Category Archives: exchange rates

Crisis and Change in the Wine World

March 22, 2009 By in Argentina, Barefoot wine, British wine market, decanter, Economic impact, exchange rates, globalization, Supply and Demand, wine bargains, wine magazines, wine markets, wine price, wine spectator, wine taxes Leave a comment

When the economic crisis began to unfold last year many people said that it wouldn’t affect the world of wine — people will still want to drink, they said, even more so when they are worried or depressed.  Recession is good for wine, they assured us.

Well, we all know now that that line of reasoning was misguided.  The crisis is hitting almost every shelf on the Wine Wall as consumers cut back and trade down (only a few value brands like Barefoot Cellars seem to be benefiting).  The most recent issues of Wine Spectator and Decanter feature cover stories that are designed to appeal to recession-shocked bargain-hunting wine enthusiasts. (See note below.) Wine industry publications are packed full of stories about how producers, retailers and restaurants are coping with declining demand.

Cycle or Shift?

Now that we know that economic crisis is having a real impact on wine, it is time to think more seriously about what form that impact is taking. Most people that I have talked to are thinking in terms of boom-bust cycles. The current downturn will be very difficult — and a shake out will take place across the industry — but, they say, the wine economy will bounce back again once the economy itself starts to recover.  This is probably the correct way to think about the future of wine markets, but it isn’t the only way.

A second possibility is that the crisis will produce a long term structural change in the wine market.  The market won’t bounce back from its low, but rather will reset itself and proceed along a new and possibly unpredictable future path. Economists who study other sectors (finance, automobiles, agriculture) and taking the possibility of structural shifts seriously.  Could it be happening in the world of wine?

I have given a lot of thought to question of cycles and shifts over the years.  My best known work in this regard is a comparative economic history of public debt in advanced economies called Mountains of Debt: Crisis and Change in Renaissance Florence, Victorian Britain and Postwar America (Oxford University Press, 1990).  (Mountains went out of print in the Clinton years when the US deficit went away, but George W. Bush and the current crisis convinced the publisher to bring it back).

One point of the book is that some crises are more significant than others.  Sometimes a crisis is a tremor that shakes things up for a while but leaves the landscape pretty much unchanged.  Other crises are major earthquakes, with more lasting long term implications.  Maybe this is a “Big One,” at least in terms of wine. I’m going to use the next few blog posts to think through this important question.

The Market Center Shifts

One early indicator of structural change comes from London, the center of the wine world.  Great Britain, as I’ve said before, is the most important wine market in the world. The British don’t drink the most wine in the world or produce the most, either, but they buy a lot of wine from other countries, making them the largest import market and therefore the focus of international competition (Germany and the United States along with Britain form the Big Three import markets).

But this may be changing.  Britain’s economy is being badly battered by the economic crisis, as an article in yesterday’s Financial Times makes clear.

As the UK economy contracts at its fastest rate since the second world war, the … Industry Watch report predicts that more company casualties will follow in 2010. It says 39,000 businesses, or one in 50, are likely to fail next year.

Britain’s banking sector is in bad shape, perhaps even worse than the US industry, and its government budget deficit is also spiraling into the red.  This has general wine market effects similar to those in the US (cutting back, trading down, switching over), but some different ones, as well, the most important of which is due to the exchange rate.

As Britain’s economy has imploded the pound has collapsed as well. The pound has fallen by about 25% against both the dollar and the Euro. It took about $2 (or €1.30) to buy a pound a year ago, now it is selling for $1.45 (or €1.06) today.  This means that imported wine (which in Britain is, well, wine) costs much more because of the exchange rate at the same time that the slumping economy (and lowered expectations) are undermining demand. The US dollar, on the other hand, has appreciated relative to most currencies apart from the yen, promising wine buyers lower prices to match their reduced economic circumstances.  So the recession is affecting wine in Britain more than the US wine market.  A shift is taking place — is it temporary or will it be permanent?

Although it is too soon to know for sure, I think it is possible that these factors could cause London to lose its preeminent position in the world wine market.  I see indicators in the decline of the Australian industry (complicated by other factors, I know — but the collapse of the British market is part of it) and the recent global focus on Argentina and its excellent wine values (both Wine Spectator and Decanter make this point).

Although Argentinean producers are looking to export wherever they can get a foot in the door, my strong sense is that they see their future in the U.S. market more than Great Britain.  Perhaps they are at the head of the pack as the world wine market resets and proceeds on a different path.

