Bottoms Up: Extreme Value Wine Demand

“Life is too short to drink cheap wine,” but either life is getting longer or the definition of cheap is changing, because cheap wine (or extreme value wine, as I called it in my last blog post) is a booming market category.

The US off-premises wine market grew by 3.7 percent dollar value in the last year, according to Nielsen Scantrak results reported in Wine Business Monthly, but sales of wine under $3 per bottle equivalent rose by more than 5 percent and sales of $3-$5 increased by 9.4 percent. This gives the old toast “bottoms up” a new meaning. The bottom of the wine wall is currently leading the way.

Bottoms Up!

Since I’m an economist I tend to approach market problems from the perspective of supply and demand. It is easy to understand where the supply of extreme value wine is coming from. The global wine surplus combined with structural falling demand in the Old World and recession-induced slow growth in the New World means that there is a lot of wine out there searching for a home. Some of it ends up being deeply discounted or dumped in stores like the Grocery Outlet chain.

A lot of it goes into own-brand wines at mainstream stores. Safeway has introduced its Quail Oak brand and 7-Eleven just announced a line of $3.99 wines called Yosemite Road.  Both wines (and many other own-brands) are made by The Wine Group, the giant privately held California winemaker that, like Fred Franzia’s Bronco Wines, seems to specialize in making wines to hit particular price points.

Demand Side Puzzle

Although it just seems wrong, let me assure you that supplying wine to sell at $5, $4, $3 or even two bucks per bottle is not that difficult once you set out to do it. Cheap surplus grapes, cheap surplus wines, low-cost winemaking processes and economies of scale all contribute to extreme value supply. Nope, supply is easy. The challenge, until recently at least, has been selling the stuff.

Studies have repeatedly shown that wine drinkers are influenced by price – but not in the way you learned in Econ 101.  A lower price does not always produce more sales because insecure buyers infer quality from price. They assume that higher price means better wine. In a blind tasting of two identical wines, buyers will often rate one above the other if they are told it costs more.

So why are many wine drinkers now stooping down and buying cheaper (sometimes very cheap) wines – and shopping at stores like Grocery Outlet — when in the past they have been programmed to consider these products inferior? I think there are three forces at work.

Two Buck Chuck Effect

The first factor is what you might call the Two Buck Chuck effect. Trader Joe’s stores have led the way in introducing American wine drinkers to inexpensive own-brand wines. Because shopping at Trader Joe’s is cool, trying Trader Joe’s discount wines is cool, too (or at least not as un-cool as buying Carlo Rossi at Kroger would be).

You might ask “How good can a $3 wine  be?” elsewhere, but at Trade Joe’s it’s “How bad can it be?” TJ’s lends its reputation to the wine, which is the key to all own-brands. It is clear that Safeway, 7-Eleven, Target, Wal-Mart and many other chains that have introduced own-brand wines believe that they can do the same.

Costco Effect

Costco, the big box store chain, is the largest retailer of wine in the United States. Although their selection of wines is surprisingly limited (fewer than 150 different wines in each store compared with 1000-2000 or more at a typical upscale supermarket), it draws people in with low prices, made possible in part by the fact that buyers pay annual membership fees for the right to shop. The maximum markup on Costco wines is 15 percent above wholesale, which is hard to beat if you want to buy what they want to sell.

Costco has trained its upscale clientele to look for low price, but that’s not the Costco Effect I’m talking about here. Costco doesn’t sell extreme value wines – it leaves the bottom-feeding market to others.

The Costco Effect refers to the fact that shopping for wine at Costco is a lot like a treasure hunt. The wine selection changes all the time and so you need to come back often. Costco makes a point of stocking limited production wines, which run out. So if you see something you like, you better buy it now. I have friends who have scored one or two spectacularly good buys on impossible to find iconic wines at Costco and who are now completely addicted – they stop by as often as they can just to see what might be in the bin today.

Costco’s success with its treasure hunt strategy has generated a group of upscale customers (including perhaps my friend Jerry who was featured in the last blog post) who find the hunt almost as pleasant as the wine they buy. It’s a big a step but not an impossible one to go from Costco to Grocery Outlet since both position themselves as happy hunting grounds.

