“Tighten Up” was a big hit for a Archie Bell and the Drells back in 1968. If you aren’t familiar with this R&B tune and its trademark dance you might want to take a moment to learn it because Tighten Up is where the U.S. wine market is headed.
[This is the second in a series of articles on Tight, Fat and Uncorked, the three trends I see shaping the wine industry in the near future.]
Up and Down Economics
There is nothing new about tight wine markets (where shortages pull prices higher) or slack markets either. Wine is an agricultural product subject to the sort of persistent cycles that economists have long studied. Today’s high price encourages farmers to plant more even as it discourages growth in demand. Result: future surplus and falling price when the new crops hit the market. Low prices discourage production but encourage consumption growth, resulting in shortages and future price hikes.
Up and down — that’s happens in wine markets. The Turrentine Brokerage’s “Wine Business Wheel of Fortune” illustrates the U.S. wine cycle — click here to view a detailed pdf version that will be helpful in understanding what follows.
This Time Really Is Different
If tight and slack wine markets are not uncommon, what’s the big deal? The answer is that we are coming off an unusually long period of low prices and most likely headed into a long period of tight supply. It is the length of the cycle, not the fact of it, that is striking and important.
The current Turrentine Wine Wheel shows the most recent cycles. The figure shows that prices started falling in 1982, for example, hitting bottom in 1986. By 1989 prices were at their peak again, setting up the next cycle, which ran from 1990 until 1999. It took seven years for the first cycle to work itself out and nine years for the second cycle.
Now let’s look at the current wine cycle, which Turrentine says began in 2000 and that they project will last an incredible 18 years! The slack side of the cycle was exceptionally long — 2000 to 2011 — because it combined several factors. First was the typical domestic surplus that results as vineyards planted at the previous cycle’s peak begin to bear fruit. The second factor was increased global wine production, which served to keep prices low even as some domestic producers cut back. This extended the period of falling price.
The Great Recession is the final factor, depressing prices and further extending the slack side of the cycle past 2010. As you can see from the figure, Turrentine originally expected the down side to last only through 2006, but a “perfect storm” kept prices low through 2010 as demand and supply slowly moved into balance.
Now we have finally entered the tight market phase where demand exceeds available supply at the current price and this part of the cycle is likely to be extended as well. Vineyard capacity did not expand sufficiently during the long down cycle and in fact it contracted dramatically in particular places. The EU wine market reforms removed some capacity in Europe and the collapse of part of the Australian industry has done the same there. In the U.S. some Central Valley producers, tired of low or negative margins, switched from wine grapes to more consistently profitable crops like tree nuts.
In theory it should take only a few years to rebuild vineyard capacity but in practice it will take longer for several reasons. First, the length and severity of the slack part of the cycle will naturally make some who have left the market in the U.S. and elsewhere hesitate to reenter it. The supply response in the U.S. will be delayed for this reason and also because of what I am told is a shortage of nursery stock needed to establish new vineyards and renew old ones. It will take a few years to rebuild stocks needed to rebuild vineyard capacity.
Prices for grape contracts and bulk wine have already risen (dramatically in some specific cases) as they must do to eventually bring the market back into balance, but this will be a slow adjustment process. Domestic wines must compete with imports, which act to limit price increases in some segments of the market. And of course consumers have become accustomed to lower prices and are not generally expected to “trade up” (except in response to bargain pricing) as much as they may have previously traded down.
Hysteresis: Winding and Unwinding
Rising grape costs are good news for growers, who have borne the brunt of adjustment costs during the long slack cycle. Now the big squeeze will move up the supply chain in the form of tighter margins and the effects are expected to be substantial precisely because the length of the tight market cycle will be so long.
What will the wine industry look like when we get back to the top of the cycle? One thing we can be sure about is that it won’t look the same as it did back in 2000. Economic adjustments are not necessarily symmetrical — they don’t wind up the way they unwound. (Economists have a name for this property: hysteresis.) The history that unfolds in the intervening years matters a lot and there has been a lot of time for things to change since the last market cycle began.
In particular, the long slack tide brought new products, new consumers and new consumer behavior into the market. This doesn’t change everything, but it changes a lot — as I’ll explain in next week’s post.
Your last statement is key; I’m looking forward to reading your reasons for it next week Professor.
“And of course consumers have become accustomed to lower prices and are not generally expected to “trade up” (except in response to bargain pricing) as much as they may have previously traded down.”
That’s the key, because it’s never happened before in wine. Also, what will happen if the biggest wine retailers, like Costco and Walmart, start to use their pricing power in the same way they do for sweatpants and lettuce?
Is there anything to be gained from comparing the current wine business cycle to the post prohibition depression era?
To be just a little parochial about all this, I would like your comments on how this will affect Washington State value wines.
In due course … I like a challenge.
great stuff, Mike.
Interesting to look at the wine wheel as it relates to my 17 years in the wine biz…
and, if you overlay individual brands on the wheel, which often have thier own rise and fall (especially commodity brands, as opposed to estate producers) you can see their activity as a canary in the coal mine of the overall wine industry. often a brand will begin to suffer before the catagory does, as other brands undercut the business…
also, you mentioned the possible shortage of nursery stock; I wonder if that has been caused in part by various vine disease or malady (parasites) causing the need for more replanting.
Plus the fickle consumer tastes determining what the trendy varietal that everyone needs to graft to (Merlot, Pinot Noir, and the latest flavor of the month, Muscat!)