An article in today’s Wall Street Journal about the collapsing market for expensive wine provokes an essay on luxury goods. (Click here to read previous posts on wine and the economic crisis.)

Conspicuous Consumption

In his 1999 book Luxury Fever: Money and Happiness in an Era of Excess, Cornell economist Robert H. Frank analyzed the economic consequences of  the status-driven arms race that has raged for some years among the group that I call the affluenza. I guess affluenza is both the social class and the disease that afflicts them rolled into one.

The affluenza don’t simply consume goods and services, they use them to construct identities much as the singer in the video above (see note). Identity building is a complex process (ask the parent of a teenager) and sometimes an expensive one, too. You need to send status signals to others, of course, and you’ve also got to convince yourself. The acquisition and display of consumer goods (including but not limited to luxury products) is one aspect of identity building. Thorstein Veblen coined the term “conspicuous consumption” to describe it.

Private Choice, Social Consequence

Affluent consumers purchase increasingly expensive and scarce commodities as a way of telling others (and convincing themselves) of their status and taste. Robert Frank was concerned about the rise of luxury fever because of its boundless ability to soak up resources that might be better used somewhere else.

If you are just buying a car for transportation, for example, you can get pretty much what you might need for less than $30,000 (much less, in fact). But if you are building a self-image or staking out a place in the social pecking order, then the sky is the limit, both in terms of the car itself and the gadgets, accessories and so forth. Pretty soon you’ve got enough automotive wealth parked in your garage to feed and clothe a small Africa village for several years.

Luxury fever isn’t a new phenomenon. Affluent citizens of renaissance Venice engaged in competitive conspicuous consumption that threatened to bankrupt the city and its great families. In desperation, sumptuary laws were enacted to protect the citizens from their own excessive zeal. Such conspicuous displays as the number of rings that women could wear in public were strictly regulated.

To this day the gondolas that ply the waters of Venetian canals must by law be painted plain black — a regulation that dates back to the era when elaborate and expensive decorations threatened to sink both the boats and their owners “under water.” I think about sumptuary laws whenever a Hummer fills my rearview mirror.

Positional Goods

Robert Frank isn’t the first economist to express concern about luxury fever. John Maynard Keynes wrote his famous essay “The Economic Possibilities of our Grandchildren” in 1930, in the depths of the Great Depression. Keynes’s main point in the essay was that the temporary problem of the Depression would eventually disappear leaving a bigger problem, which Keynes called the Permanent Problem: how to live a rewarding, fulfilling life.

Keynes meant the essay to both calm panicked citizens and to inspire them to think beyond their wallets and purses to bigger issues that matter more in the long run. I have been thinking a lot about this essay recently, since 2009 bears a family resemblance to 1930.

Keynes thought that we would be getting to that point where the economic problem was fading and the permanent problem being solved right about now. He thought we would be rich enough, most of us in the developed world, to have enough stuff to satisfy our needs and be ready to think about more important matters than material goods. He put a number of conditions on this forecast, however, and one of them was that we would get over our interest in positional or status goods — that we would get over luxury fever. But I guess he was wrong.

Luxury Fever Cools

Or maybe I am being too hasty. “Luxury Wine Market Reels from Downturn” is the story in today’s Wall Street Journal. It reports a collapsing market for high end wines in the United States with lower sales, discounted prices and the prospect of industry consolidation as the wine market shakes out. Some of these wines are the sort of rare, expensive luxury products that have an irresistible appeal to the affluenza. Their value goes beyond what’s in the bottle to the people who long to own them.

The collapsing luxury wine market is bad news for the wineries, distributors, retailers and restaurants that earn a living on luxury wines. Good news for bargain hunters and collectors, I guess.

And possibly good news for our grandchildren. The decline in luxury wine sales is probably simply an exaggerated reaction to the economic crisis and this market will likely bounce right back when the economy starts looking up. But maybe, just maybe what we are seeing here is a reassessment of the economic and social role of fine wines, designer clothes, and other luxury goods.

I’m not saying that luxury goods will disappear, but if they become a mere end in themselves, not a means to a more complicated  psychological goal, then they will lose a little of their toxic social effect. Perhaps the economic crisis will change public perception of conspicuous consumption and encourage individuals to define identities in the ways that Keynes imagined. It’s a long shot, I know. Or maybe it is just a beginning.

Video note: Elton John and Tim Rice wrote this song for their Disney musical Aida. The cartoon characters are from the Disney series Kim Possible. Enjoy!

People are always asking me what I think about the stimulus package and they never seem to be satisfied with my answers.

What Stimulus Package?

For a while I was telling people, “Stimulus package? What stimulus package?” My reasoning was that the tax cuts were more political than economics — no one seriously thought they would stimulate much consumer spending — and the big government spending programs will take several quarters to kick in. Only a small percentage of the money has been spent so far. The promise of economic stimulus in six or nine months is a useful thing, but there hasn’t been much in the way of a direct effect yet.

Here in Washington State, cutbacks at the state level seem to be more than offsetting whatever Federal stimulus there has been. Although the Washington situation is very serious (see the recent Economist article on the recession in this state), things could be worse — think California.