Trading Down Effect

The final piece of the demand puzzle is the recession, which made most of us stop and think about what we are paying and what we are getting. The data indicate that trading down (lower price), trading over (adopting a more casual and lower cost wine lifestyle) and drinking up (drinking from the cellar rather than buying expensive wines) are significant effects. Paying less for wine doesn’t carry the social stigma it might have in the boom-boom days and it doesn’t dent your personal wine identity as deeply either.

When you combine these three effects you get a market where extreme value wines can enter the mainstream. The demand for these wines is increasing, with different wine buyers responding to different motivations. It will be interesting to see if the market shift is permanent or if wine buyers will go back to their old habits.

Good, Bad or Ugly?

It is easy to conclude that the extreme value trend is a bad thing for the wine industry. People are paying less for wine, buying more generic wine and less of the quality product. I don’t see this as a completely negative trend, however. At least they are buying wine and not switching to other beverages. That would be ugly. This is part of the story of the collapse of wine demand in Europe. Wine became just another beverage and faded away as a quotidian pleasure. That hasn’t happened here, at least not yet.

I am actually hopeful that the extreme value trend will ultimately benefit the wine world, although I admit that my viewpoint is backed up by anecdotes more than hard data. I spoke with a young couple at the local Grocery Outlet who seem to me to be an optimistic future of wine in America. They had parked their shopping cart (with two small kids) in the wine corner and were busy picking out three or four bottles of wine from the huge selection of inexpensive bottles.

Do you buy wine here often? Yes, every week. We try different wines, which is fun. Some of them are disappointing, but it doesn’t cost very much to try them and we can also buy something different the next time. It’s been a long time since we found something that made us want to come back and buy a case, but that’s OK – it’s still fun.

Serious Business

What I like about this couple is that they use the extreme value store as an opportunity to experiment and they have the confidence to trust their own taste rather than some wine critics ratings. If they keep this up I think they will work their way out of the bargain bin. But I hope they never lose their sense of fun and willingness to take a chance on something different.

Wine is a serious business, but it is a mistake to take it too seriously. Wine can be intimidating, that’s for sure, especially the high-stakes wine game. It might be a healthier business in the long run if more people learn to love its treasure hunt side. If mainstreaming extreme value wine helps accomplish that, I think it is a positive development.

Restaurant Wines: Good, Bad and Ugly

Many people have written to me over the years expressing their dismay at the sorry state of restaurant wine. Usually they complain about high restaurant prices and ask how they can possibly be justified. They are seldom satisfied with my answer — restaurants charge high prices because people will pay them. Now, however, the critique has shifted to the wines themselves and what they reveal about wine in America.

What Does American Really Drink?

My recent post on “Olive Garden and the Future of American Wine” (see previous post) seemed to catch many wine enthusiasts by surprise. It reported data from Restaurant Wine magazine for the best-selling wines in American restaurants as determined by distributor “on-premises” shipments. This data, based on volumes shipped to all “on-premises” establishments in 2008, reveals that when America goes out it drinks a lot of White Zinfandel, Pinot Grigio and (gasp!) “Chablis.” Only one red wine made the top 20 list: Yellow Tail Shiraz.

The list changes only a little if we look at the data for wine brands (as opposed to specific wines):

  1. Kendall-Jackson
  2. Sutter Home
  3. Beringer Vineyards
  4. Franzia Winetaps
  5. Inglenook
  6. Yellow Tail
  7. Copper Ridge
  8. Cavit
  9. Woodbridge
  10. Salmon Creek (Bronco)

The complete list of the top 20 brands is dominated by America’s three largest wine companies with three brands each from Constellation Brands (Woodbridge, Taylor California Cellars and La Terre), Gallo (Copper Ridge, Barefoot Cellars and Ecco Domani) and The Wine Group (Franzia, Inglenook and Almaden). These three giants have large brand portfolios and strong distribution machines. They get their wines into every nook and cranny, both retail and on-premises sales. You can see the results virtually everywhere.

