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.

Starbucks and the Coffee-Wine Paradox

The Water-Diamond paradox is a classic problem in economics. Water is essential to life, but it is relatively cheap in most situations. Diamonds, on the other hand, are non-essential luxuries in most uses, yet they cost the earth compared to water. How is this possible? How can market price deviate so clearly from practical value? A tough problem. John Law, John  Locke, Copernicus and Adam Smith all tried to provide sensible answers.

In Vino Paradox

Starbucks (the Seattle-based company that sells coffee with a side of lifestyle) presents us with a similar puzzle today. I call it the coffee-wine paradox in honor of the original problem.

Starbucks has started selling wine. Not at branded Starbucks stores, but at three experimental “15th Avenue Coffee and Tea” shops in Seattle.  As near as I can tell they have not yet begun to market a Starbucks wine (the image here, courtesy of Google Image Search, is apparently bogus), but who knows what will happen in the future?

I know a number of coffee bars here in the Pacific Northwest that double as wine bars and authentic espresso bars in Italy nearly always serve alcoholic beverages including wine. Starbucks knows how to sell branded goods. Connect the dots. Maybe there is Starbucks Pinot Grigio in your future?

So what is the paradox? Well, the joke is that Starbucks coffee products are very expensive. You know what I mean — the mythical four dollar caffè latte? But when you compare Starbucks coffee to wine, it looks like coffee is unbelievable cheap. Thinking in terms of absolute price both wine and coffee cost a lot but, as in the water-diamond problem, their relative prices seem totally out of line. Why is wine so expensive compared to coffee and why is coffee so darn cheap?

Pulling the Supply Chain

Coffee cheap? Well, consider what a diagram of the global supply chain for a Starbucks latte would look like. The high tech espresso machine is usually Italian-made. The milk is probably a local product and the labor likewise, but the coffee and flavorings such as chocolate and vanilla come from all over the world and pass through many processes and middleman hands on their way to you.

Wine, by contrast, is the simplest of products. It practically makes itself. Even with the notorious three-tier distribution system here in the US, it is a whole lot easier to get wine into your glass than coffee into your 20-ounce cardboard takeaway cup.

And think about the wine bar versus espresso bar experience. Servers at the wine bar retrieve the bottle and pour some in your glass.  Pretty simple. At the espresso bar, by contrast, your coffee made to order with sometimes extravagant special requests (a tall half-caff soy vanilla latte with caramel?). No doubt about it, in terms of both global sourcing and labor-intensive local production,  Starbucks coffee seems like it would be a lot more expensive to produce and serve than my mythical Starbucks wine.

So here’s the paradox. $4 for a cup of coffee (or espresso-favored coffee drink) seems impossibly expensive. Ridiculous. A joke. But $4 is impossibly cheap for a glass of decent wine these days when you are dining out. What do you think Starbucks would charge for a glass of wine? If they conform to the industry rule of thumb (and I don’t know if the 15th Avenue shops do) the price for each glass would equal the wholesale cost for the bottle. So you’d expect to pay $6 and up for fine wine (wine poured from a bottle in this context) or less if it is drawn from a bag-in-box hidden somewhere in the back room.

Generic industrial wine sells for more than a premium custom-brewed coffee product. No question about it. Wine costs too much and coffee is too cheap. Why? That’s the first part of the coffee-wine paradox.

A Factor of Sixteen

A second aspect of the coffee-wine paradox is revealed in the November 2009 issue of Decanter magazine in a short but very interesting article on coffee. It seems that coffee, like wine, comes in all sorts of variations from cheap bulk product to the equivalent of vineyard-designated grand cru coffee cuvées (if that isn’t stacking the adjectives a bit too high).

Coffee connoisseurs will pay enormous sums to get the finest, rarest coffees. Decanter quotes the price of the winning coffee from a recent international competition at £13 per 250 grams of roasted beans or roughly 40 U.S. dollars per pound. On a per-cup basis, according to the article, the top coffee sells for about sixteen times the most humble Cup of Joe. That’s a pretty high premium to have the best instead of the simply pretty good.

