The Father of [Wine] Economics?

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Adam Smith is generally regarded as the Father of Economics, even though many wrote on economic topics before him. Was he also the Father of Wine Economics?

The case for Smith’s paternity is made in the most obvious (and least likely) of places, The Wealth of Nation (1776), his most famous work. It is the obvious source because Smith wrote about everything in Wealth of Nations: history, theory, policy, even provided practical advice. It is the least likely place to look, however, because it is so little read (really read, if you know what I mean) and because people only remember the book for two thing: the Invisible Hand and the Pin Factory example of the division of labor. But there is a lot more to be found, including an early treatise on wine economics.

Adam Smith wrote a good deal about wine. This was partly because he traveled in France and learned about wine markets first hand. But it was also a fact that Britain was for centuries a wine-drinking country, as John Nye’s fine book explains, just as it is so today, with a practical interest in wine market concerns.

The foundation of Smith’s wine economics is laid out early in Wealth of Nations, Book One, Chapter 11: Of the Rent of Land. Here Smith tries to explain why some kinds of land earn more than other lands. Land suitable for viticulture earns higher rent, Smith said, and has long done so.

That the vineyard, when properly planted and brought to perfection, was the most valuable part of the farm, seems to have been an undoubted maxim in the ancient agriculture as it is in the modern through all the wine countries

But viticultural profits were constantly threatened, Smith argued. Not by nature, although this could cause bad crops, and not by high taxes, although he argued against them. The chief threat (or perceived threat) to viticultural earnings was expansion to new lands. Old vineyards, as he called them, were threatened by New Vineyards — and would seek protection from them or to prevent their development. This section reads very well today if you change Old Vineyards to Old World wine and New Vineyards to New World Wine. Certainly New World Wines (and their vineyard, cellar and marketing practices) are seen by many Old World producers as a threat to their livelihood. Adam Smith understood why Old would seek by any means to prevent development of the New. You don’t have to have a Ph.D. in economics to already know that he did not approve.

Smith wrote about terroir, too. I can’t really say that Adam Smith invented terroir, the idea of a special taste of place that winemakers strive for, but I can say that he understood its economic value. Smith wrote that

The vine is more affected by the difference in soils than any other fruit tree. From some it derives a flavour which no culture or management can equal, it is supposed, upon any other. This flavour, real or imaginary, is sometimes peculiar to the produce of a few vineyards; sometimes it extends through the greater part of a small district and sometimes through a considerable part of a large province.

I note with interest that Smith recognized terroir and doubted the reality of its existence in the same sentence (“real or imagined”). It isn’t terroir that really matters to a wine economist, I suppose, it is only that people think there is terroir. Smith wrote at length about the economics of these special wines and, because of their limited quantities, the premium prices they could command. Any modern winemaker, upon reading this section, would immediately try to create an A.V.A. to cash in on the possibility of terroir by limiting supply.

The whole quantity of such wines that is brought to market falls short of the effectual demand, or the demand of those who would be willing to pay … The whole quantity, therefore, can be disposed of to those who are willing to pay more, which necessarily raises the price above that of common wine.

A small part of this higher price … is sufficient to pay the wages of the extraordinary wages bestowed upon their cultivation, and the profits of the extraordinary stock which puts this labor in motion.

Smith’s treatment of wine is not complete – there is no discussion of cork versus screw-cap, for example, and no treatment of en primeur wine futures, but what he does say shows pretty clearly how well he understood the political economy of wine.

So, to answer the question that started this entry, is Adam Smith the Father of Wine Economics? Probably not, is my answer. His analysis in Wealth of Nations is certainly very good, but I am pretty sure that earlier economists did not ignore the wine market. The reason: because wine was so very important to economy and society from the earliest days.

The Wizards of Oz

20_australian_wine_industry_segments.jpgWhen I think about the future of the global wine market, my thoughts frequently stray to Australia because that’s where I see so many current trends originating or being most effectively exploited.

