The Wine Economist column was provoked by a conversation with some California growers at this year’s Unified Wine & Grape Symposium and connected the dots linking their observations with Vinpro data presented a few weeks earlier for South Africa. Only 9 percent of South African winegrowers earn a sustainable return on their vineyard investment. A little more than half break even or earn small nominal profits, but not enough to sustain continuing investment. And almost 40 percent reported losses. And the margin gap is getting wider.
My California grower friends said their situation was not much different from the South Africans and, indeed, this is a problem I have seen around the world, although not typically backed by the sort of data that Vinpro collects for the South African industry.
The two simple strategies to claw back margins are to reduce yields to try to raise quality and therefore price or to reduce unit cost by increasing yields. South African growers have found it difficult to raise prices enough to make the first strategy work, so many are focusing on higher yields. But it is not as simple as that, the California growers told me, because sometimes buyers won’t allow higher yields and, in any case, some older vineyards just aren’t set up to make high yields possible.
Losing in Lodi
W. Blake Gray’s article digs deeper into the California situation, specifically for District 11, the San Joaquin Valley North, which includes Lodi. He quotes Aaron Lange of Lange Twins Family Winery and Vineyards in Lodi, for example, who explains that average grape prices are lower now than they were 25 years ago (despite higher costs throughout the production chain). Lodi Cabernet Sauvignon, for example, sold for an average of $695 per ton in 2022 according to the UDSA grape crush report. It sold for an average of $794 in 1997. The figures for Chardonnay grapes are $627 in 2022 versus $774 in 1997. That, my friends, is a big squeeze.
Is it possible to increase yields enough to break out of the big squeeze? Gray provides data from a 2021 UC/Davis study of the District 11 situation that suggests that higher yields can sometimes, but not always, solve the problem. At a price of $650 per ton (which is close to the average current Chardonnay and Cabernet prices), for example, the Davis study calculates a $156 per acre profit at 12 tons per ace and a $780 per acre product at a yield of 13 tons, but losses at lower per-acre yields.
The situation is only a little different at a price of $750 per ton. Profits ($633 per acre) appear at a yield of 11 tons per acre, rising to $2080 at a yield of 13 tons. But yields below 11 tons per acre still generate red ink even with the higher price.
Lower prices make things much worse. At a price of $550 per ton, no level of yield between 7 tons and 13 tons generates a profit. It’s red ink all the way down.
These data and reports make me wonder if winegrape growing is economically sustainable for many producers in District 11 and similar regions and these doubts are heightened by Gray’s interview with Jeff Bitter, the President of Allied Grape Growers (and a grower himself). Bitter notes that the economics of winegrape growing have made it difficult or impossible to focus solely on grape production.
Why continue to farm grapes? Some farm winegrapes because it is what they want to do (a “lifestyle” choice), Bitter suggests at one point, or because the alternatives are unattractive. There are a lot of factors that define the situation, including market conditions in different regions (Central Valley, Central Coast, North Coast) and farm size. There is money to be made in winegrapes under the right circumstances, but there are plenty of losses, too, and it is easy to understand why generational transitiions among growers are often in doubt.
When we talk about sustainable winegrowing, we usually focus on the environmental impacts, but Gray’s article suggests that we need to take the issue of economic sustainably more seriously, too.
Thanks to Wine Business Monthly for all the great articles in this issue and to W. Blake Gray for his focused report on the vineyard margin problem and the economic issues facing growers generally.
One of the highlights of our visit to the Catena winery near Mendoza a few years ago was the opportunity to spend a few minutes in Nicolas Catena’s private study. Catena was an economics professor before he returned to the family wine business to guide it through the turbulent wine markets of the time and I was interested to see what was in his library (and on his mind) from those days.
As I scanned the bookshelves I was struck by the fact that, back in the late 1970s and early 1980s, Catena and I were following the same news reports and reading the same research, including books such as Charles P. Kindleberger’s classic Manias, Panics and Crashes: A History of Financial Crises. Relevant reading then and now, too, don’t you think?
This Time is Different?
It is easy to imagine that financial instability, including manias, panics, and crashes, is something that happens in other places to other people at other times, but the recent banking crisis in the United States (and elsewhere) brings the problem clearly to our attention, especially given the involvement of Silicon Valley Bank (SVB), an important part of the U.S. wine industry’s financial ecosystem,
It has always been the case that financial instability potentially affects all types of businesses and, as Professor Catena understood all too well, the wine business. But, as I argued in my book about the global financial crisis, it is easy to ignore risks, forget the lessons of crises of the past, or to simply conclude that “this time is different.”
Financial instability is baked into the cake, as they say. Crises are a durable feature of modern capitalism so businesses are unwise to ignore potential risks, both direct (the risk that someone who owes you money can’t pay) and counter-part risk (the risk that someone who owes money to someone who owes you money can’t pay).
Wine’s Minsky Moment
It is possible to argue that the four most relevant economists of the 20th century were Schumpeter, Keynes, Friedman, and Minsky. Joseph Schumpeter studied growth. John Maynard Keynes helped us understand unemployment. Milton Friedman’s ideas of money and inflation are very important. Schumpeter, Keynes, Friedman — these are names you might know. What about the fourth, Hyman P. Minsky?
This is a Minsky moment because his work examined instability and crisis, which he thought were an inherent part of the financial system. I first studied Minsky when I was writing my book Selling Globalization. Using Minsky’s analysis, I argued that globalization was more fragile than most scholars believed because it was built, fundamentally, on the unstable foundation of global finance. People thought I was crazy as I worked through my ideas … and then the Asian Financial Crisis hit!
How do financial crises start? And how do they end? Like Tolstoy’s unhappy families, each is different in the details, but Minsky established a general seven-stage pattern that is a good guide. I will paste an excerpt from my book Globaloney 2.0 below so that those of you interested in the details can follow along. Pay particular attention to the distress, revulsion, and contagion stages and see if they sound familiar.
