LaFitte Castle Wines Niagra on the Lake, Ontario

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1 August 21, 2006 Student Consultants 2006 Graduation Way Denton, TX Dear Consultants, LaFitte Castle Wines Niagra on the Lake, Ontario I am writing to solicit your input regarding the future direction of LaFitte Castle Wines (LCW). LCW has enjoyed reasonable success since being founded by my father, Andre LaFitte, in the early 1980s. With that success, however, have come a variety of business issues and my father is better at making wine than addressing business concerns. The company is currently running at nearly full capacity and something must be done. In response to this, my father has proposed replacing the current winery, a concrete block building, with a new $5 million castle-style winery. This would double the company's production capacity. While I am not necessarily against building the new castle, I have concerns because it seems that our management has been running to keep up" with company growth that it is increasingly difficult to maintain internal consistency and a sense of control over day-to-day activities. My father, however, has been obsessed with the idea of a castle-style winery for many years. When he first presented the castle proposal, he said: "I don't think there has been a day in my career that I haven't thought about this castle. Do you think we should move ahead with it? Accordingly, I am coming to your company for help. I would like for you to evaluate our situation and make a recommendation for how we should proceed. I hope that your recommendation will not just focus on whether to build the new building, but will also look at what will need to be addressed in all areas of the business, from marketing and operations to accounting and information systems. To assist you in your research, I am including information on LCW, both historical and current, as well as some initial information on the southern Ontario region where we are located. I presume, however, that you will do further research and consider additional information regarding the wine industry and competition in Ontario and beyond. I am in favor of doing what is best for the company, whether that involves building the castle or not. As such, I would like your best recommendation as to where LCW should go from here in order to be successful in the future. Please remember that I will have to sell your ideas to my father, so please give me as much justification for your recommendation as you can. I look forward to working with you. Sincerely, Andre LaFitte, Jr. VP Marketing, LaFitte Castle Wines

2 LAFITTE CASTLE WINES, LTD Andre LaFitte, Jr. and the other members of the firm s management team were meeting in Andre Jr. s trailer office which was overshadowed by the LaFitte Castle Wines Ltd. (LCW) current winery. 1 The company, a boutique-type winery located on the Niagara Peninsula of Ontario, Canada, had sales of over $2 million the previous year. LCW s management team was reviewing a proposed plan by Andre LaFitte Sr. to replace the current winery, a concrete block building, with a new $5 million castle-style winery. This would double the company's production capacity. Andre LaFitte Senior (Andre Jr s father), was not only the founder of the company, he was also its current President. Andre Jr.'s enthusiasm for the new castle was tempered by his reflection that management had been running to keep up" with company growth. LCW s management team was concerned that it was increasingly difficult to maintain internal consistency and a sense of control over day-today activities. At the same time, everyone knew that Andre Sr. was obsessed with the idea of a castle-style winery. When Andre Sr. had presented the castle proposal, he had said: "I don't think there has been a day in my career that I haven't thought about this castle. Do you think we should move ahead with it? As Vice President of Marketing, Andre Jr. was concerned about the marketing implications of his father's grand vision and the broader implications about the future of this family business. He was also sensitive to the industry environment. Sales of wine in Ontario had suffered in the mid 1990's, falling from a peak of 90 million liters to 80 million liters. While sales had turned back around, a combination of economic factors, the aging of the baby boom generation, and a more socially responsible, health conscious society meant that sales growth was likely to be fairly slow over the next few years. Nevertheless, Ontario wines were continuing to build awareness and sales, both within Ontario and elsewhere. In the morning sunshine of May 2006, LCW s management was trying to decide how they should respond to Andre LaFitte Senior 's proposal. LAFITTE CASTLE WINES LTD. ORIGINS Andre Sr., the founder of LCW, was born in French Algeria in 1941 and had grown up in the wine business. With his degree in oenology, the science of wine-making, from the University of Dijon in France, he returned to Algeria to manage his family s vine-yard and subsequently a cooperative winery. He emigrated to Canada in 1966 following revolutions and social striff in Algeria. 1. Original Copyright by Ruth A. Cruikshank and Kenneth F. Harling, Wilfrid Laurier University. Case has been extensively modified and adapted for use as a Competitive Team Case in Business Policy, BUSI 4940, by the Department of Management, University of North Texas. 1