Too Soon to Tell

Recently I’ve changed my tune a bit. Stimulus package? Too soon to tell, I say, or impossible to know. These are both good answers even if my friends don’t like them. Too soon to tell because it will take more time before the full effects, positive and negative, are felt. Too soon to tell because we haven’t figured out yet  how to deal with the inevitable consequences of the recent spectacular money creation and public debt increases. Some people fear that the cure to these problems will be more deadly than the recession’s disease.

Impossible to tell? Yes, because economics isn’t a hard science and we don’t have the luxury of running controlled experiments. We know that unemployment has increased to 9.5% with the stimulus package in place — that’s pretty shocking — but how high would it have been without the federal emergency programs? We will never know for sure, so these policies are sure to be debated back and forth for years.

No one seems to appreciate my analysis of the economic stimulus package so I’m going to change gears again. Now when people ask me my opinion I’m going to give them a wine review. That’s because I recently discovered an interesting white wine called Cavatappi Stimulus Package 2008.

In Vino Stimulus

Cavatappi (it means corkscrew in Italian) is a winery founded some years ago by former restaurateur and Italian wine lover Peter Dow. Cavatappi produces mainly Washington-grown Italian varietal wines (23 vintages of Washington Nebbiolo and Sangiovese). I’ve seen a Cavatappi white blend before, but this is the first one with an economic crisis hook. I couldn’t find anything about the wine on the web so I wrote to Peter Dow. He reports that

It is a blend of SB and Viognier. I tasted a similar wine in the Rhone last winter that was a Marsanne Roussane and SB blend and I really liked it.  It is designed to be a simple summer quaffer and at 10.00 retail it is being well received.

I was speculating about what message Cavatappi is trying to send by naming this white blend in honor of the economic stimulus program. Is it to show support for the Obama plan? To send a message to consumers: spend your tax savings on wine? Or maybe it’s a cash flow thing — white wines can be turned over relatively quickly, providing an economic stimulus to the winemaker. Buy this wine and stimulate the Cavatappi economy!

Unfortunately the correct answer is much less complicated. “I used the name because I thought there was some humor in it, but mainly wanted to see if I could get it by the TTB,” according to Peter. Apparently he did!

So here’s the bottom line: what do I think of the stimulus package? Refreshing, but restrained. (I’m not a skilled wine taster but it seems to me that the Viognier tames the Sauvignon Blanc and shapes it a bit.) It made a nice match with a hearty salad at dinner last night.

Refreshing but restrained. Not a perfect description of the economic stimulus package, but not completely off the mark either.

And I can honestly recommend this stimulus to all my friends. (Or almost all of them: ten dollars is more than my senior cheap wine researcher  Michael Morrell likes to spend — I guess you can’t please everyone.)

The Business of Wine (edited by Geralyn G. Brostrom and John C. Brostrom) is organized as an encyclopedia with entries from A (Airlines comes first) to Z (for Zinfandel, of course). I opened the book with two questions on my mind: Why an encyclopedia? And why another encyclopedia?

Why an encyclopedia?

This question comes up because there are a lot of different ways to tell the story of the business of wine and to organize that story. An encyclopedia, with alphabetically arranged entries of various lengths, is a peculiar choice when you think about it.

On one hand, it gives a lot of freedom to the reader to cut and paste her own story by darting back and forth among items, possibly but not necessarily hitting all the key points along the way. On the other hand it also gives the editors quite a bit of control, since they get to choose what gets in (and in which author’s account) and what and who are left out.

Does the encyclopedia format work, or would a series of essays by various experts  (the format chosen for another recent book also titled The Business of Wine) have been more useful?

Why another encyclopedia?

This question arises because we already have a really excellent encyclopedia of the business of wine — it is embedded in The Oxford Companion to Wine 3/e edited by Jancis Robinson. Although the Oxford Companion is an encyclopedia of wine in general, there is a lot of great wine economics to be found here.

This is understandable. It is difficult to think about wine without straying, intentionally or not, into wine economics. Winemaking is an art, a science and a business and you really can’t leave the business part out if you want to understand the whole process. That’s why about a third of the Masters of Wine exam deals with questions about the business of wine.

The Oxford Companion does a good job dealing with many wine economics topics. Does the new encyclopedia add something to a bookshelf that already contains the Oxford Companion?

Managing the Trade-Offs

How does the encyclopedia format work? Well, having spent some time with this book I have to say that it is an OK compromise. It is a lot more hit-and-miss than the ideal book of essays that I imagine, but apparently that book is very difficult to write because no one seems to have written it. The business of wine is very complicated and the parts of the business and the factors that affect it are both numerous and highly interconnected.

The encyclopedia format is problematic, but all the other wine business books I have read have had their problems, too. (One in particular — I won’t name it, but you probably know the one I’m talking about  —  promised a first-person account of the wine trade  but descended into something closer to a personal vendetta against professional colleagues.)

Do we need another encyclopedia – this specialized one – when the Oxford Companion already does a pretty good job covering wine economic topics? Yes, I think so, but as a supplement to the Oxford Companion not a replacement for it. I find it useful to have a book that drills down into the wine business in many cases, rather than treating it as part of a more general survey.

