Australia’s Wine Crisis Deepens

It seems like I’m always writing about problems in the Australian wine industry (see Big Trouble Down Under, Bottom’s Up and Fosters, Wine, Rice and Drought in Australia or Australian Winequake).

It’s ironic that the Australian industry is so threatened given that many of the wines are so good (see Robert Parker’s reviews, for example), but you cannot judge the health of a wine industry by the top wines alone.

Two recent reports combine to paint a dismal picture.

Rock Bottom

There aren’t many names in Australian wine that are bigger than Wolf Blass, so his comments at a recent Barossa Generations lunch at the Peter Lehmann winery were newsworthy enough to be reported on Decanter.com. Blass blasted out at what he sees as wrongheaded Australian wine strategy, which he said aimed to promote “overproduced wine from Australian irrigated fruit” in export markets.

These simple wines, he argued, cannot compete with products from South Africa and represent the wrong way to think about Australia’s wine future. The right way for Barossa, he said, was to focus on full-bodied Shiraz – balanced wines with not too much alcohol. Australia will hit “rock bottom” if it continues in this direction, Blass said.

I’m not surprised that Blass would favor quality over quantity as a global wine strategy and it is part of Australia’s official wine marketing plan. This is obviously the way forward, but supply hasn’t caught up with demand. Australia’s production still falls disproportionately in the threatened Yellow Tail category and changing directions on the supply side is easier said than done.

Blass’s remark about South Africa caught me by surprise, I must admit, since most of what I’ve read recently about South Africa has stressed the challenges they too face. If Blass is right, then I need to rethink South African wine – look for a blog post in 2009.

How to Fill a Lake

The 10^th annual Australian Winegrape Crush and Price Report was released recently and it shows just how big the gap between demand and supply Australia faces (and why, presumably, it ends up promoting the “wrong” wines just to try to clear stocks). Here are some of the findings, quoted from a summary of the report that I received .

2008 total crush – up 32% to 1.8 million tonnes (red up 45% and white up 20%). Districted weighted average price up 28% to $817 per tonne (red up 30% to $923 per tonne and white up 24% to $566 per tonne).

Good news so far. Higher price, higher output — can’t beat that if you are a producer. But of course this comes after a number of drought years have helped to dry up the huge oversupply created earlier in the decade, so we need to keep this context in mind.

Demand (required intake) is expected to grow by 109KT, or 6%, over the forecast period (2009 to 2013). The largest amount will be an expected 31KT increase in demand for warm-inland whites (up 16%) while the fastest growing sector will be cooler-climate whites (up 25KT or 10% off a lower base).
The Australian crush is forecast to grow by 260KT over the forecast period with the biggest contributor expected to be warm-inland whites (up 180KT) while the tonnages of cooler-climate reds are expected to constrict (down 30KT).

Now here’s your problem. We are back to the pre-drought scenario of supply growing much faster than demand, especially for the warm-inland whites, which I think means Chardonnay and Semillon. Supply of these varietals is projected to rise nearly six times faster than demand. That’s how you fill a lake.

Growth in supply exceeds the growth in demand over the forecast period, resulting in an oversupply of fruit, by 7%, in 2013.
By 2013, warm-inland whites are expected to be in significant oversupply (21% over) while moderate oversupply of cooler-climate reds is expected to remain (7% over), albeit down from a serious oversupply in 2009 (18% over). Warm-inland reds are expected to be in modest shortage by 2013 (8% undersupplied) and cooler-climate whites in balance.

When Even the Good News is Bad

You know you’ve got a problem when the good news is that you will have a moderate oversupply, down from a serious oversupply.

The top five varieties expected to be in demand in 2013 are Pinot Noir, Cabernet Sauvignon, Pinot Gris, Sauvignon Blanc and Viognier. Off a low base, Tempranillo also deserves special mention.

What’s missing from this list? Chardonnay and Merlot, the money grapes. And Shiraz, the grape that defines Australian wine in the export markets.

In 2013, the top five oversupplied varieties are expected to be Chardonnay, Muscat Gordo Blanco, Merlot, Semillon and Sultana.

Here they are — Chardonnay and Merlot finally make the list, but it is the wrong list, the wine glut list.

These are just projections, of course. Demand can be fickle, as the Pinot Noir boom shows, and supply is by its nature hard to predictable. What I take from this, then, is that the basic structures of supply and demand are currently misaligned and look to stay that way through the five years of the forecast. In the long run, something will have to change.

This brings me back to Wolf Blass’s comments. He criticized the marketing strategy’s focus on trying to sell what Australia has a lot of (the oversupply wines) rather than trying to sell your best product (investing in reputation) and letting the markets for lower quality wines sort themselves out. This would be a pretty controversial thing to say in Australia — no wonder it make the news.