3 He soon found employment with Chateau Gai Wines, a profitable, family-owned business located in Niagara Falls, Ontario. During the next 15 years, he rose to become Chateau Gai s chief wine maker and director of research. He introduced numerous innovations at Chateau Gai, including the development of Alpenweiss, a blended wine that became Canada s largest selling white wine in the late seventies. He also promoted the use of French hybrids and vinifera grapes for making wine. Following the purchase of Chateau Gai by John Labatt Ltd. in 1974, Andre Sr. became increasingly frustrated with the internal politics that predominated under the new ownership. He felt that the new management was interested only in meeting the numbers, that new workers being hired lacked the technical knowledge necessary to produce high quality wines, and that his own ability to innovate was being curtailed. He was frustrated because, as he later said enthusiastically: I enjoy making good wine and I want people to consider the wine I make the best in Ontario. Convinced that he would be unable to pursue his dream of producing a high quality, European style wine at Chateau Gai, Andre Sr. decided to establish his own winery. In 1982, he joined with two partners to buy 62 acres near Niagara-on-the-Lake. The same year, 57 of these acres were planted in grapes. The next year, he left Chateau Gai and founded LaFitte Castle Wines Ltd., building a winery on the land and processing its first grapes. In 1984, LCW sold its first wines commercially. Since then, further land was acquired by LCW and planted to grapes: in acres of which 50 were planted and in acres of which 14 were planted. In 1996, a further 33 acres already owned by the company were planted. LAFITTE CASTLE WINES LTD. TODAY Andre Sr. was generally pleased with the inroads his winery had made into the Ontario market over the decade. By 2006 LCW estimated it was shipping 40,000-50,000 cases of wine annually, where a case equaled 9 liters of wine. In addition, LCW was consistently profitable (See Exhibit 1 for the financial information). By that time the company had four separate but related operations: i.e., several vineyards, a winery, a nursery, and a research laboratory. THE VINEYARDS Andre Sr.'s original vision for the winery had included growing its own grapes. You just can't make good wine without growing your own grapes. You have to control their quality it you want to make good wine." Furthermore this was important in 1982 since few farmers grew the European vitis vinifera varieties of grapes, more simply know as vinifera grapes, needed to make the kinds of wines Andre Sr. was interested in making. For this reason, 70% of the tons of grapes LCW crushed each year came from LCW's three vineyards and the LaFitte' family's vineyard, the LaFitte Estate. The other 30% of grapes used came from three growers who had supplied the company for many years based on verbal contracts. These growers were unlikely to expand their production of grapes in the future. While Andre Sr. had been careful to select only the best available land for LCW vineyards, he 2

4 was especially pleased with the 50 acres of the estate, of which 33 acres were planted. He considered it the best land in the Niagara peninsula. All the planted land and half the unplanted land had drainage installed at a cost of $5,000 an acre. Andre Sr. felt that well-drained land enabled the roots of the vines to grow deeply and extensively, producing healthier vines and higher quality grapes. Andre Sr. managed the four vineyards with the help of Pierre Jean Stephane, Andre Jr.'s younger brother. Agricultural practices in the vineyard were what Andre Sr. considered optimal for producing high quality grapes in Ontario. They included both traditional and innovative techniques developed by him. He observed: "France is steeped in tradition. In Canada, we have been working to make our own tradition." Andre Sr. had introduced many innovative cultural practices to Ontario including how to prune the vines in May and when to harvest the grapes in September and October. Using these practices, LCW had been one of the first vineyards to grow vinifera grapes commercially in Ontario. The grape harvest varied over the life of the vineyard. The first viable harvest was produced three years after the vines had been planted and was half normal yields; in the fourth year it was 75 percent and in the fifth year it was a full 3.5 tons of grapes per acre. Andre Sr. chose not to pursue higher yields because he felt the grape juice would then be lower in quality and the risk that some vines would die from severe winter weather would be higher. As the vines aged, the quality of grape juice tended to improve but after years the vines might have to be replanted. The prices paid for grapes by wineries were set through negotiations between the Ontario Grape Growers' Marketing Board and the wineries. All wineries paid the same price adjusted for the variety and quality of the grapes delivered. Andre Sr. felt that prices were approximately the same price as equivalent quality grapes tn France. THE WINERY The present winery was a concrete block building of 13,000 square feet. It housed all production and storage activities. Maximum capacity was 60,000-70,000 cases of wine a year. However, actual capacity was only 45,000 cases because vintaged varietal wines had to be handled separately to maintain their identity by grape and year produced. The building also contained a retail wine store and some offices. Serious overcrowding had led to 12 surplus stainless steel tanks being placed outside, up against a side wall of the winery, and the LaFittes' offices being located in a trailer parked behind it. Andre Sr. was modest about his abilities although he was regarded as a vintner extraordinaire" by those who knew him. He commented: Anyone can make wine. All you have to do is follow a recipe. But to make good wine every time, you have to know what you are doing. This is why wine-making is a science and an art. When I make wine, I check things daily, making corrections as necessary. Every time I make wine the decisions are different and I don't blend or bottle a wine until I have tasted it personally. Big wineries have problems making good wine because their management just wants to blindly follow recipes. 3