And some of the choices the editors have made are interesting. The Argentina entry, for example, is written by Laura Catena, VP of Bodega Catena Zappa and owner of Luca winery. And Joel Butler MW, the head of wine education at Ste. Michelle Wine Estates, wrote the Washington State essay. Interesting to get these industry insider views.

Possible Improvements

My initial doubts about this new book have been overcome to a considerable extent. There are a number of ways the book could be improved, however. It seems to me that the editors might want to tinker with ratio and proportion a bit. Most encyclopedias like this divide entries into short, longer and longest (the longest being a couple of thousand works at most) and it is probably difficult to match topics and lengths. Maybe the entry on Airline wine sales could have been shorter and the discussion of Biodynamic wine a bit longer – you know what I mean. It’s a tricky business.

Most of the entries include suggestions for further reading and these are often  inadequate (as is the brief attempt at a bibliography). An encyclopedia like this is usually the introduction to a topic for readers, not the last word, so readers need to know where to go next. A little more guidance would be useful, especially for students.

And although this is an encyclopedia, I would have appreciated a longer introductory essay that tried to say something interesting about the state of the wine industry today and its challenges for the future.

Got data?

Finally, I am an economist, so I’d naturally like to see more data. Many of the entries include a good deal of data, as you would expect, and there is an appendix on “international wine data,” providing basic consumption and production information on many but not all the countries discussed in the main text. I think this could be usefully expanded to include more country-level data as well as data about international flows and time series data on prices and quantities.

Let me end on a positive note. This book exceeded my expectations and I think it is a useful reference, especially good for anyone just getting started in the study of the business of wine. And especially useful when read alongside other standard references like the Oxford Companion and Tom Stevenson’s excellent Wine Report annual series.

My copy of the second edition of Michael Cooper’s Wine Atlas of New Zealand arrived this week and I am having trouble putting it down. Cooper’s coverage of the wines, the wineries, the people, the industry and the market is exceptional. And it is stunningly beautiful, too, with excellent maps and spectacular photos. A coffee table book in terms of size and weight, but with real substance. One of the two best regional wine atlases I own (the other is Burton Anderson’s Wine Atlas of Italy, which is still a valuable reference 20 years after its publication).

(Note: Cooper’s NZ Wine Atlas hasn’t been released yet in the US, but it is easy buy from UK online sellers like Amazon.co.uk.)

The Amazing NZ Wine Story

I’ve always been fascinated by the New Zealand wine story — how a tiny (0.5 percent of global output) wine producer at the far corner of the earth could become a leading global brand (a NZ wine is the #1 Sauvignon Blanc in the US) and earn the highest average export price of any country in the world.

I couldn’t wait to get Cooper’s second edition because a lot has changed for New Zealand wine since the first edition was published in 2002 and my last research trip there in 2004.  A lot has changed, but a lot has stayed the same, too.

The biggest threat to New Zealand’s success has stayed the same: the problem of balancing supply and demand. New Zealand was plagued by boom and bust cycles for many years. Overproduction of low quality wines created a crisis in the 1980s. Many winemaking businesses collapsed and were snapped up by NZ or foreign buyers, leading to the internationalization and consolidation of the industry. The NZ government initiated a grubbing up scheme in 1986 to reduce vineyard plantings, especially of low quality wines, setting the stage for the current boom.

New Zealand has been extremely successful in this era of global wine, which has been characterized by high quality, a strong global brand (Marlborough Sauvignon Blanc and now Pinot Noir as well), and a liberal trade regime that accepts high import levels of inexpensive wine as the price to be paid for high levels of higher-priced exports.

The Spectre of Surplus

Despite this success — or more precisely because of it, fear of wine and grape surpluses, price wars and market collapse continue to haunt New Zealand producers — at least those who are old enough to remember the crisis of the 1980s. In agriculture we know that nothing generates a surplus tomorrow faster than high prices today.

Cooper’s data make this boom-bust concern easy to understand. New Zealand’s industry has grown rapidly — can it be sustained? Producing vineyard area in New Zealand tripled from 10,000 hectares in 2000 to more than 31,000 hecrates (projected) in 2010. Wine production rose from 60 million liters in 2000 to 200 million in 2008. The number of wineries risen, too, if not quite so quickly: about 600 today, up from 334 ten years ago.

NZ domestic wine sales and wine imports have been relatively flat over the last ten years, so essentially all of the increased production has been targeted for export: 87.8 million liters in 2008 compared with just 15.2 million liters in 1998.

So far the world market has been wiling to absorb this rising production (and without diluting the NZ brand and the price premium it commands).  Can this continue into the future or does Stein’s Law (see note below) apply?

A recent Rabobank report on “New Zealand Wine Supply — Testing Limits” provides mixed indicators. Rabobank acknowledges the importance of balancing supply and demand, especially given the world economic crisis, and notes that nature may limit runaway growth. Marlborough is running out of land suitable for vineyards, according to the report.

The day will come when the quantities of Marlborough Sauvignon Blanc available … will reach its physical limit and the long term supply and demand outlook looks very favorable for growers and producers in the region. It is vital that in the next 10 years the reputation and bargaining power of producers in this region be maintained in order for the region to enjoy higher returns in the future.

In other words, things look good in the long run, it’s the short run that NZ needs to worry about. Persistent short term surpluses could devalue NZ wines from premium products to commodities. That would be enormously damaging to the industry.