This would be a big change and, to repeat, changing directions is easier said than done. I wonder if there is some grubbing up in Australia’s wine future?

Turning Water into Wine

November 27, 2008 By Mike Veseth in Australian wine, Chateau Ste. Michelle, climate change, Economic impact, sustainability, Yellow Tail 5 Comments

The Bible tells us that Jesus turned water into wine (John 2:1-11) — a miracle! Given the amount of water used in making wine today I think the miracle isn’t so much the conversion itself (no sacrilege intended) as the efficiency with which it was accomplished. Jesus didn’t waste a drop. Improving water use in winemaking is a serious issue today.

The End of Cheap Water

Readers of this blog know that water is important in wine production, but you may not appreciate just how much the wine industry depends upon cheap water supply. I have written about the effects of the Australian drought on wine output there, for example, and how producers like Casella (Yellow Tail) are adjusting. But water isn’t just an Australian wine problem, as everyone in the business knows, and the situation isn’t getting any better.

So the December 2008 issue of Wine Business Monthly is especially welcome. WBM chooses a theme for the last issue of each year and this time it’s “The End of Cheap, Plentiful Water;” it is required reading for anyone interested in the economics of wine. Much of what follows is based on data from the WBM report.

Given all the attention that the Australian drought has received it would be easy to dismiss wine’s water woes as just another example of the challenge of global climate change. And while this is undeniably true to some extent, I think it is more useful to think about the water problem in terms of supply and demand.

Winegrapes: Squeezed and Dried

The supply of water for wine production is limited by nature, of course, especially in the long run, but that’s the easy part (and the focus of the climate change discussion). It is perhaps more realistic to consider that the supply of water for wine is limited by competing water needs. Water is valuable for environmental purposes, such as to maintain fish runs, for example. Water is needed for residential and industrial uses, too. And of course water is in very high demand for agricultural crops other than winegrapes. About 80% of California’s annual non-environmental water “budget” goes to agriculture, including wine. Residential and business use accounts for rest. As population continues to grow, the squeeze will affect everyone.

Between competing uses and recent drought conditions, it is no wonder that the water supply for winegrape production is being squeezed.

All agriculture suffers when water becomes scarce and drought conditions force both a general reduction in farm output and also a shift away from the most water-intensive crops to those that use water more sparingly. In Australia, for example, we have seen a decline in grape production in some areas due to drought and a shift from rice to grapes in other areas. 2001 data from the California Department of Water Resources estimates that grape growers in that state use an average of 2 acre-feet of water. That’s about 25% more than used for grain crops, but much less than rice production (nearly 6 acre-feet of water) or corn and tomatoes (about 4 acre-feet).

Water use in winegrape production varies considerably. Irrigation isn’t always necessary or even desirable, but high volume production is very water-dependent. It takes 75 gallons of water in the vineyard to grow the grapes for one gallon of wine in the California North Coast area. That seems pretty inefficient until you compare it with Central Valley production, where the ratio is 430 gallons in the vineyard to one gallon of wine! Water is also used in some areas for frost protection, which can adds to the total water bill.

Water use doesn’t end once the grapes have been harvested. On average it takes about six gallons of water in the cellar to make a gallon of wine. Barrel-washing and tank cleaning account for much of the water use, but everything in a wine cellar needs to be as clean as possible, and water is often the most convenient tool.

The trick, as many wineries have discovered, is to conserve and recycle. High pressure / low flow nozzles and barrel-cleaning rigs can do more with less. Waste water can be collected and filtered for many uses from irrigation to flushing the toilets. Erath Winery in Oregon employs a filtration process that allows it to reused 97 percent of winery processing water in one way or another. (Local ryegrass farmers use the rest as fertilizer.) Snoqualmie Vineyards, like Erath part of the Ste. Michelle Wine Estates group, uses just 2.9 gallons of water in the cellar per gallon of wine, an indication of the sort of savings that are possible.

What’s Your Water Footprint?

article. It’s only a matter of time, I think, until we start worrying about our water footprint as well as our carbon footprint. You can learn more about the water footprint concept at WaterFootprint.com. Here are some estimates of water costs associated with various products as reported on their website.

One cup of tea: 30 litres of water
One slice of bread: 40 litres
One apple: 70 litres
One glass of beer: 75 litres
One glass of wine: 120 litres
One cup of coffee: 140 litres
One glass of milk: 200 litres
One liter of wine: 960 litres
One hamburger: 2400 litres

I have seen reports that a Big Mac’s water footprint is 5000 litres, a huge number but understandable when you consider that the production of beef and cheese are both very water-intensive (particularly when the cattle are raised on diets of irrigated grains instead of natural grasses). I guess a kilo of beef requires 15,500 litres of water. Amazing!

