Crisis and Change in the Wine World

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.]

Santa Margherita Syndrome

Many articles have appeared recently advising wine consumers on “trading down” strategies for the recession — where to find the best values and bargains as the market slump continues. (Thanks to my crack team of research assistants — Michael, David and Tom — for your tips on this topic.)

One of the best pieces I’ve read comes from Dorothy J. Gaiter and John Brecher at the Wall Street Journal: 10 ways to save money ordering wine at restaurants. All their advice is timely, but rule #6 really caught my eye:

6. Never order Santa Margherita Pinot Grigio. We don’t mean to pick on Santa Margherita. We know many people like it and that’s fine. But because so many people like it, it is routinely one of the most outrageously priced wines on the list.

Nothing personal, Dottie and John said, it’s just supply and demand plus a certain bandwagon effect that seems to afflict wine drinkers when confronted with a complicated and uncertain set of choices.

We note it here only as a classic example of this: If you stay within your comfort zone, ordering only wines you already know, you will be punished for it, price-wise. In addition, no wine is going to seem like a good value to you when you know you could buy it at a local store for half the price or less. That’s why it’s so important to focus on labels or kinds of wines that you wouldn’t otherwise see. …  Remember: There is value in tasting something new.

Sensible advice, although not always easy advice to follow in practice given the high cost of restaurant wine. Everyone wants to find that delightful unexpected bargain, but no one really likes paying the bill for a wine experiment that disappoints.  So restaurants and wine consumers alike seem to find themselves drawn to a small set of “usual suspects.”

Demand and Supply

Wine & Spirits magazine surveys restaurants each year to try to discover  trends both in general and in specific segments of the market. This year’s poll (see the April 2009 issue) provides early data on how the recession is affecting wine sales and some of the strategies that restaurants are trying to deal with this increasingly serious problem.

W&S provides a lot of information about what successful restaurants are doing to cope with the weak economy.  One unexpected implication of the survey seems to be this: 

Always try to sell customers Santa Margherita Pinto Grigio.

The W&S editors do not advise this, of course (they are very careful in this regard — they just report the findings); it just seems to be restaurant conventional wisdom.

W&S asks restaurants to identify the wines that they offer by the bottle or serve by the glass and then publishes the names of the most-reported products.  The most listed wine-by-the-glass, for example, is Sonoma-Cutrer Russian River Chardonnay (11.1 responses per 100 restaurant replies), which sold for an average price of $12.67 per glass in 2008.  Santa Margherita Pinot Grigio was #6 on the list (number six again … spooky), reported by 6.7 per 100 restaurants.  It sold for an average price of $14.40 per glass in 2008.

A quick internet search reveals that Santa Margherita often sells for around $20 per bottle retail, which suggests a wholesale price of $14-$15 — suspiciously close to the $14.40 average per glass tariff.  You can begin to see why it would be a popular restaurant choice.  And why Dottie and John’s number one rule is …

1. Skip wine by the glass. Restaurateurs like to make enough on a single glass to pay for a whole bottle, which is great for them but not so great for you.

W&S lists Santa Margherita as the number one wine in both the Pinot Gris/Pinot Grigio and the Italian wine categories.  The average per bottle restaurant price was $52, which indicates a somewhat higher mark up over wholesale than the usual restaurant rule of thumb.  All of which makes me think that wine consumers need to become a bit better educated about wine economics because it is pretty plain that restaurants have been hitting the books on how to use demand and supply to preserve profit in these unsettled economic times.

What Should I Order?

So where are the values on restaurant wine lists?  The simple answer is that there is no simple  answer (apart from Dottie and John’s good advice).  The W&S poll asked restaurants to list wines under $25 per bottle and the most frequent response was Cooperidge White Zin and Chardonnay, $24 average price.  Cooperidge is a Gallo restaurant brand.  Interestingly, it appeared in just 1.9 per 100 responses.

The number two and three bargain wines were both Ste Michelle Wine Estate products from Washington State — Chateau Ste Michelle Riesling ($24 / 0.7 responses per 100) and 14 Hands Columbia Valley Cabernet Sauvignon ($21.50 / 0.7 responses per 100).

No very strong conclusions can be drawn from this data but they do suggest that (1) there is no one wine or brand that restaurants consistently go to for the value-seeking customers, so you will have to explore the wine list carefully to find what you are looking for, but (2) it might be smart to include Washington State wines in your treasure hunt.

Wine, Recession and the Aldi Effect

Aldi stores are about to expand in the United States, drawn here by the recession according to an article in today’s Wall Street Journal ( “Aldi Looks to US for Growth” ).  I wonder how this will affect the wine market?

