Wine Recession: Winners & Losers

Some people think that the long hard winter of the economic crisis is coming to an end and “green shoots” are emerging. It is too soon to tell if this view is correct, but not too early to begin to assess which parts of the wine economy have been hardest hit by the recession and which have actually benefited. Herewith a brief analysis of winners and losers.

Wine Market Breakdown

There are several ways to break down the winners and losers in the wine market. The first and most obvious is by price segment. Distributors are finding wines in the $25 and up category difficult to move through normal retail or “off premises”  sales channels. This doesn’t mean that everyone is buying Two Buck Chuck, however. The “super-premium” $10-$15 segment continues to grow, for example, although the trading down effect is still significant. The woman who was willing to pay $20 two years ago now aims to spend $15 or less, with similar changes further down the line.

Some wine brands have been particularly well positioned to attract value-seeking buyers. Gallo’s Barefoot wines, for example, have gained market share among the “fighting varietals” and the CMS by Hedges red and white blends have done well in the $10-$12 category, as have many others.

Since most Wine Walls are arranged with the most expensive wines on the top shelf and the cheapest at the bottom, it is almost as if the top shelf has been eliminated and all the other wines moved up one rank. Whether this is a temporary or a permanent shift remains an open question. I explicitly do not assume that everything will reset back to “normal” once the recession’s game of musical chairs has come to an end.

On-premise sales have declined, too, as restaurants have felt the recession’s sting. It has been especially interesting to watch as restaurants adjust by switching to lower cost wines from beyond the “usual suspect” regions. Reds from Spain and whites from Oregon, for example, can be sold profitably at lower price points than the better known French and Californian alternatives. Because buyers may not be as familiar with these wines they can enjoy the adventurous experience of “switching over” rather than simply “trading down.” Restaurants can maintain their margins at lower prices.

Wine Geography

Inevitable the recession has had uneven effects on different regions and countries. The news from Northern California is not good, for example, with many reports of surplus grapes, some that will not find a buyer this year. Cost is a big factor. Napa and Sonoma are high cost growing regions. The rule of thumb is that $2000/ton grapes produce $20/bottle wine — that’s how it pencils out when all the costs and mark-ups are accounted for. It is difficult to know who will buy wine made with $3000/ton grapes in the present market if, as we are told, the $25+ segment is a “dead zone.”

There is better news here in Washington state, on the other hand. Sales of Washington wine are rising at a 9% rate according to recent data. This makes sense because so much of Washington’s wine is positioned in the $15 and under category. About three quarters of all Washington wine is produced by Ste Michelle Wine Estates’s brands such as Chateau Ste Michelle and Columbia Crest that provide good quality and good value.

Argentina is another winner. Much like Washington State, Argentina produces good value wines at every price point and has increased sales across the board, although I suspect that Malbec at $10-$12 leads the way. While the overall US wine market has grown by 4.8% over the last year according to the most recent Nielsen Scantrack numbers, sales of Argentinian wines have risen by 46.8% — a tremendous if unsustainable rate of growth. By comparison Chilean wines sales have risen by 12.7%.

New Zealand’s wine industry is heading toward a crisis, as I have written before, but this seems less about the recession than a simply matter of demand and supply. You cannot double and redouble vineyard acreage forever and expect the export market to absorb every drop.

Australia is suffering, too, but like New Zealand I think the recession is a secondary “tipping point” factor. Wine imports from Australia are down 2.5 % for the last 52 weeks and Syrah/Shiraz sales are off 5.2% for the same period. Australia is facing all sorts of problems — drought, fire, recession and so forth — but the biggest problem maybe that “brand Australia” has gone out of sytle, taking the whole Syrah/Shiraz category with it. Even unfashionable Merlot has done better, with 0.8% growth.

The French Connection

I think France is the big loser from the recession, especially the segments that previously earned a “prestige premium,” particularly Bordeaux and Champagne. There is enough Champagne squirreled away in producer cellars to supply the market for several years. I think the big houses would pass on making any new wine this year if they could.

Even the famous chateaux are cutting price in Bordeaux this year, so I can only imagine what things are like for the producers of ordinary bottlings and bulk wine. French wine is a drag on the market even in Britain, where South African wines are surging ahead. Brand France, like Brand Australia, is in steep decline, although for different reasons.

There is a lot to be learned from a close study of the wine recession. The most important, at this point, is that it is more than a decline in demand. There are hints of more profound structural changes taking place. The more things change, the French say, the more they stay the same. I wonder if that will be true this time as the recession’s grip slowly weakens?

8/31/2009 update: An article in today’s Times of London suggests how severe the crisis is in Champagne. (Click on the link to read the rest of the story.)

Hopes of a glut of cheap champagne are set to be dashed when vineyards meet next week to agree on a big cut in production to prop up prices.

With sales falling, producers may be ordered to leave up to half their grapes to wither on the vine in an attempt to squeeze the market.

Merchants are pushing for an historic reduction in yield as they seek to ensure that champagne remains an expensive luxury. “Everyone agrees that production has to be cut because no one here wants to see prices fall,” an industry insider said. “The only disagreement is on the scale of the cut.”

The backdrop to the debate is a slump in sales for champagne makers, from 338 million bottles in 2007 to 322 million last year and a predicted 270 million this year. The fall stems in part from a slide in demand, estimated at about 10 per cent, and in part from destocking by distributors, notably in Britain and the United States.

9/3/2009 update:  A great article in today’s Wall Street Journal on the crisis in Champagne. Check it out!

Wine Recession Reports

Economists joke that data usually come in one of three forms: the incomplete, the inaccurate and the forthcoming. No wonder we are such unreliable oracles!

Wine economics data generally takes one of three forms, too: highly processed  statistics, persuasive but unscientific anecdotes (bloggers are a big source of these) and public reports, such as newspaper and magazine stories.  Each type of data has its uses and each has its weaknesses.

The wine economist’s job is to try to piece them together to get a reasonably accurate picture of what’s going on.  This post tries to do  just that — I use a recent statistical release, a personal anecdote and a magazine report to reveal an outline of some of the ways the economic crisis is affecting the wine market.

Lies, Damned Lies and Statistics

There are three kinds of lies, Mark Twain said, and statistics are the worst of them. They can be pretty useful, however, if you know how to handle them. The Global Drinks Market: Impact Databank Review and Forecast has just released data about worldwide wine consumption and the news is a bit grim.  Global per capita consumption of wine was down in 2008. At 3.5 liters per capita, the global average is a full liter per person per year than in 1990.

A close look at the data indicates that the falling average is the net effect of two opposing trends.  Wine consumption in the New World continues to grow in volume terms (the increase in terms of value is somewhat less due to the on-going trading down effect).  At the same time wine consumption in the Old World, where both production and consumption are still the highest, has fallen off the table (also continuing a trend).

New World consumption is rising, but not enough to compensate for falling Old World demand. The falling per capita average is real, but it masks somewhat an even more important trend — a fundamental global restructuring of the wine world.