Export driven marketing strategy? That’s Australia. Branded varietal wines? Everyone talks about Gallo and Constellation brands, but who has done it better than [Yellow Tail]? Foreign market penetration?  The Aussies again, replacing the French as the strongest competitor in the British market and a strong presence in the United States.

Australia even wins the prize for the most sophisticated national wine strategy. Click on the image above to see a representation of the latest Australia wine strategy, which divides the market into twenty (20!) key segments where Aussie wines can compete.

Australia’s Boom and Bust

No doubt about it, if you want to learn about wine economics and integrated wine business, you should look to Australia. But that doesn’t mean that all is well down under. As I have written in previous posts, Australia has experienced a roller-coaster of wine market problems. First it was the problem of over-supply, which pushed prices down to unsustainable levels. And then, just when it seemed like things couldn’t get worse, they did and the early signs of wine shortages began to appear, which caused me to declare that the era of cheap wine was coming to an end. In each of these cases, trends that I see in many places now were first apparent in Oz. No wonder that I’m starting to view Australia as my leading indicator of global wine market trends.

This makes the news in Jancis Robinson’s column in Saturday’s Financial Times particularly sobering (not a good word for wine lovers). Robinson’s article suggests that Australia has hit ecological limits to the production of cheap wine. Water is scarce and expensive and this means that the cost (and therefore price) of bulk wines like [Yellow Tail] must rise — from A$0.40 in 2006 to A$1 in 2007 according to the article. That’s not quite a leap from unsustainable to unaffordable (the A$ is about 91 US cents today), but it presents a completely different business model. More to the point, however, the price rises exist because costs are high and the product is in short supply. Robinson is optimistic that Australian winemakers can compete and even thrive in the new market environment, but adjustment won’t be easy.

Robinson reports that Fosters has started sourcing some of its Lindeman’s brand from its vineyards in Chile (for the British market) and South Africa (in the U.S.). This continues the practice we have seen in the U.S. for some time for short-supply Pinot Noir. U.S. brands like Pepperwood Grove and Redwood Creek frequently contain Chilean and French wines respectively. Now, Robinson reports

There is much talk, though not much evidence, of basic bulk wine being imported into Australia from southern Europe, South Africa and South America to fill the so-called “casks” (boxed wine) and the cheapest bottles and flagons for the bottom end of the domestic market, prioritising export markets for such inexpensive Australian wine as the brand owners can afford. Australia has swung from famine to feast and back to famine in terms of its wine supply recently and bulk wine imports are nothing new. I remember encountering a director of one of Australia’s largest wine companies looking very shifty round the back of some fermentation vats at Concha y Toro outside Santiago de Chile in the mid-1990s.

Ecological Limits?

Now the problem here is not that the Australian’s are passing off foreign wines as their own. The wines I have seen have been clearly labeled and the few cases I know about where winemakers have tried to fool the public (some years ago in New Zealand, as I recall) ended badly for the dishonest producers. They were punished pretty severely in the marketplace when their tricks were revealed.

No, my concern goes more to the heart of the problem. Maybe Australia’s ecological constraints are a short term problem that will disappear. Maybe it is an Australian problem with no implications beyond the land of Oz. Maybe ready supply from Australia wannabe producers in South America, South Africa and Europe will always be there to fill the gap.

But that’s a lot of maybes and economists are trained to get nervous when it’s maybe this and maybe that. We know that the effect of climate change on the wine industry is real. And we know — or at least I think I know — that Australia has often been a good indicator of emerging trends in global wine. If this is the case, then we are indeed about to enter a new wine world, one where the natural constraints on wine production may be about to become as important as marketing strategies.