Try to Remember …
So how should the wine industry react to financial crises like the one we are experiencing today? It would be easy to say that crises are a finance problem, not a wine industry problem. Wine just happened to get caught in the cross-hairs this time because of the SVB’s particular pattern of business. What are the odds of that happening again? That’s a fair point. Wine loans had nothing to do with the bank’s collapse.
My view is a little different. Financial crises are a wine problem because wine is a business and businesses are necessarily disrupted by unstable finance. Businesses need to take their financial risks more explicitly into account. That goes for wine businesses, too.
I don’t think that wineries in Argentina have forgotten this lesson, mainly because they have suffered repeated and severe crises (the current 100+ percent inflation rate suggests another crisis in on the cards).
The wineries who found their accounts at SVB frozen for a few days (because they exceeded the $250,000 limit to FDIC insurance that applied at the time) will not quickly forget this lesson, although I wouldn’t be surprised if the memory eventually fades once “normal” operations are fully restored. That’s one of the reasons why Minsky moments like this return.
The leading authority on the theory of financial crises is Hyman P. Minsky, an economist who never received the respect he deserved within the profession because his theories challenged the orthodoxy that markets are generally quite stable (I will have more to say about this later).i Every financial crisis is different in the details (and not all bubbles or potential bubbles actually burst), but there is a family resemblance that Minsky explains as the seven stages to a financial crisis.ii
The first stage is called Displacement and it represents a change in expectations. It could be a new invention, discovery or government policy or it could be simply a change in expectations about the future. Whatever it is, Displacement creates a new object of speculation and at least some insiders rush in to take advance of the news.
Displacement happens all the time, of course. That’s why the stock markets go up and down every day and every hour of the day and every minute of every hour. People constantly react to real news, fake news and changing expectations. So there are a million little potential financial bubbles filling the market like fizz in a glass of Champagne, rising up and popping all the time. But some of them are a bit more substantial and gather the attention of both insiders and outsiders. It is hard to predict in advance when it will happen, but when it does a speculative bubble starts to form.
Minsky’s second stage is called Expansion. More and more money begins to focus on the speculative object, whatever it is – gold, silver, real estate or even tulip bulbs. The market can expand in several different dimensions. The most obvious, of course, is through money creation. When central bankers expand the money supply, as they sometimes do, they may expect that new funds will flow pretty much everywhere, but sometimes they are disproportionately diverted to particular investments fueling bubbles.
Leverage is another source of expansion. Leverage refers to the use of borrowed funds (other people’s money) to increase the return on your money. Suppose you have $1000 and you believe that XYZ Corporation’s stock will double in the value in the next month. You could invest your $1000 and, if you are correct, earn a $1000 profit, a 100% return. Or you could take your $1000 and borrow $9000 to invest $10,000 in total. This would be a leverage ratio of nine to one. If your expectations are fulfilled, the profit would be $10,000 on your $1000 investment (minus whatever interest costs you had to pay). Instead of a 100% return you would receive something approaching a 1000% return. Leverage is a wonderful thing when it works, but it is of course very risky. Just as you can earn much more than your initial stake you can also lose much more.
Expansion also takes place as the population of potential investors grows. Insiders (people with specialized investment knowledge) are joined by well-informed amateurs and then rank amateurs who sometimes just follow the herd based on what they read on the internet or hear from friends and co-workers. Water-cooler investors, I guess you could call them. The movement from professionally managed employee pension funds to individually managed 401k and similar retirement instruments has facilitated this sort of expansion in many countries. It is easy to belittle the ill-informed financial decisions that “blind capital” makes, but highly paid geniuses do not always out-performed them.iii
Finally, expansion can occur if the speculative object draws the attention of international or even global investment markets. Interconnected global financial markets are capable of focusing enormous sums on particular speculative objects, with predictable results. It is as if a giant magnifying glass focused the full power of the sun on some object or creature. Destruction seems assured, but first comes the heat.
Expansion does not always produce a crisis because investors can be fickle. There is always something new to consider, always a million different things to displace expectations and the funds that fuel expansion now can quickly withdraw and move on. The markets can achieve a state that Minsky calls Euphoria, however, if attention remains focus and expansion sustained. Euphoria produces a sense that investors can do no wrong. It is impossible to make a bad decision, since the general rise of the market covers any poor individual choices.
Economic logic simply evaporates in the Euphoria stage. Logic warns to buy less as price rises. Euphoria whispers that rising prices today are harbingers of even higher prices now – time to buy! And buy even more as those future price increases appear. The buying binge and the higher prices they produced are indeed self-fulfilling prophecies, which are the best kind. Sometimes Euphoria just fizzles out, but sometimes it can be sustained, especially if expansion from whatever source is maintained.
Distress comes next in the classic seven stage scenario. Distress is the moment when insiders begin to believe that the market cannot be sustained. Doubts creep in and alternative scenarios are reviewed. The market may pause or slow or the collapse could begin.
Revulsion follows as some investors begin to act upon their doubts. Insiders head for the door first, often leaving with substantial profits in their pockets. Others follow, causing the Crisis stage. The self-fulfilling rising price prophecy of Euphoria is reversed as lower prices trigger sell-offs that drive prices even further down. Everyone wants cash in this market, but it is hard to come buy. Who will lend in a falling market? Who will buy when prices are falling to fast? Someone does, obviously, but at much lower prices.
Crisis is often accompanied by the seventh stage, Contagion. The crisis in one market spreads to others. Contagion can happen in several ways. Sometimes the bubble in one market expands to others and all collapse at once. This was the case with the Peso Crisis of the 1990s. Unlucky investors, drawn to Mexico by the prospect of NAFTA gains, ended up putting money into many Latin American markets, all of which surged and then collapsed together. They called it the “Tequila Hangover” effect.
Leverage creates another contagion vector. As prices fall, leveraged investments go “under water” and speculators are required to put up additional funds. Since credit is hard to come by in the crisis stage, there is often little choice but to sell off good investments to cover losses on increasingly bad ones. Thus the Russian financial crisis of 1998 triggered contagion in Brazil as speculators sold off Brazilian investments to cover their rouble losses.