A Wine Spectator’s article reports that

Until recently, overall wine consumption was growing, thanks to emerging markets. But the recession has depressed total consumption as well. The United States still represents tremendous potential for the world wine market—Americans consumed an average of only 9 liters per-capita last year, compared to 51 liters and 44 liters, respectively, for the French and Italians. Canada, Chile, South Africa and Australia have all enjoyed steady consumption growth also, as have the emerging markets of India, Taiwan, South Korea and Norway. But China will probably account for much of the future growth in global wine consumption, as the Chinese drink less than a bottle of wine per person annually. The financial crisis has slowed down this growth momentum somewhat, but huge opportunities still abound, especially for large multinational wine companies doing business in China.

I remain suspicious of the potential of the Chinese market, especially in the short run, but I agree with the gist of this. When examined closely, the data tell an interesting story.

Listening to the Wine Wall

Anecdotes are a second source of wine market information. Anecdotes are dangerous because, while they are usually more casual observations rather than rigorous studies, people find them incredibly persuasive.  It is their personal nature that is so appealing, I guess, and the fact that you can dine out for weeks on a really good story. A good statistic or table of econometric results (sigh) just can’t compare.

My anecdote is about a particular wine, Leonetti Cellars Merlot.  Leonetti is an iconic Washington State wine producer.  The conventional wisdom is that you cannot buy it — they sell out every year to insiders, people say. The Leonetti Cellars website hints at this without saying it.  The “mailing list,” it says, is full.  There is a waiting list to get on the waiting list, but it will probably take 5-8 years to get to top of the wait list.

My friends who are on the mailing list (or the wait list for the mailing list) vouch for Leonetti’s scarcity.  They snatch up their allocated 3 (or however many) bottles quickly, knowing that people like me, lacking insider status, will never get a taste. (Note: Leonetti doesn’t say that their wine is impossible to buy, only that their waiting list is limited. And I think that limiting the wait list is a good business decision.)

Many people tell me that iconic wines like Leonetti are recession -proof because they are so hard to get that there will always be a market for them. So (here is the anecdote) I was a bit surprised to see Leonetti Merlot advertised a few weeks ago in a Wednesday supermarket ad for a local upscale farm store.  Yup, we’ve got it, the wine buyer told me — want some?  We’re even doing a tasting later in the week, she said.  Further conversations with my wine business friends suggest that Leonetti (and some other “impossible to buy” wines) have often been available, although they are a bit easier to come by now. You just have to ask.

I suspect that some wine distributors find themselves with more high priced wine that they would like to carry in stock right now, especially with restaurant sales slumping in many areas, and the surplus is filtering down the distribution chain, even showing up on farm store shelves.  It’s only a story, but it suggests that the economic crisis is hitting wine producers even at the top of the ladder.

And the grocery store ads that arrived today (anecdotally) back this up — they feature more hard-to-get wines and, unlike the Leonetti case, they are being sold below their release price!

RH Phillips, RIP

The Sacramento Bee reports today that Constellation Brands is closing the RH Phillips winery. Here is an excerpt from the report

R.H. Phillips Winery is being shut down by its parent company, Constellation Brands Inc. The Victor, N.Y.-based company, which also owns the Robert Mondavi Corp., is the world’s largest wine company with annual sales of 95 million cases of wine.

R.H. Phillips Winery’s 1,700 acres of vineyards, in the Dunnigan Hills area of Yolo County, will remain under the ownership of Constellation Brands.

“(The closure) is part of an ongoing strategic initiative for efficiency,” said Nora Feeley, a Constellation spokeswoman. “We could produce the wines and keep the grapes, but produce them with no damage (to quality) to the wine at Woodbridge.

RH Phillips and Toasted head wine will still be made, but production is being shifted to the big Mondavi plant in Woodbridge, which apparently has some excess capacity.  A big loss for the local community, apparently, and an opportunity to save cost through consolidation for Constellation.

What does this article tell us? Well, it is more like an anecdote that a statistic in that it reports just one story that may or may not be representative of the broader population. It tells us, I think, that the weak wine economy is putting pressure on even the largest players to cut costs and increase efficiency.  The wine recession is affecting the entire market, not excluding Toasted Head and RH Phillips, wines that sell in the intensely competitive $8-$12 range.

Surrounded by Data

It is pretty hard to prove anything with wine economics data but sometimes you can use a combination of statistics, anecdotes and news reports to sort of surround a question.  The three stories I’ve reported here don’t prove anything, but taken together they suggest that the wine recession is being felt globally, nationally and at the local level and at every shelf on the wine wall.

The wine recession is real. Restructuring is already under way.  Or is that just a rumor, too?

Wine, Recession and Argentina

The global economic crisis has been bad news for Argentina, but good news so far for Argentinian wine. Will the wine part of the story have a happy ending or, like so many Argentinian economic booms, turn eventually to bust?

Bad News and Good

The Economist Intelligence Unit reports that Argentina’s economy has been hard hit by the economic crisis. The economic forecast is gloomy (see below) with the only good news being that inflation, while still high, is falling.

Given rapidly declining business and consumer confidence, the government’s fiscal stimulus measures will have a limited effect, and we expect the economy to contract by 3% in 2009, before only a mild recovery in 2010.

Unofficially measured inflation will ease to 10-15% in 2009, as private demand falls. The official rate will end 2009 at 6.8%, with a similar rate in 2010.

The peso will continue to depreciate in 2009 owing to weaker foreign-exchange inflows, before the pace of depreciation slows in 2010. The current-account position will weaken in 2009-10.

The Argentinian wine economy situation is sunnier.  The May 2009 issue of Wine Business Monthly includes two reports that paint a bright picture of Argentinian wine trends.

The first story is a competitive analysis of Argentina wine in the United States market.  It reports that U.S. imports of Argentinian wine have risen dramatically in recent years, from 2.6 million cases in 2006 to 4.3 million in 2008.  The total value of Argentinian wine in the U.S. rose from $75 million to $146 million in this period.

It is important to put this increase in perspective, however. Total Argentinian imports are roughly equal to the annual output of a single US winemaker, Washington State’s Chateau Ste. Michelle. So the Argentinian presence is rising, but from a modest base.

Molto Malbec

Unsurprisingly, Malbec is Argentina’s calling card in the U.S. market. Malbec’s share of Argentinian wine imports increased from 35% to 48% over 2006-2008 measured by volume and from 44% to 55% measured by dollar value. I was interested to learn that Argentina wine sales are rising at all price points, not just in the value brand segment as you might imagine.  But value is still important.  Argentinian wine prices are rising, but still relatively low.  The article reports that the average FOB price has increased from $29 to $33 per standard 9-liter case.

In the same issue the results of the Nielsen company wine market survey for the period ending 2/7/2009 are reported.  Argentinian table wine imports were up 40% by dollar value for most recent year.  This compares to a 10 percent increase for Chile, one percent for Italy and a one percent decline for Australia.  Overall growth in imported wines was 2.4 percent by dollar value for the most recent year.

The 40 % annual rise is spectacular, but  Argentinian wines account for just 1.4 percent of U.S. domestic wine volume compared with two percent for Chile, nine percent for Australia, almost 10 percent for Italy. This shows that Argentina either has a lot of room to grow in the U.S. market, as optimists will perceive, or a lot of work to do to escape niche player status.