There are some indicators that the damage is happening now. I have heard of deep discounts on some New Zealand wines in Britain, for example, and I even saw iconic Cloudy Bay on sale at Costco this week for just $20, about $10 less than its price last year.  More to the point, however, today’s Gisborne Herald reports that Pernod Ricard, which owns a number of important NZ brands, is terminating many or most grower contracts in the Gisborne region (North of Hawkes Bay on the North Island). The president of the Gisborne Winegrowers group is quoted

I have fielded a lot of calls from very concerned and distressed growers — my advice to them is to certainly not spend any more money on any of those blocks … Meantime, they should talk to their accountants and bankers.

Gisborne is a major producing area, but it doesn’t have the name recognition abroad of Marlborough, Martinborough, Hawkes Bay and Central Otago. It is Chardonnay country with 52.8% of producing vineyard area in that varietal compared to 8.2% planted to Pinot Gris and less than 4% each to Sauvignon Blanc and Pinot Noir. Chardonnay has become unfashionable — it is not where the market growth is these days. It makes sense therefore that Gisborne might be the first area to feel the combined effects of an overall surplus and shifting demand.

The Next Big Thing?

What is to be done? The Rabobank study looks to Pinot Gris, arguing that it could join Sauvignon Blanc and Pinot Noir as a leading NZ export wine thereby expanding and diversifying the NZ export market. The expected growth of wine consumption in Asia is one factor in this optimistic scenario, since Pinot Gris is said to pair well with Asian foods. Food friendly and premium price — these are attractive qualities it is said in the growing Chinese wine market, according to Rabobank.

Pinot Gris is also thought to be a style that younger wine drinkers will find fun, friendly and easy to like (but also flavorful, unlike certain Pinot Grigio  you may have been served …). Michael Cooper is optimistic, too, in his Wine Atlas discussion of the varietal., citing “high potential” and “impressive weights and flavour richness” on both North Island and South wines.

Pinot Gris is profitable, too. Made in stainless steel tanks with no oak aging, Pinot Gris is a good cash flow wine.  I can’t remember seeing NZ PG on store shelves here in the U.S., however. Perhaps I’ve just missed them or maybe NZ producers are focusing on different markets — Britain, Australia or Asia? — to avoid undercutting Sauvignon Blanc sales here.

“Demand for Pinot Gris,” the Rabobank report asserts, “should underpin even greater returns for growers in the medium to long-term.” A good thing, I think, if things hold together until the medium- and long-term arrive (there’s a famous Keynes quote about this, although I don’t think he was talking about wine). There is still the old problem of the short-term supply-demand balance to be worked out.

Note: Stein’s Law (named for Presidential economic advisor Herbert Stein, is that if something cannot go on forever it will stop. Stein’s point was not that all bubbles burst but rather that market forces tend eventually to rein in unsustainable trends (although not always in a gentle way) and you don’t necessarily need government to do the job for you.

Spain has the largest area devoted to vineyards of any country in the world and has achieved considerable international success, both critical and commercial. But it also confronts the many challenges typical of Old World producers. As I write The Wine Economist blog and work on my new book^* I am increasingly convinced that much rides on the ability of Old World wine producing countries like France, Italy and Spain to adjust to and succeed in changing market conditions.

Spain is an especially interesting case study in this regard. On one hand Spain faces  many of the problems we associate with Old World wine. Although overall production has fallen in recent years it is still well above consumption (which has fallen, too). The surplus — poor quality wines with no market — have been sent to the distillery in recent years, but this is about to end as the new EU reforms kick in. These reforms will benefit wine regions and producers that increase quality and are able to adapt to the new more competitive global market environment.

Map of Spain’s Wine Regions

The Spanish wine industry is well positioned in some ways to take advantage of this situation. Consumers are looking for good value in wines today and I have found a number of interesting and distinctive wines from Spain in the competitive sub-$14 price range, where demand is still relatively strong as buyers trade down from more expensive products. White wines from Spain are attractive options for the growing number of consumers who have lost interest in Chardonnay and the reds would be a good choice for those who’ve grown tied of Australian Shiraz. Jaded ABC (Anything But Chardonnay) and ABS (Anything But Shiraz) buyers are up for grabs and Spanish producers are making their case.

Today’s market, for all its economic discontents, is a good opportunity for Spanish wines to move deeper into the American market, but there are problems that must be addressed. American wine buyers have learned to speak Italian, French and, well, Californian when it comes to wine in terms of varietals and appellations. They have trouble, both literally and figuratively, translating Spanish wine.

Spain has an unusually rich heritage of native grape varieties, which is both an advantage and an obstacle to be overcome. Unfamiliar varietal names are not an insurmountable barrier, although you won’t know if you like Tempranillo, Albariño and Garnacha and other native grape wines until you try them, so getting consumers to take that first taste or make the first purchase is very important. Appelations are a bigger hurdle. Spain has more than 50 regional appellations – Denominaciones de Origen or DOs – and mastering this system and understanding the differences is a challenge – an educational challenge.