Finally, contagion can take place as credit markets freeze up generally. Businesses that are accustomed to ready access to credit (for themselves or their customers) are shocked as liquidity disappears. Economic misery spreads from the financial sector to the so-called real economy as declining wealth and restricted credit affect change buyer and seller behavior.
This is how a classic financial crisis unfolds. Not every crisis goes full term, of course, and the damage when they do is not always substantial. But as Kindleberger explained 30 years ago and Reinhart and Rogoff’s study has more recently confirmed, major damaging financial crises happen often enough to be considered a common feature of international finance. So no one should be surprised when these markets behave as they so frequently do.
i John Kenneth Galbraith is another economist whose status outside the profession was much higher than within it due to his failure to his unorthodox views.
ii See chapter 2 of Kindleberger Manias, Panics, and Crashes.
iii Walter Bagehot coined the term “blind capital” to refer to uninformed but enthusiastic amateur investors who are drawn into speculative bubbles.
We are suffering just now from a bad attack of economic pessimism. It is common to hear people say that the epoch of enormous economic progress … is over; that … a decline is prosperity is more likely than an improvement.
The economist John Maynard Keynes wrote these words in a 1930 essay called “The Economic Possibilities of our Grandchildren” and I have been thinking about them quite a lot recently in the context of the wine industry. Keynes was writing in the depths of the Great Depression. Is wine in (or headed towards) a Great Depression of its own?
On the Other Hand …
Certainly the mood at last month’s Unified Wine and Grape Symposium was mixed. Obviously I didn’t talk to all the 10,000 people who attended the 3-day event, but I think I got a general sense of what wine industry people are thinking and feeling from those I encountered.
On one hand (a classic economist opening phrase), there was an upbeat mood because the meetings and trade show themselves felt back-to-normal after several years of covid-driven disruption. The house was packed for our State of the Industry session, for example, and there was a record number of exhibitors at the trade show (and a waiting list for next year). Glass at least half full, for sure.
One the other hand (you knew that was coming), it was impossible to ignore some of the discouraging news in the air (I reported on some of this in last week’s Wine economist column). Some people blamed this on the recently released Silicon Valley Bank report, but I think that is unfair. Like our State of the Industry session, the SVB report has an obligation to be objective — to report the straight facts without a lot of spin. And I think their report does that well. Facts are facts. The question is what you do with them and whether, like Keynes, you can see beyond the current crisis to the possibilities of the future?
The Generation Gap: Got vs Not
Keynes was thinking in generational terms when he wrote his famous essay and a lot of the analysis of wine’s current malaise is generational, too. The baby boom generation powered the golden age of American wine, the story goes, but the generations that followed haven’t embraced wine with the same warm hug. What can we do to make Gen Z consumers love wine as much as their grandparents do? How can we close the wine generation gap?
This is a good question (and I am glad so many people are asking it), but it by-passes part of the problem. Yes, boomers as a group drink a lot of wine, but in fact wine consumption is concentrated among just a small fraction of boomers. The baby boom generation is large — it contains multitudes. It is both Gen Got Wine and Gen Not Wine. Generalizing about generations like the boomers is a risky business.
This is true, I believe, for other generations, too. What makes the wine drinking boomers different from the boomers who don’t drink wine or don’t use alcohol at all? And what, if anything, does the boomer wine cohort have in common with wine-drinking members of other generations? Maybe generational differences aren’t the whole story (or even the most important part of the story)? Is the gap as much within generations as between them?
How Full is your Glass?
Should we be optimists or pessimists as we consider the future of wine? Well, our situation is nowhere near as dire as what Keynes faced back in Depression days. The wine market requires only relatively small adjustments by comparison to restore a balance and a bit more to kick-start growth. Not easy by any means, and it might not happen, but not at all hopeless.
Keynes was an optimist and he used this essay to look far into the future, peering past the short term problems necessarily on his readers’ minds. The prospects for our grandchildren are bright, he said, so long as we are able to avoid certain obstacles — over-population, violence and war, and the politicalization of science. Our current economic situation, since we are the future of Kaynes’s past, is indeed prosperous compared wtih 1930 if not quite so bright as he hoped.
A Half-Full Future?
Let me follow Keynes’s example in talking about the future of wine. Wine has endured for thousands of years and survived many dark periods, so it is not unreasonable to imagine a bright future for wine as both culture and industry. But there are obstacles to be avoided.
In my recent book Wine Wars II I propose that wine must deal with a triple crisis: environmental crisis, economic crisis, and identity crisis. The identity crisis is most relevant to today’s topic. Wine is an alcoholic beverage — the fermentation process doesn’t just add alcohol, it transforms the grape juice in miraculous ways. If, as I think is possible, wine becomes defined by its alcoholic content — grape juice alcohol the way that hard seltzer is fizzy water alcohol — then something very important is lost and wine’s future grows dark.
Another obstacle — and this allows me to circle back to the generational issue — is occasion. Opening a bottle of wine is an occasion (there is both an element of ceremony in the cork-pull and the more-than-single-serving quantity to deal with) and must align with occasions in consumer life.
Mind the Gap?
Dinner is an occasion sufficient to pull a cork at our house, but that’s not true for everyone. I wonder how much of the wine that is sold is consumed with meals versus other types of occasions and how this might differ for different demographics? The wine industry would be wise to try to adapt to the occassions that younger consumers (and older consumers, too) actually experience rather than the ones we imagine they should enjoy.
An article in yesterday’s Wall Street Journal suggests that at least one big beer company is rethinking its marketing plans in light of the threat of recession. Home consumption is rising at the expense of on-premise, for example, so marketing will work to put beer at the center of home and family occasions. Smart thinking!
A recent Financial Times column by Gillian Tett provides food for thought regarding Generation Z attitudes. The article doesn’t talk about wine, but maybe there are implications for wine. Tett cites studies that show that Gen Z workers demand more control over work environments than employers are used to. If they can’t customize the job, they prefer to quit, one expert suggests. Dangerous to generalize, of course, but it makes me think about how the wine experience compares with, say, cocktails in this context?
The generation gap is complex. Lots of food (and drink) for thought!