American Exceptionalism

I think the Argentina producers were wise to focus on the U.S. wine market for their export surge.  Although the European Union is more important to Argentina in other major export sectors, the U.S. is the target wine market, and that’s a good thing in this economic environment.  EU wine consumption has long been in decline because of demographic and market shifts, for example, while wine sales have been rising in the U.S.

The recession is likely to depress wine sales growth in both the U.S. and the EU, but the impact will be less in the U.S., I believe, if only because I think the recession will be shorter here. My current thinking is that the U.S. economy will benefit from greater short term fiscal and monetary stimulus, compared with the EU, and more effective medium term structural adjustment.  That said, the recession is and will be very severe.

Early U.S. evidence suggests that wine sales have actually continued to rise during in the first year of the recession, when measured by case volume, although the dollar value of those sales has declined as consumers trade down.

Opportunities and Threats

Reading the latest articles on WineSur, a noteworthy Argentinian industry website,  it pretty clear that Argentina producers appreciate both the opportunities and threats inherent in the current situation.  The opportunities — to establish a market presence built around good value and the rising popularity of Malbec — are significant. But I think it must be hard for Argentinians to see silver linings without looking around for associated dark clouds — their country has suffered repeatedly from the global market booms and busts.

Some of the threats are strictly economic. Argentinian producers are currently benefiting from a falling peso value relative to the US dollar, for example, which helps their wine hit market-friendly price points in the US.  But the falling currency is in part a reflection of high domestic inflation rates, which ultimately lead to higher production costs. A lot will depend upon how the inflation (cost) and exchange rate (export price) factors balance out in the future.

Some of the threats relate more to the fickle nature of the wine market itself.  Malbec and Argentina are nearly synonymous today, but this could change as other wine regions adopt their signature varietal. A recent visit to the Walla Walla AVA, for example, found many producers experimenting (successfully, I think) with Malbec.  Argentina has the first mover advantage in Malbec and must capitalize on this because it will face more competition in the future.  This happened to New Zealand (Sauvignon Blanc) and Australia (Shiraz) and I do not think Argentina will be different.

In exploiting its Malbec lead Argentina will need to strike another difficult balance, between establishing a useful “house style” that will build market identity and letting this deteriorate into a stylistic “monoculture” that soon bores consumers.  It seems to me that Australian Shiraz is currently suffering from the “monoculture” curse, perhaps unfairly, while New Zealand still benefits from a popular “house style,” although I’m not sure how much longer it can ride the gooseberry wave, especially given the vast quantities of Sauvignon Blanc that need to be sold.

Argentina is at a crossroads at a critical moment and moving in the right direction.  Count me cautiously optimistic regarding the future of Argentinian wine.

Update: Just hours after I posted this piece about Argentina the following item appeared on the Decanter.com website.

Argentine wine harvest down 25%

May 1, 2009  / Jimmy Langman

Due to climatic conditions, this year’s wine harvest in Argentina will be down 25% as compared to last year.

According to Argentina’s National Wine Institute, hail in some provinces, and overall higher temperatures in February and March, are factors in the lower production output this year.

The lower production this year has occurred despite Argentina having a 12% increase in land under cultivation for wine grapes.

Guillermo Garcia, president of the National Wine Institute, said: ‘If there had not been an international crisis, we would not have been able to provide wine to countries with developed markets.’

Garcia added that Argentine wine companies need to begin keeping more than three months of stock on hand to make up for such production shortfalls.

Exequiel Barros of the Mendoza-based Caucasia Wine Thinking consultancy told decanter.com that many Argentine wineries are worried about their ability to supply medium-priced wines but added: ‘We need to see how the international outlook develops this year before we can dare to make any projections.’

In Chile, wine growing areas that are not irrigated, such as Cauquenes in the Maule Valley, are predicting a similarly low harvest, with an estimated drop in production from 30 to 40% because of higher temperatures and low rainfall.

Most wineries in Chile, however, are reporting a good harvest. ‘The lack of rain has been good for this year’s harvest. But wineries in the far south, such as in the Bio Bio, may experience changes to quality because of the higher temperatures,’ said Edmundo Bordeu, professor of oenology at Chile’s Catholic University.

Wine, Recession and the Aldi Effect

Aldi stores are about to expand in the United States, drawn here by the recession according to an article in today’s Wall Street Journal ( “Aldi Looks to US for Growth” ).  I wonder how this will affect the wine market?

A Tough Nut to Crack

Aldi is a German “hard discount” store chain.  A “hard discounter” sells a limited selection of house-brand goods at very low prices in small, bare-bones outlets.

Hard discounters are a niche, albeit a growing one, in the U.S.  Wal-Mart is a successful discounter, of course, but not a hard discounter because it still features many mainstream branded products, its prices are higher and its stores a bit more plush.  Aldi and other hard discount stores drove Wal-Mart out of Germany, according to the WSJ article, but the U.S. market has been a tough nut for the hard discounters to crack. American consumers are primed to buy brand-named products and they like lots of choice, marketing experts say, and so tend to resist the house brands that hard discounters feature, which has limited their penetration here.

Germans are more willing to sacrifice brand names for low prices, apparently.  Aldi and other hard discounters are dominant powers in German retailing. The WSJ reports that 90% of German households shop at Aldi stores and 40% of all grocery purchases are made in hard discount outlets.

Divide and Conquer

Interestingly, there are actually two Aldi store chains in Germany (with similar but different logos — see illustration above).  Aldi is short for ALbrecht DIscount. The Albrecht brothers  who founded the company after World War II fell out over the issue of tobacco sales in their stores.  They divided the German market between them (Aldi Nord and Aldi Süd) and then, eventually, split up the world market too.  Here are links to Aldi USA and Aldi International websites if you want to learn more about this retailer’s local presence and international reach.

Aldi Süd has been in the United States since the 1970s.  The corporate website tells the story this way.

The ALDI way of shopping has been continuously honed and refined since our first store opened in Southeastern Iowa in 1976. Committed to bringing food to customers at the lowest prices possible, our early stores set up shop in small spaces and introduced shoppers to the limited-assortment concept, carrying only 500 private-label items. Compared with other supermarkets, our stores seemed tiny. But ALDI found a niche with Americans hungry for real value, and the chain grew rapidly.

Over time, more products were added, including more refrigerated and frozen foods. ALDI also began experimenting with Special Purchase items, to great success. More recently, Sunday hours were instituted, and ALDI began accepting debit cards.

Today, there are nearly 1,000 ALDIstores in 29 states, from Kansas to the East Coast. And today’s ALDI store carries about 1,400 regularly-stocked items, including fresh meat, and, in certain locations, beer and wine. Though the original ALDI concept has been modified somewhat to accommodate our ever-changing tastes and preferences, the core concept remains: “Incredible Value Every Day.”

The German origins of the store are apparent in this description, from the traditional Sunday closing to the very limited selection.  Your local upscale supermarket carries at least 10 times as many products as a typical Aldi.

Wine is an important product in Aldi’s German stores, as you can see from the wine selections featured on their website.  I believe that Aldi is the largest single retailer of wine in Germany.

Since Germans are rich and Germany makes great wines, you would think that Aldi must sell mainly fine wines, but you would be wrong.  Aldi’s median  German wine sale is red not white, imported from a low cost producer, sold  under a house-brand name, packaged in a box or TetraPak and priced at around one euro per liter.