A Tough Nut to Crack

Aldi is a German “hard discount” store chain.  A “hard discounter” sells a limited selection of house-brand goods at very low prices in small, bare-bones outlets.

Hard discounters are a niche, albeit a growing one, in the U.S.  Wal-Mart is a successful discounter, of course, but not a hard discounter because it still features many mainstream branded products, its prices are higher and its stores a bit more plush.  Aldi and other hard discount stores drove Wal-Mart out of Germany, according to the WSJ article, but the U.S. market has been a tough nut for the hard discounters to crack. American consumers are primed to buy brand-named products and they like lots of choice, marketing experts say, and so tend to resist the house brands that hard discounters feature, which has limited their penetration here.

Germans are more willing to sacrifice brand names for low prices, apparently.  Aldi and other hard discounters are dominant powers in German retailing. The WSJ reports that 90% of German households shop at Aldi stores and 40% of all grocery purchases are made in hard discount outlets.

Divide and Conquer

Interestingly, there are actually two Aldi store chains in Germany (with similar but different logos — see illustration above).  Aldi is short for ALbrecht DIscount. The Albrecht brothers  who founded the company after World War II fell out over the issue of tobacco sales in their stores.  They divided the German market between them (Aldi Nord and Aldi Süd) and then, eventually, split up the world market too.  Here are links to Aldi USA and Aldi International websites if you want to learn more about this retailer’s local presence and international reach.

Aldi Süd has been in the United States since the 1970s.  The corporate website tells the story this way.

The ALDI way of shopping has been continuously honed and refined since our first store opened in Southeastern Iowa in 1976. Committed to bringing food to customers at the lowest prices possible, our early stores set up shop in small spaces and introduced shoppers to the limited-assortment concept, carrying only 500 private-label items. Compared with other supermarkets, our stores seemed tiny. But ALDI found a niche with Americans hungry for real value, and the chain grew rapidly.

Over time, more products were added, including more refrigerated and frozen foods. ALDI also began experimenting with Special Purchase items, to great success. More recently, Sunday hours were instituted, and ALDI began accepting debit cards.

Today, there are nearly 1,000 ALDIstores in 29 states, from Kansas to the East Coast. And today’s ALDI store carries about 1,400 regularly-stocked items, including fresh meat, and, in certain locations, beer and wine. Though the original ALDI concept has been modified somewhat to accommodate our ever-changing tastes and preferences, the core concept remains: “Incredible Value Every Day.”

The German origins of the store are apparent in this description, from the traditional Sunday closing to the very limited selection.  Your local upscale supermarket carries at least 10 times as many products as a typical Aldi.

Wine is an important product in Aldi’s German stores, as you can see from the wine selections featured on their website.  I believe that Aldi is the largest single retailer of wine in Germany.

Since Germans are rich and Germany makes great wines, you would think that Aldi must sell mainly fine wines, but you would be wrong.  Aldi’s median  German wine sale is red not white, imported from a low cost producer, sold  under a house-brand name, packaged in a box or TetraPak and priced at around one euro per liter.

You could say that it is Two Buck Chuck (TBC) wine, but in fact TBC is more expensive.  TBC is to Aldi wine as Wal-mart is to Aldi itself. (Note: Wal-Mart now has its own brand of two dollar wine, which makes this comparison even more appropriate. It is called Oak Leaf Vineyards and is made for Wal-Mart by The Wine Group.)

The Aldi Effect

Aldi figures that the recession is its moment to press more vigorously for U.S. market share.  Data indicate that consumers are much more cautious now, so perhaps they won’t be so picky about brand names and will, like their German cousins, be willing to trade down for a lower price. The Financial Times reports that Aldi sales in Great Britain are up 25 percent! Aldi plans to speed up store openings in the U.S. and to expand into New York City. New York!  If you can make it there … well, you know.

This may be Aldi’s opportunity in wine, too. Most but not all Aldi stores in the U.S. (damn U.S. liquor laws!)  sell beer and wine. Aldi’s U.S. website boasts that

ALDI believes that life’s little pleasures should be affordable for everyone. In many of the countries where ALDI calls “home,” we’re known for exceptional values in wine and beer. And now, we’re bringing that tradition to the United States.

Thanks to our global reach, we’re able to partner with winemakers and brewers around the world, to bring you exceptional beers and wines at remarkably modest prices.

Our wines come from all of the world’s best wine producing regions: Germany, France, Spain, California, Argentina, and Australia. Our beers are sourced from Holland, Germany, and Latin America. Some carry our private labels, others carry the labels they wear in their native lands—but all are exclusively ours in the U.S. So now you can raise a glass to “Incredible Value Every Day.”