These figures are estimates of the total water use, including transportation and packaging, which is why the wine figures are so high. I’m sure that it takes a lot of water to produce and clean wine bottles. The labels (paper), closures and shipping boxes add to the water footprint. It all adds up, for wine as for other products.

It Isn’t Easy Being Blue

The wine industry is in the vanguard of many important environmental movements. Being green (and now blue, I suppose, to represent water) is good marketing for a lot of industries.

But it is good economics for the wine industry, too, because water is such a key resource that we need to manage well in the vineyard, in the cellar and throughout the production process.

[Thanks to Wine Business Monthly for the information in their December 2008 issue and to a former student, Jenna Silcott, for making me think about water resources once again.]

Australian Winequake

June 12, 2008 By Mike Veseth in Ascentia, Australian wine, brands, Constellation Brands, Foster's, The Wine Group, wine brands, Yellow Tail Leave a comment

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

Wine Tremors

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

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

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

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

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

Winequake

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

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

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

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

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

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

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

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

The Future of Wine?

May 25, 2008 By Mike Veseth in Australian wine, Berry Bros. & Rudd, China wine, Economic impact, New Zealand, Supply and Demand, wine price, wine taxes 2 Comments

What will the world of wine look like in 50 years? A look in the crystal ball.

What if the Chinese were French?

A journalist with a Brazilian newsweekly called me on Thursday to ask for help with a story on China. The magazine is doing a sort of “worst case scenario” report on the potential impact of China’s economic growth on world markets. What would happen to oil prices, for example, if the Chinese used as much fuel per capita as Americans do? Yikes, that would be a lot of drivers using a lot of gas and it would send oil prices through the roof. What would happen if Chinese consumers generated as much waste and pollution per person as people in the West? Once again, the global effects would be dramatic.

What would happen, the journalist asked me, if Chinese tastes changed and they drank as much wine per capita as the current world champtions, the French? Well, that is a very interesting question, even if it isn’t a very realistic one. Annual Chinese consumption of wine is about a half-liter per capita and rising, according to my copy of The Global Wine Statistical Compendium (and a lot of that wine isn’t grape wine, as I wrote in The China Wine Syndrome). Wine consumption in France, on the other hand, is 55 liters per person and falling (it was more than 120 liters per capita in the early 1960s). The figure is about 8.5 liters per capita for the U.S. and 20 liters per capita for Great Britain.

It is hard to imagine how Chinese wine consumption could rise to the current French level. Heck, it is unlikely that the French will sustain their current level for long. But isn’t entirely out of the question that Chinese consumpion could rise to the world average, which is about 3.5 liters per capita per year. That’s a lot smaller increase than the Brazillian reporter was concerned with, but it would still have a huge impact on global wine markets. Much of the increase would probably be met by higher Chinese production; China is already a major wine producer — smaller than Chile but larger than Portugal in total production. But the global effects would be substantial and prices would surely rise.

We can already see some indication of the potential “China Effect” in the market for fine wine. Everyone seems to think that at least some of the rise in Bordeaux prices in recent years is due to Asian and especially Chinese purchases. This trend seems likely to accelerate now that Hong Kong has eliminated its high tax on wine transactions so that it can become the auction hub of the Asian wine market. The latest Wine Advocate reports prices of 2005 Bordeaux that reach stratospheric levels — $500, $1500, $2500 per bottle! This is what happens when a global market focuses on an object of speculation — huge rents (excess returns) are created. As China (and India, too) become more completely integrated into global markets for products like fine wine, these rents will likely rise higher still.

The View from London

The Brazilians are not the only ones interested in the future of wine. Berry Bros. & Rudd (BBR), the London fine wine house, recently celebrated its 310th anniversary with the release of the Future of Wine Report written by four of their top wine buyers (Alun Griffiths MW, Jasper Morris MW, Simon Field MW and David Berry Green). It makes pretty interesting reading if you are interested in what wine markets might look like in 2058.

I say wine markets (plural) because BBR correctly recognizes that there is not one wine market but many interrelated ones. The fine wine market, BBR predicts, will see the rise of China and India as important factors in terms of both demand and supply. “I absolutely think China will be a fine wine player rivalling the best wines from France,” writes Jasper Morris. Britain will become an important producer of fine wines, too, perhaps especially Champagne-like sparkers.