You could say that it is Two Buck Chuck (TBC) wine, but in fact TBC is more expensive.  TBC is to Aldi wine as Wal-mart is to Aldi itself. (Note: Wal-Mart now has its own brand of two dollar wine, which makes this comparison even more appropriate. It is called Oak Leaf Vineyards and is made for Wal-Mart by The Wine Group.)

The Aldi Effect

Aldi figures that the recession is its moment to press more vigorously for U.S. market share.  Data indicate that consumers are much more cautious now, so perhaps they won’t be so picky about brand names and will, like their German cousins, be willing to trade down for a lower price. The Financial Times reports that Aldi sales in Great Britain are up 25 percent! Aldi plans to speed up store openings in the U.S. and to expand into New York City. New York!  If you can make it there … well, you know.

This may be Aldi’s opportunity in wine, too. Most but not all Aldi stores in the U.S. (damn U.S. liquor laws!)  sell beer and wine. Aldi’s U.S. website boasts that

ALDI believes that life’s little pleasures should be affordable for everyone. In many of the countries where ALDI calls “home,” we’re known for exceptional values in wine and beer. And now, we’re bringing that tradition to the United States.

Thanks to our global reach, we’re able to partner with winemakers and brewers around the world, to bring you exceptional beers and wines at remarkably modest prices.

Our wines come from all of the world’s best wine producing regions: Germany, France, Spain, California, Argentina, and Australia. Our beers are sourced from Holland, Germany, and Latin America. Some carry our private labels, others carry the labels they wear in their native lands—but all are exclusively ours in the U.S. So now you can raise a glass to “Incredible Value Every Day.”

The good news here is that Aldi’s U.S. push may also help drive wine deeper into the U.S. consumer mainstream.  You can say all you like about the quality of Two Buck Chuck but it sure did help expand the wine culture in the U.S. and some (but not all) my TBC-drinking friends have moved upmarket for at least some of their purchases. The wine may not be very good (a matter of taste), but its market impact has not been all bad.

Will Aldi Succeed?

Will Aldi’s drive be successful?  There is reason to think it will be. They seem committed to tailoring their hard discount operations to local market conditions, which is important because markets have terroir as much as wine.

But there is a more important reason.  Both German Aldi chains are present in the U.S. now, although you are probably not aware of them.  Aldi Süd operates on under the Aldi name, of course, with the same logo as in Germany.  The owners of Aldi Nord invested years ago in a different chain, based in California and intentionally tailored for thrifty but upwardly mobile U.S. consumers. It’s an upscale Aldi Nord and it has been very successful here.

Perhaps you’ve heard of them.  They have limited selection, smaller stores, lots of house brands, and low prices.  They even sell a lot of wine.  The name?

Oh, yes.  Trader Joe’s!

Trading Down: Wine and Recession

The second in a series of reports on how the economic crisis is affected the wine market. (Click here to read the first post.)

A Wine Recession?

Evidence continues to pour in that the economic crisis is having a significant impact on the world of wine, but some industry people seem to be in denial.  They tend to fall into three groups.  The first say that yes, customers might trade down and away from your part of the wine market, but my wine is still selling fine, thank you! The second group believes that people drink more, not less, in bad times, so the overall wine market is recession proof.  The third likes to think of wine as an investment and argues that with traditional financial investments doing so poorly affluent people will switch over to fine wine and power a continuing boom in these “liquid assets.”

There is of course some truth in each of these views. Cult wines like Screaming Eagle will still sell out no matter what happens on Wall Street — no one wants to be dropped from the distribution list in bad times because it’ll be impossible to get back on when the economy picks up. And there are wines that are positioned to benefit from a down market (see below) while others suffer.  But this only tells us what we already knew, which is that wine isn’t one big market, it is a lot of big, small and medium sized market segments and it is no surprise that they all aren’t affected equally by any trend.

People may in fact drink more alcohol in a a down economy — call it wine relief or corkscrew therapy. But even if they do, it doesn’t necessarily mean that they’ll drink more wine, does it?  Wine isn’t always the cheapest way to drown your sorrows. And it sure doesn’t mean that they’ll pay more for wine, even if they do drink more of it, because they are likely to trade down to cheaper products. Econ 101 teaches us that total expenditure falls with price when demand is inelastic, as it may be in some wine market segments.

And the evidence shows that some but obviously not all wines are good financial investments, but it is important not to over-generalize this effect.  When the influential Canadian wine writer Beppi Crosariol recently quoted the importer of wines such as Domaine de la Romanée-Conti on the benefits of wine investment in his column in the Global and Mail he was flooded with comments ridiculing the idea of wine as a general investment strategy.

The Permanent Lifestyle Hypothesis

There is lots of evidence that the economic crisis is affected the demand for wine.  Restaurant sales have been especially hard hit and grocery store customers are trading down in the quest for good value.  But is trading down really the right term to describe this phenomenon?  We know from Constellation Brand’s market surveys that some wine buyers are influenced mainly by price, so that trading down to a cheaper product comes naturally to them.

But other market segments (the ones responsible for much of the growth in wine sales in recently years) are what I think of as lifestyle wine consumers.  They watch the Food Network, buy lifestyle magazines like Gourmet and Bon Appétit that are heavy with wine advertising and think of themselves as people with sophisticated lifestyles that include wine, fine dining and probably even wine-related travel. (Note: even Cooking Light magazine has a wine column now — I was quoted on page 184 of the October 2008 issue.)

Lifestyle wine consumers are unlikely to give up wine during a recession because it would mean more than changing consumption patterns, it would mean sacrificing an important element of their carefully constructed identity.  But I don’t think they will necessarily simply trade down to lower priced wine — Carlo Rossi or Two Buck Chuck — either, because that would also undermine self image (to the extent that this is based upon consumption patterns).  I believe that people will try to maintain their lifestyle identity through the economic cycle to the extent they can.  This is a lifestyle variation on Milton Friedman’s economic theory of the permanent income hypothesis.

So while some people will trade down to lower price, others will trade over — to a different idea of wine that allows them to spend less without feeling like they are giving up their lifestyle.  I’m still serious about wine, their choices say, but I don’t take my self so seriously all the time.  I like to have fun with wine and so I’m buying wine that reflects this fact now.

Barefoot Cellars: Trading Down or Trading Over?

This, I argue, is what’s behind the recent success of Barefoot Cellars wine, which has experienced rising sales in the decling market.  It is pretty clear that consumers are trading down or trading over to Barefoot.  Why?

Barefoot Cellars is a wine with a casual image — kick off your shoes and relax! — but the wines have a serious side, too.  Barefoot wines are entered in various wine competitions and the labels proudly display the gold medals they’ve earned, something that gives these products credibility on the Wine Wall despite their competitive price point.  (Barefoot California Zinfandel retails for $6.99 or less in most markets.) Wine critics have given some of the wines favorable ratings and they often appear on published “Best Buy” lists.

The Barefoot brand was founded in 1965 by Davis Bynum and passed through various hands before being purchased by Gallo in 2005. (Here is a history of the brand.) Jeremy Soine, a former student of mine at the University of Puget Sound, is the brand’s manager; I asked him why it has been so successful.  Here is our Q&A.

Who is buying Barefoot and why?

