Have you ever wondered why family Monopoly nights usually end in tears and an overturned game board? The reason is simply that the game was designed that way. The player with the most properties grinds the other players to dust, making sure they are one bad roll away from losing. Designed in the early 1900s, it was to illustrate the negative effects that the robber barons of the era and their economic monopolies have on industries.
In South Africa the largest wine business controls over 30% of the local market and the top four companies control more than 40% of the total market share. South Africa is partly in this situation due to the state-sponsored monopoly that the KWV had over the wine industry in the past. This crushed many small competitors that tried to enter the market.
The businesses that were able to overcome the larger capital barriers to entry and enter the wine industry were able to carve out large pieces of the wine industry market share for themselves in the wake of the rapid deregulation of the industry before many small players could even start thinking about entering the market.
The Herfindahl-Hirschman (HHI) Index was developed by two economists in 1950. This is a easy tool for quick calculations to determine market concentration and a fast and “dirty” way that competition commissions gauge the severity of concentrations in an industry.
When this formula is applied to the South African wine industry, some warning signals go off. The South African wine industry is what is considered an oligopoly. This is where a small number of businesses control a large amount of the market share. Although not a monopoly, where there is only one business that controls the majority market share, oligopolies are concentrated enough that it enables the few big players in the industry to start engaging in monopolistic behaviors.
The benefit of having these big firms in the market is that they are, usually, economically more stable than smaller producers. This helps to buffer the ups and downs in the wine industry as the last two years have illustrated. They can also help with price negotiations because of their big size, especially when doing business internationally, which is essential in today’s conglomerated retail space.
In South Africa, the top 4 local supermarkets control more than 90% of the market having the effect that, if you want to move wine in any significant quantities, you will have to do business with one of these four no matter how skewed the terms may be.
In the UK, 9 supermarkets control 90% of the market and in The Netherlands, 5 supermarkets control 90%. The US are the kings of monopoly, in terms of supermarkets, with only 3 supermarket chains being responsible for 90% of market share.
This conglomeration of the retail and food industry is a growing phenomenon worldwide, and already apparent in the challenge created by the biggest South African markets. Having more negotiation power by being a bigger company helps restore some of the power back to the producer away from the retailer.
But now you might be asking: So, what is so bad about having a few big players with the money and muscle to give the relatively small South African wine industry more negotiation power?
The concentration of power of the big firms enables them to dictate the direction and terms the industry should go in, for their own maximum benefit and not necessarily that of the whole industry. Their immense capital power enables them to also buy out any potential competition or simply deny them market access through their influence on distribution and other supply chain industry players.
In South Africa, 36 wine producers produce more than 10 000 tonnes annually, while 369 producers produce less than 500 tonnes. The top producers process, at a conservative estimation, 30% of the entire grape harvest in South Africa. While the smallest 369 producers only process, at the top end of their estimations, 14 % of total grape harvest.
This means that the market is so concentrated on the few big producers that if all the small producers banded together, they would only have half the negotiation power of the 36 biggest wine producers put together. These big producers determine the future direction of the South African wine industry. If they decide to focus on a certain market segment or style of wine, the whole industry can be skewed to move in that direction or risk getting crushed trying to move against the tide.
The vertical integration of the industry through insourcing of supply and distribution industries can make it even harder for small producers to enter the market as there are few options to upstream supply companies that can service them.
In South Africa you can see this by the sale of Nampak glass to AB InBev, effectively leaving one local manufacturer in South Africa to supply glass for the rest of the wine industry. The result of this is that bottles, that fall outside of the ranges used by the big producers, are hard to come by.
One of the other drawbacks of having such big companies control large portions of the industry is conformation and conversions of products. On an intrinsic side, one of the negative impacts the market concentration has on an industry is the lack of new development. There is a conversion of products between the companies, meaning you end up with a lot of the same kind of product competing for the same place in the market. It promotes mediocrity and monotonousness.
The effect on small wine producers is that they are being crushed between the production supply market and the retail market with suppliers having a chokehold on pricing while completely outsized in their negotiations with the few retail players that control the market.
This has caused the input costs to far outstrip the income generated from wine sales in the last decade. It can be seen in the data from Vinpro with a steady decline in small producers during the last couple of years that was expediated by COVID finishing expediating the demise of a lot of producers already on the edge.
The glimmer of hope for small producers is the growth in direct online sales. South Africa still lags behind the international market in this regard, with the USA already reporting up to 23% market share for online wine sales in the US market.
But still, there has been an exponential growth in the South African online wine market. The large players are starting to throw their weight around, as can be seen by the expansion of online delivery services by three of the four major retail brands in South Africa.
The small nature of many producers, however, can work to their advantage in that they are able to make discussions faster and implement change more efficiently compared to large corporations. This gives them the edge in this new retail space that has a much lower barrier to entry.
We have to be keenly aware that 40% market share is not 100% market share and that although these big companies can easily dictate the direction of our industry, that what is good for them in the short and medium term is not necessarily good for the industry in the long term. If we do not take heed of this the South African wine industry can easily end up as an upturned Monopoly board with all of us left crying.