Tequila Brands and Producers Have Already Sailed Into the Sucker Hole
For those new to the expression, a “sucker hole” is a colloquial term referring to a spate of good weather that “suckers” sailors into leaving port just in time for a storm to resume at full force and wreak havoc on the ship and crew.
For both Tequila Brand Owners and producers of a certain size, their ship has already sailed, and the storm is now closing in on them. Some in denial, others looking through rose-colored margarita glasses, still believe they can navigate through to that glimmer of light on the horizon. However, the perfect storm of doom looms just past the horizon of hope, and will soon envelope and destroy most, if not all, in its wake.
Oh, and that’s the good news. The bad news is that only a few of the big and the very nimble will survive.
This is because of a number of factors, primarily that too many of us bought in to the Yankelovich and similar studies that declared premium and above 100% Agave Tequila brands as the next big thing.
While the premises of these market premonitions were undoubtedly true, too many of us jumped headfirst into the juice just before the world economic decline. Six hundred brands have turned into 1200 brands in less than five years. The growth of the market has been dramatic compared with other distilled spirits, yet, it’s still relatively small, ranked only 4th in US volume. It has not grown fast enough to accommodate all of the entries into the field.
Resistance is Futile – Change is at Hand for the Tequila Market
The Gravy Train Wreck Ahead
I’m sure that for many of you, in just reading the title of this article, your blood pressure has escalated, and you may already be misdirecting your anger at the author.
For others who have experienced the many similar economic paths to consolidation in the global beverage industry, you have already accepted that change has to occur, and you will soon better understand and appreciate the math behind what I am about to lay out, and why everything I’m about to outline here will happen in due course.
For those of you who have your personal fortunes riding on the Tequila Train, both prominence and profit may still seem to be so close that you think you can see the light at the end of the tunnel, or beyond the next bend. But, I’m sorry to say that for most of us in the biz, the light at the end of the tunnel is that of an oncoming locomotive. This will be a catastrophic collision, albeit in slow motion, that will drain your resources and your resolve.
What can be learned from the Russians? (Excerpted from JustDrinks.com)
The global economic crisis has had a significant impact on the Russian spirits market, changing market dynamics and briefly halting the much-lauded premiumisation trend, according to current research.
A recently released report from the International Wine and Spirit Research (IWSR) on Russia’s spirits market claims that the downturn has also led to “…disruptions across the supply chain, with many suppliers and distributors going bankrupt or halting production. For healthier companies, however, it has presented an opening to establish their brands and take market share…”
The Silver Tequila Clouds have a very Dark Lining (Excerpted from Global market review of Tequila – forecasts to 2013 www.researchandmarkets.com )
The history of the Tequila industry has been one of boom and bust. Sales rose during the 1940’s only to collapse again in the mid-50’s. Export sales rose steadily from the 1960’s onward, although domestic sales fell sharply in the 1980’s due again to an economic slump, and the severe Mexican economic crisis of the early 1980’s resulted in plummeting sales.
The market was again disrupted by a critical shortage of Agave beginning in the late ’90’s, which served to hold back the category’s international development as brand owners were forced to divert limited supplies to the core US market, and quality perceptions were damaged as some manufacturers moved from 100% to 51% (Mixto) Agave products.
Today, that dynamic is in reverse, and the market is in oversupply. More and more 100% Agave products are coming into the market. This is helping to raise quality perceptions, and in turn, demand is surging not only in core Mexican and US markets but across a number of other countries.
The outlook for the category has rarely been better, and Casa Noble Tequila president and COO David Ravandi commented, “Tequila is entering a stage of consolidation in the world markets. It is no longer a fad. The fact that 100% Agave Tequila exports have increased tremendously over the last two years is extremely positive for the product’s outlook in the years to come.”
US Tequila Importation is a Sucker Bet
“My cousin will make the best Tequila for you Mr. Gringo”
“So, my friend, you want a great Tequila brand? We will make it for you. Just fifty percent cash up front to start the process.”