5 The time span from crushing the grapes immediately after their harvest to shipping the wine varied. A few wines were shipped soon after crushing--beaujolais nouveau was shipped in November and young white wines were shipped in the late spring of the next year. In general, production of higher quality vinifera wines took longer because they required aging; 1-2 years for white wines and 2-3 years for red wines. Andre Sr. produced 130 gallons of juice per ton because he felt doing so produced superior quality juice even though he could produce more gallons per ton under provincial government regulations. Andre Sr. monitored manufacturing costs informally. He felt that the cost of manufacturing each type of wine was roughly the same. He thought the big cost difference among the wines he made was the price of the grapes, with grape costs being higher for vinifera varieties. Wine could be improved by blending in low cost-higher quality imported bulk wines or using unfermented grape juice. This wine, which came from various countries including Chile, Argentina, the United States, and France, was chosen based on price, availability' and quality. Only 8% of LCW's volume consisted of bulk wine. This was considerably less than other medium sized wineries in Ontario. OTHER OPERATIONS Research at the company had been largely funded by federal and provincial government grants given in recognition of the technical expertise at LCW. These grants had been an important source of revenue for LCW in earlier years. Early efforts had focused on cloning superior vines Andre Sr. had identified in LCW's vineyards. This work was done by a scientist with a doctorate in biology that Andre Sr. had hired from the University of Waterloo. The clones he produced went to LCW's nursery where they were grown into vines. Andre Sr. considered the cloning work finished and was now directing the scientist's research into production practices such as reverse osmosis and carbonic maceration. The scientist was attempting to do this work in a small laboratory in the winery. The nursery was important both to LCW and the Ontario wine industry because it was the one of the principal sources of vine stock for vinifera grape varieties in Ontario. The LaFittes were proud of their contribution to the Ontario wine industry. They were also pleased that their wines were often compared with wines from other Ontario wineries, all of which were produced from grapes grown on vines which came from LCW's nursery. The nursery's sales represented 10% of LCW's sales revenue. It had always been a profitable operation and provided timely cash flow each spring. MARKETING LCW's marketing activities are influenced significantly by the heavily regulated environment in which it operates. Pricing By 2006, the company's product line spanned the low and medium prices. This had not always been so. Initially, LCW produced lower priced blended table wines appealing to the mass market. Its "Cour Blanc" was, in fact, the same blend as the Alpenweiss'' blend that Andre Sr. had developed while at Chateau Gai. Starting in 2001, Andre Sr. moved to upgrade LCW's product line to higher quality wines, typically vintage varietals and estate bottled (See Exhibit 2 4