The Big Squeeze? Many winegrowers have for some time been caught in a squeeze between rising costs and stagnant or sometimes even falling wine grape prices. Your margins are getting squeezed, I asked? Margins? What margins? they replied. Margins got squeezed away some time ago.
The Big Squeeze is significant and not limited to the United States. When I travel the world speaking to wine industry groups I will ask quietly about how the growers are doing? Often the reply is a shrug, downward look, and slow shaking of the head. Not so good, they tell me.
South Africa is a good case in point. Every year Vinpro, the important South African winegrowers organization, reports its survey of vineyard profitability. Rico Basson, Vinpro’s executive director, released the results for 2022 at the annual Nedbank Vinpro Information Day last month and the chart above summaries the conclusions.
Only about 9% of the South African winegrowers were earning a sustainable level of income per hectare — a high enough return to support long-term investment. Fifty percent were caught in a low profit zone, with positive net income, but less than they might earn elsewhere. (If you remember your Econ 101 definitions, this would be positive accounting profit but zero or negative economic profit — it’s an opportunity cost thing.)
The actual level of income per vineyard hectare (the green line in the chart above) is far below the sustainable income level (black line). Fully 41% of the South African winegrowers in the survey were either at break-even (3%) or bleeding red ink (38%). The average return on investment in 2022 was minus 2.4% and the gap between costs and revenues was widening. That, my friends, is a really big squeeze.
Volume or Value?
Which is the better strategy to escape the squeeze: volume or value? Do you push to raise vineyard yields or try to raise price though lower yields but higher value?
I don’t know the answer for South Africa today, but when I spoke at the Vinpro event a few years ago the answer was clear. The higher the yields, the better the chance for success. Sacrificing quantity for quality didn’t consistently pay, I was told, because South African wine found it hard to break through the premium price-point ceiling on international markets. Most producers couldn’t manage to raise price enough to compensate for the higher unit costs. Ouch!
I told this South Africa story to my winegrower friends and they shook their heads. Pretty much the same here, they said. Given the limits on what buyers would pay for their grapes, the best way to profits was to increase yields to, say, 12 tons per acre or more depending on grape variety.
Limited Yields, Limited Opportunity
But there were two problems,, I was told. First, some buyers won’t go along — they were concerned about loss of quality at the higher yield, although modern viticulture practices make it possible to raise yields without loss of quality possible in certain circumstances. So in these situations raising yields is a non-starter.
And it isn’t always possible to get yields up to an economically sustainable level because many older vineyards just aren’t set up for that and have built-in limits that were OK when they were planted years ago, but make life difficult today.
So what are you supposed to do, one grower asked me, if you have an older vineyard that needs to be renewed at high cost? This is where the unsustainable profitability issue really hits. Do make a big bet that the Big Squeeze will loosen up in the future? My winegrower friend was less than optimistic.
Not all vineyards bleed red ink, of course. The situation is different in different winegrowing regions with different market conditions and vineyards of different ages and farming set-ups. But the problem remains. As I reported last year, wine prices have fallen in real terms recently and one result has been to make the already-serious vineyard squeeze even worse.
When you talk about sustainable vineyards, people naturally think about environmental sustainability. But economic stability is an issue, too.
We are starting to gear up for the State of the Industry session at the 2023 Unified Wine & Grape Symposium and it looks like we will have a lot to talk about. The challenges the wine industry faces are significant and this year’s expert panel (Danny Brager, Glenn Proctor, Dr. Liz Thach MW, Jeff Bitter) is well-prepared to help us navigate the wine-dark seas.
Everyone wants to know what’s in the future — what will the U.S. wine market look like a a year? Five years? Ten years? Prediction is difficult for a variety of reasons, however, not least because the wine economy is embedded in the national and global economies, which are themselves full of uncertainty these days.
Looking for a Crystal Ball
Back in the days when I was writing university-level economics textbooks I told students looking for clues about the future to consult what are called leading economic indicators. The idea is that there are a lot of economic statistics available. Some tell you what has already happened (these are the lagging indicators), some give you an idea of what’s going on right now (coincident indicators), and a few offer a glimpse of possible future trends (leading indicators).
The number of new building permits and housing starts are leading indicators, for example. Once a permit is issued or construction begun, that sets in motion a chain reaction of economic activity that extends out into the future.
Durable goods orders are another leading indicator of economic activity in general, but they speak to attitudes and expectations. Durable goods, by definition, are long-lasting and need not be re-purchased every week or month. If consumers and business increase durable goods purchases, then it suggests that they are optimistic about the future and willing to make an investment now rather than wait for the future.
One economist, famous for his mastery of esoteric details, used to focus in particular on sales of new brooms on the theory that an old broom will always do if you are concerned about future finances. Buying a new broom is therefore a clear statement of economic optimism. That makes sense when you think about brooms as a gateway durable good.
It is maybe a little bit disturbing to learn that Alan Greenspan, the former Fed chair, once identified sales of men’s underwear as an important leading indicator. Really? Apparently, underwear sales are pretty steady, so any blip one way or another says something significant about consumer expectations. If you want to start an interesting conversation, try asking your male friends how long it has been since they re-stocked their underwear drawer. “Why are you asking?” People are so suspicious!
Where is Wine Headed?
There are many other recognized leading indicators for the overall economy — the yield curve, for example — but there isn’t room here today to talk about them because I’m interested in the wine industry and I wonder what statistics might be particular useful in forecasting the future of wine sales?
One approach is to use the chain-reaction theory. Where does the decision to buy more or less wine begin? What early indicator can we monitor today that will reveal something about how much wine, what kind of wine, and at what price consumers will choose in the future? Corkscrews? Well, I suppose that’s a wine-specific durable good, but I don’t think tracking corkscrew or even wine glass sales is going to help much.
Lots of people enjoy wine and it is sold in lots of ways and places. But, as we all know, the core wine market is surprisingly narrow. When you take away the U.S. consumers who don’t consume any alcohol (about 35% according to a Wine Market Council study a few years ago) and then those who use alcohol but not wine (21%), the residual is surprisingly narrow.