Only 4 of top 20 are international brands (Yellow Tail, Cavit, Ecco Domani and Mezzacorona). I think the fact that three of these four are Italian wine brands says something about the importance of Italian restaurants, including especially Olive Garden, in the American wine market.

Another Picture: The Wine & Spirit Rankings

The Restaurant Wine data give us one picture of the market, Wine & Spirits magazine’s annual restaurant report (April 2009 issue) provides a different (and perhaps more comforting) image. W&S asks a group of wine-focused restaurants to report which wines are on their lists — now how much they sell, but which ones are on offer. Since wines don’t stay on lists long if they don’t sell, this is an indirect measure of availability and popularity, although it isn’t the same as as volume rankings. Here is the W&S top 10 for 2008.

  1. Sonoma-Cutrer Vineyards
  2. Cakebread Cellars
  3. Jordan Vineyard & Winery
  4. Silver Oak Wine Cellars
  5. Ferrari-Carano Winery
  6. Robert Mondavi Winery
  7. Veuve Cliquot
  8. Chateau Ste. Michelle
  9. Rombauer Vineyards
  10. Kendall-Jackson Vineyards

Sonoma-Cutrer is #1 on this list, yet it appeared on only about 14% of the surveyed wine lists (and, as noted above, there is no indication of how much was sold).  Only one winery appears in both top 10 lists – Kendall-Jackson. Only two other wineries appears in both top 20s – Beringer and Chateau Ste. Michelle. Gallo and The Wine Group are missing from the W&S top 20, although Constellation Brands makes the list through Robert Mondavi.

Looking over the data, I find myself especially impressed by the performance of Kendall-Jackson and Chateau Ste. Michelle. Both makers seem to combine wide distribution with a range of wines at attractive price points. It isn’t surprising that they rank high on both lists. Perhaps other producers will try to emulate K-J and CSM, especially given this tough economic climate.

Good, Bad or Ugly?

If the first list of restaurant wine brands depresses you, then ignore it and focus on the second list, where White Zin is much harder to find, but don’t get too smug. Remember that there are many markets for wine and that the US is no different from other countries in this regard. Compared to Germany, in fact, much more fine wine is sold here and proportionately less of the bulk product.

For myself, I see a glass half full. My experience working with college students who study wine is that the inexpensive wines serve a really useful function of introducing students to wine and diverting them from beverages that are more closely associated with binge drinking.

Although some White Zin drinkers suffer from arrested development and never move beyond it, I am persuaded that many do. Every staircase, no matter how high it reaches, needs a bottom step.  We have a broad first step in America — no surprise there — but I think it is a step up.

Australian Winequake

Market tremors seem to be felt everywhere — food, fuel, money, natural resources. And now in the wine world.

Wine Tremors

It has been hard to ignore the feeling of instability in the wine world for the last few months. There has been a lot of shifting around of brands and alliances, as if the big wine producers are feeling off balance and need to get recentered. In January, for example, Constellation Brands, the world’s largest wine company, sold off their high volume Almeden and Inglenook brands along with the Paul Masson winery to The Wine Group. The reported logic was that Constellation wanted to focus more on premium and superpremium wines. The Wine Group is a privately held San Francisco-based company that has its roots in Coca Cola’s old wine division. (See Note below.)  It makes and markets a variety of high volume brands, including Franzia, Concannon, Corbett Canyon, Glen Ellen, Mogen David and several international brands.. It is the third largest wine company in the United States, behind on Gallo and Constellation, with 44 million case sales in 2007.

I felt another tremor on Tuesday, when a Decanter.com story reported that Constellation had sold more of its wine brands, this time to a new Healdsburg, California-based group called Ascentia Wine Estates. The wineries are Geyser Peak Winery in Alexander Valley, Atlas Peak in Napa, Sonoma Valley’s Buena Vista Carneros, Gary Farrell Winery, Washington’s Columbia Winery and Covey Run, and Idaho’s Ste Chapelle. They produce about a million cases of wine a year between them. Vineyards in Napa and Sonoma county were included in the $209 million deal. The logic, the article said, was to allow Constellation to continue to sharpen its focus on key upmarket brands.