6 for the winery's recent product mix). Andre Sr. also sought the VQA (see supplemental section on the wine industry for a discussion of VQA) designation on all its varietal wines to help validate their quality. Andre Sr. priced all of LCW's wines so that they represented "good value" for the consumer. He priced the company's basic table wines directly against low price foreign wines. He priced LCW's better wines so that the customer received higher quality wine than similarly priced French wines. Generally speaking, higher price point products and specialty products provided higher margins for the company. On average, the margins for varietal wines were 20% higher than for table wines. In spite of the higher prices, these products sold relatively well. For accounting purposes, sales were recognized at the FOB price when the wine left the winery. Sales Approximately 80% of LCW's sales dollars were generated through sales to the Liquor Control Board of Ontario (LCBO). LCW wines were carried regularly in over 80% of the approximately 600 LCBO retail stores. LCW s penetration of LCBO stores was lowest in northern Ontario. The other 20% of company sales came from its own retail stores. LCW had only three stores in 2006 although it had licensees for six. One store was in the winery. This store sold primarily to those touring the winery, although some direct sales to licensees were also made through the winery store. A second store was located in Ottawa's Minto Plaza, a large office development in downtown Ottawa, while a third store served customers in Oakville's trendy Bronte Harbour. Andre LaFitte Jr. estimated that initial setup costs for starting up these stores were approximately $50, and annual fixed operating costs were $70, He also knew that the average selling price of a case of LCW wine was $94.29, and that the average direct cost of each case sold at their stores was $22.15 plus approximately $44.00 in taxes, levies. and fees. LCW had yet to decide whether to open additional stores using their remaining licenses. Andre Jr. was concerned that the government might issue licenses to a broader retail base, including grocery and convenience stores. This made him uncertain about the long-term viability of company owned stores outside of the winery. Advertising and Promotions Both Andre Sr. and Andre Jr. saw the wine business as a lifestyle business. Consequently, they worked hard to be close to the customer". They sought to learn what the consumer wanted and to educate everyone about wine and wine appreciation. LCW encouraged consumer demand using wine tastings at the winery and at other private and trade gatherings in Ontario. In the past several years, Andre Jr. had attended every trade show in the province, seeking to influence opinion leaders such as food and wine journalists with the wine s quality and at the same time establish and reinforce the perception that LCW's wines were imbued with a "sense of artistry. The LaFittes had their own perceptions of customer purchasing behavior. They believed consumers purchased wine on the basis of price, quality, sweetness, originating country, and reputation. They thought brand loyalty was a purchase factor, although switching was more common with lower priced table wines. Wineries, they said, encouraged this by often changing labels and names of wines to catch the "roving consumer". At LCW Andre Sr. tried to emulate this in his own way, bringing out one or two new varietal wines each year. Selection of a wine, they said, was heavily influenced by personal recommendations, and to a lesser extent by the reputation of the winery. A certain romance was often associated with the winery of choice. Andre Sr. was often personally featured in promotional literature because of the image he projected. He spoke with a French accent, looked Italian, and was the principal owner of the business -- all features which consumers were thought to associate with quality wine. 5

7 To date, much of LCW's promotion had been based on personal selling to those who could in turn sell the wines to others. The company's four sales representatives called on over 500 licensed restaurants and bars. Once the licensee was ordering LCW wine on a regular basis through the LCBO store, the representative would approach the store manager and encourage him to stock LCW wines for public sale. Andre Jr. realized that LCW would need to develop greater customer awareness. One avenue for further promotion was point-of-purchase promotion in LCBO stores. The LCBO rented out the right to promote in its stores for three weeks at a time. LCW would have to pay the LCBO $750 for each store used and at least 100 stores would have to be included in the promotion. Andre Jr. was convinced that this could be effective though it would cost $30,000 for the promotional materials. What had held him back from pursuing this so far was has concern that the company simply did not have the people needed to erect all the displays in a timely fashion. The Four Ontario Sales Regions The sales mix in each of LCW's four sales regions (Ottawa/Eastern Ontario, Toronto, the Niagara horseshoe, and Southwestern and Central Ontario) was very different although total volume was similar in each region. For example, in Toronto "Chardonnay" and other varietal wines were the company's best sellers, while in Niagara white table wine was the best seller. Sales volume was highest in Toronto, and lowest in Southwestern and Central Ontario. From monthly sales reports produced by the LCBO, Andre Jr. knew that 75% of all wine sales were in the "Golden Horseshoe," the area ringing the western end of Lake Ontario. A survey by a wine industry trade group in 2004 had found that 29 percent of Ontario wine drinkers recognized the company. The Competition Although 75% of Ontario's wines were produced by the largest wineries in the province, the LaFittes viewed such small to medium size wineries as Colio, Hillebrand and Pelee Island as LCW's major competitors. ORGANIZATIONAL STRUCTURE LCW operated with a relatively informal organizational structure. While the lack of clear delegation of authority and responsibility had initially worked well for the company, more recently it had caused staff to feel that "everybody was going in different directions." Andre Sr. admitted he lacked expertise in administration. Although he still signed every check, he said, How should I know what to say to a bookkeeper? Recently the structure had started to formalize with Andre Sr. taking charge of the vineyard and the winery and with Andre Jr. taking charge of marketing. Andre Jr. had divided Ontario into four sales regions and hired a sales representative for each. Sales representatives were paid salary plus a modest bonus based on performance. The structure in 2006 is illustrated in the organization chart marked Exhibit 3. The formalization and expansion of the sales function had followed Andre Jr.'s joining LCW after graduating from the University of Toronto in political science and completing business courses at Niagara University in New York state. Initially, Andre Jr. had been the sole sales representative. He had been promoted to his current position after demonstrating a high level of commitment to the business. Andre Jr. felt hiring good sales representatives was one of the biggest challenges facing LCW. Sales representatives, he felt, did not need to be wine experts, but certainly needed to be more 6