Consider the corresponding wine ratio. If we take Two Buck Chuck as our Nescafé equivalent, the most expensive wine on the market would cost $32 in California (where Two Buck Chuck really costs $1.99) and $48 dollars per bottle nearly everywhere else in America. But this is ridiculous. The most expensive wines cost much more than this. If you read the wine magazines you frequently encounter prices of hundreds and even thousands of dollars for the finest, rarest wines. The coffee factor is sixteen from bottom to top. The wine factor, by comparison, is fifty, sixty, a hundred, even more.

What is the solution to the coffee-wine paradox? Why does wine seem to cost so much more than coffee despite the factors that would seem to raise coffee’s cost? And why do the best wines cost so much more, in relative terms, than the best coffees? What’s your answer? Watch this space for mine!

Wine’s Future: It’s in the Bag (in the Box)

One of my favorite globalization books is The Box: How the Shipping Container Made the World Smaller and the World Economy Bigger by Marc Levinson. It is the story of how the invention of the standard shipping container (those 20-foot steel boxes you see on ships, rail cars and truck beds) made international trade much cheaper, more efficient and more secure. Now it looks like another kind of box is about to shake up the wine world.

Cheap and Nasty

I’m talking about box wines or bag-in-box (BIB) wines (the Australians call them cask wines) that feature an airtight wine-filled plastic bladder inside a cardboard box. You use a built-in spigot to get to the wine. They can be found on the bottom shelf of the wine wall and behind the bar and out of sight at your local restaurant. They come in several sizes — 3 liter and 5 liter containers are the most common.

Box wines have a bad reputation. They first appeared in the 1970s and were filled with generic bulk wines.  They were one step down from the popular 1.5 liter “magnum” bottles of  “Burgundy,” “Chabils” and the notorious “Rhine” wine. Box wine was cheap, nasty stuff that acquired a frequently deserved bad reputation.

[Re]-Thinking Inside the Box

It’s time to reconsider box wine. Screw caps had a bad reputation, too, until quite recently. We associated them with low grade swill until fine wines appeared under screw cap (the New Zealand producers were in the vanguard) and we began to appreciate that that screw caps have many advantages. Now screw caps are actually associated with quality for some types of wine, especially youthful whites, and no one expects to pay less or get less because of the screw-top closure.

The technology of box wine is very solid. The airtight bladder is a neutral container that is well suited to holding wine for relatively short periods of time. (Don’t cellar box wine — consume within a year of production — check out the “drink by” date on the box.) The bladder and spigot do in fact protect the wine from oxygen in the short run, so it will last longer once opened (especially if the box is stored in the fridge) than similar leftover wine in bottles.

Bladders are so good at the particular thing that they do that they have become an industry standard technology for bulk  imported wines, which are shipped in huge bladders inside steel shipping containers (big bag in big box) and then bottled in the import market. So you may already be drinking box wine and not know it.

The Box Also Rises

The most recent Nielsen retail wine sales figures (reported in the October 2009 issues of Wine Business Monthly) suggest that box wine sales are growing. Wine sold in 3, 4 and 5 liter containers (most of it is box wine, I think) accounts for just under 10 percent of US supermarket wine sales, according to the Nielsen data (compared to 65% for standard bottles with the remainder in 1.5 liter and other formats). Sales are rising in this category, with 3 liter packages up 8.7% in the last year on a dollar basis, for example, and 5 liter packages are up 9.3% by value.

The total market for box wines rises if we include on-premises sales. Recent data (see previous posts) indicate that box wines (served to customers in carafes and by the glass) are strong sellers in casual dining establishments.

The rise of box wine is part of the trading down effect, clearly, since most box wines fall into the two price categories that are experiencing the highest growth. Sales of wines that are less than $3 per 750ml bottle equivalent have risen 7.1 percent according to Nielsen and by 10% for wines between $3 and  $5.99. Supermarket sales of $20+ wines, on the other hand, have fallen by 3.4%.

Nasty, Brutish and Short?