The Spanish wine industry has wisely decided to confront this problem directly this summer by organizing a series of 3-day educational seminars around the country organized by The Wine Academy of Spain in association with Catavino. Wine professionals and enthusiasts will meet in Denver, Houston, Chicago, Boston, New Haven, Atlanta, Seattle, Portland, San Francisco, San Diego, Cleveland, Washington and New York (click here to see dates and registration information) and learn about the wines of Spain. Three days? Well, yes. Looking at the schedule it seems to me that it will take at least three days to learn the basic of Spain’s regions and their wines, appellations, terroirs, varietals, history and production and market structures.

Mario Battali once said that there is no such thing as Italian food, there are only the regional cuisines of Italy, which is why Italian food is endlessly interesting. I suspect that the same can be said about Spain and its wine. There is no Spanish wine, only the wines of Spain – and American wine enthusiasts have a lot to learn about them.

Mastering the Spanish wine vocabulary will take work, but it should be pleasant work. I am hoping to be invited to participate in the Seattle workshop (Chateau Ste Michelle and Dr. Loosen invited me to the Riesling Rendezvous last year and I found that experience very valuable) so that I can report on it here and write about the Spanish industry with more authority in my book. I hope to gain a better understanding of the wines of Spain and where they fit into the future of wine.

^* The working title of my new book is The Future of Wine: Globalization, Two Buck Chuck and the Revenge of the Terroiristes.

Special thanks to Steve De Long of delongwine.com for alerting me to this interesting and ambitious program.

Decanter.com reports that Nobilo Marlborough Sauvignon Blanc has overtaken Kendall Jackson as the best selling Sauvignon Blanc in the United States. The ranking is based upon sales volume, but the wines retail for about the same $10 to $12 price,  so Nobilo probably ranks first by value as well. An amazing achievement, given the many obvious challenges the New Zealand wine industry faces in terms of size, production cost, shipping distances, access to US distribution and so on.

A Matter of Style

It is interesting to consider how Nobilo and the New Zealand industry have  managed to achieve this success. The first reason is the distinctive quality of Marlborough Sauvignon Blanc itself. Even wine critics who don’t think very highly of Sauvignon Blanc in general (I’m talking about you, Jancis Robinson) acknowledge that the Marlborough wines are distinctive and that the best of them are truly exceptional. In my house they set the standard for Sauvignon Blanc.

Why are these wines so good (and so popular)? Winemakers always start with the vineyard and it is certainly true that Marlborough seems ideally suited to produce Sauvignon Blanc grapes. (Ironically, no grapes at all were grown there before the mid-1970s). The skills of the winemakers are also important. The distinctive style of the wines is another factor. The June 2009 Wine Business Monthly includes a fine article by Curtis Phillips on Sauvignon Blanc yeasts that nicely explains the NZ style. NZ SB, he writes, emphasizes a varietal style, letting the fruit speak forcefully. The French SB style is “anti-varietal,” he says, emphasizing texture and minerality over fruit aromas and flavors.

Finally there is the oak-influenced style, which originated in France but was made famous by Mondavi as Fumé Blanc. This barrel-fermented SB style remains very popular in the U.S., but has obviously been eclipsed in the marketplace by the fruit-forward Marlborough product.

The New Zealand varietal style is a hot commodity. New Zealand producers should hope that it stays hot and doesn’t fade as some popular regional styles have done (I’m thinking about how quickly Australian Shiraz has fallen from favor).

The International Influence

Nobilo’s rise to #1 in the US market is not an accident, according to the Decanter.com article. Nobilo is a Constellation Brands product — one of five New Zealand export brands of ConstellationNZ (see logos above).  Joe Stanton, the ConstellationNZ CEO, explains that his company’s strategy was to make Nobilo the top US SB by focusing on “traditional” wine buyers and giving them what they expect in the way of packaging for premium wine: cork instead of screw-cap, for example, and flint-colored glass bottles instead of traditional French green. Plus, of course, the intense Marlborough aromas and flavors. New wine in old bottles (and closures), I guess, and it worked.

ConstellationNZ accounts for 40% of all NZ wine sold in the US — an astonishing figure, but understandable given the strong brands that it has acquired (Nobilo, Kim Crawford, Drylands, Selaks) or built (Monkey Bay)and the efficient distribution system that has evolved to get these wines and all the other Constellation products on store shelves and restaurant wine lists.

In fact, the New Zealand industry is dominated by foreign-owned wineries, as wine writer Michael Cooper points out in the new edition of his fine Wine Atlas of New Zealand. Of the top wine producers only two (Delegat’s and Villa Maria) are Kiwi-owned. The largest producer is Pernod Ricard NZ (formerly Montana wines), part of the big French drinks group. Pernod manages 25 NZ brands according to their website, including of course Montana (sold as Brancott Estate in the US), Corbans, Church Road and others.

The most famous NZ wine — Cloudy Bay — is owned by LVMH Möet Hennesy-Louis Vuitton, the French luxury goods conglomerate.  Matua Valley, another leading NZ producer, is part of the Australian Foster’s Group. The list goes on.

It is tempting to consider the pluses and minuses of international ownership as Michael Cooper does briefly in the article linked above. This is a topic that I plan to analyze in more detail my next book. In the meantime, however, it is perhaps best to consider how the combination of the local (New Zealand’s wonderful terroir) and the global (big multinationals like Constellation and Pernod Ricard) have combined to both produce New Zealand’s tasty wines and to deliver them to our doorsteps.