8 knowledgeable than their customers. This was challenging because of the spectrum of customers encountered - that is, from those wanting to buy an inexpensive dinner liter to those wanting wines with specific characteristics. Finding good representatives was also difficult because the sales function had evolved from selling based on relationships to selling based on knowledge and strategic marketing. Andre Jr. said a representative now required a full year of training on the job before they were productive. LCW had hired four representatives in 2004 but was only satisfied with the performance of two of them. The company had relied in the past on Andre Sr.'s judgment rather than formal decision making processes. Andre Sr. was still the ultimate authority, making the crucial managerial decisions. Two clerical staff handled the day-to-day office tasks. They enjoyed the authority they exercised under this arrangement but had trouble coordinating their work. Sometimes some products were out of stock and orders went unfilled. Part of the reason was that LCW s inventory system did not allow for integrated control of inventories, shipping and billing, nor did the record system provide sales data by representative. FINANCE Andre Sr. had strong views about the financial aspects of the business, In this business you can't be poor. You are exposed to a lot of bad luck so you have to have a lot of equity in the business because you can't control risk. You don't want to be heavily in debt. There is nothing wrong with this. For me, having money in a business is as good as having money in the bank. Either way you have to administer your investment. He went on to say: Our business has been a very good investment for us. When we started, the company's book value was $1.6M and now it is $3.6M. The Estate vineyards' book value was $180,000 and now it is $600,000. LCW purchased land over the years because Andre Sr. saw it as a valuable and productive asset. He explained: When you own the land your grapes come from, you also own a vineyard designation. You have to have this designation to be in the highest price points for wine. The French have made consumers think that each location produces a unique wine." Andre Jr. appreciated these land acquisitions. "Dad has made the tough decisions about site selection and land acquisitions. He has bought some of the best land around. He has made the wine business easier for me and my children. LCW and the LaFitte family had benefitted from the sale of easements for a gas pipeline through three of their properties in LCW itself had negotiated $2 million as compensation for the impact that the installation of the pipeline had on the productivity of their vineyards -- vineyards were a valuable use of land. Some of the money had already been received but most would be forthcoming over the next 4 years. Cash flow was most difficult during the harvest season and improved through the winter as wine was shipped. LCW received payment from the LCBO six weeks after it shipped the wine from its warehouse. The company had arranged an operating line of credit from the bank to provide working capital during these periods. 7