Does this mean that Americans have traded down all the way to the bottom, back to the nasty box wines of the 1970s? The answer, incredibly, is no. Or at least not necessarily, according to the October 15 issue of Wine Spectator.  You can’t miss this issue on the newsstand — it features a cover story on “500 Values for $20 or Less” and includes a set of box wine reviews that make interesting reading.

Wine Spectator purchased 39 box wines in packages that ranged from 1 liter to 5 liters. Twenty seven wines were rated as “good” (a score of 80-84) and ten “very good” (85-89). The names of the 2 wines that scored below 80 were not reported.

The top box wine, going by the rating numbers, is a white: Wine Cube California Chardonnay, which sells in Target Stores for $17 per 3 liter box, which is $4.25 per standard bottle equivalent. It earned a very respectable 88 points. Wine Cube is a partnership between Target and Trinchero, the maker of a wide range of wines including Sutter Home.

The best red wine (at 87 points) is the Black Box Cabernet Sauvignon Paso Robles 2006, which costs $20 for 3 liters or $5 per standard bottle equivalent. Black Box is a widely distributed Constellation Brands product.

Good and Cheap?

Some box wine, apparently, is both pretty good and pretty cheap. Perhaps just to show that they really do rate wines blind, Wine Spectator gave a pretty good 84-point score to a non-vintage Carlo Rossi Cabernet Sauvignon California “Reserve” wine. Five liters for $13, in case you are interested,  That’s $1.97 per standard bottle equivalent.

How can decent wine be this cheap? One answer, of course, is that you can choose to make the wine itself less expensive by economizing in the cellar in many ways (less oak or none at all for red wines, for example). But to a considerable degree the box itself is responsible for the savings.

The bag in box container costs less than $1, according to the Wine Spectator article, which automatically saves $4 to $8 compared with a similar quantity of wine in standard glass bottles and the box they come in. Shipping costs are also less since the boxes weigh much less than glass bottles for the same quantity of wine and are less likely to be damaged in transit.  There are environmental benefits too, especially in areas where glass bottle recycling is problematic because the sour economy has undermined the market for recycled glass.

Is box wine the future of wine? No. The wine market is too complex to be dominated by any single trend. But with better wine in better boxes (and with consumers embracing a more relaxed idea of wine) box wine deserves to play a bigger role in the future of wine. Another triumph for The Box!

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November 1, 2009: I was recently interviewed about box wines by Simon Morton of Radio New Zealand’s  This Way Up . Click on the link to listen to the interview.

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!

Chateau Cash Flow: The Rise of House Brand Wine

Decanter.com reports that house brand wine sales are rising in Great Britain even as the overall market slumps.

Retailers are reporting impressive growth of own-label wines as cash-strapped customers look to rein in their spending.

A Datamonitor survey reports 41% of all grocery sales in the UK are now own-label, up from 38.2% in 2008, and wine sales are following the upward trend.

Supermarket retailer Sainsbury’s told decanter.com its own-label wines had grown at double the rate of its wine range this year. A spokeswoman said: ‘Last year we revamped our own-label packaging and we have put a lot of effort behind the range in store and in the media.’

House brands aren’t so important in the U.S. wine market [yet] but they may well be in the future. The best known U.S. house brand wines are Charles Shaw (a.k.a. Two Buck Chuck) at Trader Joe’s and Kirkland Signature at Costco. Big Box retailers Target and Wal-Mart have launched their own house brands in recent months and other retailer’s have commissioned discount brands (not yet closely associated with their names) in an attempt to get a grip on the trading-down market. Look for this trend to continue, especially if the economic downturn persists.

Chateau Cash Flow

House brands are a solution to several problems, which is why they are likely to increase in importance. On the consumer side, they provide buyers with reputational assurances. You might wonder if a $3 wine can be any good, but you are more likely to try it if Trader Joe’s or Wal-Mart stands behind it. As I have written before, a $3 unknown wine at Safeway makes you think “how can it be any good?” while a $3 wine with the Trader Joe’s imprimatur makes you think “how bad can it be?” You might buy the latter but not the former.

