days
DSO 97 days
# Days of Payables -120 days
Days of Inventory on Hand (DOH)
Days of Sales Outstanding (DSO)
15-SepGrapes delivered to winery; winemaking process begins
15-DecNew wine elaborated
Number of Days of Payables
© Francisco Guillermo Cervantes Medina
Cash Conversion Cycle or CCC (periodo de maduración de una venta)
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t0 t1= 90 t4= 545
15-Mar + 1Sale of aged wine
t2= 120
15-JanPayment to grape suppliers
t5= 642
22-Jun + 1Client pays
Average Production Time Time from Inventory to Sale
Average Time to Pay
Collection Time
90 days 365 days 97 days+ + =
CCC 522 days
DOH 545 days
DSO 97 days
# Days of Payables -120 days
90 days
t3= 455
15-Dec + 1Aged wine elaborated
15-SepGrapes delivered to winery; winemaking process begins
15-DecNew wine elaborated
Days of Inventory on Hand (DOH)
Days of Sales Outstanding (DSO)
Number of Days of Payables
+
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Expenses and Cash Flows associated with Inventory
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CAPEX (Long Term)
Warehouse
Tanks
Barrels
Barrel supports
Cages
Forklift, etc.
Depreciation
Interest
Repayment of outstanding debt
Fiscal deduction
Expense
Expense
Less Expense
Flow
Flow
Flow
Flow
Current Expenses
Grapes, wine, bottling supplies purchases, etc.
Expense Flow
Direct Labor Expense Flow
Power & other utilities Expense Flow
Other production and ageing costs
Expense Flow
© Francisco Guillermo Cervantes Medina
Expenses and Cash Flows associated with Inventory
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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 resourcesb) Equity holders’ resourcesc) 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.
© 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.
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© 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?
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© Francisco Guillermo Cervantes Medina
www.fcervantes.es
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