Barefoot Wine is marketed to the “young at heart.”  The idea of “getting barefoot” is universally appealing, whether you are 25 years old or 75 years old.  At the end of the day, most of us look forward to that moment where we can “kick our shoes off” and disconnect for a few minutes from our hectic lives.

What can you tell me in terms of sales trends? 

Barefoot Wine is one of the top selling wines in the United States, and sales growth continues to significantly outpace the wine category. The sales growth of Barefoot has actually increased during the past six months, and I believe this is because people are seeking out better values as they have fewer extra dollars to spend. Much of Barefoot’s popularity has occurred during the past few years, but many people don’t realize that Barefoot Wine was actually started in 1965 by Davis Bynum, who is not now famous for his Pinot Noirs.

Have you changed your marketing strategies in any way to compensate or take advantage of the changing market conditions?

Barefoot is the most awarded Winery in U.S. wine competitions for under $15 per bottle, and we actively communicate these awards to people by placing medallion stickers right on the bottle.  We believe that the medallions give people the confidence that they are buying a wine that has been recognized by wine critics.

Do you think that Barefoot’s succcess is due mainly to the trade-down effect — that is, is it driven by the poor economic times, with consumers trading down to cheaper products?  Or is there more to it than that?

Barefoot does not spend money on traditional advertising like other large wine brands.  Rather, we donate wine to local non-profit organizations.  This allows people to try Barefoot wines, and also frees up funds for non-profit organizations.  In 2008 Barefoot Wine will be poured at more than 3000 non-profit events in most communities in the United States.  We believe that this grass roots approach will win in the end because people appreciate these donations, will love the wine and will recommend the wine to their friends.  Fewer than half of all wine drinkers have even heard of Barefoot Wine, and we are fine with that because people want to “discover” wine, not be mass-marketed to through television ads or billboards.

So Barefoot seems to have benefited from the trading down effect, but I think you can also see a trading over effect.  Paying less?  Yes.  But buying a different idea of wine: relaxed but not unsophisticated and with a social agenda that fits the times. I don’t want to push the Barefoot case study too far — to over-generalize it — but I think there’s something to be learned from this brand’s success.

The Curious Dominance of Family-Owned Wine Businesses in the U.S.

Last week’s column about the rise and fall of the Taylor Wine Company of New York raises a number of interesting issues and one of them is the singular importance of family-owned and privately-held businesses in the U.S. wine industry and the very mixed record of publicly-listed wine corporations. In retrospect, a case can be made that Taylor’s downfall began when they made the initial move from family ownership to public corporation.big10

The conventional wisdom holds that family-owned and privately held firms can be very successful, but their scale and scope are necessarily limited. Corporations, it is said, can have better access to capital and may be able to negotiate risk more successfully because of limited liability structure. You might expect the largest firms in any given industry to be corporations and this is true in some industries, but not in others.

Wine Exceptionalism

Wine is one exception to the dominant corporation rule. Here (above) is a table of the ten largest wine businesses in the U.S. market (measured by estimated or reported volume not value of sales) for 2014 and 2003. The data are from Wine Business Monthly, which publishes an analysis of the 30 biggest U.S. wine firms each February.  I’m looking at just the top ten to keep the analysis simple, although I should note that these ten firms collectively account for about three-quarters of all wine sold in the U.S. You can find a link to the whole list at the end of this column.

Looking at the 2014 data, you will note that only four of the top ten firms (those in italics) are public corporations or subsidiaries of public corporations. The other six are family-owned or, like The Wine Group, privately-held and together they produce more than half of all the wine sold in America. The bias towards private- and family-ownership is even stronger if we look at the next 20 wineries where only a few corporate names like Pernod Ricard make the list.

The picture becomes even more interesting if you look at the list for 2003, the first year that Wine Business Monthly released its Top 30 report. Many of the players remain the same, but the names of three public companies (shown in boldface) that were in the top ten a dozen years ago have disappeared by 2014: Beringer Blass Wine (now part of Treasury Wine Estates), Robert Mondavi Winery (now part of Constellation Brands), and Brown-Forman Wines, which sold its big Fetzer wine business to Concha Y Toro in 2011 so that it could focus on spirits. Concha Y Toro is #11 on the 2014 list.

Looking closely at the 2014 numbers it is hard not to be impressed by the growth of family firms Delicato and Jackson Family Estates and also the success of Ste Michelle Wine Estates, which seems to behave like a privately-held firm even though it is a subsidiary of a public one, albeit in a different line of business (Altria specializes in tobacco products, not drinks).

All in the Family

Family- and private-owned wine companies are if anything more important today than they were before the Great Recession. Why are family-owned wineries so vibrant despite their structural economic limitations?

The conventional answer to this question — and there is in fact a substantial academic literature dealing with family businesses and even family wine businesses — stresses the ways that family businesses take a multi-generational approach and are able to negotiate the trade-off between short run returns and long run value. Corporations, it is said, are sometimes driven too much by quarterly returns and end up sacrificing the long term to achieve immediate financial goals.

When business requires a long run vision, it is said, families gain an advantage. Wine is certainly a business where it is necessary to look into the future if only because vines are perennials not annuals like corn or soybeans and successful brands are perennials, too.

Another school of thought examines issues of trust and transactions costs within the firm and the ways that family ties can reduce internal barriers and make interactions more effective.  It is commonplace to say that wine is a relationship business and family firms may have advantages in this regard. I have knows some family wine businesses that even go out of their way to work with family-owned distributors and so forth.  I think one author saw family-to-family links (the Casella family and the Deutsch family) as keys to the success of Yellow Tail brand wine.

Maybe the Real Question Is …

There are good explanations for the success of family-owned wine businesses, but sometimes they feel a bit ad hoc, tailored to explain a particular case and less capable of generalization.  And they often fail to fully account for the fact that many family businesses (and family-owned wine businesses) either fail or, like the Taylor family, end going over to the dark corporate side. Family relationships can be good, bad or ugly — you cannot think of the Mondavi family story without channeling an episode of Family Feud) and not every new generation wants to stay in the business. So there must be something more here than simple families think long-term. But maybe we are actually asking the wrong question.

Maybe the question isn’t why family-owned wine businesses are so strong and instead why corporate owned wine businesses are sometimes so ineffective. Is there something about wine that turns smart corporate brains to mush (not all of them, of course, but maybe some of them)? Come back next week for some thoughts on this provocative question.

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You can view the February 2015 issue of Wine Business Monthly here. The story on the Top 30 wine U.S. wine businesses begins on page 40.

Premiumization: Is This the Wine Market’s New “New Normal?”

Is the current U.S. wine market the new “new normal” — can the recent upmarket shift in wine sales be sustained into the future? Two recent Wine Economist columns have detailed the surprising bifurcation of the U.S. wine market and tried to understand what forces are behind it. Wine sales below about $9 are stagnant or falling while upmarket sales revenues are increasing, with the largest percentage rise in the $20+ segment.

This is a surprising state of things, I argued two weeks ago, because the conventional wisdom once held that the Great Recession had created a “new normal” that centered on trading down behavior and discounting strategies. Not many people argued that we’d be “trading up” in the post-recession world.

