Change is at Hand for the Tequila Market, Part II

Part II of II

Written by Chris Zarus of TequilaRack

The Economic Fall of the Medium Sized Producer

As the dooms day clock ticks down, all but the biggest distilleries, short on cash and heavy in liquid inventory, will soon be courting anyone with a US dollar. But that market is rather small, and unless the CRT (Consejo Regulador del Tequila, Tequila’s governing body) changes the law and allows 100% Agave Tequila to be bottled outside of the appellation area, the price of a “pipe” of 100% Agave Tequila will begin to drop faster and farther than that of its half brother mixto. Too much 100% Agave Tequila chasing too few in-zone buyers and/or bottlers will cause another price collapse, except this one will be a price collapse on the finished product.

As this scenario starts to unfold, a few things will begin to happen simultaneously:

1) The largest producers (top 5) will buy out the top 20 as their values will be diminished. Larger or well-financed producers will be able to buy out their smaller rival producers with little cash and mostly their own corporate stock. These bigger players will do this not just to shut down a competitor, but to get their hands on their vast value depressed inventory of 100% Agave Tequila for their own use, and perhaps get some under marketed brands of promise as a bonus to develop or sell.

2). The next tier of 25-75 producers will die out.

3) The smaller producers, like micro-distillers, will survive by remaining small and being content just making incredible craft Tequila.

Tic Toc…

The Mayan calendar ends on Sunday, December 23, 2012.

“Both the Hopi and Mayans recognize that we are approaching the end of a World Age… In both cases, however, the Hopi and Mayan elders do not prophesize that everything will come to an end. Rather, this is a time of transition from one World Age into another. The message they give concerns our making a choice of how we enter the future ahead. Our moving through with either resistance or acceptance will determine whether the transition will happen with cataclysmic changes or gradual peace and tranquility...” — Joseph Robert Jochmans

First, let me start out by saying that I’m not the Nostradamus of Tequila, or “Z-Doctor-of-Death-&-Despair” that I was referred to as most recently.

However, as far as I’m concerned, the Mayan’s have it right regarding the current business economy of Tequila and its transition from one World Age into another. In my opinion, the Mayan’s prophesy that the end of the world is rapidly approaching for many in the Tequila system, is spot on.

2012 The Mayan Curse of the US Bonded Warehouse

Many have already made their containers of US tequila brands and now they reside in bonded warehouses across the US, mostly in the Southwestern Border States (Arizona, California, New Mexico, and Texas). Few ever thought they needed to know that the US federal spirit taxes are due either prior to withdrawal or when the clock strikes five years, then the Tequila will be considered as invulnerably abandoned and shall be transferred into General Order Warehouse for liquidation.

The fifth year for many young Tequila importers has already begun; for others, it is fast approaching. My phone has already started ringing regarding pallets of product being liquidated. Trailer loads will be next. It seems that the US economic crisis almost exactly coincided with the CRT report of over 1200 Tequila brands. This inverse relationship of too many brands chasing a down world economy will, by my calculations, put the bulk of the bonded brands ready for liquidation near the end of 2012.

While the one container per month business plan is long lost, the taxes will come due. With no money left in the coffers, products will begin to liquidate. At first, prices will be reasonable, perhaps as high as $7.00 per 750ml. But prices will rapidly erode as a still saturated Tequila market will not be able to absorb the extra inventory. Prices will continue to decline for these unknown and ill-marketed brands.

I predict that the bottom feeders with cash will be able to get 100% Agave Tequila FOB (Freight on Board) bonded warehouse for as little as $3.14/750ml. Just enough to cover the federal taxes, plus $1 for the broker and warehouse fees.

Run, Don’t Walk to the closest Exit Strategy

If any of the following describes your business, you need to be a seller or begin the shut down process:

You do not have a business plan, or the boilerplate business plan you bought states that you will sell 10-12,000 in the first year (and you are not even close in year two).
You are undercapitalized and do not have access to at least $1M per year for the next 10-20 years.
Your company does not own at least a portion of the distillery that produces your product.
You have pre-ordered and pre-paid for containers of product at a price higher than you could buy it for today (or tomorrow).

If however, any of the following describes your company, you may be a survivor:

You’ve won PowerBall or similar lottery and have the resources to stay afloat for 8-10 more years.
You have distribution in most of the US states and Duty Free.
Your brand is backed by a very large multinational corporation.
You, your distillery, and your brand have generations of lineage.