Wine prices will soar even higher, according to the report. “If values increase by 15% per annumn, as they have been doing recently, a case of 2005 Ch. Lafite-Rothschild, currently available for £9,200. could be worth just shy of £10 mllion by 2050,” according to Simon Staples.

The forecast changes are more dramatic in the volume wine market. China will be the world’s largest wine producer. Global warming will shift wine production from France to Eastern Europe and from Napa Valley to Canada. Australia, the report speculates, could see a collapse of its volume wine industry if recent droughts persist. Goodbye Yellow Tail. Hello boutique producers in cooler, wetter areas like Tasmania.

Brands will become even more important in the volume business, BBR suggest. “In 50 years, consumers will ask for wine by the brand name or flavour and won’t know, or care, where it has come from. Grapes will be genetically modified to change a wine’s taste,” according to Jasper Morris, “and producers will add artificial flavourings to create a style wanted by consumers.” Wait — OMG I think I drank those wines back in the 1970s when I was in grad school!

Bottles and corks? They’re history. Corks will disappear because they are inefficient — the contamination rate is too high. Bottles are heavy and environmentally problematic. Tetra pak containers (like the ones used in today’s French Rabbit wines) and other sustainable packaging systems will prevail for volume wine.

The Future of Wine?

So what should we think of these visions of the future of wine? Economists like to say that prediction is difficult, especially about the future, so long range forecasts need to be taken for the educated guesses that they are.

Some forecasts, will be wrong because they are more or less simple straight line extrapolations (How much wine would the Chinese drink if they were French? How much will fine wine costs if its price compounds at the current rate?). It seems to me that simple projections are usually wrong because they are sensitive to initial conditions. Who is to say if long term trends will match those of the recent past?

Some predictions, like the £10 million case of wine, are extreme, but others are probably too conservative. The wine world has a way of surprising us — who in 1958 would have predicted the importance of Chile and Argentina today or the decline of consumption and production in France? People matter, too. People and their ideas are powerful forces that do not always respect historical trends, as refelction on the recent death of Robert Mondavi remind us.

Kenneth Boulding, the great 20th Century social scientist, once wrote a history of the future. He looked back to see what people in the past had said about the world just ahead. What he learned, he told me, was that when the future eventually rolled around, it never matched the predictions, it was always unexpected. The best way to prepare for the future, he concluded, was to prepare to be surprised. I expect this rather general advice applies as well to wine.

Wine, Rice and Drought in Australia

April 18, 2008 By Mike Veseth in Australian wine, climate change, globalization, Supply and Demand, wine markets 1 Comment

The effects of Australia’s continuing drought on the wine industry are well known; I wrote about drought and other problems that Australian winemakers now confront last September in a post titled Big Trouble Down Under. An article on the front page of yesterday’s New York Times explains how the crisis is deepening and evolving in frightening ways.

The Global Food Crisis

The article is part of a series on the global food crisis. If you haven’t been paying attention, food supplies around the world are drying up (both literally and figuratively), causing chaos in many places. Food riots are reported in the press almost every day. The crisis has many causes. Drought and climate change have reduced supplies in some areas, for example. Increasing demand is part of the problem, too, especially in China where, rising incomes have encouraged greater consumption of pork, which in turn increases the demand for grain. Rich countries like the U.S. are not helping the situation. Our biofuel policies divert food to the gas pump. All these factors push up food prices and the poorest people are the most affected.

As prices rise and surplus supplies shrink, food-exporting countries have begun to impose export taxes or even export bans in an attempt to keep domestic supplies plentiful and relatively cheap. The effect, of course, is to drive international prices even higher and “beggar they neighbor.” The price of rice rose by 40 percent in a single day last week as these export controls kicked in.

The Rice-Wine Connection

What part does wine play in this problem? Australia was until recently a major exporter of rice, but rice is an especially water-intensive crop and the continuing drought in Oz has dramatically limited production there. The Australian drought is a key part of the global rice shortage story. Wine production, however, makes the problem worse.

As the New York Times explains, winegrape production uses much less water than rice and so, as irrigation costs have soared, farmers have shifted production from rice to grapes. The graphic above shows the economic reality of the situation. Even at today’s crisis price of $1000 per ton for rice, higher water costs make winegrapes the more profitable crop. So while drought has reduced production of both grapes and rice, the substitution effect has reduced the impact on grapes and made the crisis in rice even worse.

Many authors suggest that what we are seeing here is part of an important transformation in the global economy. Globalization linked up producers and consumers at the far ends of the earth in the 1990s and produced a world of abundance and falling prices. The growth this helped produced (plus the associated environmental effects, according to some) are now combining to turn surplus into shortage. It is easy to see this in rice, but it is true in wine as well, as I argued in my post on The End of Cheap Wine. Protectionist policies conspire to raise the problem to crisis level for those who are least able to deal with it.

