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Out of the shadows

Published:  23 July, 2008

With all the growth in wine production seen in China of late, a key question is whether there are enough local grapes to meet demand. The largest vineyard areas are in Xinjiang province in the west (northern Silk route) and the eastern coastal province of Shandong, where most of the grapes used for wine production are grown. OIV forecasts 450,000 hectares (ha) for 2004, making China fifth in the world rankings, with more land planted to vines than the United States. This figure
is more than double the amount of 1997, which was under 200,000 hectares. Industry analysts calculate 15-20% of
the total vineyard area to be dedicated for grape-wine production, which is 70,000-90,000ha. Bo Tan at Macquarie Research says total grape production is expected to grow 17% per year.

The majority of vines are wild species of Vitis such as Longyan (dragon's eye), although newer plantings are predominantly Vitis vinifera. Most new plantings are of red varieties, with Cabernet Sauvignon being the most popular. Vitis vinifera plantings have only a short history, though there are some exceptions such as in Shandong. Changyu, the oldest winery in China, claims that in 1898, 640,000 vines were imported from Austria, while in 1901, 50,000 grafted vines were also imported into Shandong.

In China, the concept of individual land ownership was wiped away by Mao Zedong's land reforms. To this day, public and collective ownership allows millions of farmers to have the right to work tiny parcels of land, often only 3-5 mu each (15 mu is roughly 1ha). Wineries are reliant on farming cooperatives as well as individual farmers for their supply, and due to the rising cost of farming, quality is highly variable. Over the past five years, farmers have found that while grape prices have remained fairly stable, the cost of running a vineyard has increased by 20-30% a year.

At Grace winery in Shanxi, French winemaker Gerard Colin oversees 70ha of vineyards that produce 34,000 cases of wine. Colin says 350 farmers work the 70ha, each farming a fraction of 1ha. They are paid by quality but receive on average 2,400 RMB per mu (RMB 36,000 or US$4,500 per hectare). Most vines for wine production in China are planted with the fruiting zone very low to the ground to allow it to be buried in the winter (in eastern as well as western China). Typical planting density is 0.5m (between vines) by 2.5m (between rows). Sprays for mould and pesticides are a necessity, and irrigation is common (usually by flood or furrow). At Grace, anti-botrytis spray is used in the autumn to allow grapes to hang longer on the vines.

Phylloxera has not been a problem in China, but Gerard Colin believes this is due to lack of identification. Being based in China for five years and travelling around the vineyards, he believes about 20% of the vineyards in China have phylloxera and predicts that, in 10 years' time, 50% of the vineyards will be affected.

Unspoken rules

The route to market in China is winding, rocky and full of surprises. Restaurants and bars make up the largest segment of the on-trade business (86% of all alcohol sales are through HoReCa, according to Access Asia), and getting listed in a restaurant is no easy business.

Ethan Perk, sales and marketing director of Montrose, one of the largest wine-importing companies, confides, It's not an easy market at all. The hidden cost of doing business in China is enormous. Restaurants require an entrance fee [listing fee] of anything between RMB 1,000 and RMB 100,000 [US$130-13,000]. This is a first-time listing fee for every SKU. Then there is the sponsorship fee, which is recurring every year in the form of Chinese New Year "gifts" and can be from RMB 1,000 to more than RMB 10,000 per year, depending on the relationship.'

Perk, who has been with Montrose for five years and speaks fluent Chinese, says those are just the first steps in the battle'. In addition,' he says, there are exclusive arrangements that can run as high as RMB 100,000 or more.' But the cost doesn't end there: there is the cork rebate of RMB 5-10 (US$0.65-1.30), which works as a sales incentive. There is also the cost of having promotional rights at an outlet by sending promotional girls' to the exclusion of other competitors. This entails not just a fee to the restaurant for sending the girls, but also a commission for each of them as a sales incentive (RMB 5-50 per bottle). Summing up doing business in China, Perk says, Whatever it seems is not what it is, and the price tag is never the price tag.'

Cesar Yang, sales manager for Grace winery says, The cost is very different in different cases. It could be a few thousand renminbi up to RMB 700,000 [US$86,500] per year. These payments are mostly under the table and without an invoice Now some of the big five-star hotels are beginning to charge this kind of sponsorship for listing or for banquet wine.'