My recommendation for all those that do not have at least $10M worth of investment to weather the storm? Find the funding or get out while you still have your home and sanity. The Tequila market will remain saturated until at least 2016. Pricing will continue to drop in order for Tequila to compete with other spirits categories, primarily vodka and rum.

This is a Time of Transition from one Tequila World Age into Another

The Future Ahead

Unless some government interference changes the course of this tsunami and rescues the lot, 100% Agave Blanco Tequila pricing will fall in line with other white spirits, vodka and rum, with the bulk of the volume at $9.99 per 750ml for the low-end, and $29.99 at the Grey Goose/Belvedere high-end. Aged Tequilas will march down in lockstep to accompany their Blanco brethren at a $5-$10 spread on the shelf. Exotic Tequilas will still command higher prices, but the volume to run a business will be the same range as vodka.

How should we enter the New Age of Tequila Transition?

An updated industry survey showed that nearly 100 percent of respondents feel drinkers are now more focused on value. Only 75 percent felt similarly last year, according to the annual survey conducted by Robert Smiley, director of wine studies at University of California-Davis.

With continued education and time, Tequila will mature into its own. Maturity will cause a further divergence in pricing for Tequila. Mixto will remain the mixer of choice as prices continue to decline so that only mega producers of mass volume will be able to make any money. The money-makers in this segment will have to go to larger, more efficient containers beyond 1 and 1.75 liters. Think of large, aseptic packaging such as boxed wines and bigger. Also, kegs of mixto Tequila, like beers, in up to 50 liter sizes.

Blanco, and perhaps to some extent Reposado 100% Agave Tequila styles, will begin to follow the pricing of other mainstream spirits, vodka and rum. In this $9.99 – 29.99 price category volumes will grow. The big players are already in this segment with Patrón, Cazadores, Cuervo’s Azul and 1800, Sauza’s Hornitos, Brown-Forman’s El Jimador, and the new Gallo entry, Camarena. This category with be dominated by the big manufacturers that have the distribution muscle and can afford the promotions support of at least $10M per year.

Sure, there will be other Blanco’s in the stores, but unless they are store supported as a “house brand,” volumes will be relegated to 5-10% of the segment. Why buy a $39.00 Blanco when you can get an Añejo at the same price? Yes, some will continue to buy Patrón Blanco, but the pricing will fall to that of comparable high-end vodkas like Grey Goose and Belvedere, at least a $10 discount from today’s price, about $29.99 per 750ml in the volume liquor and chain grocery stores.

Añejo, and extra-aged products, will begin to command the ultra premium price points and above. Moreover, Añejo’s (Tequila and Mezcal) will begin to follow pricing similar to Irish and Scotch Whiskey, with its own price segmentation based on perceived quality and marketing. This will be the market of the small survivors with the ability to make consistently great, aged craft Tequila.

As the clock ticks down to the end of 2012, a new world order is approaching. It may come gradually enough for some that it is hardly noticed until it’s too late. I foresee the slow starving of all but the nimble and mighty Tequila brands, producers and farmers alike.

Some will fight this impending consolidation, I’m sure. But this change will come nonetheless, and it will be a profitable event for the few that survive their trip through the sucker hole. I myself have decided to remain nimble, strapped into my dingy, Riedel in hand, waiting out the storm.

Copyright 2010 International Tasting Group (ITG), All rights reserved. Unless otherwise noted, ITG is the legal copyright holder of the material on our blog and it may not be used, reprinted, or published without our written consent.

Links

SPIRITS TRENDS

U.S. Spirits Market 2008, Gross Revenues by Price Category

http://www.discus.org/pdf/2009IndustryBriefing.pdf (This is the most recent report by DISCUS for 2009. Tequila volume is still listed as 4^th.)

http://www.thefreelibrary.com/Spirits+fast+track+brands.-a0144204154 (shows Patrón reaching 119K cases in volume in 2001.)

http://archive.cyark.org/2012-understanding-the-maya-calendars-blog

http://www.forgottenagesresearch.com/index.htm

http://www.nostradamus.org

http://www.oceanfreightusa.com/topic_impg.php?ch=19 (Bonded warehouses.)

http://dsc.discovery.com/news/2009/02/09/tequila-agriculture.html (agave farmers)

http://www.yankelovich.com/ (state of the consumer)