[Yellow Tail] Tales

February 26, 2008 By Mike Veseth in Australian wine, sustainability, Trader Joe's, Two Buck Chuck, Yellow Tail 2 Comments

Yellow Tail is the best selling imported wine in the United States. Yellow Tail accounted for 11 percent of all U.S. imports in 2005. This one wine brand represents about 8 percent of all Australian wine production and 15 percent of that country’s total wine exports. Yellow Tail sells more wine in the U.S. than all French producers combined.

This is an aerial photo of the winery, which is located in a small village called Yenda in the Riverina region of South East Australia. If it doesn’t look like a quaint little craft winery it is because the volumes are so large. The warehouse structure in the upper right corner can store 900,000 cases of wine at a time, according to Wine Business International. The bottling line next door is the fastest and loudest in the world, filling 30,000 bottles per hour (two more lines are planned to increase capacity). Total production is about 11 million cases, of which about 8.5 million are exported to the United States.

It is a sophisticated factory, with blending facilities that assure that each bottle tastes just like the one before. That differentiates it from Charles Shaw wine (a.k.a. Two Buck Chuck), the Trader Joe’s wine, which people say can vary considerably from case to case.

Yellow Tail is expanding in every imaginable way: more varietals (an Australian Pinot Grigio), a Reserve line of wines sourced from cooler-climate vineyards and now sparkling wines, too. The Yellow Tail’s distinctive yellow-footed rock wallaby “critter” is everywhere.

Yellow Tale is a phenomenon, but not one you will read about in the supermarket wine magazines. They don’t waste much ink on wine that costs about as much per bottle as the magazine itself does per issue. Magazine? Bottle of wine? It’s easy to tell which one the Yellow Tail customer will purchase! So I’ve been trying to find out more about Yellow Tail and here is my report.

Wine as a Family Affair

The interesting thing about the Yellow Tail success story is that it can be told in several different ways. This is not unusual in my experience. Stories of success and failure are frequently spun into meaningful narratives to try to make particular points. One version of the Yellow Tail story, for example, focuses on family and the importance of family businesses in the wine business.

This Yellow Tail Tale begins with the Casella family, winemaking immigrants who came from Italy in the 1950s and eventually planted their own Australian vineyards in 1965, selling grapes under contract to larger producers. Keen to make their own wines and export them, Casella invested in production facilities in the late 1990s and started looking for ways to crash the emerging U.S. wine party.

The key event in this version of the story is the alliance that was struck between Casella Wines Ltd, an Australian family business, and an American one, the William J. Deutsch company. Deutsch is a major U.S. wine distributor — they helped make the French Georges DuBoeuf wines a major U.S. brand — and they were willing to take a chance on an unknown Australian wine with a clever label. A partnership was established, with each family firm owning half of the Yellow Tale brand. Casella made the wine, Deutsch sold it. U.S. sales soared, from about 60,000 cases in 2001 to more than 8 million cases today.

Why was Yellow Tail so successful? One theory is that it is family and trust that are the key elements and that the cooperation and commitment that Casella and Deutsch have demonstrated would not have been possible if either of them had been a public corporation, beholden to shareholders and driven to meet quarterly profit targets Family is the key to Yellow Tail.

Red Ocean, Blue Ocean, Yellow Tail

A second group of business analysts have also appropriated Yellow Tail and made it the basis of a wholly different narrative, this one told using some unfamiliar jargon (unfamiliar to me, at least). Here is the Yellow Tail story told in terms of Blue Ocean versus Red Ocean.

The oceans in question are markets. Blue Oceans are markets for new products. Red Oceans are markets for existing products. Why are they red? I don’t really know but based upon what I saw last summer on the Discovery Channel’s “Shark Week” I’m willing to guess that existing markets are a tough environment to enter. You’ve got to compete with well-adapted predators who will cut you up badly if you aren’t really strong (Red Ocean = bloody ocean — get it?). A Blue Ocean, on the other hand, is uncontested open water. You’ve got a much better chance of profit if you can stake out the market for a new product before the competition gets there.

So how is Yellow Tale a Blue Ocean product? According to one article it is because Yellow Tail isn’t wine as we know it — it’s a whole new thing. The Wine Business International article cited above provides the details. People don’t really like wine, the article suggests. Even the Casellas don’t like it (is this possible?). It’s very tannic and acid and people aren’t used to those qualities except in tea. Who wants to pay $6 a bottle for something that is bitter and sour. The key to Yellow Tail was the realization that wine without tannin and acid could be very appealing, especially to the majority of Americans who really don’t like wine. (It was designed to appeal to the 85% of non-wine drinkers, according to the article, while not offending the 15% who already like wine. That’s 100%, if my math is correct. No wonder it is so popular). Yellow Tail isn’t as strong a brand in Great Britain — maybe it’s because the British actually like wine, acid tannin and all?

