We are very happy to host on our blog a commentary by Jacques Fleury, the person behind the resurrection of Borjomi and a key player in the Georgian wine industry. Jacques reflects on the experience of surviving the Russian embargo, on the one hand, and dealing with a series of heavy-handed and incompetent government interventions, on the other. In the second part of his comment, to be published next week, Jacques also proposes a new vision for the future of the Georgian wine industry, a future in which the government and the private sector work hand-in-hand to support small vine growers and promote Georgian wines to new markets. In his expert opinion, Georgia has the potential to get on the world wine map given its unique history and existing grape varieties. However, this will not happen without a properly orchestrated marketing communication campaign, which not a single Georgian company can undertake on its own.

PART A. 2006-2012 – DARK YEARS FOR THE INDUSTRY

2006-2008: A SUCCESSION OF EXTERNAL DISASTERS

During the last 7 years, the Georgian wine industry, always dependent for 80-90% of its sales on export markets, has been hit by a succession of economic and political disasters.

1. The Russian embargo of March 2006 (Russia represented more than 80% of Georgian wine exports)
2. Russo-Georgian war of 2008
3. The Ukrainian devaluation of 60% in 2008 (Ukraine represented then 50% of the export volumes of Georgian wine)

Despite relatively high growth from 2009, export volumes in 2011 were still well below 50% of what they have been before the Russian embargo.

2009-2012: NEW HOME MADE DIFFICULTIES

Unfortunately, the Georgian wine industry had to meet many other difficulties in Georgia due to the awkward and utterly unhelpful policy the Government of Georgia developed vis-à-vis the private sector. Instead of supporting an industry seriously downsized by the three above mentioned events, the Georgian Government pursued a policy quite contrary to the interests of private investors in the sector.

This policy had several components:

1. State intervention in the sector - fixing the price of grapes

One of the problems the Georgian administration had to address after the Russian embargo, was the survival of the many small grape growers who could not sell their grapes anymore. The wineries, which used to purchase their grapes, had lost 80% of their market.

Instead of leaving the price to be determined according to the new market conditions and compensating the small farmers directly (with a direct subsidy per kilo of grapes), the Georgian administration decided – without any discussion or negotiation with the private wineries – to impose higher guaranteed prices for the small farmers. This policy forced private wineries to pay higher prices than would have resulted from the existing market conditions.

2. Creation of a state wine industry

The fixing of the price of grapes, as described above, has had very negative consequences for the development of the Georgian wine industry and the profitability of private wineries. These wineries could not expand as much as they would have if faced with more moderately priced grapes, comparable to the prices faced by competitors in the New World countries or even in France and Italy.

Furthermore, the Government decided to develop a state industry, Gruzvinprom, in order to acquire a large quantity of surplus grapes that the private sector could not process at prices that were inappropriately high for the new market conditions and the slow recovery from the Russian embargo. [Which industry can quickly recover from the loss of 80% of its market???]

Instead of helping, this Government policy slowed down the development of the private sector by imposing higher prices on the exports of Georgian wines, which has been already subjected to increased competition from Chile, Argentina, France and Italy (even in the traditional ex-Soviet markets).

Initially, Gruzvinprom processed the purchased grapes into distilled alcohol which it had a hard time selling. In 2011, the state decided to invest in a new winery and thus start competing with the private sector. In this way, Gruzvinprom not only imposed a de facto limitation on the purchase of grapes by the private wineries, but also started dumping its wines at prices 30 to 40% below traditional prices in markets where the private Georgian wineries were successfully operating. The Georgian Government actually squeezed the private sector upwards and downwards.

In 2012, an election year, this strategy resulted in an increase of 40% to 70% (!) in the price paid for grapes by private wineries (who did not own vineyards).

3. Destruction of the value chain

Since there was still an excess of grapes in the market, to make sure that all grapes would be purchased, Gruzvinprom started harvesting the grapes long before maturation and long before the private wineries would start operations. Instead of giving priority to the private sector, as requested by the Georgian Wine Association, and have the state company harvest the grapes remaining at the end of the crop, they started to harvest long before the acceptable maturation dates of the grapes.

We can imagine now the quality of wine Gruzvinprom could have in stock. This was an unacceptable value destruction in our industry.