While 29% of consumers buy wine a few times and month or year, the industry actually relies on a relatively small number (15%) of high frequency wine drinkers who pull corks or unscrew caps pretty much every week. The demographics of this group — and especially the high-end buyer subset — is key to the future of American wine.
If you want to know what these consumers look like, I think a good place to start is by going to your closest Costco warehouse store. I am not saying that the Costco demographic matches up perfectly with wine demand or that purchases in other sales channels are unimportant. It is just that the relatively affluent user base at Costco, the people who are willing and able to pay the $60 to $120 annual membership fee here in the United States, are a group worth watching closely. They buy lots of stuff at Costco, including a surprisingly large amount of wine given the limited number of stores.
Now you might think that tracking Costco wine sales would be good economic indicator, but it doesn’t serve our purpose here because it would be a lagging or maybe coincident economic indicator and not the forward-looking insight needed. But there is one bit of Costco data that I think it useful — and it is flashing yellow (but not yet red) right now: the annual membership fee.
Hot Dogs and Rotisserie Chickens?
Most prices at Costco rise and fall with market forces (the costs of rotisserie chickens and the hot dog meal are notable exceptions having been fixed for years). The membership fee is a critical factor at Costco. The fees themselves account for a substantial amount of the company’s net profit and the renewal rate is high — over 90 percent. Costco typically adjusts its membership fee about once every five years, according to news reports, and the last time they did was in 2017. So no one would have been surprised if a rise was announced in 2022.
But this time around the Costco gurus looked hard at their customer base … and blinked. They decided to pass on a fee increase, which could mean a lot of things but might mean that they believe even their affluent member base is feeling the economic heat. And that’s not good news for wine, since these are the customers driving the U.S. market these days.
Is this the leading indicator for wine sales I was looking for? No, it isn’t, so I am still looking. Ideas? Please let me know. In the meantime, while as a Costco member I am glad that the annual fee is frozen this time around, it will be good news for the wine trade when Costco decides that their affluent, wine-drinking patrons are secure enough to tolerate a rise in rates.
Storm clouds are on the horizon for the global wine trade and I am worried because I can’t really say how things are going to develop in the short and medium terms.
The problem is that the disruptions are both broad and deep. They are widespread throughout the commodity chain and impact both the supply- and demand-sides of the market. It’s a lot to take in. Herewith a brief sketch of the situation as I see it today.
Storms on the Supply Side
Some of the storms on the supply side are literally storms — wind, hail, freezing temperatures in the main winegrowing regions of Europe plus drought and wildfire smoke taint elsewhere, especially California.
The increasing extreme weather impacts are unlikely to diminish and inject elements of risk and uncertainty into the supply side of the market. Some of this risk is inherent to agriculture, of course, but it seems like the factors that punctuate equilibrium are both larger and more frequent. Increasingly hard to predict what’s coming over the horizon.
Storms on the Demand Side
From a global perspective, as I explain in my recent book Wine Wars II, a small number of countries and regions (France, Italy, Spain, California) shape supply conditions and an equally small number (USA, UK, Germany, China) are key forces on the demand side.
Each of these countries if facing its own economic crisis and taken together they suggest major impacts on both global wine imports and, according to a recent IMF report, the prospects for a global recession. JPMorgan CEO Jamie Dimon is predicting a US recession within six to nine months.
The storm clouds are somewhat different in each country but the fact that they have come together at the same time raises concerns. Inflation is both high and persistent in the US, for example, causing the Federal Reserve to double down on interest rate increases. The hope is a “soft landing” that would slow the economy enough to reduce wage growth without actually increasing joblessness and tipping the economy into recession.
This is a tough target, especially because monetary policies are subject to what are called “variable lags.” You roughly understand what will happen, but not when. Imagine driving a car with variable lags on the brakes, accelerator, and steering! In theory you might be fine but in practice you will probably end up in the ditch.
The recent declines in equity prices and widespread cooling of the housing market is another concern. A recent Rabobank report suggests that sales of super-premium wines, which seem to persist even when income takes a hit, are not immune to changes in net worth.
So it is entirely possible, following Dimon’s lead, that the US will spend 2023 with both falling income and rising prices. Some wine market niches might be little affected by this combination, but the broad market will certainly suffer.
German and UK Problems
Germany is known for its bulk wine imports, and these are likely to be squeezed by rising energy prices and falling output in its energy-dependent manufacturing sector.
What will German consumers choose: shivering in the cold while they drink their usual ration of wine? Or staying warmer but cutting back on price or quantity? I will leave the answer to you.
The UK market, which is in some ways the wine trade’s most important, will suffer higher energy bills this year and next, too. But its problems go deeper. Already more economically fragile than the other countries discussed here, it must now confront the fact that its new government seems to be both economically reckless and politically tone-deaf (an unusual combination — it is usually one or the other). So the Bank of England has had to raise interest rates even faster than expected and invoke emergency measures to prevent fire-sale losses among pension funds.
To invoke the car example once again, the UK’s drivers are stomping down on both the brake and accelerator pedals at the same time. Not a very safe situation according to most driving instructors. Jeremy Hunt, the newly appointed chancellor, signaled a big U-turn in economic policy yesterday, but much damage has already been done and fundamental problems remain. Watch for more shoes to drop.
Although there was some good wine business news in the original “mini-budget (scheduled duty increases had been postponed), the alcohol tax increases have been restored and the outlook for the wine trade is grim. Will UK consumers spend their inflation-reduced purchasing power on the higher mortgage bills that are coming soon due to rising interest rates … or will they buy wine? Once again, the answer’s up to you.
China’s Economic Bicycle
A few years ago we would have looked to China for a ray of sunlight in the global storm, both in terms of the wine trade and more generally. But not today. The Chinese economy is fragile right now, with many risks to consider, especially in the possibility that the property bubble might burst or deflate.
I have argued that the Bicycle Theory of Economic Growth applies to China. A bicycle is only really stable as long as it keeps moving forward. Once it stopes, staying upright is a real balancing act. I think China is much the same — it has to move ahead rapidly to keep its inherent contradictions from tipping it over. The property market crisis is a clear example of this. As growth has slowed, consumers are now refusing to pay their mortgage bills for housing still under construction.