There are several interesting things about this sale. From the Constellation standpoint brands like Geyser Peak, Buena Vista Carneros and Columbia are a good deal more upscale than high-volume Almaden and Inglenook brands that were sold in January. Constellation sold 59 million cases of wine in the U.S. alone in 2007, so the loss of a million case capacity is less important, I think, than the sign that the company is very serious about reshaping itself to adapt to changing market conditions. Constellation says that they are going to focus on fewer brands at the top of the pyramid and I guess they really mean it.

Ascentia is clearly making a different bet. Ascentia is a private group that includes major investors GESD Capital Partners, a San Francisco-based private equity fund, wine distributor WJ Deutsch & Sons and Jim DeBonis, former chief operating officer of Beam Wine Estates (several of the brands included in this deal were part of the Beam Wine Estates portfolio when Constellation acquired that operation last year).

The involvement of the Deutsch family is significant. Deutsch is the masters of marketing and distribution of value-priced wines. They partnered with Australia’s Casella family to create [Yellow Tail], the best selling import wine in the U.S. (I have written about this in my [Yellow Tail] Tales article. They also import and distribute George DeBoeuf, J. Vidal Fluery and other important wine brands. They clearly see opportunity where Constellation does not. It will be interesting to see how this group adapts to the shifting wine landscape. I cannot believe that they are through assembling their new portfolio because I think there may be more wine brands on the market soon (see below).

Winequake

The news from California on Tuesday regarding the Constellation-Ascentia deal was interesting. But the news from Australia in yesterday’s Financial Times as stunning and represents the first of what might prove to be a series of significant winequakes.

Foster’s, the big Australian drinks group, announced major write-downs of its wine assets and the resignation of its CEO, Trevor O’Hoy. The FT’s Lex column summarized the situation like this:

We all know the feeling: a night of bacchanalian excess followed by regrets and a light wallet the next morning. Foster’s, after a 12-year bender in which it spent A$8bn in the wineries of Australia and the US, has a severe hangover. Australia’s biggest beer and winemaker on Tuesday announced A$1.2bn of write-offs, lowered profit forecasts and parted company with its chief executive.

Foster’s last big splurge, the A$3.7bn purchase of Southcorp, is partly responsible. Foster’s bought the Australian winemaker in 2005 for a generous 14 times enterprise value to forward earnings before interest, tax, depreciation and amortisation, among the highest multiples for deals in the wine sector at the time. It even mocked Southcorp, as it attempted to defend itself against the hostile takeover, for being unduly conservative with respect to its own earnings forecasts.

Fast-forward three years and the hubris has been punished. Integration was botched, partly due to the ill-judged decision to blend sales forces into a single unit in Australia. In the US, distribution was poorly managed. External factors packed the final punch. Australia’s vineyards produced a glut of wine and prices plummeted. The Aussie dollar surged, from about 76 US cents at the time of the acquisition to 95 cents today. Foster’s reckons that every cent move lops A$3.2m off the wine business’ earnings before interest and tax – forecast to total A$1.2bn this year.

Fosters owns 22 wineries in five countries and 60 wine brands, including Beringer, Lindemans, Wolf Blass, Penfolds, Rosemont and Matua Valley. Among other things it is writing off A$ 70 million of bulk wine inventory. It will try to trim its US inventory by 1.4 million cases. (Fosters was the fifth largest wine seller in the U.S. in 2007 with 20 million cases, about the same as Bronco wines and its Two Buck Chuck brand). This is more than a tremor. What does it mean? It is a Foster’s problem, or does it have larger significance?

The assumption for the last few years has been that bigger is better in the global wine market and that big global firms like Constellation and Foster’s had an unbeatable advantage. Is this just a shakeout, or are these recent events a signal that the world of wine is experiencing a fundamental change? Watch this space for updates.

Note: Coke purchased Franzia some years ago and built its wine division from that foundation. The Franzia family now owns Bronco Wines, the Two Buck Chuck company.

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