Unfortunately, far too many have fallen for this old gag. Relying heavily on the forecasting reports of the early 2000’s that suggested that luxury Tequila would be the next big spirits category after vodka.
With dollar signs in their eyes, the believers drank the Tequila Kool-Aid, most of them spending way too much to buy a brand, custom molded bottles, etc. But the worst part was that this left little if any money for marketing. Many did not even understand brand marketing inflation was happening right under their noses.
It had started soon after Patron hit 100,000 cases in volume in 2001, and the cost to market a Tequila brand in the US went from $1 to $10M per year. Today it takes at least $20M per year just to play in the same ballpark as Patron’s $50M plus, Sauza’s $35M plus, and Cuervo’s $30M plus marketing budgets.
Who could have predicted that a “realistic” business plan for the next successful ultra-premium Tequila brand calling for only 10,000 cases in the first year would end in it’s investors taking a bath?
The problem with this equation is three-fold:
1) Pricing: Unlike vodka and white rum, 100% Agave Tequila is just too expensive to produce and bottle in Mexico. Unless, like rum, vodka and mixto Tequila, it is able to be shipped in bulk and bottled near the final consumer, the cost involved with 100% Agave Tequila is always going to be too high to attain critical volume and profit levels.
2) Volume: US mass volumes are best when a spirits category is between $9.99-29.99/750ml. One hundred percent Agave Tequila is currently profitable only at the upper ranges when higher volumes are attained.
3) Distribution: The US “3-Tier” Distribution System is at best an oligopoly, and 19 states run a monopoly. Of the 1200 plus Tequila brands, want to guess how many they want to carry? Well, after the top 20, you are very lucky to be “special order only”. If you are fortunate enough to live in the states of California or Arizona, where one can be both the importer and distributor, you will find yourself driving your precious Tequila brand around to each account in your car.
Without product volumes or market clout, you will be hard pressed to get even an appointment, let alone a vender number with the chain restaurants and grocery stores. These major chain stores like Chili’s, Chevy’s, Costco, Kroger, etc., drive at least 85% of the combined volume in all but the control states. Without access to the chains, your market becomes the handful of privately owned, “Mom & Pop” accounts that usually know that small independent distributors are easy prey for bending the law on consignment, stringing out payments, or not paying at all.
While driving your own brand around certainly makes time for the personal touch and focus, these hand-selling efforts prove to be the most inefficient ways to distribute one Tequila brand. Your glass ceiling to fame and fortune becomes that next level of chain distribution that can only be had by a state-wide delivery system of the large wholesale distributor.
With Tequila segment Pricing, Volume and Distribution all against you, one will need to have a lot more money than the brands of the past in order to simply survive in the US.
Tanks-a-lot for Nothing
Call the tank maker and raise your stocks of liquid now!
Unfortunately, most of the mid-sized Tequila distilleries have bought into the notion that Agave prices will go up in the very near future. They base this notion on the boom and bust cycle of the past, and like Lehman Brothers, believe that they have successfully timed the market.
Greedily, many producers are now mortgaged to the hilt in order to produce all the Tequila that they possibly can afford to store in stainless tanks or wooden barrels. Fear of the impending Agave price increase that has yet to happen (and may not for many, many years) has seemingly forced them all into a squirrel-like stockpiling frenzy.
Are they storing Blanco, like acorns, for the hard winter ahead? These stored nuts of liquid demise are in reality winds conspiring to produce the perfect storm for all but the most financially secure and/or nimble producers.
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.
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
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.
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http://www.discus.org/pdf/2009IndustryBriefing.pdf (This is the most recent report by DISCUS for 2009. Tequila volume is still listed as 4th.)
http://www.thefreelibrary.com/Spirits+fast+track+brands.-a0144204154 (shows Patrón reaching 119K cases in volume in 2001.)
http://www.oceanfreightusa.com/topic_impg.php?ch=19 (Bonded warehouses.)
http://www.yankelovich.com/ (state of the consumer)