9 Ownership in the company was divided among Andre LaFitte Sr., several other family members and Rodger Gordon. Andre LaFitte Sr. and his family held 55% of the common stock while Rodger Gordon, the company's lawyer and a supportive but passive investor, held the balance. THE NEW WINERY Under Andre Sr.'s proposal, the existing winery was to be replaced with a 35,000 square foot castle boasting sufficient equipment to produce 120,000 cases of wine per year. LaFitte Sr. was not concerned about its larger size, saying: "You do not have to be small to be good." In fact, the proposed winery was generally thought by industry experts to be optimal size for a boutique winery, permitting the winery to maintain quality while benefitting from economies of scale. The planned castle would contain, in addition to production equipment, sufficient storage space for the aging of wines, a tasting room, a kitchen, an entertainment room, a wine store, and a research laboratory. The grounds would provide parking for 72 cars and four buses, a garden, and an experimental vineyard. The exterior of the new LaFitte Castle winery would realize Andre LaFitte's dream of a castle in the French/Italian tradition. Andre Sr. was eager to move ahead with the new castle because construction costs were currently favorable. The castle could be built on property already owned by LCW. This property was in an area that was the warmest part of the escarpment. It sat directly across the road from the 50 acre LaFitte Estate. The land was fronted by a regional road which had an average daily traffic flow of nearly 5000 cars. The land was backed by Highway No. 405 which was constantly busy with people going to and from the United States over the Lewiston bridge. Access would only be possible from the regional road although the castle would be highly visible from Highway 405. Andre Jr. thought aloud about how the new castle could contribute to the company's success. A castle would be good for everyone around here because it fits so well with the tourist business in the Niagara region. The tourists who come to Niagara Falls and the Shaw Festival in Niagara-on-the-Lake fit the profile of high consumers of quality wines, middle to upper class tourists who enjoy fine dining, and are able to afford entertainment. A castle would give us a way of prolonging their stay in the area. It could even draw some to the area. And it could be featured in all promotions. That would help build consumer recognition and recall. A castle should be able to draw 90, ,000 tourists annually, compared to the 8,000 we now get. Other wineries in the area attract 75, ,000 visitors each so we should have no trouble. That means the store in the castle should sell 15,000-20,000 cases of wine each year. We're going to have to add two or three staff to handle that volume. Also, Dad's idea of having hospitality rooms in the castle would let us hold lots of events like food and wine seminars for opinion leaders. We can t even think of that in the current building. The castle would also let us make plenty of essential operating changes. Equipment layout would allow for a more efficient product flow, eliminating the occasional stoppages we now have. The new $250,000 bottling line that we've been considering could be installed as well. That would cut bottling costs by $1.05 a case. 8

10 The total cost for building and equipping the new castle would be over $5 million. Anticipated costs (production equipment included the new bottling Line) were: Land $ 250,000 Building $4,000,000 Processing Equipment $1,100,000 Lab Equipment $ 70,000 Total: $5,420,000 Actual cash requirements would be less than suggested in the capital budget because the land was already owned by the company, and $840,000 of processing equipment could be transferred from the old winery. Andre Sr. planned to use the existing winery as warehouse space. A $2.2 million forgivable loan, in effect a grant, had already been approved by the Ontario government based on this projected capital budget. It was available under the terms of a program developed to make the wine industry more competitive. In order to qualify for the grant, LCW had to put up an equal amount of capital and had to have invested all funds by March 31, This meant that either the LaFitte family would have to put more money into the business or a new equity partner would have to be brought in. Andre Sr. did not anticipate any startup problems with the new winery that could not be handled. He felt that the new castle could be built and be operational in months. Once in operation, marketing costs, which included the cost of tours and wine tastings, were naturally expected to rise. Increased costs would be offset by increased revenues as sales rose. 9

11 Exhibit 1: LaFitte Castle Wines Ltd - Financial Summary for Fiscal Years ending August (est)_ thousands of dollars BALANCE SHEET Assets Current Assets Trade Other Inventory Prepaid expenses Fixed Assets Other Assets Total Assets Liabilities & Shareholders Equity Current Liabilities Bank loan Accounts Payable Current portion LTD Total Current Liabilities Long Term Debt Shareholder s Equity Capital stock Retained earnings Total shareholders equity Total Liabilities & Shareholders Equity INCOME STATEMENT Sales Gross Profit Expenses: Marketing expenses Administrative expenses Depreciation & amortization Interest Operating Income (Loss) (55) Other income, tax credits, etc LESS Taxes PLUS Extraordinary items Net Income (Note: in 2006 extraordinary items include compensation paid for pipeline easements on land) 10