The payouts usually reach all levels. Judy Leissner, CEO of Grace winery, says, On top of all the listing and sponsorship fees, you also need to pay the general manager, food and beverage (F&B) manager, the purchasing manager and the accounting manager - and all other relevant staff.' Depending on whom you are negotiating with, listing fees and sales incentives can vary. A rule of thumb is: senior management equals fewer layers and thus lowers the cost. However, that may overlook the junior sales staff who are actually on the floor doing the selling.

Success also means understanding regional differences and preferences for styles, as well as biases towards countries and brands. Domestic wineries have all carved out different regional markets in which they are especially strong. For example, China Daily reports that Tonghua winery enjoys 45% of the northeast China market, while Dynasty is particularly strong in Shanghai, Beijing and Tianjin. Great Wall has a loyal following in southern China. Shanghai, due to its western influence and high proportion of foreign residents, is more open to experimenting and has a higher proportion of white-wine sales compared to other cities. The wine portfolio of major importer ASC Fine Wines closely resembles the urban market's preference for French wines at 40%, Australian at 20%, and with the US and Chile following close behind the two market leaders.

If the road from distributor to end consumer seems challenging, the route from producer to distributor is equally daunting. Domestic powerhouse wineries such as Changyu, Great Wall and Dynasty have the upper hand because they have easier access to the thousands of wholesalers (predominantly government controlled) at both the provincial and national levels. China is divided into 22 provinces, five autonomous regions, four municipalities and two special administrative regions (Hong Kong and Macau). Each province and municipality has very different laws pertaining to retail and wholesale distribution, as well as alcohol sales and distribution (not unlike the United States). The four municipalities - Beijing, Shanghai, Tianjin and Chongqing - have the greatest political and economic freedom, while eight other major cities have deputy province level' economic status, with some freedom.

For an overseas producer, the first step in finding an importer to bring in its wines can be difficult. The top three importers for bottled wine - Montrose, ASC and Summergate - have pretty much closed their portfolios to additional brands. Don St Pierre Jr, managing partner of ASC, says, We represent more than 65 wineries around the world. We get daily requests from at least two to three wineries that want to be added to our portfolio, but currently we are not interested in adding more producers.' In addition, white-wine producers will have an added disadvantage since most importers, such as ASC, reflect the market demand with white-wine products representing only 20% of their portfolio. In major cities, there are plenty of local distributors catering to a specific market, but for multiprovincial and national distribution, there are only about half a dozen reputable importers in China.

St Pierre says, Wholesale and distribution is a key hurdle to success. Currently there are no wholesalers who specialise in wine. Most sell everything, and they want to sell big brands [domestic wineries] supported by large A&P budgets. Most don't deal much with foreign wine importers.' However, they do provide an important benefit: a buffer against credit problems, which is the number-one reason for low profits in the wine industry.

At every level of the wine industry chain, credit that turns into bad debt is cited as the most critical issue. UBS reports that, in 2004, Changyu winery closed sales offices in eight large cities after suffering from problems with restaurants and retailers.

St Pierre says, In 1996, we had problems when starting out because we were forced to sell into customer channels that are high risk.' He says risky channels include Chinese restaurants, bars and KTVs (karaoke clubs), which represent more than 65% of their business. Major state-owned retailers can also be risky says St Pierre, and one of the problems is that they are not loyal and will easily switch from one supplier to another without settling payment. However, St Pierre adds, Now, our business has grown so we are in a position to choose the channels and the customers we want to work with. And competition is changing the scene: the risky channels will be forced to change.'

Trouble with Customs

I am not paid to translate - that is not my job!' exclaims Bong Ha, national sales and marketing manager at Torres. He is particularly frustrated over Peter Lehman's 8 Songs Shiraz, with eight different labels for the same wine. Bong has been struggling for more than six months to get clearance from Customs. Bong says, Each application [for a product] takes two to three months to process. If it is rejected, then it must go back into the queue again for approval.' That is precisely what happened to Lehman's Shiraz. Each bottle's front and back labels need to be accurately translated. The first time around, the translation did not meet with Customs' approval. Now I need to waste my time going over the fine print of each label just to make sure the staff don't get the translation wrong!' The wines have already arrived in Shanghai and are sitting in bond. I'm not sure how long it will take to clear customs,' Bong admits.

According to Ethan Perk of Montrose, Prior to 2005, a hygiene document could be used for one brand even being brought in from different lots, but now new documents are needed for each shipment.' To process all the paperwork, Montrose has eight full-time staff just to take care of registration, importation and logistics.