The Red Ocean, then, is the market for wine and the Blue Ocean is the market for wine that doesn’t taste like wine. (You might call it the Blue Nun Ocean in honor of a popular semi-wine wine of the 1970s.) If this analysis is correct, then you can see why Yellow Tail is such as success. But you can also see why its success might be short lived (and why, therefore, Casella may be moving into other markets). The Blue Ocean of semi -wine was quickly populated by competing predator species. Two Buck Chuck is an obvious example but there are really dozens and dozens of copycat critter wines out there. The trick for Yellow Tail is thus how to succeed now that their Blue Ocean is turning Pink.

Water Torture

Here’s a final Yellow Tail Tale that continues the focus on water. A third explanation for Yellow Tail’s success can be summarized in a single word: irrigation. Yellow Tail was made possible by the existence of enough water to irrigate the vast Casella and South East Australia vineyards. Water made it possible to grow grapes so efficiently that you could ship the wine half way around the world and sell it cheaply and make a fortune.

But the environment is changing for Casella’s vineyards. It’s not Blue to Red, but wet to dry. Australia has experienced several consecutive drought years, which have caused vineyard yields to crash and changed the whole business model of Australia wine. Put simply, the plentiful cheap fruit that has fueled Yellow Tail’s growth is now just a memory. What is to be done?

Casella seems to be considering several approaches. The first is conservation. According to their website, they have invested heavily in water recycling facilities, which will allow them to reclaim 400 million liters of wastewater each year for use in their vineyards. That’s a good start — and sustainable winegrowing is everywhere a concern — but I don’t think it will be enough to irrigate all the vineyards.

So another strategy may be considered: outsourcing. There are many places on earth where inexpensive wine can still be produced. Will Yellow Tail consumers care if their wine comes from Chile, South Africa, France or maybe even Romania instead of Australia? My guess is that it won’t matter very much and that Yellow Tail may become a globally-sourced brand. Boy, that little wallaby gets around.

But the long term threat to Yellow Tail probably isn’t water, it is wine. If Yellow Tail customers ever learn to like wine (you know — the stuff with tannin and acid?) then the brand’s days will be numbered! Until then, little critter, wallaby wine is safe.

The Wizards of Oz

February 19, 2008 By Mike Veseth in Australian wine, British wine market, Constellation Brands, Gallo, globalization, Jancis Robinson, Supply and Demand, sustainability, Yellow Tail 1 Comment

When I think about the future of the global wine market, my thoughts frequently stray to Australia because that’s where I see so many current trends originating or being most effectively exploited.

Export driven marketing strategy? That’s Australia. Branded varietal wines? Everyone talks about Gallo and Constellation brands, but who has done it better than [Yellow Tail]? Foreign market penetration? The Aussies again, replacing the French as the strongest competitor in the British market and a strong presence in the United States.

Australia even wins the prize for the most sophisticated national wine strategy. Click on the image above to see a representation of the latest Australia wine strategy, which divides the market into twenty (20!) key segments where Aussie wines can compete.

Australia’s Boom and Bust

No doubt about it, if you want to learn about wine economics and integrated wine business, you should look to Australia. But that doesn’t mean that all is well down under. As I have written in previous posts, Australia has experienced a roller-coaster of wine market problems. First it was the problem of over-supply, which pushed prices down to unsustainable levels. And then, just when it seemed like things couldn’t get worse, they did and the early signs of wine shortages began to appear, which caused me to declare that the era of cheap wine was coming to an end. In each of these cases, trends that I see in many places now were first apparent in Oz. No wonder that I’m starting to view Australia as my leading indicator of global wine market trends.

This makes the news in Jancis Robinson’s column in Saturday’s Financial Times particularly sobering (not a good word for wine lovers). Robinson’s article suggests that Australia has hit ecological limits to the production of cheap wine. Water is scarce and expensive and this means that the cost (and therefore price) of bulk wines like [Yellow Tail] must rise — from A$0.40 in 2006 to A$1 in 2007 according to the article. That’s not quite a leap from unsustainable to unaffordable (the A$ is about 91 US cents today), but it presents a completely different business model. More to the point, however, the price rises exist because costs are high and the product is in short supply. Robinson is optimistic that Australian winemakers can compete and even thrive in the new market environment, but adjustment won’t be easy.

