So, You Want To Be In The Tequila Business?

You Better Think Twice!

Other than rock stardom: Sammy Hagar, Justin Timberlake, Santana and Vince Neal, of Motley Crew, have one other thing in common.  They have all taken a “shot”, pun intended,  at the Tequila business.  

In the vodka market, Grey Goose Vodka’s “overnight success”, motivated Kevin Spacey to try his hand at upscale branding his own label.  If, as a Tequila aficionado (after a couple of shots), you have been struck by  the thought of branding your own Tequila - read on…

For the past 25 years I have assisted foreigners in establishing joint ventures with Mexican partners.  Most of my clients

established ventures 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.  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.

These past three years I have had the privilege of working with a man who has been a successful grower in Central California and 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.  Ten years is a long time before a plant reaches that right sugar content for fine Tequila (8-10 years).  During those ten years, an exploding worldwide Tequila market, spurred overplanting and resulted in a huge market surplus.

My client spent twelve thousand dollars to care for, harvest and transport agave to the distillery.  The market price had dropped from a twenty peso per kilo high in year 2000, to fifty cents a kilo, this past year (2010).  He  was paid $2,000.00 for agave that cost him $12,000.00 to deliver.  During this ten year period, of repeated trips to check on his plants, he began visiting artisan distillers of 100% agave.   In search of the beverage that most satisfied his palette.  His explorations led him to his now Mexican partner-distiller who places quality of product  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 Autlán Valley in  Jalisco,  where the distillery is located.  Experts say the best Tequilas don’t come from the area around Tequila.  The Autlán Valley, where the water is superior, produces the best liquor.  The Cisneros family had 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.  The list included: new oven doors for the cooking stage, new fermentation caldrons, a laboratory for product testing and an area separated from production for the bottling operation. 

Estimates for the physical improvements was forty thousand dollars.  In exchange for plant investment, my client was provided with an ownership position in the distillery.  

My client, to date,  has invested nearly $300,000.00 total: unplanned additional plant investment,  consulting fees,  barrels for ageing of product, trademark registration, bottle molds, bottles and labels, label design and engraving, permits to import, authorized U.S. warehouse, travel and lodging.  Marketing of product in the United States will require another sizable investment.  Experts in the liquor business, unanimously 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 spent over 400 man hours in shopping for providers, comparing bottle designs, label alternatives, bottle corks & tops, plus consumer feedback on our selections.  The cost per bottle for blown glass, a burned on label (non paper), and a glass top is three dollars and fifty cents.  

The image costs more than the cost of producing the liquor content.  The custom mold for the bottle was $4,200.00.  The standard volume order for bottles is 12000, which represents a container load.  Total costs for producing this first container of bottles, not counting the liquor,  is approximately thirty thousand dollars.  Now, the clients’ investment is more than  300k  and we still have not sold a drop of Tequila.

A major decision was whether to sell our product only to export markets or include Mexico as a secondary market. Selling in Mexico would allow us to begin selling sooner and 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 accountant gave us the reasons we needed to decide on an “export 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)

Tax number one – a 50% tax on liquor sold from distiller to retailer- $15.00 now $7.50

Tax number two – a special tax on alcohol equivalent to $17.5% of profit - Our cost per bottle is $4.00   selling at $15 we have a profit of $11 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 - $29% = $1.62 tax

This leaves us, after taxes, $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 and then collects another 53%,  for the government, in the purchase of that liquor by the consumer.  My rough calculations tell me that the government is earning over 160% of 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 identification “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.  These are on going costs, whether or not we produce or sell our Tequila.   These fees, again, do not affect the large distillers to the degree it affects 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, and despite vast differences in sales volume.  The association does not offer any sales or marketing classes or consulting.  The key to success in this highly competitive industry.  And, 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 the lowest cost possible.  Enabling the U.S. partner/importer/distributor to provide product to the retailer at a very competitive price.  The retailer’s profitability is maximized, instilling  incentive for providing prime shelf space and promotions.   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, like medical marijuana.