And, as I noted in last week’s column, it is not clear that it is a simple return to previous behavior. I analyzed several theories for the change and concluded that none of them told the entire story, but together they explain the situation fairly well. So now we have to ask if those trends will continue — if the new market structure is the new “new normal” — or if the upmarket movement is unsustainable.

My answer — typical of an economist — is that it depends. It is really too soon to tell what will happen in the long run because there are so many unpredictable factors to consider. But since I asked this question I feel I ought to give more of an answer, so here’s my attempt at crystal ball gazing.

It’s too soon to tell about the U.S. market in the long run, but the current pattern is likely to be sustained for the medium term, although not necessarily due to the same factors that created it in the first place. Here’s my reasoning.

Decline and Fall of Down-market Wine

Inexpensive wines are not going away, but it seems unlikely that they will soon return to solid growth. This might be because of the alleged “bad wine” effect that I talked about last week, but it is more likely due to supply-side effects.

With water issues rising to the surface almost everywhere and higher irrigation costs in many places, the economic sustainability of low-cost wine grapes is in serious doubt at current prices. Jeff Bitter’s presentation at this year’s Unified Symposium in Sacramento included photos of acres of healthy Central Valley grapes left to rot on the vine because they were not worth the cost of harvest this year and probably not worth irrigation costs next year.

What is the future of these vines? Thousands of acres of vines have been grubbed up in California in recent years to make way for other crops with higher potential value — almonds and pistachios are the most frequently cited crop alternatives, but I’m sure there are others.  Imported bulk wines can easily fill in the gap left by falling California production in the short run, but sustainability issues (both economic and environmental) are a global phenomenon.

Low-cost wine grapes (and the wines they produce) are not going away, but there is limited incentive to invest here and so the focus is upmarket, where margins are better and business sustainability is more feasible.

Up the Down Staircase?

The upmarket movement in wine sales is likely to be sustained at least for some time because it is driven by factors affecting both demand and supply that are not specific to the U.S. but part of strong global trends. The supply-side element is easy to understand. Intense competition has cut margins on basic wines to the bone (and even deeper than that in some markets). Follow the money, Deep Throat said, and wine producers are listening to that advice now more than ever.

Once again, that doesn’t mean that basic wines and the bulk wine trade that has evolved around them are going away. It is simply that this is not the market segment that will get investment in future. Producers are likely to focus even more on the premium, super-premium and ultra-premium segments in the future. Every wine producer I have talked with around the world is focusing on moving up the up staircase and plotting effective distribution and marketing strategies.

On the demand  side I would point to the increasing importance of retailers like Trader Joe’s and Whole Foods and their many upscale local market competitors that attract customers by providing them with a sense of authenticity and affordable luxury in the quotidian consumption experience.

Products of origin and artisan creations with sustainability credentials — these are the hallmarks of the new retail environment and upscale supermarkets and a growing number of their customers seek out wines that fit that profile. Even hard-discount Aldi is playing along on the wine aisle, providing unexpectedly premium wines in their U.K. stores.

Bronco Busting

Don’t believe that the shift is important? Well, it wouldn’t be the first time that I’ve been wrong, but I think you will find evidence all around you if you look for it. Let me give you just one data point to get you thinking.

Consider the Bronco Wine Company, the famous maker of Two Buck Chuck and many other inexpensive wines. Bronco chief Fred Franzia once said that no wine should cost more than $10 and he built the 4th largest wine company in the U.S. by making those wines both for his own labels and, under contract, for other firms.

Where is Bronco headed today? Well, Two Buck Chuck is still in the picture and I think it is probably still selling about 5 million cases a year as it was the last time I wrote about it. But Bronco is busting out of that market segment via a variety of new products that, while they don’t aim for Screaming Eagle or DRC cult status still fit the profiles I’ve outline here. Several of Bronco’s wines illustrate the upmarket trends that I see for the future, including Garnet and Green Truck.

Garnet Vineyards are maybe not what you’d expect from the maker of Two Buck Chuck. They are all about cool climate Chardonnay and Pinot Noir from Monterey and more cool climate Pinot Noir from the Sonoma Coast. The highly-regarded Alison Crowe (author of the popular blog The Girl and the Grape)  makes the wines . The Garnet Rogers Creek Vineyard Sonoma Coast Pinot Noir ticks the boxes key to buyers seeking authenticity and sells for $29.99 on Amazon.com, about ten times the price of a bottle of Two Buck Chuck.

(Editor’s note: Bronco is the sales agent for Garnet but does not make this wine — see Alison Crowe’s comment below, which clarifies the relationship. Thanks to Alison for her correction.)

The long list of wines that Bronco produces and/or distributes includes six different organic wine brands plus a number that are vegan-friendly. Green Truck wine from Mendocino County is a good example. The wines are made from organic grapes and when I searched to see the nearest retailer to me there was Whole Foods near the top of the list.

Buckle Up!

Wine is looking up! The new normal will focus on wines that tell as good a story as other contemporary market products, such as craft beers and spirits and locally-sourced food products. It’s a great opportunity for wine producers, but the market is very competitive and will only get more so.

Buckle up!  It’s going to be a wild ride.

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I thought you might enjoy this 2007  video of  wine critic Oz Clarke and “Top Gear” presenter James May meeting Bronco’s Fred Franzia. Their reaction to Two Buck Chuck may surprise you. Cheers!

Trading Up? The New Conventional Wisdom About the U.S. Wine Market

Last week I wrote about the unexpected state of the U.S. wine market today, where sales of wines above about $9 are strong and growing while the below $9 segments are stagnant or in decline. Thinking back to the dismal state of the wine market a few years ago, with trading down and heavy discounting, the current situation comes as a big surprise.

What accounts for the transformation of the U.S. wine market? And is this the “new normal” that we should expect for future years? Let’s look at the emerging conventional wisdom on these questions.

Trading Up?

I don’t know many people who think that the shift toward more expensive wines is a simple reversal of the recession years’ trading down, although that doesn’t mean that it doesn’t happen. Consumers seem as price sensitive as ever, which is why store shelves are still papered with “shelf talkers” like the one shown here that beckon buyers with discounted prices.

Yes, discounting is still going on, although perhaps not quite at the same level as during the Great Recession. The best argument for trading up is that consumers who had an opportunity to sample better wines during the deep discount days and  liked them now are feeling more economically secure and are continuing to buy them at higher prices. I’m sure that this is happening to a certain extent, but I don’t think it is the whole story.  Consumers are simply too focused on price to have suddenly changed.

Price resistance means that most consumers aren’t willing to pay more for the same or similar wine, but they are willing to spend more for something different. Who is doing this?

The Millennial Theory

One theory holds that the changing shape of the wine market is driven by younger wine drinkers — we often call them the millennials here in the U.S. but I have also seen the term “echo boomers” used and Constellation’s latest Project Genome study calls them “engaged newcomers.” As a group they tend to buy wine less frequently than some other groups (they also drink spirits, craft beers and so on) but spend more per bottle. This is the opposite of my behavior as a young wine drinker and probably a good thing.

If what we think we know about millennials is true, then they can account for some of the trend towards higher price wine sales, but they are certainly  not the whole story.  They don’t explain the shift away from lower-priced wines because they were never the driving force there. And they cannot account for all of the upmarket shift because at this point they don’t buy enough wine to move the whole market this way. Millennials are part of the story, but not the whole answer. What else?