New Zealand has done specutacularly well in the global wine market so far. What lies ahead? Watch this space!

October. This is one of the peculiarly dangerous months to speculate in stocks. The others are July, January, September, April, November, May, March, June, December, August, and February.” — Mark Twain, Pudd’nhead Wilson (1894)

I wonder what Mark Twain would say about speculating in wine in October, May or any other month? I expect he would be suspicious of the idea. Mark Twain was a great author but a lousy investor. His cautious attitude toward investment was based upon his own disastrous financial experiences.

I was reminded of this quote this morning when I opened the New York Times “Special Section on Wealth & Personal Finance.”  The cover features a half-page color image of an exploding cherry pie (or maybe it’s strawberry — what do you think?). I am not really sure what it means.

What Time Is It?

But the theme of the special section is pretty clear — time to consider alternative investments and investment strategies.  And on page 4 I found the article that got me thinking about Mr. Twain’s investment advice: Investing in Wine: Now May Be the Time by William L. Hamilton. It’s an interesting article — click on the link to read it.

The idea, of course, is that wine prices have been falling, so this is an opportunity to buy in at the market bottom.

“It’s a great time to buy wine, the best time in a decade,” said Charles Curtis, who is in charge of Christie’s North American wine department. “People we’ve never heard of are jumping into the market, taking advantage of the lull to get into collecting, now that they have access.”

I am naturally a bit suspicious of buying advice given by people with an interest in the sales.  They always seem to think that now is the time to buy.  Rising prices? Buy now because they can only go higher.  Falling prices? But now before they rise again.  Mr. Curtis may be right, and I’m sure his recommendation is honestly given, but he might be wrong, too.

Uncommon Times

These are uncommon economic times and market changes are unusually hard to predict, which makes investing even in fine wines feel a bit speculative. Alfred Marshall, the great Cambridge economist, argued that markets are generally as stable and predictable as an apple in a bow. Prices fall when there is a surplus until the excess supply is gone. Prices rise when there is a shortage until the shortage disappears.  The movement towards stable equilibrium is quite strong and predictable.

But wine markets today look a bit more unstable — more like that exploding pie now that I think of it.  Here’s another quote from the New York Times article.

Though falling prices kept many collectors from selling, reducing the amount of wine on the market, returning prices in the last four months have produced an uncomfortable volume of wine to sell, said Charles Curtis of Christie’s.

The first part of the sentence describes how a market responds to surplus  — falling price causes sellers to pull some goods out of the market.  The second part describes a market in shortage — the opposite condition — where rising price brings sellers into the market. This is not a combination of forces that you expect to see in the same paragraph much less the same sentence.

There are a number of supply-demand changes that could account for this (Econ 101 students — do your stuff), but one distinct possibility is what economists call over-shooting, which is a characteristic of some financial markets and especially foreign exchange markets and maybe now wine markets.  When over-shooting occurs, prices don’t drop smoothly to equilibrium like an apple in a bowl. Rather they over-shoot the equilibrium and then shoot back up. Back and forth, sometimes in increasingly unstable cycles. Market equilibrium and the “true market price” are hard to determine.

It is difficult to know where prices will go next in a market like this and the difference between “investing” and “speculating,” at least in the short run, is not completely clear. I don’t give investment advice (or rate wines, either, which makes this an unusual wine blog), but I’m not planning to rush into high end wine markets just yet. Too risky for me.

Investors vs Collectors

But then I’m not really a wine investor.  In my reading I find the terms wine investor and wine collector often used as synonyms, but I’m not sure they should be.  A wine collector buys what he or she wants to own (and, presumably, drink). It’s a personal thing. A wine investor should buy what other people will want to own, which might have nothing to do with personal taste.  I have known only a few real wine investors but lots of wine collectors who  justify at least some of their purchases as investments, but don’t manage them as they would a real investment.

In today’s market, however, both groups need to realize that there is a significant speculative element to their wine purchases and keep Mark Twain’s 115 year-old warning in mind!

Note:  Stephen Bachmann at Vinfolio posted an interesting reponse to this article. Click here to read it.

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

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

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

Lies, Damned Lies and Statistics

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

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

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

A Wine Spectator’s article reports that

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

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

Listening to the Wine Wall

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

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

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

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

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

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

RH Phillips, RIP

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

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

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

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

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

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

Surrounded by Data

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

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

The birth of a new AVA (American Viticultural Area) is generally greeted like the birth of a baby – a good thing, a cause for celebration.  So a recent Wine Spectator article was somewhat bittersweet – it announced two successful births (Snipes Mountain AVA and Lake Chelan AVA – both in Washington State) and one failure.  But I’m not sure that that “two cheers” is necessarily the right toast (and I found myself quoted to this effect in the Wine Spectator).  My problem, I guess, is that I can’t stop thinking like an economist, even when it comes to good news like new AVAs.

It isn’t that AVAs are bad, it is just that they are complicated and new AVAs produce both benefits, which are celebrated, and costs, which economists like me can’t seem to ignore.

Good or Bad?