12 Exhibit 2: LaFitte Castle Wines Ltd - Product Shipments for Year ending August 31, Brand Retail Price* Cases Shipped** VARIETAL WINES 2005 Seyval Blanc $ Gamay Noir (VQA) Gamay Blanc Chardonny (VQA) Estate Chardonnay Reislingt (VQA) Estate Reisling (private order) Estate Aligote (VQA, vintaged) Estate Pinot Noir Pinot Noir Champaign Brut (private order) Champagne Sec Estate Auxerrois (VQA, vintaged) Late Harvest Reisling (VQA, vintaged, 375 mi. bottles) Est. Gewurztraiminer (Private order, 375 mi. bottles) Average weighted price & total case volume TABLE WINES Sentinel Blanc, 1.5 litre bottles Sentinel Rouge, 1.5 litre bottles Sentinel Blanc Sentinel Rouge Sentinel Blanc, 375 ml bottles Sentinel Rouge, 375 ml bottles Gamay-Cabernet Cour Blanc, 1 litre Cour Rouge, 1 litre Average weighted price & total case volume C Unless stated otherwise, prices are per 750 ml bottle ** in nine litre case equivalents 11

13 Exhibit 3: Organizational Chart for LaFitte Castle Wines Ltd., 2006 President Andre LaFitte, Sr. Office Manager Research Director Field Staff (15) Winery Staff (7) VP Marketing Andre LaFItte, Jr. Book Keeper Research Assistant Executive Assistant Sales Mgr. Eastern Ont. Sales Mgr. Western Ont. Sales Rep. Toronto Sales Rep. Niagra Store Mgr. Oakville Ottawa Store (3) Oakville Store (2) The number in brackets is the number of workers in this component of the organization 12

14 SUPPLEMENTAL INFORMATION ON THE ONTARIO WINE INDUSTRY 1 WINE PRODUCTION IN ONTARIO Ontario wineries competed both among themselves and with foreign competitors. In 2005 imported wine accounted for about 70% percent of all wines sold through the major channel, the Liquor Control Board of Ontario (LCBO). It held such a significant share because it was seen as higher in quality and better value for the money. This dominance was being challenged by the Ontario wineries through the development of higher quality wines more in line with consumer preferences. These new wines were based on a recently introduced vitis vinifera grapes, premium European grape varieties. Making these wines using such grapes was a relatively new business in Ontario. While it cost these wineries more to make these wines than the traditional way, customers had shown they were willing to pay higher prices for these products. In order to bolster its quality image, participants in Ontario's wine industry had formed a voluntary organization, the Vintners Quality Association (VQA), to set and administer an Appellation of Origin system that would put Ontario wines on a par with the leading wine producers of France, Italy and Germany. BASIC PRODUCTION REQUIREMENTS (Data Compiled by the Liquor Control Board of Ontario) The principal steps in making wine are no different in the Province of Ontario than in other wine-making regions on the globe. It involves preparing grapes, fermenting them, extracting the fermented juice and then bottling it. The breakdown of variable costs for wineries in Ontario is approximately 31% for labor, 29% for packing materials, 12% for grapes and 26% for other items. Wineries are in a position to capture economies of scale - for example, a winery making 20 thousand cases a year can produce a bottle of wine for 15 percent less than a winery making five thousand cases, a winery making 100 thousand cases for 25 percent less and a winery making 2 million cases for 50 percent less. Provincial government regulations, administered through the Liquor Control Board of Ontario (LCBO), control all wine-making in Ontario. All wineries must follow strict control procedures to ensure that all taxes are collected on all the wine produced in Ontario. Wineries are limited to pressing no more than 150 gallons of juice per ton of grapes, although some wineries chose to press less gallons of juice per ton in order to produce a superior quality juice. The amount of imported juice or wine a winery can blend with its Ontario grapes is also strictly limited although no winery has been constrained in its production in the past. Finally, all labels used on wine bottles must be approved by the provincial government. 1 Additional information on the industry and the LCBO can be found through Strategis ( through the LCBO site ( and in a number of other sources. 13