Five years ago, China would have been the engine we counted upon to pull the global wine trade and, indeed, the global economy, out of its storm. Now its weakness on both fronts (covid lockdowns prevent a return to normal wine market conditions, for example) stand in the way of recover.
What next? That’s the question on the cover of last week’s Economist newspaper. The Economist speculates that we are entering a new era of global economic policy. Hard to know where that path will lead.
What’s next for the global wine trade? The combination of demand- and supply-side storms I have outlined here make it hard to know. What next? Too soon to tell, I think. Stay tuned.
Are we headed for a recession here in the United States? Or are we already there? What about the future — the second half of 2022 and 2023?
If you follow economic news reports you have encountered all sorts of answers to these questions. And you can be forgiven for being a little confused and maybe quite a lot frustrated that the answers to these important questions are not clearer. Herewith a brief guide for the perplexed with implications for the wine sector.
The Recession Question
The “rule-of-thumb” definition of a recession is when there are two consecutive quarters of falling gross domestic product (GDP). The U.S. economy is in a recession now by this definition because GDP fell in both the first and second quarters of 2022 (second quarter data subject to revision). By this measure, many of the world’s most important economies are either in recession, too, or teetering on the brink.
The two-quarter rule is very useful, but it is not the final world. The National Bureau on Economic Research (NBER) more formally defines a recession in a way that stresses depth, diffusion, and duration: a recession is a significant decline in economic activity that is spread across the economy and lasts more than a few months.
The NBER’s more nuanced definition is better than the two-quarter rule, but it has some downsides. How significant is significant, for example? And how widely spread need the decline be? There is also the problem, unavoidable with lagged economic indicators, that a recession can only be declared well after it has started and will probably be over before the conclusion is called.
So we might be in a recession now — one that started months ago in fact — or we might not. We will only know for sure later on — perhaps when the recession (if there is one) is already over. Argggh!
Up, Down, Twist
If you follow business and finance news you will find evidence to back up any hypothesis you may have about a recession. Prices in some sectors are rising quickly (have you bought a airline ticket recently?) and plunging steeply in other areas.
There are plenty of stories of firms with squeezed profits, declining sales, and employee lay-offs. But there are also stories about rising sales and profits and, of course, the labor market puzzle, where the number of unfilled positions is about twice the number of people who say they are looking for work (but apparently cannot find it).
Last week’s job report was unexpectedly strong — the unemployment rate is only 3.5% and total employment is back to the pre-pandemic level — suggesting that the U.S. is not currently in recession, despite what the GDP figures say. Ironically, some analysts speculate that this good jobs news actually increases the odds of bad news in the near future. The reasoning is that the Federal Reserve will be forced to raise interest rates even higher now in order to slow control demand-driven inflationary pressures.
What’s the story? Is the economy up or down? The correct answer (which applies to wine, too) is … yes. If you are looking for a generalized answer to the recession question you won’t find it. Maybe it is best to say that the economy is twisting. The devil is in the details here and the answer you get depends upon where you look and how.
The Price is Right?
There are several reasons for this complicated picture. One of them is that the economy — like the wine market — is never all one way or another. Like the climate, it is always running hotter in some areas and colder elsewhere.
But another, particular to this moment, is the fact of rapid inflation because an inflationary economy works by different rules. In an economic system with stable prices, consumers cut back purchases when employment falls or when there is fear of unemployment. In an inflationary economy, the pressure to cut back spending affects a much broader set of consumers who find their budget squeezed by rising prices of necessities. Higher energy and housing prices (although moderating somewhat in recent weeks) have put the squeeze on millions of households regardless of job market status.
And so that’s what we are seeing now. So maybe the recession question isn’t the right one to be asking.
The Squeeze: A Tale of Two Worlds?
The conventional wisdom is that wine is recession-proof. Maybe. But an inflationary squeeze and the twist it creates is different and I don’t see how wine sales can escape unscathed.
Under these circumstances it is more important than ever to know your customers and the product chain that connects them with your business. Based on recent quarterly reports, for example, it looks like selling wine into mass market Walmart World’s part of the retail spectrum, where both the retailer and its clients seem to be really feeling the squeeze — is much different from selling wine into high income Costco World, where the squeeze is still on but the impact seems more moderate. So far.
The conventional wisdom is that we are likely entering the first significant period of stagflation — inflation + stagnant economic growth — in several decades. We have experienced recessions in the recent past, but not rising inflation, and not the two of them at once.
Inflation is in the headlines every day, but unemployment is very low — so why worry about slow growth or a recession? The answer is that while Federal Reserve policies will try to finesse the situation and bring inflation down to a “soft landing,” most observers think that a sharp contraction will be necessary to bring inflationary expectations down. Growth will fall while inflation still runs high, at least for a while.
So, these are uncharted waters for business and government leaders, especially since it comes on the heels of the covid crisis, which has shaken so many economic and social structures. It is, as I have argued here, uncharted territory for the wine business, too.
So far, as I suggest in last week’s Wine Economist newsletter, wine prices overall have not risen to the degree you might expect given the many cost pressures the industry confronts. Average wine prices seem to have actually fallen in real terms so far according to the data I have surveyed.
It may be premature to begin worrying about how wine consumers will react to higher prices in the stagflation context if and when they arrive. Or — and this is my point — it might be strategic to consider possible scenarios in order to prepare for the eventuality. Because this is uncharted territory — and because, as Jon Fredrikson says, there are no one-liners in wine — it makes sense to consider the range of consumers responses rather than to look for a single silver bullet answer.
Herewith, therefore, a brief and incomplete list of possible consumer responses to rising wine prices in the context of stagflation.
Econ 101: substitution, income, and wealth effects.
We begin with Econ 101 basics. An increase in the relative price of wine would create a substitution effect to some extent. It might be to substitute other beverage alcohol products for wine or — the trading down effect — to substitute less expensive types of wine for previous purchases. How this plays out depends on a number of factors. Younger drinkers, for example, are known to be less loyal to wine and more prone to dividing their purchases among many beverage types, so the substitution effect may be stronger for them than for boomers, for example.