The World’s Best Wine Magazine?

decanter-china.jpgDecanter bills itself as “The World’s Best Wine Magazine” and is sometimes referred to as the bible of wine. It is probably the most influential wine magazine in the world, too, although that could be a contested claim. It is the most-read wine magazine in the world’s most important wine market: Great Britain. Founded in 1975, it is based in London and published monthly in more than 90 countries including, since 2005, China. The Chinese Decanter (click on the image to see the Chinese cover) includes about 30% special content for the growing East Asian market.

The Most Important Wine Market

How can Great Britain (and not the United States) be the world’s most important wine market? The simple answer is that the British produce little of their own wine and import quite a lot, so just about every winemaker in the world wants to compete for British sales. The German market is large, too, but it’s a cut-throat pricing environment with emphasis on discounted price. The American market is big, but it is tough for international winemakers to compete with American wines at most segments of the market (especially for popularly priced branded varietal wines).

A slightly more complex answer is that entry into the British market is relatively straightforward, because it is for all intents and purposes an integrated national market with one set of rules and distribution channels. The American market is a maze, with 50 (plus the District of Columbia) different sets of rules and regulations to understand and comply with plus the nightmarish “three-tier” distribution system (retail/wholesale/producer) that adds cost and increases the mark-up at each stage.

You want national distribution in the U.S.? Better hook up with one of the big brand managers such as Constellation Brands or Cobrands. And you’d better have a lot of product to sell. Otherwise you should settle for regional distribution and hope for the best. No wonder many international sellers focus on the British market or go there first.

Decanter is published by a company called IPC Inspire, which produces a number of lifestyle monthlies including Country Life, Horse & Hound, Rugby World, SuperBike, Shoot Monthly and Yachting World. It is Britain’s largest specialist magazine publisher.

Although Decanter really is arguably the most important wine magazine in the world, it is not as ubiquitous as Wine Spectator and Wine Enthusiast here in the United States. You won’t find it on many supermarket racks. Like Robert Parker’s Wine Advocate, it attracts a specialist audience in America.

Mrs. Thatcher and the Rise of the British Wine Market

Decanter was founded in 1975, just at the moment when the British wine market was becoming the world’s most important. Most American’s think of the British as a beer and spirits drinking nation, but this has not always been the case. The British preference for ales and whiskey was partly the result of a tax and regulatory regime that biased the system against consumption of imported wine. High tariffs made wine expensive and retail sales regulation made it inconvenient to purchase.

Britain’s entry into what is now the European Union resulted in tariff rates more favorable to wine imports. Mrs. Thatcher’s programs of retail industry deregulation opened up the opportunity for cheaper wine and more convenient distribution, especially though the supermarket chains. These supermarkets – Tesco, Sainsbury and Waitrose among them – became world’s most important wine distribution channels. The produce of the world’s vineyards are now sourced to these British stores and, having made an impact there, have passed into the global market. Costco, I have argued elsewhere, is beginning to play a similar role in the United States.

Ironically, U.S. wines are underrepresented on the British market.  The U.S. and British distribution and marketing systems are so different as to represent a barrier to entry, at least for now.

Decanter was created to serve the consumer market created by the explosion of wine in Britain. As the global market has grown, Decanter’s distribution has followed (and sometimes, I suspect, leads the way).

If Decanter is so important, why doesn’t it have a stronger presence in the United States? The answer, I would argue, is that the British wine market is global and dominated in terms of volume by the large national supermarket chains selling wines from all over the world. The U.S. market is far more local (favoring American wines) with a far more fragmented distribution system and large firms like Gallo and Constellation Brands leading the way, selling branded wines from their large portfolios. Simply put, you won’t find a lot of the wines reviewed in Decanter in American stores. As vast as our selection is here in the U.S.A., it’s just a slice of what the global market offers. Really.