The good news here is that Aldi’s U.S. push may also help drive wine deeper into the U.S. consumer mainstream.  You can say all you like about the quality of Two Buck Chuck but it sure did help expand the wine culture in the U.S. and some (but not all) my TBC-drinking friends have moved upmarket for at least some of their purchases. The wine may not be very good (a matter of taste), but its market impact has not been all bad.

Will Aldi Succeed?

Will Aldi’s drive be successful?  There is reason to think it will be. They seem committed to tailoring their hard discount operations to local market conditions, which is important because markets have terroir as much as wine.

But there is a more important reason.  Both German Aldi chains are present in the U.S. now, although you are probably not aware of them.  Aldi Süd operates on under the Aldi name, of course, with the same logo as in Germany.  The owners of Aldi Nord invested years ago in a different chain, based in California and intentionally tailored for thrifty but upwardly mobile U.S. consumers. It’s an upscale Aldi Nord and it has been very successful here.

Perhaps you’ve heard of them.  They have limited selection, smaller stores, lots of house brands, and low prices.  They even sell a lot of wine.  The name?

Oh, yes.  Trader Joe’s!

How will the Economic Crisis affect Wine?

Some people think that wine is recession proof.  They’re wrong.

Demand and Supply

The still evolving economic crisis is already having serious impacts on the wine industry.  Although some segments of the industry are gaining as a result of the collapsing credit markets and contracting real economy, there are a lot of losers, too.  Herewith a brief report compiled from a variety of published and industry-insider sources.

In the short term the problem is all about falling and shifting demand.  In the longer run, the supply effects of the financial crisis need to be considered.

The hospitality industry is a bellwether of the overall economy — restaurant meals and hotel stays are some of the first things to be sacrificed when people and businesses are uncertain about the future.  It is no surprise, therefore, that restaurant wine sales are down, apparently a reflection both of fewer customers and smaller tabs (wine tourism is falling, too, although high gas prices are part of that story).  This is already affecting both wineries who target restaurant sales and restaurants that have invested in high-margin wine programs in the last year to try to compensate for soaring food costs.  The squeeze is on, as I wrote in March, and getting worse.

The evidence I’ve seen concerning supermarket and wine store sales suggests that buyers are trading down.  The $10 and up market segment has been the fastest growing part of the Wine Wall in the last two years.  It’s still expanding, but the pace of growth has slowed considerably and there is evidence that buyers are trading down within it.  An article in today’s New York Times suggests that even very affluent buyers are being more cautious.

Low cost wines ($4 and less) are seeing a surge in sales.  This has apparently created something of a crisis in Great Britain that pits the big retailers (the supermarket chains) versus the big producers (the global wine companies like Constellation Brands) in a battle for control of the Wine Wall.  The producers see their long term future in upmarket wines and have worked hard to reposition themselves in at the top of the Wine Wall.  They are very much committed to this strategy.  The retailers, however, are focused on value wines.  They see a real short term threat in discount store competitors.  They need to stress value and lower price, on the Wine Wall and throughout their stores, they believe, to keep their customers from switching to Aldi-class hard discount outlets.

There is a lot of turbulence in the middle of the Wine Wall ($4-$10), which is the heart of the market in some respects.  Microdata harvested from grocery store loyalty card programs suggests that buyers really are trading down from $7.99 to $5.99, for example.  Since the cost of making the distributing a $5.99 wine is not $2 less than a $7.99 wine, trading down has a big effect on producer and retailer profits.  Wine may be recession proof if you look only at overall volumes, which have held up pretty well for the industry as a whole, but don’t expect revenues and profits to tell the same sanguine story.

Not everyone will lose from this trend, of course, as there are many wines that are positioned to appeal to value-conscious buyers.  But the upmarket strategy that so many winemakers have embraced, and which I still believe is wise for the long run, is taking a short term hit.  And the effects on the wine industry may be especially large because some of the key regional wine markets are also the areas that have been most affected by the mortgage crisis and will be heavily hit by credit tightening.

Credit Crisis Effects

Most industry people I’ve talked with are focused on the short run impact of the recession on wine demand, and that makes sense.  Making wine is all about long term decisions and relationships, but making a living  from wine means holding onto buyers now. But I think there will be longer term supply effects that should be considered because this economic downturn isn’t just a recession, it is also a credit crisis.

Even if the Treasury rescue plan is a success, I still believe that credit will be much tighter for the next three years (some of my colleagues think it will take even longer to work though the credit cycle).  This will have serious effects because so much of the real economy has become dependent upon ready credit to finance business operations and to fund customer purchases.  Winegrowers are obvious potential victims of this trend.  Winegrowing is a risky business with special credit needs and an overall credit freeze could have serious effects that may extend all the way from the price and availability of the grapes themselves to the value of vineyard properties. Retailers and distributors may also need to scale back their operations to match their reduced access to credit.