Of these three effects the substitution effect is the most interesting to me because we don’t have much recent experience of supply-driven price increases in wine (versus demand-driven “premiumization”.
The income effect, driven by both higher wine prices and higher prices in general, points towards lower consumption of wine overall. Wine is already more expensive than most beer and spirits on a per-serving basis, and so vulnerable to income-driven consumption adjustments.
There is also likely to be a wealth effect, with wine consumption falling as consumers (mainly but not exclusively boomers) re-assessing buying decisions in light of changing net worth. Rising interest rates implemented to fight the inflation tend to reduce the value of bond holdings directly and equity values indirectly through their impact of the present value of corporate cash flows. Substantial interest rate rises are likely to affect portfolio balances and 401k holdings. If you have been watching the way that equity markets have reacted to the Federal Reserve’s initial 1/2 percent interest rate increase you know what I am talking about.
Stalking the Illusive Wine Bargain
In a perfectly competitive market the “Law of One Price” rules, but the wine market has many quirks and peculiarities, so similar products can sell for very different prices. Rising wine prices are likely to push price-sensitive buyers to even more aggressive bargain hunting efforts. Expect your local Grocery Outlet store to do even more wine business.
But bargain hunting doesn’t necessarily mean searching for rock bottom prices. We recently received samples of two wines that represent good value in their respective categories. The pitch that came with the wines was that these are inflation-fighters. The first wine was Villa Maria Marlborough Pinot Noir Private Bin, which retails for about $19.00. It is an excellent wine that sells for less that many comparable products from, say, Oregon or France.
The second wine was Le Volte dell’Ornellaia, a “Super-Tuscan” from the Bolgheri region that, at around $29, represents a way for many consumers to raise a glass in high style without breaking the bank. How do you find inflation-fighter wines like these? Start by asking whoever sells you wine to solve a puzzle — I’d like a wine like this, but I want to pay something more like that. A good wine seller will appreciate the challenge.
Buying wine is not easy because it is what economists call an “experience good.” You won’t really know if you will like a particular bottle of wine until you buy it and pour yourself a glass. Reviews and so forth help, of course, but the taste of wine is ultimately very subjective and the risk of disappointment almost inevitable.
As inflation pushes wine prices higher, the disappointment risk becomes more of an issue. One strategy that consumers are likely to adopt in this circumstance is to concentrate their purchases on a few tried-and-true brands or grape varieties that they trust to consistently please. Trying new wines from different regions and brands made from different grape varieties is great fun, but the high reward when you find an exceptionally pleasing wine comes with high risk of disappointment.
So don’t be surprised if consumers — and the stores and shops who sell them wine — react to wine inflation by doubling down on tried-and-true wines. This reinforces a trend that emerged during the pandemic wine surge.
But don’t forget that all this is predicated on wine prices finally rising as fast or faster than the general inflation rates. This hasn’t happened yet … and it might not happen at all. Stay tuned.
The U.S. is experiencing the highest inflation rates since the 1980s and cost-of-living increases are on everyone’s mind here and around the world. The Federal Reserve has signaled that it will speed up monetary tightening to try to reverse rising inflationary expectations — too little and too late, according to the Economist newspaper (The Federal Reserve Has Made a Historic Mistake on Inflation).
I am very concerned about how higher inflation will impact the wine industry, especially when combined with a stagnant overall economy (GDP actually fell in the US in Q1/2022).
The Big Squeeze
Costs are increasing, some dramatically, throughout the wine and grape commodity chains and rising interest rate expenses will add to cost woes. The list of cost factors is long and includes energy, fertilizer, transportation, glass and other inputs, and especially labor, which remains in short supply.
Will growers and wineries be able to hold on to their margins by passing higher costs along to consumers in the form of higher prices? A lot of people I talk to think so. Surveys suggest that many wineries plan to raise prices in 2022 and there is an attitude that consumers might not push back too much, given that the price of everything else is rising, too.
So I am a little bit surprised that some of the data suggests that wine prices have not risen along with the prices of other goods — at least not yet. Wine Business Monthly, for example, cites NielsenIQ data on average bottle prices. The May 2022 issue reported an average price of $8.52 for the most recent 4 week survey period, up from $8.18 reported in the May 2021 issue — an increase of 4.1 percent. Average domestic bottle price rose from $8.12 to $8.46 and average import bottle prices rose from $8.35 to $8.69.
The Booze Bust
Prices are rising, according to these figures, but at about half the current rate of overall inflation. NielsenIQ doesn’t measure all sales channels, of course, and there is a lag in the data, so maybe prices are really rising faster than these numbers suggest and wine industry margins will hold.
But the IRI data shown above, taken from a recent Rabobank report about inflation and the beer market suggest that wine in particular and beverage alcohol in general is struggling to increase prices in line with rising costs. Take a close look at the top half of this table, which shows that some non-alcohol beverage categories have been able to boost price much faster than the roughly 8% general inflation rate for the U.S. economy — topped by sports drinks with an incredible 17%+ annual rate price increase. Wow!
Beer, wine, and spirits have all increased average prices, but much less than, say, coffee, and substantially below the overall inflation rates. In other words, the real price of wine, on average, has actually fallen in the last year and the relative price of wine with respect to some other beverage categories has fallen, too. Averages hide a lot, of course, and some strong brands have successfully pushed prices higher while others have not. But beverage alcohol generally, according to the Rabobank figures, has fallen behind in terms of price.
Why haven’t wine prices increases faster.? Here are a few of the many possible explanations.
Radar’s Rule. Wine prices will increase — “wait for it,” as Radar used to say on M.A.S.H. — it just takes time for price changes to work their way through the system. It is hard to refute this because it is impossible to know the future. Maybe there is something about wine’s annual production cycle that causes price changes to come more slowly. But then why do beer and spirits, which are in continuous production, also lag behind the inflation rankings?