Uncorking Decanter

Decanter is a full service wine publication with something to offer almost any British wine enthusiast. There are interviews, topical essays and regional travel surveys (drink this, stay here, try this place for dinner). Columnists include such notables as Michael Broadbent, Steven Spurrier and Andrew Jefford. Decanter obviously includes wine investors among its readers because it contains very detailed monthly reports on wine auction sales prices. Bordeaux reds and the main focus (vintages dating back to 1961), but white Bordeaux, Burgundy and Port prices are also listed. It even publishes a wine auction index. This probably reflects Broadbent’s influence – he was for years head of the wine auction practice at Christie’s.

The monthly wine ratings are very interesting. Rather than try to sample a selection of all the new wines on offer each month as some American publications do (an impossible task in Britain, I reckon, with so many wines), one or two types of wines are chosen and about 100-150 wines from each of those segments of British market are tasted and rated.

The February 2008 issue, for example, has comparative ratings of just two types of wines, South Australian Shiraz and Loire (France) Reds (Cabernet Franc to Americans). Wines are first rating using a 20-point scale (with average scores from several tasters reported) and then grouped together into quality classes ranging from one to five stars. The five star (18.5 points or more) and four star wines (16.5-18.49 points) are listed along with photos of their bottles for easy identification in the shops. Three star wines get nice write-ups – this, after all, is where the real market is – and lesser wines are listed in appropriately grim tombstone format. It’s hard to imagine a Decanter reader buying a “fair” or “poor” wine except by accident.

How Decanter Rates Wine

I am impressed with the information provided for each wine. Besides the average 20-point rating, we learn the retail price, the degree of age-worthiness, receive brief tasting notes and find out where to buy it. Good value wines receive a gold £-sign designation. Thus, for example, the 2006 Shingleback Cellar Door McLaren Vale is rated at 14.75 points and sells for £7.99, which is a good value. Is has short term aging potential and can be purchased at Tesco. “Dark cassis jam notes. Medium body. Nice spicy notes. Fine velvet texture. Ripe and well-balanced fruit. 3-8 years.” Sounds good to me. Lots of useful consumer information here about these particular wines, although each monthly issue rates only a small slice of the British market.

The “stockist” listings are noteworthy. Wine Spectator will tell you what to buy, but not where to buy it. That would be nearly impossible in the U.S. The reason Decanter can tell you where to buy this wine is that the British wine system favors a relatively small number of national distributors and retailers, many of whom feature their own brands, much as Costco does here in the U.S. with the Kirkland label. The best value in the Shiraz tasting, for example. Was Berry’s Own Selection Elderton Australian Shiraz Barossa Valley 2006 (£8.50 and 16.5 points). “Big yet somehow seductive.” Berry isn’t a person, it is Berry Brothers & Rudd, a major British retailer.

Decanter wine critics are tough, by the way, stingy with the highest grades (the 4-5 star As and Bs) but generous in giving Cs that seem to really mean something.

Decanter and Global Wine
Decanter reflects the unique features of its main market, Great Britain, which makes me realize that this is probably true about all wine publications. Gambero Rosso has a strong regional focus because the Italian national wine market is less important there and regional identities matter more. U.S. magazines will be different because the U.S. market is so different.

Britain’s market is national in scale and global in reach so Decanter‘s strengths and weaknesses (particularly its inability to evaluate the majority of wines that are available) reflect this. I am not surprised that it would appeal to wine-drinking elites around the world, but it makes sense that it would not have a big market in the United States. The market is just too different over here.

Washington and Oregon Wines in London

There is a special tasting of Washington and Oregon wines in London today, held at the Institute of Contemporary Arts at 12 Carlton House Terrace. More than 190 wines from 40 Pacific Northwest wineries are being sampled. Marty Clubb of L’Ecole 41 in Walla Walla is leading an educational seminar about the Washington wines and Howard Rossback of Firesteed is doing the same for the Oregon products. The event is funded in part by a $200,000 federal trade grant. I believe it is the largest organized effort (so far) by Northwest winemakers to break into the European markets. It will be interesting to see if this seedling can grow to bear fruit.