The years 2011-2012 have seen a repetition of the practices of the previous years: destruction of high quality grapes by early harvesting, ending up in distillation or, more recently, in the production of low quality wines. This inexplicable strategy has even resulted in the shortage of white wines available in Georgia since 2011. Note that the country had always had sufficient supply of traditional white wines, such as Rkatsiteli.

In this manner, Gruzvinprom actually took a very large part of the crop out of the private sector. In 2012, facing grape price increases of 60 to 70%, a few private wineries abstained from buying grapes at such a high price only to find out that there was no crop left when the time of election passed. We suspect that Gruzvinprom has bought more than 20,000 tons of grapes, for an amount exceeding 20 million GEL, but would appreciate knowing the exact amount of funds spent during the 2012 harvest.

This policy resulted in enormous industrial losses. Additionally, by promoting very low quality wines, it tarnished the image of Georgian wines abroad, having a negative effect on the sales of private sector wineries who had been for the last 6 years trying to undo the damage inflicted by the Russian embargo by investing heavily in the reputation of Georgian wines (with visible success in certain countries).

4. Dumping the Georgian wines abroad – destruction of image and market value

Despite many promises by the Minister of Agriculture that Gruzvinprom will not sell wines in the countries where the Georgian private sector was well established, the company started selling, at prices 40% below the prices of the main Georgian private wineries. The wine was produced and promoted under the Gruzvinprom brand in a marketing exercise similar to the worst Soviet examples.

At the level of prices offered by Gruzvinprom on the export markets, and taking into account that the Georgian private industry is not very profitable, we can expect heavy losses to be financed by the Georgian budget.

5. Lack of support for the Georgian private wine industry

Facing increasing competition with the state industry, 34 private wine producers created an association – the Georgian Wine Association (GWA). During meetings with the Ministry of Agriculture, GWA tried to convince the Government to redirect state investment of tens of millions of dollars into properly organized promotion and marketing abroad in order to create better awareness of Georgian wines in new markets. Any proposal of this sort was rejected. Our counterparts refused to understand that the bottleneck was not in production but in export sales promotion. Without professional marketing, Gruzvinprom would merely replace private Georgian exports with lower quality, lower priced products, a step back for the Georgian industry.

6. Another Government intervention – the unfortunate example of the glass bottle industry

SISECAM, the leading glass manufacturer from Turkey, and currently one of the global leaders, had been investing tens of millions of USD in Georgia since 1996. The development of the glass bottle factory in Ksani by SISECAM was instrumental for the successful development of the mineral water industry in Georgia.

In 2006, SISECAM decided to meet the increasing demand from the mineral water and the wine industries, by building a new furnace at a cost close to $30 million. While the new equipment was on the way to Georgia, Russia imposed a trade embargo on Georgia, reducing the demand for Ksani to below its initial capacity. The company had at a high cost to divert this equipment to other destinations and consequently faced huge losses from the Russian embargo.

Obviously, this left Georgia without a producer of glass wine bottles, forcing the industry to import more expensive glass bottles, presenting yet another obstacle for the Georgian wine industry.

In 2011, while the demand was picking up, SISECAM decided that time was ripe to implement its 2006 plan to double the production capacity in Ksani by undertaking a new $25 million investment. Unfortunately, soon after this decision had been taken, the Georgian Government announced its plan to invest in the reconstruction of another glass bottle factory in Khashuri. Since there is no room for two players in such a small country with relatively high energy cost, SISECAM reacted by cancelling its own investment. This means that in 2013 Georgian wineries will still have to import highly priced bottles from abroad.

State investment in such a low margin, heavy investment industry is not unthinkable. But when it results in the cancellation of a $25 million Foreign Direct Investment by a world class operator, it raises many questions as to the Georgian Government’s real desire to attract and give priority to foreign investment.

by JACQUES FLEURY
Vice Chairman of the Board, The Georgian Wine Association
C.E.O. Georgian Wines and Spirits
Founder and Director Chateau Mukhrani

The second part of the article, 2013-2017: DEVELOPING A SUCCESSFUL STRATEGY FOR THE GEORGIAN WINE INDUSTRY – SUGGESTIONS FOR A NEW POLICY, will be published next week.