The British have years of experience with house brands — it is why they are [for now] the world’s most important wine market and why Britain’s supermarkets are arguably the most sophisticated wine distribution machines on earth. The U.S. is catching up, but Britain still leads.

Reputation is especially important when consumers are trading down, moving into unfamiliar territory on the lower shelves. Decanter reports that while some British consumers are trading down to house brands, building that market, existing customers are trading up within the house brand portfolio! If this trend continues it will be hard to resist the house brand strategy.

Supply Side Wine

House brands have big advantages on the supply-side, too. Producers with surplus wine are often happy to sell it off through house brand bopttlings because it generates cash flow without directly undercutting their own brands and market. In my international economics class we call this “dumping.” You sell off unintended surpluses (of which there are plenty just now) through retailers in a different market segment, allowing you to maintain reputation and price points in the home market. If you start discounting wine to sell it, we have learned, it is sometimes difficult to regain the ground you have lost.

Some British retailers have moved aggressively into the supply chain, buying up grapes and surplus wines and acting as full-fledged negociants, but it isn’t really necessary to make such a large commitment to get into the house brand wine business. There are plenty of regional and national firms who can quickly respond to demand. No large investment is required, cost is low.

House brands can also have a somewhat fluid identity (not tied tightly to a particular region or style), which allows them to benefit from global opportunities, sourcing Sauvignon Blanc from Chile, for example, and Pinot Noir from Northern Italy or the South of France.

The main problem is to be sure that quality is good enough. Otherwise you have put your own brand in jeopardy.

Three Way Battle

The world’s wine markets are a battleground for three models of wine sales. The German model is based upon low cost (one euro per liter) and hard discount sellers like Aldi. The American model is all about corporate brands like Gallo and Constellation Brands. The British model is built upon upscale supermarkets and the house brands they sell.

Recent news suggests that the British model is gaining ground, both in the UK and here in America, where it is the model that drives Costco sales (Trader Joe, on the other hand, uses a version of the German system). It will be interesting to see if this trend persists once the recession eases up.

Wines from Spain: Challenges and Opportunities

You know that a market niche is expanding when Constellation Brands decides to move into it, as it  has done with Red Guitar, an old vines Tempranillo-Granacha blend from Spain’s Navarra DO that sells for about ten bucks.

Red Guitar is marketed as “a rich, smooth and stylish celebration of the Spanish lifestyle” — a wine for the times, I guess, when consumers are looking for products that let them trade down in terms of price while trading up to a fun, more casual way of living.

Don’t Know Much

I didn’t know very much about the wines of Spain and the Spanish wine industry, so I went back to the classroom this week to try to catch up at a three day seminar on Spain’s wines organized by The Wine Academy of Spain and taught by Esteban Cabezas. My fellow students came mainly from within the wine industry — sommeliers, distributors and retailers. I learned a lot and sampled dozens of great wines. We didn’t taste Red Guitar, but we did survey the market from $5 bottles on up to the highest levels, including table wines, Sherry and sparkling Cavas. Yes, I know. Tough work …

Education is important to the future of the wines of Spain.  As I have written before, the number of unfamiliar regions and grape varieties is a challenge that must be addressed if wines from Spain are to achieve their obvious market potential. Constellation Brands’ decision to market Red Guitar as a “lifestyle” brand probably reflects the difficulty of selling wine from unfamiliar places made with unfamiliar grapes in a market where the international  varietals and styles are the lingua franca. Spanish winemakers need to get the word out — to educate consumers and sellers. Classes like the one I attended are a good step in this direction.

Uncorking the Potential of Wines from Spain

It’s useful to think about Spain’s wine industry using a basic SWOT (Strengths-Weaknesses-Opportunities-Threats) framework. Wines from Spain have many strengths that go beyond their obvious quality in the glass. Spanish food and culture are hot and Spain is a popular tourist destination, factors that can be leveraged in the marketplace. Intangible cultural factors have always helped sell Italian wines, so it is not unreasonable to think that Spain will benefit from them as well. Red Guitar’s marketing strategy is an obvious attempt to do just this.