The Bad Wine Theory

One very interesting theory is that the relative quality of wine below about $9 has fallen, driving customers away in search of something better to drink. They have found it, too, in craft beers, ciders and spirits.

W. Blake Gray recently made this point in a column titled “Wine under $10 sucks. Should we care?”  Tim Atkin made a similar point about wine in the UK market.  It’s very difficult to find decent wine below £5, he says, which is a change from the past.

A recent article on Bibendum’s website tells the sad UK story, which this graphic illustrates. If you want to get value in wine in the UK, it seems you have to move upmarket. The actual cost of the wine is more than a third of the total cost of a £20 bottle, but less than 10% of the cost of a £5 wine. Shocking!

This deteriorating value of inexpensive wines, if true, is a surprising situation. Only a few years ago we experienced something of a revolution when the character of commercial quality wine improved  quite dramatically (I called it the Miracle of Two Buck Chuck in my book Wine Wars). A structural surplus of decent wine and grapes on the U.S. and world markets made it possible for winemakers to assemble products at low price points that rivaled some brands in higher price segments. The unexpected value they provided drew millions of consumers into the wine markets Is poor quality and value pushing them away?

Well, poor value is certainly part of the answer in the U.K., where high wine duties have distorted the market and undone much of the miracle of the past. And I have some friends in California who complain that cheaper and lower quality bulk wine imports are now filling bottles of California-brand wine. The brand is associated with California (like Barefoot, for example) but the wines themselves come from many places (and are so-designated on the packaging).

Have quality and value suffered? I’m an economist not a wine critic, so I will leave it up to you to decide, but some of my California friends think that’s what’s happened. If this is true, then where is the better California wine going? Some of it is sitting in tanks, which are pretty full after a couple of generous vintages in a row. The rest? Some of it, I think, fills the bottles of wine brands specially created for the new market environment.

The Branded Age

This supply-side theory holds that smart wine executives have noticed that many consumers are willing to pay more for something different (and are put off by the commodity wines) and they have responded by creating new brands to fill specific upscale market niches. This helps explain the great proliferation of wine brands and even virtual wineries on the scene.

Each year I enjoy Jon Fredriksen’s talk about the state of the U.S. wine market at the Unified Wine and Grape Symposium, but recently I have noticed that his list of the hottest wine brands is full of unfamiliar (to me) names. These aren’t new wineries, simply new brands created by innovative existing large- and medium-sized wine firms.

Jon’s data suggest to me that these are some of the wines that are attracting buyer interest and pulling the market along. An example? Take The Wine Group, which is the second largest wine producer in the U.S. with 57.5 million case sales according to Wine Business Monthly. A few years ago I thought of them in terms of brands like Almaden and Franzia wines, which are  in that lower market tier that is stagnating today.

Now when I think of The Wine Group I think of Cupcake Vineyards, which at 3 million cases is small compared to Franzia’s 26 million, but perfectly fits that upmarket profile and is often priced right at or just above key $9-$10 threshold along with Apothic, 14 Hands and other hot brands.

Which Theory? The New New Normal?

No single theory explains what has happened and the market is full of special cases. Take Argentinian wines, for example. Customers are buying more expensive products from Argentina now in part because the cheaper labels have disappeared. With inflation still soaring and the exchange rate stuck, many Argentinean firms cannot afford to export cheaper Malbecs to the U.S., which shifts the center of gravity upmarket.

All these ideas (and others, too) are part of the explanation of today’s transformed market. It’s a perfect story of effects (or a train wreck, depending which end of the market you are in). Is this the new “new normal” and, if so, how long will it last? That’s a question for next week.

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Thanks to everyone who commented on last week’s columns — great ideas! Keep them coming.

The Surprising Rebound & Unexpected Bifurcation of the U.S. Wine Market

Let’s climb in my time machine and go back a few years to 2008-2009, when the impact of the global financial crisis was beginning to be felt in the wine markets. It was a pretty gloomy time and there was a lot of talk about the need to reset our expectations to the “new normal.”

Gone were the days of great expectations as everyone scrambled to cope with the changing economic and consumer environment. What did we imagine the future would hold? Well, opinions varied, of course, but the “conventional wisdom” generally revolved around a few dire trends.

Trading Down and Trading Over

One of the most-cited trends was trading down. It sure looked like wine consumers were pulling away from wines at higher price points and shifting to less expensive products — or even moving away from wine altogether. Here’s a video that captures the moment fairly well (it was the first time I was ever interviewed by an animated character)

Trading down seemed like an unstoppable force at the time, although I suggested that it was more complicated. I noticed the strength of the Barefoot wine brand and proposed that it wasn’t just the price of the wine that made it so appealing to recession-battered wine drinkers, it was also the casual image that it offered with its surfer dude footprint in the sand style.

No one wants to admit to themselves that they are trading down, I wrote. Not good for self-esteem. But we can all embrace the idea of trading over — over to a more relaxed, less serious (and incidentally also maybe less expensive) idea of wine. Relax (there is even a brand of Riesling called “Relax”) and just enjoy wine. That’s what I thought I saw in the marketplace.

The $20+ Dead Zone

Whether it was trading down or trading over, the result was the same: the $20 and up segment of the wine market was declared a “dead zone” where nothing moved.  People still drank more expensive wines, then just didn’t buy them. They “drank up” from their cellars rather than “trading down” at the wine shop.

Wineries found that many wine club members were pulling back from scheduled shipments. Restaurant wine sales took a very big hit, too, as consumers dined out less frequently and economized on wine purchases when they did. Restaurants coped by trading down themselves, putting more pressure on wineries.

Dumping, Discounting and Flash Sales

Some wineries held their prices and absorbed inventory accumulations rather than discount or dumped excess wine on the bulk market (where Cameron Hughes and others found some outstanding bargains for their customers). They saw price cuts as a one-way street. You can lower prices, but can you raise them back up again when good times return?  Some wineries split the difference by bringing out second labels to sell for less — chateau cash flow wines — while holding the price line on prestige brands.  Lots of mistakes were made along the way and some wineries fell out of the market.

Many discounting strategies were rolled out. Safeway stores began running promotions where $20+ wines could be purchased for 30% off the regular price (or 40% off with a 6-bottle purchase) — a clear attempt to reduce inventories in the “dead zone” category. A number of “flash sale” wine websites appeared that allowed wineries to sell off surplus stock quickly and outside of the usual sales vectors.

Sometimes wineries found themselves caught in competition with their own wines as buyers (wine club members, restaurants, a few distributors) dumped their stock back on the market, under-cutting carefully calculated producer pricing strategies.

There were some great bargains for buyers who recognized them (and had the credit card headroom to take advantage), but there were not very many true winners among wine producers, especially those in the higher price ranges. The frankly defensive strategy of generating cash flow while protecting key price points was the best that many wineries could hope for.divide

Up the Down Staircase

Would consumers shift back when the recession was over? Not many people held out hope for a reset of the reset. So the current state of the U.S. wine market, which Jon Fredrikson has called “A Tale of Two Markets” comes as something of a surprise.