Washington and Oregon are important winemaking regions, of course, but their reputations and sales are concentrated in the United States. Although Oregon Pinot Noirs are always included in the discussion when people anywhere talk or write about new world Pinots, the fact is that not much of it is sold abroad. Oregon wine sales in the UK and France were just over 2000 cases in 2006, for example, out of total production of 1.6 million cases. The word may be out around the world about Oregon wines, but wine distribution and sales haven’t followed — yet.

I don’t have figures for Washington wines, but I suspect that the situation is more or less the same. Washington makes excellent wines (better than Oregon wines, if you judge by the Wine Spectator and Wine Advocate ratings, where several Washington wines receive 95+ points), but so far Washington doesn’t seem to have that one distinctive wine that could establish an international reputation. The state is too varied, I think, in terms of climate and geography for that to happen. Washington is Riesling country, judging by volume of production, but it hasn’t yet established an international reputation with this wine (although it is trying to do so with the Riesling Rendezvous conference). A variety of reds do well here, including both the Bordeaux and Rhone varietals, but no signature style of wine has emerged as the champion. Marty Clubb is telling the people in London that Washington has the ideal climate for wine (that’s the official Washington wine theme), which may be true but doesn’t really define the product for confused international buyers.

Washington does have one advantage over Oregon in the export market: distribution muscle. The Washington wine industry features a few very large players that have the financial clout to potentially open up foreign distribution channels. Money is necessary; it isn’t easy to establish a brand abroad in this crowded market and margins on exports are necessarily lower than for domestic sales, at least at the beginning. I have read that export sales by small scale winemakers are “vanity” projects and there may be some truth to this. That doesn’t mean it’s not worth doing, however.

The Chateau Ste Michelle family of wines have penetrated some European markets. I was surprised to discover a large display of CSM wines in an upscale supermarket next to the train station in Riga, Latvia, for example. I haven’t been able to find out how the wines got there yet — my guess is that CSM’s deal to distribute Antinori wines in the U.S. may be reciprocated by Antinori in Europe but I don’t really know. Other Washington wines including Columbia, Covey Run and Hogue are part of the Constellation Brands portfolio, which may aid in their international distribution, too.

The London tasting isn’t the first effort to get Northwest wines attention in the UK. I remember being in London in about 1990 and walking into Fortnum and Mason only to be shanghaied by an excited clerk who was directing anyone she could to a lonely wine tasting display where they were sampling wines from Hogue Cellars of Yakima. Needless to say, no one had any idea where Yakima was located, but they were amazed that such a unlikely place could produce good wine. Today’s London event is a much larger project than that Fortnum display, but the goal is much the same, to make friends, establish relationships, and get our foot in the door.

I hope the London tasting goes well. Many of the wineries are apparently looking for UK distribution, which makes sense. The UK is the most important wine market in the world. It is a good market to sell wine and to establish a worldwide reputation. A disproportionate number of the world’s leading wine writers and experts are based in London, including Jancis Robinson, Oz Clark, Michael Broadbent and Steven Spurrier. A good word by any of these celebrity wine critics would encourage wine enthusiasts in the UK and around the world to give Northwest wines a try. But the real prize would be a distribution deal with Tesco or Sainsbury’s, which dominate supermarket sales, or one of the big high street wine store chains, since you can’t try wines you can’t buy.

One reason this is a good time to try to break into the UK and European markets is that the exchange rates favor U.S. exports. The dollar fell dramatically in 2007 against both the Pound and the Euro, making U.S. wines relatively less expensive. This will help, but it will still be difficult to get British wine drinkers to think beyond Gallo and one end of the market and Napa Valley at the other.

It’s tough to break into foreign wine markets. Ernie Hunter famously did it the DIY way — he brought his wines to London and entered them in the Sunday Times wine festival, where they won the people’s choice award. Ernie was from New Zealand and his surprise victory paved the road for Marlborough Sauvignon Blanc’s dramatic rise in the world of wine. Washington and Oregon are taking a direct and organized approach, with tastings and seminars. Every case is different. My next post will tell an unlikely story of how Washington wines first came to Sweden.