15 THE VINTNERS QUALITY ASSOCIATION (VQA) (Data Furnished By The Vintners Quality Association) In order to bolster the quality image of wines produced and sold in Ontario, participants in Ontario's wine industry have formed a voluntary organization, the Vintners Quality Association (VQA), to set and administer an Appellation of Origin system that puts Ontario wines on a par with the leading wine producers of France, Italy and Germany. (Andre LaFitte Sr., founder and owner of LaFitte Castle winery, has been one of the key leaders in establishing the VQA.) Regulations that wineries have to meet to have their wines carry the VQA symbol are as follows: 1. To carry an appellation of origin bearing the word Ontario the wine must be made of 100% Ontario-grown vinifera grapes. 2. To be called a varietal, that is, to bear the name of a grape variety, 75% of the wine must be the specified variety. 3. To be a blended or non-varietal wine, the wine must be 100% Ontario-grown vinifera grapes. 4. To carry a vintage date, at least 95% of the wine must be from the designated year. 5. To be a designated vineyard, 100% of the wine must come from that vineyard, and 6. To be estate bottled, the wine can not have left the estate and the estate must have been leased by the winery bottling the wine for at least three years. Wines meeting these criteria and satisfying taste tests are allowed to carry the VQA symbol. Those that fail to meet these criteria can still be listed with their original varietal label but can carry no other designation. Though only 10% to 20% of Ontario wines are expected to meet the VQA standards, those backing the system thought that the rating system would improve the perceived quality of all Ontario wines. The advantage for an individual winery in having its product designated VQA is that it is likely to be listed automatically by the LCBO. In 2004, VQA wines made up approximately 14% of domestic sales and were selling at an average price of about $20.00, significantly more than the average price for all wines. 14

16 THE LIQUOR CONTROL BOARD OF ONTARIO ITS OPERATIONS & PRICING STRUCTURE The Wine Purchasing and Pricing Structure In the Province of Ontario In the Province of Ontario, consumers buy wine for home consumption at stores of the Liquor Control Board of Ontario (LCBO) and at winery-owned retail stores. In , the 602 LCBO stores sold nearly $1 billion of wine while winery-owned retail stores sold over $100 million of wine. Retail prices are controlled by the LCBO and are the same at all stores. The LCBO sets the price of a wine by taking the wholesale price from the winery, and adding various taxes, markups and charges. The structure of these markup costs has changed over the last few years. Of particular significance has been the change in the LCBO's retailing markup due to agreements under the General Agreement on Tariffs and Trade (GATT) and the Free Trade Agreement between Canada and the United States. Where Canadian wines used to enjoy a significant advantage by having much smaller markups than the wines from other countries, the difference in markups has now been narrowed. Though retail prices are the same at LCBO and winery-owned stores, their retail margins are different. The margin at the winery-owned stores was greater because they did not have to pay a number of taxes and fees that were required of the LCBO. At the same time, though, the winery store did have to cover its operating and marketing costs. The LCBO Retail Stores All products carried by LCBO are "listed" after they pass a rigorous screening for quality and uniqueness. The year a wine is listed, its supplier can force up to 100 LCBO stores to carry it. It should be noted that LCBO store managers resent this practice because unknown wines often do not sell well and this adversely affects the profit margins of the stores. To continue to be carried, the wine must sell in sufficient volume to meet individual store quotas and an LCBO system quota. Managers are very quick to drop a wine that fails to meet these quotas so the supplier's sales representatives work hard to make sure their wines sell in sufficient volume to stay on the shelf on the LCBO stores. The Wineries Retail Stores Individual Ontario wineries have their own retail stores provided they hold the necessary license for each store. Virtually every winery has a store at its winery where it sells wine to tour groups and conducted special promotions. The older wineries have large numbers of additional stores while the newer wineries have varying numbers. All available store licenses have been distributed among the wineries. Each store is only allowed to sell its own wine. Most operating decisions including location, pricing, promotion, and hours of operation have to be approved by the LCB0. Restaurants and Bars Licensed by the Liquor Licensing Board of Ontario Wine is also sold to consumers at restaurants and bars licensed by the Liquor Licensing Board of Ontario (LLBO) to serve poured drinks. Sales representatives from the wineries try to convince each establishment's wine buyer to carry their wines. Often they have to educate the buyer and servers about wines. Once the licensee decides to carry a wine, all purchasing activities are handled through the local LCB0 store. Wine in bottles is picked up at the store while wine in kegs (sold by the glass or carafe rather than the bottle) is shipped directly from the winery to the licensee. The licensee pays 10 percent below the LCBO's retail list price but the taxes paid on each liter of wine is the same as those paid by the retail customer. The LCBO applies its markup on bottles but not kegs; the winery charges the licensee directly for delivery of kegs. 15