Robinson reports that Fosters has started sourcing some of its Lindeman’s brand from its vineyards in Chile (for the British market) and South Africa (in the U.S.). This continues the practice we have seen in the U.S. for some time for short-supply Pinot Noir. U.S. brands like Pepperwood Grove and Redwood Creek frequently contain Chilean and French wines respectively. Now, Robinson reports

There is much talk, though not much evidence, of basic bulk wine being imported into Australia from southern Europe, South Africa and South America to fill the so-called “casks” (boxed wine) and the cheapest bottles and flagons for the bottom end of the domestic market, prioritising export markets for such inexpensive Australian wine as the brand owners can afford. Australia has swung from famine to feast and back to famine in terms of its wine supply recently and bulk wine imports are nothing new. I remember encountering a director of one of Australia’s largest wine companies looking very shifty round the back of some fermentation vats at Concha y Toro outside Santiago de Chile in the mid-1990s.

Ecological Limits?

Now the problem here is not that the Australian’s are passing off foreign wines as their own. The wines I have seen have been clearly labeled and the few cases I know about where winemakers have tried to fool the public (some years ago in New Zealand, as I recall) ended badly for the dishonest producers. They were punished pretty severely in the marketplace when their tricks were revealed.

No, my concern goes more to the heart of the problem. Maybe Australia’s ecological constraints are a short term problem that will disappear. Maybe it is an Australian problem with no implications beyond the land of Oz. Maybe ready supply from Australia wannabe producers in South America, South Africa and Europe will always be there to fill the gap.

But that’s a lot of maybes and economists are trained to get nervous when it’s maybe this and maybe that. We know that the effect of climate change on the wine industry is real. And we know — or at least I think I know — that Australia has often been a good indicator of emerging trends in global wine. If this is the case, then we are indeed about to enter a new wine world, one where the natural constraints on wine production may be about to become as important as marketing strategies.

Bottom’s Up at Fosters

September 27, 2007 By Mike Veseth in Australian wine, Supply and Demand, wine markets Leave a comment

An article in today’s (9/27/07) Wall Street Journal suggests that the era of wine surpluses, both in the world and especially in Australia (see previous blog entry below) may be coming to an end. The world’s second largest winemaker has started to raise prices on its premium wine after a long period of discounting and drastic bulk sales. Maybe this market cycle has finally hit bottom and prices are on their way up.

Most people I talk to assume that Gallo is the world’s largest winemaker and have no firm notion of who could be number two. But in this era of growing brand power the #1 winemaker is Constellation Brands and Foster’s is number two. Fosters makes a lot of wine, but it is really a “drinks” company more than a wine company (to use a distinction that Craggy Range winemaker Steve Smith once explained to me). Fosters manages a long list of brands, only a small sample of which are shown in this photo. They sell branded wines, beers, spirits and even Oragina soft drinks and various juices and sparkling waters. If you are thirsty and want a drink, Foster’s is ready to serve your needs.

Foster’s lager beer is the brand you might most obviously associate with this company, but its list of wine brands is long and includes Australian wines such as Penfolds, Rosemount Estate, Wolf Blass and the Little Penguin as well as Beringer and Stag’s Leap from the U.S., Matua Valley from New Zealand and Fonsecca Port and Gabbiano Chianti. More than 60 wine brands are distributed internationally, reaching from the budget bottom shelves of the wine display clear to the top.

The WSJ article reports that Foster’s raised its wine prices by between 4% and 11% in August and the higher prices have stuck — they haven’t hit strong consumer resistance or been undercut by competitors. I think it might be too early for Foster’s to declare victory, but rising prices do suggest that the wine glut has come to an end and some shortages may be emerging.

Foster’s has apparently finished selling off its inventory of surplus unbranded wine stocks, which are called “cleanskins” in Australia in reference to an international espionage term for an agent of unknown origin. (See this website for an example of Australian cleanskins marketing.) These discount sales dragged down Foster’s earnings.

Now, with the prospect of a drought-reduced 2008 vintage following drought problems in 2007, the trend of falling prices may finally be coming to an end. I am skeptical, however, because it seems to me that Australian wines face a lot of competition around the world and it may be difficult to raise prices in this market environment, with surplus stocks still available, for now at least, from other parts of the wine world.

Big Trouble Down Under: Crisis in Australian Wine

September 16, 2007 By Mike Veseth in Australian wine, Yellow Tail Leave a comment

Most people find it hard to imagine that the Australian wine industry could possibly be in trouble. Isn’t Australia the great success story of wine’s current globalization era? Australian wines are the #1 imports in Great Britain, having overtaken the French, and they may soon replace Italy as the #1 wine import in the United States. Where is the trouble in this?