The Fall and Rise of the British Wine Market

People are always surprised when I tell them that Great Britain is the most important import wine market in the world. How is this possible? Britain is so much smaller than the U.S. and the British are known to prefer beer and spirits to wine. How can they be an important wine market?

One part of the answer is that most countries that consume a lot of wine actually produce a lot, too, and so are not necessarily large net importers. This is obviously true of France, Italy and Spain and it’s even true of the United States. Countries that consume in large quantities but aren’t also major producers are rare. Britain’s wine production until recently has been tiny, so most wine is imported wine and that makes their market very important. British wine production is creeping up now, however, driven by global climate change. Rising temperatures are making it possible to produce good and even exceptional wines in Britain. It is said that some British sparkling wines already rival the best of Champagne.

A second piece of the puzzle was revealed to me recently in an excellent book by George Mason economics professor John V.C. Nye called War, Wine, and Taxes: The Political Economy of Anglo-French Trade, 1689-1900 (Princeton University Press, 2007). Professor Nye deals with many interesting topics in this book; I’m going to focus on the wine story here and not try to cover everything.

Britain was not always a beer and spirits culture. Wine was cheap and plentiful in Britain in the middle ages and Britain did in fact have its own vast vineyards for 300 years starting in 1152 because Bordeaux was British territory! The loss of those vineyards and then war with France caused Britain to turn away from French wines to those from Spain and Portugal and then, finally, from wine generally.

Faced with the need to generate war revenue, Britain imposed tariffs on wine imports. Significally, these were not excise tariffs (10% or 20% of value), but specific tariffs (x number of pence per bottle or gallon). Excise tariffs would have had an equal proportionate impact on wines of all prices, but specific tariffs introduced a bias against cheap wine. Suppose that the tariff is $10 per bottle, for example. The effect on a $100 bottle of imported wine is relatively small — the price rises by 10% and demand probably declines somewhat. The impact on a $5 bottle of wine is enormous, however. Its relative price rises prohibitively. Who will pay $15 for a $5 bottle of wine? Its market evaporates.

(Note: Transportation costs , which are more or less the same regardless of price, have something of this same effect. This helps explain why that cheap but lovely bottle of local wine you enjoyed in Provence never shows up on your grocers’ shelves here in the U.S.. By the time the transportation costs are paid it would no longer be cheap and you might not find it quite so lovely.)

The British drinks market was thus split in two. Elites continued to drink and collect fine red Bordeaux wines that they called “claret.” The masses switched from wine to now relatively less expensive beer. And Britain acquired its reputation as a beer drinking nation.

Professor Nye argues that British brewers were able to take advantage of technological innovations that allowed for large economies of scale in beer production. Once they had a near monopoly on the British drinks market, they could build huge factories to satisfy the captive demand at low production costs.

An interesting “invisible handshake” arrangement evolved, according to Nye, between the brewers and the revenue-hungry British state. The brewers permitted themselves to by taxed at fairly high rates in return for tariff protection from wine imports, which gave them a large captive market. The economies of scale in brewing were so significant as to make it profitable both for the brewers and for the taxman — so long as cheap wine was kept away.

Britain’s entry in to the Common Market combined with Margaret Thatcher’s later market reforms broke up this nice arrangement and established an environment where British wine demand could return. Britain was required to “harmonize” its wine tariffs with European partners, which removed the bias against popularly priced wines. And the market reforms allowed wine to be sold more widely and competitively, especially through supermarket chains. With wine available and at good prices, Britain’s thirst for the vine returned.

Thus did Britain, once the most important export wine market in the world, become so again because of the cost of war, the nature of specific tariffs, the economics of brewing, Britain’s entry into the Common Market and Mrs. Thatcher’s market reforms.

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