Other than rock stardom, what do: Sammy Hagar, Justin Timberlake and Vince Neal (The Motley Crew), have in common? They have all taken a “shot”, pun intended, at the tequila business. Celebrities have also invaded other liquor markets. Grey Goose Vodka’s “overnight success”, motivated Kevin Spacey to try his hand at upscale branding his own label of vodka. If you are a tequila fancier, the thought may have entered “su cabeza” of branding your own, especially after sipping a couple of your favorite añejos. If that is the case – read on…..
The past 25 years I have assisted foreigners in establishing joint ventures with Mexican partners. Most clients, establish J.V.’s to exploit cheap labor and export advantages provided by NAFTA. Joint venture contracts for products manufactured by Mexican partners were mostly agreements for marketing rights in “the states” or Canada. Separate business entities with mutual interests. Often, mistrust over “real” production costs and market pricing destroyed what should have been successful partnerships. Rarely have these joint ventures resulted in a “one company” philosophy in which the Mexican manufacturer participates in the profitability of the U.S. firm.
For more than a year I have had the privilege of working with a man whose lifetime of success has been built on a strong belief in assuring mutual benefit for everyone he does business with. An agrarian, he decided, ten years ago, to grow blue agave (tequila plants) in the Southwestern region of Jalisco – Tequila country. In the year 2000, ten year old agave plants were selling for fifteen to twenty pesos per kilo. Eight to ten years is required before a plant reaches that appropriate sugar content for fine tequila. During those ten years, an exploding worldwide tequila market, spurred overplanting and resulted in a huge market surplus. Many growers simply plowed their agave under rather than pay the cost to harvest and transport.
My client spent twelve thousand dollars to care for, harvest and transport agave to the distillery. The market price had dropped from a twenty dollar per kilo high in year 2000, to two pesos a kilo, this year (2010). He was paid $2,000.00 for agave that cost him $12,000.00 to deliver. During this ten year period, he made repeated trips to check on his plants. On these trips, he began visiting artisan distillers of 100% agave. In search of the beverage that most satisfied his palette. Fortunately, his explorations led him to his now Mexican partner-distiller who places quality of product, integrity and fairness above profitability. The opportunity presented itself to take a bad investment – agave; and turn it into a hopefully good investment – tequila.
The tequila distiller is Casta Negra. Five generations of the Cisneros family have worked the fertile soil of the Mentidero valley where the distillery is located. The family asked the “Consejo Regulador”, the association that authorizes the use of tequila on product labels, to provide a list of plant improvements to satisfy regulator criteria for labeling their product “tequila”. The list included: new oven doors for the cooking stage, new fermentation caldrons, a laboratory for product testing and an automatic bottling machine. Estimates for the physical improvements was forty thousand dollars. In exchange for plant investment, my client was provided an ownership position in the distillery.
After one year of improvements to plant and operations we are authorized to brand our 100% agave liquor as tequila. To date, the total amount invested is approximately $125,000.00: planned and un planned for plant investment, consulting fees, barrels for ageing of product, travel and lodging. Marketing of product in the United States will require another sizable investment. Experts in the liquor business, agree that the most important marketing decision is the choice of bottle and label design. When you enter a major liquor retailer, and see 200 different tequilas to choose from, you understand why an “attention getting” image is so important.
We have spent over 400 man hours in shopping for providers, comparing bottle designs, , label alternatives, bottle corks & tops, plus consumer feedback on our choices. We chose blown glass over “off the shelf” factory bottles. The cost per bottle for blown glass, a burned on label (non paper), and a glass top is around two dollars and change. The cost for 2000 six bottle cases for shipping is $3,500.00. The custom mold for the bottle was $4,200.00. The standard volume order for bottles is 12000, which represents a shipping container load. Total costs for producing this first container of bottles, not counting the liquor, is approximately thirty thousand dollars. Now, the investment has risen to $150,000.00, without selling a drop of tequila.
A major decision was whether to sell our product only to export markets or include Mexico as a secondary market. This would allow us to begin selling sooner to help carry the burden of production costs. On the surface it seemed like a “no brainer”. Lower freight costs, no customs duties or paperwork delays and less expensive to service clients close to the production site. A market of over thirty million people in Mexico City and Guadalajara, less than a day’s drive away. Our Mexican accountant gave us the reasons we needed to decide on an export market only business model. Listed below are the taxes affecting liquor sold in Mexico:
(In this example we will assume a sale of $15.00 for a bottle of Casta Negra sold to a retailer-all of these prices and costs are hypothetical, the taxes are not)
Tax number one – a 50% tax on liquor sold from distiller to retailer- $15.00 now – (tax 1) leaves $7.50
Tax number two – a special tax on alcohol equivalent to $17.5% of profit – Assume a cost per bottle is $4.00 selling at $15 we have a profit of – $11.00 X 17.5% = $1.93 tax
$5.57 is now left
Tax number three – An excise tax “Impuestos Sobre La Renta” – translation: taxes over and above rent – another excise tax $29% = $1.62 tax
This leaves us with after taxes profit of $3.95 on a bottle selling for $15. The government receives 75% of the sale and Casta Negra 25%.
But wait, there’s more: The retailer pays an excise tax of 16% to the government for his purchase from Casta Negra and then collects another 29%, for the government when the tequila is purchased by the consumer. My rough calculations tell me that the government is earning over 110% for every bottle of liquor sold in Mexico.
We realized our after tax margins were too slim to satisfy low volume sales. Only the large volume tequila companies can afford to properly service their customers and maintain profitability. The government’s deck is stacked in favor of “the big boys”. The deck is also stacked by the “Consejo Regulador” (quasi government). The agency that determines your use of the label tequila. We must pay the agency the equivalent of a thousand dollars, in pesos, per month for the right to the tequila branding. We must also pay a consulting “engineer”. A certified inspector who charges another thousand per month for weekly quality control visits. Two thousand dollars of fixed costs per month, whether or not we produce or sell tequila. If we have a plant shut down we still must pay two thousand per month to keep our rights to “tequila” branding.
These fees, do not affect the large distillers to the degree they affect our small operation and others like us. You would think the association (government) would try to help “the little guy” with lower fees, but no. Jose Cuervo or Casta Negra, we pay the same to print tequila on our bottles, despite vast differences in sales volume. The Consejo offers training and consulting in administration of the business and help with government agencies. The association does not offer any sales or marketing classes or consulting to their members. Yet, marketing is the key to success in this highly competitive industry. A unique skill set unavailable to artisan tequila producers.
Despite all these obstacles, I am optimistic for the success of Casta Negra. As I mentioned, at the beginning of this article, both parties are committed to a smart “win-win” business model between U.S. investor and Mexican product provider. The plant will provide product “at cost”. My client can then provide that product to the wholesaler/retailer at the lowest cost. The result is the retailer’s profitability is maximized, instilling incentive for providing prime shelf space and promotions. The Mexican distillery gets 50% of after sale profitability. Thus, each partner is sharing costs and profit equally. Everyone is involved in lowering costs through production efficiencies and providing an affordable, quality tequila to a price conscious public in the United States.
I’m not advising anyone to stay out of the tequila business. But just remember, without a Rock Star budget you might want to invest in another Rock n Roll lifestyle product: medical marijuana.