Supply and demand

With years of good growth in volume and value behind it, Montana certainly seemed an attractive option for acquisition. But Diageo claims the union was soured by its discovery of underinvestment in the company; declines in the low-value end of the domestic market, where Montana still has a considerable presence; and rising costs from company vineyards sold then leased back.

We saw that we wouldn't get the return we expected,' says Isabelle Thomas, Diageo's corporate communications manager. This doesn't mean that we are no longer interested in wine; it's just that on this occasion the figures didn't add up.' While some reasons behind Diageo's decision are specific to Montana, the more general issue of diminishing profitability is one currently faced by the New Zealand wine industry as a whole.

For most wineries, the greatest squeeze on profits has been from the growing strength of the Kiwi dollar since 2001 against the currency of the country's top three export markets of the UK, the USA and Australia. Despite forecasts to the contrary, it's shown little sign of softening against the pound, hitting an eight-year high of $2.51 only last month.

As an idea of how much this is hurting, rough calculations indicate that in holding a 6.99 price point, an exporter is likely to have seen more than NZ$2.50 eroded from its FOB bottle price over the past four years. And this is without taking into account the rising costs of freight, labour and taxes.

New Zealand's wine companies have largely been unable to offset currency pressures by price rises. This is due to increased competition from both international and NZ wines following New Zealand's record-breaking 2004 harvest, which was heralded as marking the transition of its wines from being allocated to actively marketed. In this climate, several wineries admit they're currently making little profit in the UK; they're present purely to get or keep a foothold in a market they consider important and that will only get more competitive, holding on to reap the rewards when the exchange rate improves.

If that wasn't tough enough, increased supply means buyers are also asking for new or existing brands at lower prices. Now New Zealand's much envied average retail bottle price is starting to slip, from 6.29 in the year ending June 2004 to 5.93 in June 2005. It's now also possible to find NZ wines

at 3.99, on promotion or even as a shelf price.

This has created some jitters in an industry that's built its success on a focus on quality at premium levels rather than volume at lower prices. New Zealand can never be a volume producer like Chile or Australia,' says Brian Johnston, MD of Allied Domecq Wines (NZ). We should follow a Champagne model that maximises value rather than trading our way to unprofitability. However, there are some companies that do not share that philosophy.'

Despite these challenging times, New Zealand has remained remarkably resilient. Things have held together pretty well,' says New Zealand Winegrowers CEO Philip Gregan, who, in the light of growing export demand, is not overly troubled by pricing in the UK at present. We've had a 50% growth in sales, with only a small drop in price, and we're very happy with this outcome.'

There are concerns that New Zealand will struggle to sell the increased volume of wine starting to come on-stream, which would exert even more downward pricing pressure. Some newer wineries still establishing routes to market are already finding it hard, and for Diageo, its conviction of an imminent oversupply of New Zealand Sauvignon Blanc was another factor that lessened Montana's appeal.

Ironically, Montana, with its strong branding and developed distribution channels, is predicting that demand is once again likely to outstrip supply in the 2005 vintage. While the harvest was 14% down on the previous year, even if 2006 is on target, most of the big players consider undersupply to be more of a problem in the coming years.

This story does perhaps have a happy ending for Montana and New Zealand. With its purchase of the boutique winery Framingham last year, Pernod Ricard was the last multinational seduced by New Zealand at a time when its future challenges were evident. This, combined with the pleasure it has articulated in gaining all Allied's New Zealand brands suggests confidence in the future of New Zealand wine and a more long-term view of its potential.

• Harpers Says...