The big global wine companies may be affected, too.  Anyone who follows the business has noticed that the big corporations are all trying to reconfigure themselves around particular market strategies.  Constellation is moving upmarket and shedding downmarket wine units while others are refocusing on particular parts of the Wine Wall.  A credit squeeze will both change the logic of some of these investments and make funding of sales and purchases more difficult.

Finally, the credit squeeze is affecting foreign exchange rates and this means that producers around the globe, who may or may not be affected directly by the crisis, will inevitably suffer indirect effects. The dollar has appreciated rapidly against many currencies in recent weeks (the Euro’s cost has fallen from $1.44 to $1.38 is just the last few days, for example) as international investors have sought a save haven for their capital until the international effects of the crisis become clearer.  This exchange rate effect will work against those US producers who hoped to increase sales abroad and benefit European exports here.

There will be a lot of economic turbulence from shifting demand and supply before we come out of this crisis. Buckle your seat belts.  We’re in for a bumpy ride.

The End of Cheap Wine?

It is becoming increasingly clear that a golden age of sorts (for American wine drinkers) is coming to an end. Good quality wine has been amazingly affordable for the last several years and New World wine consumption has risen as a result.

This is changing (or has already changed, as Jancis Robinson writes in Saturday’s Financial Times) and a quick look at the economics of the wine market explains how and why.

The demand for wine in the United States has increased for a number of reasons. Studies that show that moderate consumption of wine (especially red wine) is healthful gave consumers license to experiment with table wines. The existence of Two Buck Chuck (the Charles Shaw wines sold at Trader Joe’s stores) and other value brands made this experimentation affordable.

The increasing emphasis on wine brands helped demand grow by making the wine purchase itself somewhat less mysterious. The wine aisle is the most complex choice space in any grocery store — there are more options at more price points than anywhere else. Brands reduce uncertainty and so encourage consumption. The enormous success of [Yellow Tail] brand wine from Australia is testament to this fact. Costco, the nation’s largest wine retailer, has used limited selection and its Kirkland Signature own-brand wine to achieve spectacular results.

The demand for wine has not just increased it has also evolved as many consumers have moved to higher quality (or higher price,anyway) and developed specialized wine expertise. Wine is more than a beverage, it is a lifestyle for many people who collect wines, take wine tourist vacations and subscribe to wine publications such as Wine Spectator or The Wine Advocate and read the wine columns now found in many newspapers. There is a pretty steep learning curve when it comes to wine. Knowing more about wine and having more experience with it increases the pleasure that wine provides and makes further learning more efficient. In economic terms, the specific investment in wine knowledge makes the demand for wine more inelastic — less sensitive to changes in price since buyers are less likely to switch from wine to other products or beverages where they have less expertise.

The supply of wine has also changed to create higher prices. The falling U.S. dollar has increased the cost of imported wine, which contributes to rising domestic prices both directly, as those costs are passed along to consumers, and indirectly, as higher import prices allow domestic producers to raise price, too. I don’t think that we have seen the full pass-through effect of the exchange rate changes yet, so expect dollar-driven price increases to continue.

But domestic prices would have increased even without the dollar’s decline. Wine buyers in recent years benefited from a global surplus of wine grapes that drove down price and pushed up quality. Faced with accumulated surpluses that sometimes amounted to a year or more of sales, winegrowers held back on expansion plans (except for hot varietals like Pinot Noir). Demand has slowly grown into the existing supply and may soon exceed it for some wine types. Falling prices due to surpluses are coming to an end and rising prices seem likely, even in Australia where drought and disease have further reduced production. The new EU wine regime, if it is effective, should further reduce wine surpluses and tighten supply.

When you combine these factors along with a few others, such as growing interest in wine in Asia, the result is a new market environment and it will be interesting to see what happens next. The latest round of wine magazines seem to take higher prices in stride. The Wine Advocate reports that the cellar door price of California cult wine Screaming Eagle is now $500 per bottle — if you can get some — and a long list of wines are listed with prices above $100 or $200. Wine Spectator and the wine columnists in the Wall Street Journal and the New York Times all seem to be struggling to keep a lid on their definition of an inexpensive or good value wine — a $12 or $15 or even $20 ceiling no longer provides much choice! You can still buy cheap wine, but the good value bargains are disappearing.

It will be interesting to see how the American wine culture, which has been built in part on good quality at low prices, copes with this new world of wine. In the meantime, enjoy those bargains and good values when you find them, but don’t count on your good fortune lasting forever.