August 28, 2015 – Tequila continues to gain interest among consumers across the world with the global demand rising significantly each year. Exports of tequila from Mexico increased at a compounded annual growth rate of 4.5 percent over the past five years.1 On the other hand, agave, the raw material used to manufacture tequila, is expected to face a severe shortage in the near future and increase in price by more than 100 percent by 2018.1 Distilleries must equip themselves to mitigate the anticipated risk resulting from this rising cost of raw materials.
Small and medium-sized distilleries are expected to be significantly affected. However, the rise of the raw material’s price should have a lesser effect on large distilleries due to secured agave supply through contract farming. Therefore, these distilleries could explore opportunities to expand their existing manufacturing capabilities during the anticipated crisis situation.
Unable to withstand the rising production cost, a significant number of small and medium-sized distilleries may possibly shut down or be forced sell their facilities between 2015 and 2018. Large distilleries could capitalize on the situation and expand their manufacturing capabilities by leasing, renting or buying these facilities. This is what Licor Zone will accomplish by grouping several small and medium distilleries under one roof.
Agave production forecast
Agave production is expected to be hit strongly during the 2015-2018 period with crop production dropping approximately 40 percent from the 2011-2014 period.4 The inventories most likely will not satisfy the strong global demand for tequila, leaving Tequila distilleries in Mexico facing a severe shortage of the raw material. Price of the raw material, in turn, could increase by more than 100 percent by 2018 as compared with 2013 prices.4
The majority of tequila demand in Mexico comes from the export market. In 2013, Mexico exported 76 percent of its total tequila produced.1 There are two types of tequila: 100 percent tequila and tequila bulk, or 51 percent tequila. The former uses only agave as a sweetener and in the latter, only 51 percent of the sugar comes from agave. One hundred percent tequila is not allowed to be exported in bulk, whereas 51 percent tequila may be exported in bulk and bottled in the export destination. As interest for the drink continues to increase globally, demand for both of these tequila types should rise at a rapid pace in the near future.
Demand for the drink is projected to rise with China removing the ban on Mexican 100 percent tequila in 2013. The ban was originally imposed because of tequila’s high methanol content. The United States was the largest importer of tequila until 2012, accounting for approximately 75 percent of the export market for Mexico.5 China is expected to grow as the second largest importer by the end of 2018, importing more than 10 million liters.5 Thus, rising demand for the drink will likely keep the distilleries running at almost 100 percent utilization rates. However, the rising price of the raw material poses a severe threat to the industry.
Agave procurement differs within the industry based on the size of the distilleries. Large distilleries secure their agave supply by either contract farming on leased land or farming on their own lands, thereby vertically integrating the entire process. These large distilleries secure 80 percent of their agave supply through contract farming. The remaining 20 percent is procured from small, independent farmers to capitalize on low-price situations.
Relatively small distilleries procure all their agave requirements from independent farmers. These distilleries were largely benefited in the past five to seven years and capitalized heavily on the low-price scenario that prevailed in the industry.
However, this situation is expected to reverse during the 2015-2018 period, with agave prices rising significantly. Independent farmers will likely benefit largely from these conditions. At the same time, the large distilleries should be minimally affected due the already contracted farmlands.
Way forward for distilleries
The anticipated price increase of agave is estimated to have mixed effects on the distilleries, depending on the size of the distillery and their current operational modes.
Because the large distilleries have their agave supply secured through contract farming, effects on them should be minimal. Those distilleries which generally procure 20 percent of their agave every year from independent farmers should avoid procuring from them in the next three years. Instead, they should procure all their agave requirements from contracted farms at agreed prices.
However, these farmers are expected to demand more for their produce in the coming years as they see their neighboring independent farms earn two to three times more. In such circumstances, the large distilleries must be open to paying a premium on the produce to partially match the prices received by other farmers. This would help avoid contract violations by the farmers. The agave industry has faced situations of contract violations during previous high-price scenarios.
Alternatively, these large distilleries could capitalize on the high-price scenario by acquiring small and medium-sized distilleries that would otherwise shut down, unable to withstand the severe rise in cost in the coming years. This will be discussed in detail toward the end of this article.
While medium-sized distilleries possess the potential to withstand the severe rise in raw material costs, their ability to compete with large distilleries in such high-cost scenarios will decrease. Distilleries which buy all of their requirements from independent farmers must engage in contract farming immediately to mitigate the high-price risk. Farming on their own land would cost more than the anticipated rise in the cost of raw materials. Thus, these distilleries could engage in contract farming on leased land over a period of time at agreed prices.
However, getting farmers to sign a fixed price contract with the prices of agave to ready skyrocket poses a challenge. These distilleries will be forced into a situation of paying high prices to farmers in the next three to four years. They must fix the contract prices at an optimum level that would enable congenial profit margins for the farmers and low price fluctuation risk to the distilleries.
Small distilleries are the ones expected to feel the worst effects of the agave shortage in the coming years. These distilleries will not have sufficient funds to engage in contract farming in the current scenario unless they come under the Licor Zone group.
Opportunities for large distilleries:
Although the raw material costs are expected to increase moderately for the larger distilleries, certain opportunities exist for these distilleries to explore. Larger distilleries could have the opportunity to buy, rent or lease these small and medium-sized facilities over a period of time. On the other hand, these large companies could engage in a third-party production agreement for their brands in these facilities.
With the rising demand for premium tequila brands across the globe, large distilleries could be forced to expand their manufacturing capabilities in the near future. Paying marginally higher prices for the raw materials might be unavoidable for the large distilleries in the next three to four years. However, these distilleries could explore such opportunities to scale up their operations to satisfy the rising demand for tequila in the future. The high cost of raw materials incurred during the period could be compensated by increased sales at price premiums resulting from scaled-up productions. Therefore, the price of tequila is expected to rise with the rising cost of raw materials in the near future.
The tequila industry must equip itself as soon as possible to withstand the effects of a rise in raw material costs. Small distilleries have already started to sense the brunt of rising raw material prices resulting from speculations. Although a challenge exists for mid-sized distilleries to identify farmers with crops ready for harvest during the 2015-2018 period, contract farming is the only way out for these distilleries. On the other hand, large distilleries that are expected to face minor effects from the rise in cost could explore opportunities to expand their operational capabilities during such crisis situations.
“I am proud to be part of Licor Zone expansion. The idea of regrouping several small and medium distilleries under one roof is brilliant, this will allow Licor Zone to become a heavy weight in the tequila business by reducing cost and increasing profitability,” said Alfredo Zapata, General Manager.
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Company Name: Licor Zone S.A. de C.V.
Contact Person: Alfredo Zapata De La Cruz
Phone: +52 01 (449) – 962-0225
Address:Prolongacion Ignacio Zaragoza # 505 Villas de las Trojes