Trickle Up Wine Economics and the Big Wine Market Squeeze of 2018

trickleYou’ve probably heard of “trickle down” economics. It’s the theory that if you give money to the rich it ends up benefiting those who are not so rich as the wealthy spend or invest their money and create incomes and jobs for others.

Trickle Up and Down

Trickle down economics is controversial. Not because it is crazy to think that the rich spend or invest their funds; the question is how much actually gets down to the bottom of the economic pyramid? Mega-rich Scrooge McDuck, my favorite childhood cartoon character, didn’t spend much of his money at all, so very little of it trickled down to others.

Although it might initially seem counter to the laws of fiscal physics, it is also possible for money to trickle up. In my studies of Italian economic history, for example, I discovered that the wealthy families of Renaissance Florence sometimes successfully enacted a trickle up policy.

There were some situations where the working class found themselves tapped out and disgruntled. The economy stagnated and social tensions heated up — a dangerous combination. So the rich found ways to get cash into the pockets of the poor, which they spent immediately and, by the end of the month, the coins were back in the hands of the rich where they started, the markets were churning away steadily, and peaceful social relations had been restored. Priming the pump, we used to call it. Enlightened self-interest at work!

How Does Wine Trickle?

Under certain conditions it is possible to experience a trickle down effect in wine markets. When grape harvests are unusually bountiful and grapes therefore cheap, it is possible for a winery to have more quality wine than they need for a particular brand or line of wines. They could of course simply cut the bottle price and sell the extra wine that way, which is what you learned in Econ 101, but price and reputation are closely associated in the minds of many wine consumers, and it is difficult to raise price back up in the future if you cut it now because expectations have change. This is sometimes called an example of economic hysteresis.

So the wine trickles down, either in the form of a second label or through bulk market sales. Trickle down bottom line: the surplus of good wine can trickle down to lesser wine market tiers when the conditions are just right. In recent years a whole industry has developed to take advantage of structural surpluses and trickle down situations. The rise of “asset lite” wine businesses (which own a brand, but no land or production facilities) is predicated in part on the ready availability of wine supplies.

This Time is Differenttrickleup

This time is different. As a recent Rabobank report makes clear, Wine’s Big Three global producers (France, Italy, and Spain) all had significantly short harvests this year and many other major producers had similar experiences either in 2017 (some parts of California) or 2018 (drought will dramatically limit production in South Africa). The tight global market will be felt mainly through squeezed margins, but other impacts may be felt.

A global wine shortage renders trickle down opportunities scarce, for example,  but creates the right condition for  trickle up wine economics. Here’s how it works. The shortage is going to raise wine prices in some categories and put the squeeze on those who are used to selling them. They’ll need to give priority to wine markets where margins are higher and can better absorb the rising costs.  In Spain, for example, this may mean favoring exports over the domestic market.

At some point basic bulk wines will cost too much to go into the boxes and budget bottles where they found homes in the past. To the extent that quality permits (and this is an uncertain factor), they will migrate up to wines selling at a higher price point. And the wines that would have gone there will migrate up a bit, too, as grape demand shifts up  and the effort to preserve and protect margins moves along.

Or at least that’s what the Law of 100 suggests. This is a rule of thumb that holds that you take the cost per ton of wine grapes and divide by 100. The result is the bottle price necessary to make wine production economically sustainable. If shortage pushes the effective tonnage price up far enough, the grapes need to be used for a higher tier of wine.

If the more costly wine cannot trickle up in one way or another, then tighter margins will likely trickle down. Many links in the value chain get squeezed in this process, but wine producers with the greatest ability to substitute and avoid higher costs and shortages face fewer potential difficulties. Brands built around specific grape varieties (versus flexible blends) and narrow appellation designations with limited alternative sourcing options are more vulnerable.

Price and Quantity

How will the Big Squeeze and the trickle up game affect wine price and quality? Well, costs will certainly squeeze margins and higher prices may result, but as I’ve just noted, there are some ways to mitigate that. One of them is to sacrifice quality, so that will be an important thing to watch as grapes migrate to higher price points.

This could be a serious issue for wines at the bottom of the shelf. Some of my wine friends have told me privately in the past that they believe the stagnant market for some of these wines is due in part to a decline in quality — which they often blame on cheap bulk imports used to preserve margins.

The economic impacts of the Big Squeeze could extend to the vineyard real estate market as well. Look for some of asset lite business to try to purchase or lease more vineyards to assure future grape supplies. This is not a new trend — it has been going on for a while in the Napa Valley, for example — but it is likely to accelerate.

It is obviously too soon to tell exactly how the big squeeze will play out — especially on the global markets — but these are some of the forces and patterns that I will be watching for.

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The Wine Economist will pause next week so that I can concentrate on my role as moderator and speaker at the “State of the Industry” session at the Unified Wine & Grape Symposium in Sacramento. Hope to see many of you there.

2 responses

  1. However, the big Wine need to “hold” shelf space may compel them to subsidize their low end wines for some period of time. MBAs in action.

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