Pernod Winemakers

Submission to the Senate Committee on Rural and Regional Affairs and Transport

Inquiry into the Australian Grape and Industry.

June 2015

Pernod Ricard Winemakers thanks the Senate Committee for the opportunity to comment on the state of the and grape industry.

The Australian wine industry is one of our country’s great agricultural global success stories. Australia’s diverse wine regions produce more than 100 grape varieties, and today is one of the most prolific producers of quality . Over the last 50 years, wine as a share of domestic alcohol consumption has risen from 12 to 38 per cent, marginally below beer.

Today, the wine industry is a significant contributor to the national economy, directly employing more than 16,000 people, earning $1.8 billion in export revenue and contributing more than $8 billion to the tourism industry. The industry enjoyed rapid growth from 1997 to 2007, reaching $5 billion in annual sales at its peak.

However, the push to achieve market volume came at the expense of market value, with the overproduction of lower quality wines flooding the export market and pushing down the average price. After 2007 – when export volumes stalled – sales value plunged for Australian wine with a collapse of prices in key export markets, particularly the United States and United Kingdom. A strategy of volume growth and rapid vineyard expansion, in part driven by the prevailing tax structure, saw enormous increases in domestic wine production (which more than tripled between 1993 and 2007).

The strategy was production-driven rather than market-driven, and meant Australian winemakers had to use price to move volumes of wine through distribution channels to recover fixed costs. Using price to gain share created a consumer perception that price was the key factor in the purchase decision, damaging the perception of Australian wine in key export markets. For Australian wine in the United Kingdom, Western Europe and the United States, the push by producers to move increasing volumes at falling prices to meet fixed costs has created a “commoditisation loop” and damaged Brand Australia.

At the same time, a number of lower-cost new world wine competitors – particularly Chile, Argentina and South Africa – have exported greater quantities of commercial wine to these markets, and consumer preferences have shifted.

The result has been a damaging imbalance between supply and demand for Australian grapes, particularly at lower grades. Wine grape prices in Australia have halved over the last 15 years. The size of the industry has shrunk in real value almost 25 per cent between 2003 and 2012. And in 2014, 84 per cent of Australian wine grapes were produced at a loss, up from 77 per cent in 2012.

The industry has recognised for many years that it must address the issue of oversupply; however, little has happened. The market has not self-corrected: the nature of sunk costs in agricultural production increase switching costs to other products. Too many industry players pin their hopes on currency exchange improvements, and seeking more money for generic marketing.

These are important, but in our view, the structure of the Wine Equalisation Tax and its rebate has kept otherwise unprofitable players from exiting the industry, which in turn has distorted the market and impacted all of the industry. While wines from Chile, Argentina and South Africa have developed inroads in market share in Western Europe and the United States, global demand of commodity wine is stagnant or falling in most markets. But supply is likely to rise in the next ten years as China’s domestic industry increases its yield and supply outstrips local demand.

It is clear to us that a sustainable future for Australian wine cannot be based on competing with low-cost commercial producers in the global market, where price remains the pre-eminent factor for purchase. In our view, the sustainable future of the Australian industry is in the premium and fine wine categories, supported by reforms to the WET and its rebate.

Pernod Ricard Winemakers had lodged a submission to the Government’s discussion paper on tax reform, Re:Think, and we commend the Committee to that work to understand why we support changing the method of calculating the WET from an ad valorem approach, to one of category-based volumetric, with a single tax rate for all wine at around $2.20 per litre of wine. This would be revenue neutral for the Government, assuming no change to the WET rebate.

Previous Governments have said that tax reform should not occur while the industry is undertaking large scale restructuring; however, this has been ongoing for nearly a decade, and the resulting circumstances the industry faces are getting worse rather than better. We believe tax reform would assist, not hinder, the necessary restructuring.

We have called for the administration of wine taxation to remain through the Wine Equalisation Tax Act, leaving wine as a non-excisable good, while keeping the WET at a preferential rate to other alcohol beverages, due to the higher capital intensity and lower profit margins of the wine industry and its vital role in supporting jobs, high-value regional tourism and exports.

The current WET rebate is another major factor inhibiting industry restructure, as it subsidises producers who would otherwise not be able to compete in a free market, artificially alters business models to maximise qualification of the rebate, and restricts consolidation of the industry.

In previous submissions to government, Pernod Ricard Winemakers has called for the abolition of the WET rebate. This remains our preference, as it is simpler and does not encourage wine businesses to artificially manipulate their business model to maximise their rebate. Government support for regional development and cellar door wine tourism can be provided directly to intended recipients, avoiding the present situation which sees foreign winemakers qualifying for rebates.

However, as a first step, we support the proposed model for WET rebate reform as outlined by the Winemakers’ Federation of Australia. We agree that by extending the rebate to foreign winemakers and for the use in bulk and unbranded wine, the purpose of the rebate has been distorted and is open to abuse. We note that any rebate model should allow for industry consolidation and structural reform, and minimise distortions to the free market.

The recent entry into force of free trade agreements with Japan and Korea, and the imminent signing and ratification of a free trade agreement with China are positive developments for the Australian wine industry. Australian wine exports to Asia have a significantly higher value per litre than exports to our mature markets, and Asian consumers are willing to pay a premium for high quality Australian wine.

We would urge the Government, however, to maintain pressure in ensuring better market access for Australian wine by addressing on-going non-tariff barriers across our major export markets. Issues around maximum residue limits, acceptable additives and processing aids, labelling requirements, tax treatment, protected terms and geographic indicators all continue to inhibit the ability of Australian wine to reach overseas consumers.

Pernod Ricard Winemakers is aware of the need for sturdy relationships between grape growers and winemakers, and we are a signatory to the Wine Industry Code of Conduct. We do not support calls for the Code to be made mandatory, and believe that a voluntary code with broad adoption by the industry is the most effective mechanism to ensure conscionable conduct between industry participants. The diversity of the industry precludes any calls for a standard industry contract. We believe that the real issue for growers is the current levels of unprofitability in many regions, a result of the ongoing structural oversupply that remains unaddressed at present.

Domestically, the wine industry works in a complex regulatory environment, with confusing areas of responsibility and with areas of inefficiency and duplication. As a first step, we recommend the Government undertake a thorough mapping exercise to determine the destination and value of all payments made to industry bodies, including Government expenditure, industry membership fees, compulsory grape levies imposed on Australian producers and any other sources of revenue. There are a number of different national and state compulsory levies than go to an array of federal, state and regional bodies, and it would appear that this decentralised system results in large areas of duplication in responsibilities.

We believe that the governance model for the industry should be simplified, with more flexibility for where funding is directed (between research and development; marketing; market access etc.) provided there is a balance to ensure we maintain the necessary capability in research and development, and there is general industry alignment. We note that while generic Brand Australia marketing will not solve the industry’s current challenges, there is a relative lack of this marketing when compared with government assistance in other wine exporting countries.

We also recommend that decision-making power should better reflect the size of the contribution to the industry. The wine industry is highly fragmented, with a large number of very small players and a few large entities, the latter of which provide the bulk of the funding, but often has less influence in decision making relative to their financial contribution. Structures should better reflect a model where participants’ role in policy and program decision-making is correlated to their contribution to the industry.