The U.S. wine market has split in two as the table above shows. (The table shows recent data for off-premises wine sales as measured through the particular retail channels monitored by the Nielsen Company. These data are indicative of what’s going on in the broad market.)

While the market is expanding at a moderate +3.4% pace (at least it is growing, unlike wine markets in some Old World regions), there is a clear division between wines selling at prices below $9 and those that sell for more. Although the cheaper wines make up the majority of the market by volume, they are shrinking in dollar sales value, especially the $6.00 to $8.99 segment.

The New Conventional Wisdom?

More expensive wines, on the other hand, represent a rising market segment. All price segments over $9 are growing as per these data, with the fastest growth at the highest price point — $20 and above!

This is truly a dramatic turnaround for U.S. wine. What is behind this unexpected change?  I’ll survey the new conventional wisdom in my next column.

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BTW that’s a really old picture of me in the video — I hope that  I’ve improved with age since 2008. The Costco reference is a bit off in that interview, too. Costco sells wine at a low mark-up, but they don’t try to compete at the very bottom of the market as the video images suggest. I don’t think I’ve ever seen boxes of Franzia at a Costco, for example.

How Will the Rising Dollar Affect the U.S. Wine Market?

fxHow will the rising dollar affect the U.S. wine market? The answer, predictably, is that it’s complicated. Read on for analysis organized around three questions. Why has the dollar appreciated? What are the textbook effects of a rising dollar? How and why is the impact on U.S. wine likely to be different?

Why has the dollar appreciated?

The U.S. dollar has appreciated dramatically on foreign exchange markets, powered by several factors. Expectations of higher interest rates in the U.S. is a big part of the story as the reality of the end of the Federal Reserve’s asset purchase program sinks in. Add to this the fact that the Europoean Central Bank is finally close to beginning its own quantitative easing program, which will keep rates down on that side of the pond. This combination is a recipe for the sort of change you see in the graph above.

The relative strength of the U.S. economy, weakness of the E.U.with its potential “triple dip” recession and uncertainty regarding China and oil prices all contribute to the economic environment that has helped fuel the dollar’s recent rise. Where is money going to go in a risky world? Can you say USA? A lot of us have been impatiently waiting for the dollar to move higher for a couple of years. Now that it has happened, what should we expect?

What are the textbook effects of a rising dollar?

The classic textbook effect of a rising currency is that imports increase because they are relatively cheaper and exports decline because they are costlier to those holding foreign currencies. Imports up, exports down. That’s where the Econ 101 story often stops, but the situation is a little more complicated.

Prices adjust faster than quantities in most cases. Price effects (rising export costs, falling import prices) tend to happen quickly, but quantities take longer to change because of inventory lags, recognition lags, and contract lags. Basically, it takes time before the new exchange rate translates into real actions because existing inventories must be depleted before new orders are made, because it takes some time before economic actors feel certain that the change is sustained and not just a market blip, and because existing contracts often preclude immediate adjustments.

These lags create what economists call the “J curve” effect, with opposite short-term and long-term payments impacts. The Econ 101 results take longer to show up in significant amounts than you might think and even then will only appear if other intervening economic factors don’t offset them. So predicting the short term impact of an exchange rate change isn’t as simple as you might think even if you earned an “A” in Econ 101.

But price is a powerful force, and the fact that a rising dollar makes our exports more expensive to foreign purchasers (and imports cheaper for U.S. buyers) should not be ignored even if immediate run impacts are not obvious. Don’t expect everything to change at once.

One more complication is that although we like to talk about the dollar rising or falling, the overall trend conceals the fact that the dollar might be higher relative to one currency and still falling compared to another. During one recent period when the dollar was quite weak by some standards, for example, it still rose compared to some other currencies that were even weaker.

How and why is the impact on the U.S. wine markets likely to be different?

Given all this, it is instructive to read a 2012 report by Kym Anderson and Glyn Wittwer titled “Studying the impact of exchange rate movements on the world’s wine markets, 2007-2011” (a University of Adelaide Wine Economics Research Centre working paper — the link takes you to a pdf of the paper). The Anderson-Wittwer study examined the impact of exchange rates on wine trade during a period when the dollar was falling instead of rising and finds that the impact of exchange rates was different in different import markets and in different wine market segments. (I told you it was complicated!)

In the U.K. market, for example, the exchange rate impacts were pretty much what theory suggested both in terms of import effects and distribution among different wine exporting countries. A good textbook case.

But the U.S. was a different story, as you might expect given that we have a substantial domestic wine production base and that we both export and import wine with the two trade flows connected to a certain degree by the “wine drawback program”  (Click here to read a 2012 UC/Davis report on the drawback program.)

The wine drawback program allows a refund of 99% of import duties and excise taxes on wine for which the importer has matching exports of commercially “interchangeable” wine. Because per-unit import duty and excise tax rates are substantial compared to the price of bulk wine, use of the program is high for bulk wine imports, which compete with wine from low-price Central Valley grapes. Bulk wine exports dominated imports until 2009 and the program stimulated import growth. Now, with imports and exports roughly in balance, the program stimulates both exports and imports—leaving net trade in bulk wine roughly in balance.

– Summary of the U.C. Davis Report

The Anderson-Wittwer study found that the falling dollar had different effects on U.S. consumption of  Old World and New World wine imports during 2007-2011. Old World imports increased despite the dollar’s fall and New World imports fell.  Obviously the price effects were more strongly felt for New World wines than for Old World products (see Table 6 of the report) and although Australia accounted for much of the import decline and may be a special case in some ways, Argentina, Chile and South Africa were also negatively affected.

The study found differences by price category, too. Non-premium and commercial premium New World wines were the most affected by the exchange rate changes while super-premium wines showed less impact. This makes sense because the lower priced products are often part of the bulk wine trade, which has become highly efficient, facilitating ease of substitution from one country’s products to another. A small change in cost can have a big impact on the size and direction of trade. Textbook effects rule here.

More expensive products benefit from greater product differentiation. The power of an established brand acts as a shock absorber when costs increase, although there are obvious limits to this.

It’s Complicated

So if Old World imports increased and New World imports fell during the period when the dollar was slumping, can we expect just the reverse now that the dollar is soaring? It would be great if we could just take the Anderson-Wittwer numbers and change the signs from plus to minus and so forth, but life is more complicated than that. Anyone who has tried to sell wine can tell you that it is easier to lower a price than to increase it! It’s a kind of hysteresis in the sense that where you can go now depends on where you have been. You can’t just back out to where you started.

That said I think there are important insights to take away here, key among them is the idea that the impacts are likely to be different for bulk wine and packaged good trade and for Old and New World products.

Textbooks and research give us good guides to understanding the impacts, but there aren’t any simple answers. And the exchange rate isn’t the only thing that’s changing this time around. I know a number of New World producers who made big bets on the Russian market, for example. Seemed like a good idea at the time, but my how things have changed! They’ll be desperately  looking for markets for the wine they can’t sell to Moscow. And imports from Argentina may be more affected by that country’s domestic policies (and the upcoming elections) than exchange rates.

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It occurs to me that this column is a classic example of what Paul Krugman once called “up and down economics.” This goes up, that goes down, and so on. Made me think of the Winslow Homer painting “Right and Left” that you can see in the National Gallery in Washington D.C.

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