[Note: Wine Spectator includes 18 tips on stretching your wine dollar. My favorite is tip #7: buy by the case and get a discount (page 55 of the April 30, 2009 issue).  Sound advice, although the particular example cited may miss the point: “A 10 percent discount on a $300 case translates into a saving of $2.50 per bottle. That adds up fast.”  The problem, of course, is that the people who used to buy those $300 cases are cutting back the hardest and I’m not sure that $2.50 a bottle  is going to turn them around.]

Dollar Daze on the Wine Wall

June 21, 2008 By in exchange rates, New Zealand, Supply and Demand, wine markets 1 Comment

You know that wine economics has become mainstream when you find yourself listening to it on the car radio.

The Dollar and the Wine Wall

Marketplace, a program of American Public Media that is broadcast by many National Public Radio stations, recently featured a story called U.S. Winemakers Toast a Strong Euro. Go ahead and click on the link to listen to the story or read the transcript.

The basic idea, which my International Economics students will recognize immediately, is that exchange rate changes create many direct and indirect winners and losers. This is particularly true in the increasingly integrated global wine market. The Euro has appreciated from about USD 1.35 per Euro to about USD 1.55 in the last year, which means that a wholesale €10 bottle of French or Italian wine’s dollar cost has increased from $13.50 to $15.50. This pushes the retail price from about $20 to $23 or $24, assuming a full cost pass-through, which puts it at a different price point on the supermarket shelf. Higher shipping costs will nudge the dollar price a bit higher still. Basically, you’re looking at a $20 wine selling for as much as $25. U.S. wines are corresponding cheaper in Eurozone countries.

U.S. winemakers hope that the falling dollar will be their ticket to higher sales abroad. I wrote about this in January when a group of Washington and Oregon wineries organized an export event in London. It is difficult to get traction in foreign markets, but the dollar’s weakness should help.

In the meantime, rising import prices here give domestic wines an advantage. Wine buyers tend to make most of their purchases around particular “comfort zone” price points and rising import prices should create some advantageous substitution effects. This comes out in the Marketplace interview. One wine professional puts it this way

Say if they used to enjoy a Sancerre for $20 and now their favorite producer is $25, they’re going to look for a comparable producer in that same price range that they originally purchased.

And the idea is that the “comparable producer” might be from the U.S., although this isn’t always the case.

Now Things Get Complicated

A falling dollar encourages exports and discourages imports — so far we are following the textbook pretty closely. But real world economics, and wine economics in particular, is seldom so simple. Foreign wine producers and distributors obviously have an incentive to keep from losing their market and there are many strategies to soften the exchange rate effects. The New Zealand producers, for example, seem to have been pretty successful in finding new markets for their wine and strengthening their reputation in response to the rising New Zealand Dollar. So far NZ wine seem to be defying gravity — higher quantities and higher prices too. But not everyone can pull of this bit of magic (or necessarily do it forever in New Zealand’s case).

One way to retain market share is for European exporters, distributors and retailers to absorb some of the exchange rate effects themselves, limiting what economists call the “pass through effect.” Canadian wine columnist Anthony Grismondi wrote about this in April in the Vancouver Sun.

I think European winemakers will be under a lot of pressure this year as container shipping costs continue to rise and the Euro’s strength persist. Not all of these higher costs can or will be passed along immediately in the form of higher dollar prices. The biggest effects will probably be felt on low cost wine, where the shipping cost effect is proportionately greater and price sensitivity is higher, too. Look for foreign wineries to go upmarket if they can and to absorb costs or adjust in other ways if they can’t.

But high end wines are not immune from exchange rate problems. Decanter reported in March that the strong Euro was expected to depress prices for Bordeaux en primeur sales.

Winners & Losers

The dollar hasn’t fallen uniformly relative to all currencies. A dollar buys 3.1 Argentine pesos today, for example, which is about the same as a year ago (Argentina’s compounding economic problems have caused a run on the currency in recent days). The Chilean Peso has not appreciated as much as the Euro and the South African rand is actually cheaper in dollar terms than a year ago.

One well known Australian brand, Lindemans, has been sourcing wine from Chile and South Africa to keep costs down as the Australian dollar has risen — a controversial but not uncommon practice in today’s small world of wine. Look for the Lindemans “Country of Origin” wine series.

This suggests that the Dollar Daze on the Wine Wall might feature some interesting shifts, from France and Italy (and Australia and New Zealand) to Argentina, Chile and South Africa. Is it my imagination or are the wine critics and magazines already riding this wave by featuring these New World regions more prominently in their publications?