As I have said in a pervious post, the American Viticultural Area is an ill-defined concept.  It is a geographic indicator, of course, telling the buyer that a high percentage of the grapes used to make a particular wine come from a specific geographic area, but its significance beyond that is unclear.

An AVA doesn’t necessarily indicate a particular style of wine, for example, the way some European AOC rules do.  AOC protocols often specify region, grape varieties, levels of ripeness and even the nature of particular blends that are permitted or sometimes required.  Chianti is a region in Tuscany, for example, but it is also a recipe (albeit a flexible recipe) for the wines that carry that label.  There can be great variation among wines from a given AOC, but the idea is that they represent variations on a theme rather than completely different wines.

AVAs don’t necessarily define terroir either.  Many AVAs are quite large and contain many different soil types and microclimates.  The Napa Valley AVA, for example, encompasses rather different condition in the North than the South and on the hillsides and valley floor.  The Columbia Valley AVA in Washington State takes this to the next level in terms of terroir diversity.

Even the relatively small Snipes Mountain AVA (a sub-AVA of the Columbia Valley) includes rather dramatic differences in growing conditions.  As Kevin Pogue of VinTerra Consulting said in a comment on a previous Wine Economist post:

It’s impossible to equate US AVAs with terroir. They’re just too big and there’s too much variability in all the physical parameters (soil, bedrock, climate, geomorphology). I had temperature monitors on Snipes Mountain (one of the smallest AVAs) during the growing season last year, and they showed huge variations in several important climate parameters. The top part of Snipes Mountain rises above the cold air pool that regularly forms in the Yakima Valley and so it’s much warmer and has a much longer growing season. The Walla Walla AVA has at least 4 distinct soil terroirs and the average annual rainfall varies from 7 to 24 inches within its boundaries!

In Economics Veritas

While the viticultural idea of AVAs is ill-defined the economic idea of AVAs is relatively clear.  AVAs are brands, but not the type of brands you are used to thinking of.  Brands have a bad reputation among wine consumers because they are associated with insipid wines sold as package goods – Franzia, Yellow Tail, Two Buck Chuck.  While these wines clearly serve a purpose in the marketplace and are obviously a satisfactory choice to the people who buy them, they are seen by wine enthusiasts as an insult to the concept of fine wine.  They are industrial wine, not terroir wine, if you see what I mean.

Economists don’t react so strongly to the idea of a brand, however.  To us brands are just devices that producers use to send signals to buyers in markets with costly information. You may or may not like to eat at McDonalds, for example, but you know what to expect when you go there.  Brands do the same thing for Budweiser, Coca Cola and Starbucks.

Private brands do the same thing for wines if you think about Robert Mondavi, Clos du Val or Screaming Eagle. You have a good idea of what you are getting in terms of style and quality because producers invest in the brands to establish reputations.  Having a well known and reliable brand is a great advantage in the marketplace.

The main difference between private brands like these and AVAs is this: AVAs are communal brands.  They don’t belong to any single producer but rather to anyone who sources grapes from the region.  Hence the great difference in style that appears as different makers first seek the AVA designation to differentiate themselves from wineries in other areas and then further to differentiate themselves from other makers within the AVA.  The result is not necessarily harmonious and so the AVA concept loses value to consumers.

Essentially the problem is that the incentive to invest in the communal brand is ultimately weaker than the incentive to invest in the private brand once the AVA has been established.  This makes sense since benefits from an improved communal brand must be shared while benefits from improving your own private brand are yours alone. The market significance of the AVA can quickly disappear.

The problem gets worse as AVAs increase in number, making it more and more difficult for consumers to understand what qualities are associated with each.  As I say in the Wine Spectator article, each new AVA benefits a small set of producers by giving them a new brand, but the collective result (the number of AVAs is now approaching 200) is in fact to reduce the significance of AVAs generally.  I think it is possible that private brands gain market power as collective AVAs proliferate.  And that’s exactly the opposite of what AVAs are supposed to do.

The Ugly Side

I felt bad in raising my doubts about AVAs because I know and admire some of the winemakers in the new Lake Chelan AVA (especially Tsillan Cellars and Nefarious Cellars) and I didn’t want to rain on their parade. But I stopped feeling guilty when I discovered an article by A to Z Wineworks CEO Bill Hatcher on the Oregon Wine Press website. The continued proliferation of AVAs and sub-AVAs in Oregon, Bill says, isn’t good or even bad.  It’s downright ugly!

Oregon’s wine industry is tiny compared to California and small relative to Washington State.  But it is big in AVAs, as the map above indicates, with sixteen AVAs overall and six sub AVAs within the Willamette Valley region itself.  Wow!  Bill writes that …

Our fixation on sub-appellations at the expense of raising the profile of Oregon over the past years is coming back to haunt us. As the economy tailspins, consumers, restaurateurs and retailers are returning to familiar roots. The results are pruned wine lists, repetitive shelf facings of monolithic national brands and small wineries being culled from wholesaler books. Gone are the halcyon days when someone picked up a $50 bottle of Oregon Pinot Noir in Memphis and said, “Cool, I didn’t know they were making wine in Oregon; let’s give it a try.”