There are weaknesses, too, of course. While the sparkling Cavas are very popular, offering Champagne quality at beer prices in some cases, other segments of the Spanish industry suffer from consumer ignorance or indifference. Sherry wines from Andalusia, for example, suffer the same challenge as Riesling wines. Consumers think they know what they are (simple, sweet stuff) but they are wrong. The diversity of styles and complexity of the best wines gets lost. For those who know them Sherry wines are the great bargains of the wine world. But most consumers never find out what they are missing. That needs to change.

The amazing diversity of Spain’s table wines is a strength in this market, where consumers are unusually willing to try new products if they perceive good value. But diversity is also a weakness to the extent that it confuses consumers (especially American consumers)  who are looking for a “brand” identity and can’t find it. Spain doesn’t have  a distinct regional identity that would draw in consumers initially and then encourage further experimentation as some other wine producing areas do.

In Search of “Brand Spain”

New Zealand has “brand” Marlborough Sauvignon Blanc, for example, which put that country on the wine map and gave millions of wine drinkers an excuse to try NZ wines. Oregon has its Pinot Noir, which has helped make it a wine region of international note despite its surprisingly small total production. Spain (like Washington State wine in this regard) produces so many different types and styles of wine that no one of them defines it. The regional identity is unclear. This is a barrier when trying to break into new markets, but a strength once a market beachhead has been established.

Although my terrioriste friends cringe when they hear me say this, I think it would be great if Spain had a Mondavi or Antinori who could define a “brand Spain”  in the global market. I think that a number of quality producers are trying to achieve this, but the industry is still pretty fragmented. Perhaps the consolidation that is sure to accompany the current economic downturn will move this process along.

The continuing economic crisis  is a great opportunity for Spain to expand export market share, especially in the United States where the market for wine is till growing in the mid-market segments. Spain, like Argentina, has a reputation for good value and distinctive wines and this is very useful right now.

Catch-22

It is important, however, to avoid being defined by low price alone. Spain’s first and fourth largest export markets (Germany and France) buy mainly low cost wines to stock the shelves of Aldi and similar discount sellers. Spain needs to focus on the UK and US (numbers two and three on their export table) where higher prices and margins are possible.

Another threat to Spain’s success in the international market is the temptation to conform too closely to the international market style (Pancho Campo, Spain’s leading wine authority, called this “the Australian style” in a Skype-dialogue with my class). Wines that are all alike become commodities at some point and it seems to me that Spain, with its already huge lake of surplus wines, wants to get out of that part of the market.

But there’s a Catch-22. It is easier, perhaps, to break into the market with a good value me-too wine. But it is hard to build upon that foundation (hence Australia’s current wine slump). Better to be yourself, distinctive, even quirky, it you can get consumers to give you a try.

As you can see, the prospects for Spain are as complex and multi-dimensional as the wines themselves.  I am optimistic that Spain’s wine industry will navigate this complicated passage successfully. Look for more on this topic in future posts.

Note: I would like to thank the Wine Academy of Spain and Catavino for allowing me to participate in the seminar on wines of Spain. Special thanks to my professor, Estaban Cabezas, and to Simone Spinner.

Tasting Note 8/11/2009: We tried the Red Guitar with dinner tonight and it was completely lacking in distinguishing qualities. It is hard to imagine that anyone who was introduced to the wines of Spain by Red Guitar would try another Spanish wine. Last night, however, we had the Borsao Tres Pichos, an Old Vines Granacha that sells for only a few dollars more, which was completely enchanting. You need to try Spain’s wines to know if you like them, but quality varies (and not just with price), so choose with care.

Crisis and Change in the Wine World

When the economic crisis began to unfold last year many people said that it wouldn’t affect the world of wine — people will still want to drink, they said, even more so when they are worried or depressed.  Recession is good for wine, they assured us.

Well, we all know now that that line of reasoning was misguided.  The crisis is hitting almost every shelf on the Wine Wall as consumers cut back and trade down (only a few value brands like Barefoot Cellars seem to be benefiting).  The most recent issues of Wine Spectator and Decanter feature cover stories that are designed to appeal to recession-shocked bargain-hunting wine enthusiasts. (See note below.) Wine industry publications are packed full of stories about how producers, retailers and restaurants are coping with declining demand.