The Wall. Consumer pushback is too strong in the wine category for large price increases to take hold. Yes, I agree that wine buyers are very price sensitive, but prices do rise when they are driven by short supply. And of course there is the whole premiumization phenomenon, where consumers pay more for what they see as better products while resisting price rises on products they already buy.
The Hidden Price Increase Trick. Candy bar makers sometimes try to disguise price increases by simply shrinking the size of the product. Wine makers can do something a bit like that by shifting grape sources from coastal to inland vineyards and in some cases by blending in wines from earlier vintages. Consumers may not notice (just as they might not immediately realize their candy snack has shrunk a little). Wineries can also increase their average revenue by reducing production of lower-tier wines, shifting the grapes up the ladder.
Three-tier Blues. It’s the three-tier system, where producers sell to distributors who sell to retailers who sell to consumers. On one hand this system means that there are three margins at stake and to each tier has an interest in raising the price at which it sells wine. But each tier also has an incentive to resist increases in its cost of goods. So distributors push back on producers who want to raise price, retailers push back on distributors, and consumers push back on retailers. The three-tier effect may explain why the lowest average price increases in the Rabobank table above are for beer, wine, and spirits.
More Questions Than Answers
There are other theories and explanations about inflation and the wine category, but perhaps the most important thing to say is that, with the most recently experience of significant U.S. inflation so far back int he rearview mirror, we are left with more questions than answers.
All the basics — the who, what, when, where, how, and why of the wine market have changed very dramatically since the 1970s and 1980s.
Will wine prices rise in line with inflation? If so, when? And how will consumers react? Come back next week for more analysis.
Thanks to Steve Fredricks at Turrentine Brokerage for stimulating my thinking on this topic.
As much as we all would like to think that economic conditions and the global wine market will soon return to what we used to call “normal,” I think it is important to realize that we have actually entered what are in some ways uncharted waters. Old maps and rules of thumb do not necessarily apply and the ability to pivot quickly as conditions change is even more important than in the past.
Flashback to the 1980s
Sometimes I get to thinking that I’ve passed this point in life one time before. (That’s actually a line from a John Hartford song.) Way back in 1981 I wrote a college economics textbook because I couldn’t find a text that could help my university students understand what was happening to the economy.
The uncharted territory back them was stagflation — high inflation and high unemployment at the same time. The standard textbook analysis used Keynesian analysis to understand unemployment and the Phillips Curve to plot the trade-off between unemployment and inflation. Higher unemployment meant lower inflation. But we had both high inflation and high unemployment — how did that happen? And what could be done about it?
The problem (in very simple terms) was that inflation was caused by cost-push not demand-pull factors and had unleashed sustained self-fulfilling inflationary expectations. The Volker solution was highly restrictive monetary policy that pushed unemployment even higher until the expectations broke. Harsh medicine for a vicious disease.
Zoom Ahead to 2022
Zoom ahead to 2002. After years of relatively stable or even falling price levels, inflation is here again at rates that haven’t been seen in the U.S. since the 1980s. The problem this time is a combination of cost-push and demand-pull factors. Higher energy, food, and transportation costs plus persistent shortages of key commodities push prices higher while the huge fiscal and monetary stimuli of the pandemic and post-financial crisis era have pulled inflation higher, too.
This is not a repeat of the 1980s, by any means, but also not like anything we’ve seen at this level in a very long time. I can’t remember seeing such a combination of broad forces aligned to boost demand and constrain supply.
The war in Ukraine adds to the inflationary pressure, especially with respect to energy and food prices, and it is hard to see these forces disappearing any time soon. Even if a truce were declared today, the energy and food price effects would continue for some time. The Chinese covid lockdowns are squeezing production of many manufactured goods at the same time.
Disruptions in global trade and finance are another factor to take into account. For a long time the “China Price Syndrome” kept a lid on prices of manufactured goods. If a company was tempted to raise price, the ready availability of cheaper alternatives from Asia and especially China acted as a constraint. The “China Price” served as a price anchor then, but much less so now because of unraveling trade relations.
Getting from QE to QT
Taken together this is a situation we haven’t really seen before, but the thing that really makes people like me nervous is monetary policy, The Federal Reserve will be responsible for squeezing inflation out of the economic system (just as it was in the 1980s), but financial conditions are different now. We have had very low interest rates for a long time now and wave after wave of quantitative easing (QE — Fed purchases of Treasury and mortgage-backed securities that pump liquidity into the markets). The markets have kind of become addicted to the constant monetary boost.
Raising interests from this very low level can be expected to disrupt financial markets if only because of the mathematical impact on present value calculations. Exchange rates will shift, too, with disproportionate impact of development market currencies.
But the real “uncharted waters” factor is the transition from QE to QT, quantitative tightening. This will initially take place as the Fed’s bond holdings mature and are not rolled over, which takes liquidity out of the market. It will start slow (which still means billions of dollars a month) and could pick up speed if necessary.
The question is how financial markets will deal with this change after having a liquidity drip line month after month for this long? There is nervous talk of another sharp liquidity crisis, but maybe bigger than the last one, which the Fed addressed quickly and well. If key credit markets freeze up and contagion takes place, the Fed will have little choice but to reverse course, opening the door to even higher inflation.
The alternative is a very hard landing as the impact of the financial crisis spreads through the economy. How hard a hard landing? It depends on what it would take to shift inflationary expectations. So you can see the concern — we may be perched on a narrow ledge with higher inflation on one side and financial crisis on the other.
What About Wine?
The wine economy operates by its own rules, but it can’t fully escape the forces shaping the economy in general. To repurpose something that is said about the pandemic economic, we aren’t all in the same boat, but we are in the same storm.
Wine has also experienced a combination of cost-push and demand-pull factors, but not uniformly for various categories. Demand-pull, for example, seems focused on more expensive wines. Cost-push is everywhere, however, which means that the crunch is felt particularly in the middle- and lower-price tiers.
Honestly, I cannot remember a time when cost pressures have been so broad and deep. To what extent will price-sensitive consumers push back on price increases? Or will the consumer inflation expectations in general soften attitudes towards rising wine prices? Given that these are uncharted waters, the map holds more questions than answers.