If the majority of Americans cannot point to Iraq on a world map, do we really expect them to pinpoint the Eola Hills or Chehalem Mountains, let alone deconstruct the subtleties between the two? Further underscoring that presumptiveness, a recent study commissioned by the Oregon Wine Board revealed that over half the respondents in our target market were largely unfamiliar with Oregon as a wine-producing region. The sub-appellation movement reached absurdity with the Snake River AVA, containing one Oregon vineyard and no wineries, meaning that we had, in fact, finally parsed an appellation to someone’s backyard.

Bill Hatcher is smart and bold.  His A to Z Wineworks is now the largest single producer in Oregon and he thus has an unusually strong interest in seeing the Oregon brand strengthened since this would strengthen his own brand as well.  He argues that a complex web of sub-AVAs provides few benefits and potentially large costs. An ugly situation, but an understandable one.  It is what Mancur Olson characterized as the tension between narrow and encompassing interests. Bill Hatcher concludes

The industry has come to be driven more by politics and narrow self-interest rather than collective marketing economics or common sense, a polemic we can no longer afford (if we ever could) in these precarious times. More than a few wineries will fail in the coming months and more than a few vineyards will not be harvested. This is not the time for intellectually bankrupt parlor debates as to whose soil is redder and whose vineyard practices are greener, but rather a time to unite and underwrite the commonwealth of Oregon.

The economic crisis is likely to intensify the tension between narrow and encompassing interests and between private and communal brands.  The strong are likely to get stronger in this environment, I think, and as Bill Hatcher suggests, some of the weak will fade away.

I have often argued that to really understand an industry you first need to understand where the bottlenecks are in the value chain.  Bottlenecks disrupt the efficient flow of resources and so industries tend to evolve around them.  I believe that this observation holds especially true for wine. Herewith a brief update on the current situation.

Do the Math

Silicon Valley Bank released their annual State of the Wine Industry Report yesterday.  SVB is a major lender to US wine producers and thus has a strong interest in producing clear, relevant wine economics research. (I also admire the wine economics research produced by the Dutch agricultural lender Rabobank.)

The report provides some good news along with many worrisome  observations (click on the link above to download the study) and fresh data on the biggest single bottleneck in the U.S. wine industry — distribution.

Here’s the basic math.  SVB estimate that there are 6000 wineries actuve in the US market producing about 7000 wine brands.  All these brands need to squeeze through the U.S. three tier distribution system bottleneck.  This means they need to go from maker (first tier) to state-licensed distributor (second tier) to local retailer (third tier). That’s the law here in the United States,  where we still think of wine as a controlled substance.

There are only limited opportunities for producers  to skip a step.  I understand that Bronco Wines, for example, can sell its Charles Shaw brand directly to Trader Joe’s in California because of a legal loophole there, but has to use an independent  distributor in other states. That’s why Two Buck Chuck costs $1.99 in L.A. but $2.99 here in Washington State.  That extra buck is the cost of the extra distribution layer.

The Big Squeeze

Now we get to the big squeeze. These 7000 brands get funneled through about 550 major distributors according to SVB (obviously this does not count many smaller Mom-and-Pop and specialized distributors that I am familiar with), which is about half as many as a few years back.  Hopefully you can appreciate the bottleneck — 7000 brands worth $30 billion in retail sales have to squeeze  through 550 distributors in 50 states on their way to 76 million wine consumers.  Any blockage in the distributor tier backs up the whole industry.

And the problem gets worse because the distributors are obviously getting squeezed themselves by the economy — falling sales, trading down, shrinking margins, credit limits and counter-party risk.  Expect distributors to consolidate in some cases and pull back to reduce cost and risk in others.

The net effect is clear — distributors are reducing their SKUs (stock keeping units to non-economists) and focusing a smaller number of  reliably profitable products lines.  This means that it is harder and harder for new and niche wineries to get on the warehouse pallet.

The Missing Middle

I’m not sure exactly how this all will shake out, but I suspect the problem will be worse in the middle market. Very small wineries can often successful self-distribute.  Very large ones will probably get distribution because of the volumes they can generate.  The middle falls awkwardly in between — too big to sell it all yourself, too small to be worth a major distributor’s time. The fact that the distribution system is fragmented into 50 (plus DC) pieces just makes the situation worse.

In the same way, SVB data suggest that lower priced fine wines ($35 and less on their scale — remember that a lot of SVB’s customers are in Napa Valley) are still selling pretty well and very expensive icon wines apparently are doing OK, too.  The mid-range is in trouble.  SVB calls $35-$50 a “gray area” and $50-$125 a “dead zone.” Ouch.

I would hate to be a new 3000-5000 case winery trying to sell wine made to be priced in the dead zone.  Unfortunately, I think there may be a lot of new wineries coming on line now who planned to do just that back when economic conditions were sunnier. It will take exceptional effort (or truly exceptional wine) to make this business model work in the current economic environment. I recently talked with one middle-sized premium winemaker who has already figured this out and pulled back — lower output, lower prices — to get clear of the dead zone.

This is the “missing middle” effect that economists are familiar with in other contexts (small family operations and huge corporate businesses survive, the middle simply disappears).  The distribution bottleneck isn’t necessarily the cause of the coming missing middle effect in the wine industry, but it will certainly make it worse.