In addition to all the hidden costs, taxes currently add up to 41% for imported bottled wine and 46% for imported bulk wine. Internationally, the lowering of wine duty to 14% and the more recent spirits-duty reduction have created a storm of media attention on China. Although import tax is only 14% for wine (bulk wine is 20%), there is consumption tax at 10% and VAT at 17%. It adds up to 27% in taxes for domestic wine and 41% for imports. The irony behind the duty decrease is that, in many cases, wine prices have risen. Dan Siebers, Summergate's portfolio director for North China, says, Before China joined WTO, Customs didn't care very much about having all the right documents. It was common to underdeclare [the value of wines], and no one checked. But now, to prevent imports from gaining ground, they have made the paperwork much more difficult. Now Customs looks at everything carefully.'

Siebers also adds, There is a massive Customs check going on right now; it may take a few months or up to a year to clear investigation.' Summergate, one of the fastest-growing importers, is grateful not to have any stocks under investigation. Customs can investigate a shipment if they believe documents are incorrect or have been falsified, or if the shipment's contents or value are in question. Shanghai is low or out of stock of everything now because it is all being

held at Customs,' he says.

The dark side

Bong Ha says wine importers have two unofficial competitors: the grey and black markets. Forgeries and counterfeits are a big problem,' he says of the grey market, especially for popular brands. Despite reporting counterfeits to the Commercial Industry Association, enforcement is an issue. It is much more of a problem in Guangzhou and much less in Beijing.' The second unofficial competitor' is the black market, where smuggled wines eliminate the taxes and cumbersome paperwork, making them more affordable.

Besides the top crus classs from highly rated vintages, even the successful everyday brands have their imitators. Mouton Cadet and Great Wall have both been victims, resulting in Mouton Cadet changing its standard bottle shape to dissuade imitators. Torres recently opened an office in Guangzhou, and the staff have reported a market for empty bottles of spirits and high-end Bordeaux. Bong believes that counterfeit spirits may be as high as 50% in Guangdong.

Hidden from view

The China market of today is not that interesting,' Siebers comments. Perk at Montrose agrees and advises producers, Don't waste your time on China. It is not yet ready for too many imported brands. The cost, time and headache involved doesn't reap enough return. The big brands, those who should be here, are already here.' Perk suggests, If you are a boutique winery, go to Hong Kong, Taiwan or Singapore instead. Consider and worry about China in five to ten years.'

St Pierre of ASC adds, China is still in an embryonic stage for wine. People are confusing macro-economic data with consumer development. There is a reason why, for a market of this size, there are fewer than 10 serious importing companies in China right now.' St Pierre's strategy is to invest in the future because the growth figures are there. ASC plans to develop infrastructure and distribution and focus on education. In the past year alone, ASC has organised 300 wine-related events. Even the producers are taking

a long-term view and offering wine-education trips for F&B staff in major hotels and restaurants. Malcolm Zancanaro, executive assistant manager of F&B at the Grand Hyatt Shanghai, says that for 2005 more than 15 fully sponsored trips have been offered to their F&B staff by producers from around the world. According to Zancanaro, this doesn't happen in the United States or Australia.

Despite the warnings, there are plenty of people who believe in China as the emerging dragon. There are encouraging signs: as Changyu is quick to point out, there is a history of wine in China, and a history of wine' consumption. Wine faces no religious, social or political biases and, in fact, enjoys the sanction of the communist leaders. Distribution channels are evolving as more and more large retailers, such as Wal-Mart and Carrefour, expand or enter the scene in major cities. Smaller retailers, such as Jenny Lou's and April Gourmet in Beijing, are increasingly expanding their wine selection. Wholesalers that specialise in wine or spirits are expected to form in the near future, allowing easier movement and trading of wine and spirits.

Meanwhile, new restaurants and hotels are opening at breakneck speed. Before Shanghai's World Expo in 2010, no fewer than 10 new five-star hotels are expected to open. For each hotel group, at least two brands are expected to be present in Shanghai - for example, Ritz Carlton will have another hotel, and the Hyatt will have Hyatt Regency and Park Hyatt in addition to the Grand Hyatt.

With the pace of change and drive towards capitalism occurring under the backdrop of a communist banner, China can seem like a Kafka novel with multiple, often contradictory, realities. For long-term residents like Paul French, the publishing and marketing director of Access Asia, there are two distinct worlds - that of the suits' throwing money at China, and the one that constitutes the majority of Chinese, whose cost of living is rising faster than their income levels. The dragon's shadow is everywhere. When and how the dragon will reveal itself is a question for the rest of the 21st century.