Cycle or Shift?

Now that we know that economic crisis is having a real impact on wine, it is time to think more seriously about what form that impact is taking. Most people that I have talked to are thinking in terms of boom-bust cycles. The current downturn will be very difficult — and a shake out will take place across the industry — but, they say, the wine economy will bounce back again once the economy itself starts to recover.  This is probably the correct way to think about the future of wine markets, but it isn’t the only way.

A second possibility is that the crisis will produce a long term structural change in the wine market.  The market won’t bounce back from its low, but rather will reset itself and proceed along a new and possibly unpredictable future path. Economists who study other sectors (finance, automobiles, agriculture) and taking the possibility of structural shifts seriously.  Could it be happening in the world of wine?

I have given a lot of thought to question of cycles and shifts over the years.  My best known work in this regard is a comparative economic history of public debt in advanced economies called Mountains of Debt: Crisis and Change in Renaissance Florence, Victorian Britain and Postwar America (Oxford University Press, 1990).  (Mountains went out of print in the Clinton years when the US deficit went away, but George W. Bush and the current crisis convinced the publisher to bring it back).

One point of the book is that some crises are more significant than others.  Sometimes a crisis is a tremor that shakes things up for a while but leaves the landscape pretty much unchanged.  Other crises are major earthquakes, with more lasting long term implications.  Maybe this is a “Big One,” at least in terms of wine. I’m going to use the next few blog posts to think through this important question.

The Market Center Shifts

One early indicator of structural change comes from London, the center of the wine world.  Great Britain, as I’ve said before, is the most important wine market in the world. The British don’t drink the most wine in the world or produce the most, either, but they buy a lot of wine from other countries, making them the largest import market and therefore the focus of international competition (Germany and the United States along with Britain form the Big Three import markets).

But this may be changing.  Britain’s economy is being badly battered by the economic crisis, as an article in yesterday’s Financial Times makes clear.

As the UK economy contracts at its fastest rate since the second world war, the … Industry Watch report predicts that more company casualties will follow in 2010. It says 39,000 businesses, or one in 50, are likely to fail next year.

Britain’s banking sector is in bad shape, perhaps even worse than the US industry, and its government budget deficit is also spiraling into the red.  This has general wine market effects similar to those in the US (cutting back, trading down, switching over), but some different ones, as well, the most important of which is due to the exchange rate.

As Britain’s economy has imploded the pound has collapsed as well. The pound has fallen by about 25% against both the dollar and the Euro. It took about $2 (or €1.30) to buy a pound a year ago, now it is selling for $1.45 (or €1.06) today.  This means that imported wine (which in Britain is, well, wine) costs much more because of the exchange rate at the same time that the slumping economy (and lowered expectations) are undermining demand. The US dollar, on the other hand, has appreciated relative to most currencies apart from the yen, promising wine buyers lower prices to match their reduced economic circumstances.  So the recession is affecting wine in Britain more than the US wine market.  A shift is taking place — is it temporary or will it be permanent?

Although it is too soon to know for sure, I think it is possible that these factors could cause London to lose its preeminent position in the world wine market.  I see indicators in the decline of the Australian industry (complicated by other factors, I know — but the collapse of the British market is part of it) and the recent global focus on Argentina and its excellent wine values (both Wine Spectator and Decanter make this point).

Although Argentinean producers are looking to export wherever they can get a foot in the door, my strong sense is that they see their future in the U.S. market more than Great Britain.  Perhaps they are at the head of the pack as the world wine market resets and proceeds on a different path.

[Note: Wine Spectator includes 18 tips on stretching your wine dollar. My favorite is tip #7: buy by the case and get a discount (page 55 of the April 30, 2009 issue).  Sound advice, although the particular example cited may miss the point: "A 10 percent discount on a $300 case translates into a saving of $2.50 per bottle. That adds up fast."  The problem, of course, is that the people who used to buy those $300 cases are cutting back the hardest and I'm not sure that $2.50 a bottle  is going to turn them around.]

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