And aren’t Australia’s best wines, like the iconic Penfolds Grange shown here, recognized as among the finest wines in the world? Australian Shiraz has set a high standard and its popularity has ignited interest in Shiraz and Syrah around the world. What’s wrong with that?

And yet big trouble there is for Australia’s wine industry and it is important to understand the situation both to appreciate the forces at work in Australia and to recognize their impact on the rest of the wine world.

First, however, we have to understand how Australian wine really works. Although famous brands like Penfolds Grange established Australia’s reputation for fine wines, they are a small and limited segment of the market. The evolution of Australian wine during the 1990s has produced an industry dominated by a small number of very large producers focused on branded products for export to Great Britain and the United States (about 75% of Australian wine exports are aimed at these two markets).

The bulk of Australia’s exports are inexpensive bulk wines, like the Yellow Tail brand that sells so well in the U.S. In fact, Yellow Tail wines account for nearly one-third of all Australia’s exports, making the industry incredibly dependent upon market conditions at the bottom end of the market. And those market conditions are not favorable: price competition is fierce. Penfolds Grange is the sophisticated image of Australian wine, but Yellow Tail, with more than 10 million export cases per year, is the inexpensive “critter wine” that pays the bills.

Or doesn’t pay the bills. Three years of rising harvests from 2004-2006 left Australia awash in bulk wine and the market worked just like the textbook says: prices dropped. The fact there is surplus wine, at least for now, in many parts of the world made the situation worse, of course. Bulk wine export prices are now less than 85 cents per liter, an unsustainable level.

I have read some reports that suggest that cheap French wines are part of the problem. The wine industry in the South of France,the Languedoc, is badly fragmented, with tiny family vineyards that can undercut new world wines because they do not count the cost of inherited capital (the vineyards) or family labor. And, of course, there are those EU subsidies, at least for now.

The wine world has become very small and Australian bulk producers compete head to head with those from Chile and France in the main global markets. And this creates a problem, too, because there is only so much demand to go around at any given time. If Australia exports a bit more to the U.S., for example, it pushes that extra U.S. wine into an export market, where it undercuts existing Australian sales. The result, once again, is falling price. Australian wine producers are on the lookout for new markets, focusing on Russia, China and South Korea. I would guess that these are not the easiest markets to enter except through the undesirable bulk wine route.

The problem is compounded by the fact that Australia’s big brands seem to have hit a wall in the export markets. Everyone has “critter” wines, now (or haven’t you noticed) and the competition among branded wine products has become positively frenzied. Sales of some of the Australian “popular premium” brands have actually declined for the first time, with these wines pushed down into the bulk market, pulling prices even lower there. More and more, Australian wines compete in a single category and market conditions on that part of the wine rack have deteriorated.

There is good news, but even the good news is bad. The good news is that the Australian wine surplus is shrinking and supply is becoming more closely aligned with demand. The bad news is that this isn’t because demand is rising, but rather because 2007 was a disastrous vintage. Grade production fell by 30% due to disease, frost and especially drought. Drought conditions are projected to continue into 2008, so there is not much hope of a quick recovery. Bad news is sometimes good news in agricultural markets, where bad crops push up prices and make people rich. But Australia’s bad crop won’t do much to push up global bulk wine prices. The only good news is that the surplus stocks that Australian producers have been holding can be used up at last.

What can be done? The Australian Wine and Brandy Corporation (a government marketing agency) has released a study titled Wine Australia: Directions to 2025 that presents a plan to turn the troubled industry around without ripping out vines the way that they did in Canada and New Zealand during their wine gluts in the 1980s and the European Union proposes to do to shrink their wine lake now. The key to the plan is to “re-brand” Australian wines using a market segmentation scheme described in the report and then to move up market and away from bulk wines with more innovative brands and an attempt to focus on distintive regional terroir.

The logic is simple: move from the bottom shelf in the supermarket, where prices are unsustainable in any case, into the middle and top shelves, where consumers are willing to pay higher prices. The problem? Well, changing consumer expectations isn’t easy, although it is possible. But isn’t everyone trying to do that? It seems like every winemaker is trying to move upmarket. Gallo and Constellation have dozens of brands in these market segments, with more coming every day. (Just this week, as it happens, Gallo announced a partnership with Martha Stewart to produce a Sonoma-sourced Martha Steward Vintage brand wine to sell for $15 in select markets!)

The Wine Australia report is a good beginning. They recognize the current crisis and they know what to do. But can they do it?

The Wine Economist

Category Archives: Australian wine