I think I’ve seen the future of  American wine — or at least one aspect of the future, since nothing in wine is simple — and I didn’t need a Time Machine, Crystal Ball or souped-up DeLorean to do it. All I had to do was walk into my neighborhood Safeway store and take a look around.

[This is the final post in a series about what I think I learned at this year’s Unified Symposium regarding the future of the American wine market. Scroll down to the earlier posts if you haven’t already read them.]

The buzz at the Unified Symposium this year was about America’s growing wine market and the bodacious 2012 U.S. grape harvest. Higher demand, abundant supply — happy news.  But, as I have argued over the past few weeks, the future is more complicated, full of both opportunities and challenges.

The U.S. is unlikely to be able to meet all of the rising demand profitably in the long run if current trends continue, so imports will likely fill the gap. U.S. producers should adopt a “Machiavellian” strategy to seize control of import flows, especially important at the low-price end of the spectrum, and systematically shift U.S. products into up-market categories. The changes are coming, I’ve written, so the best bet is to think ahead and be well-positioned when the future finally comes around.

Bota Box Globalization

Not everyone agrees with this vision of the future and I’ll talk about alternative views in a moment. But first I want to show you  where things seem to be headed. Here for your consideration is a version of globalization that I think points the way.  I call it Bota Box Globalization.

Bota Box is a line of  3-liter bag-in-box and 500 ml  tetrapak wines from DFV. Jon Fredrikson named DFV winery of the year for 2011 at last year’s Unified and the company has been growing by leaps and bounds — it’s easy to see why.

When I’ve thought about Bota Box in the past, I’ve associated it with good value, alternative packaging and put it squarely in the “California wine” category. Why California wine? Well, because that’s the appellation I remember seeing on the boxes and also because DFV is a major California producer, making about 6 million cases of their own wine brands last year and about another 6 million cases for other firms.

(Data from the 2013 Wine Business Monthly top 30 U.S. producer report — DFV is #8 out of 30 if we take only their own brands into account, wedged between #7 Ste Michelle Wine Estates and #9 Jackson Family Wines.)

Sell Local, Source Global

I guess Bota Box is still a “California brand” and of course an American brand, but DFV is already doing with it what I think many large volume (and some smaller ) producers will do — sell the brand locally but source the wines globally.

The wines were attractively displayed at the Safeway on Proctor Street when I visited on Saturday — appealing enough that the 3-liter Cab boxes were sold out. The wines were priced at $24.99 for the box, which is equivalent to $6.25  per 750 ml bottle, but you could bring the cost down to $19.99 by flashing your Safeway Club Card and cut another $2 off if you purchase in quantity, as you might for a party.

This is good value, but not bottom-shelf cheap. Bota Box is a leader in the “premium box wine” category that represents a big step up from brands like Franzia.

The packaging, the brand and the grape variety are the main things you notice when you survey the color-coded Bota Box shelf, but a little investigation brings the global factor into focus. The Merlot, Riesling, Shiraz were all California wines at my store, but the rest were imports from Chile (Cabernet Sauvignon), France (the RedVolution red blend), Italy (Zinfandel!), Argentina (both  Malbec and Moscato) and South Africa (Chardonnay).

South African Chardonnay in a Bota Box? Wow! I didn’t see that coming.

Poking around the web, looking at Bota Box images, it is pretty clear that the sourcing is both flexible and global. Looks like the Malbec has come from exotic Lodi, for example, and that the Shiraz, Cab and Chard were once sourced from Australia, probably back before the Aussie dollar became so ridiculously over-valued.

And the Zinfandel once came from California instead of Puglia and probably still does in some of the containers — you sometimes find the same varieties from different countries on adjacent Bota Box shelves. The 3-liter RedVolution was from France and the big box Cab from Chile at my neighborhood Safeway, for example, but the 500 ml tetrapaks of the same wines wore a California designation.

Bota Bottom Line?

Brand, package and variety are the key factors in this business model  — the particular source of the wine is a secondary characteristic for Bota Box, so long the as quality is consistent, as I assume it is.

The bottom line of my series of posts is that I see the U.S. wine market continuing to grow and imports making up a larger and larger part of it as domestic supply constraints kick in, competition increases at the lower price levels and wine export momentum is sustained. Bota Box globalization illustrates one way that smart producers will position themselves to compete in this evolving market while controlling their own destiny.

Going back to an earlier post in this series where I compared the wine market to the apple market, I think we’ll see Juice Box Globalization at the bottom shelf of the wine wall, where pressure for global integration will be very strong indeed, Granny Smith (and Bota Box) Globalization in the middle and the highly differentiated products that represent Honey Crisp Globalization at the top. It’s already happening. Are you ready? It looks like DFV is!

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What’s wrong with my analysis? Well, prediction is difficult — especially about the future — and so there is a lot of room for error. One criticism is that my analysis is fairly simplified and a much more nuanced approach is needed. Fair enough. Fortunately Jim Lapsley has already provided that in an enlightening analysis he prepared in 2010.  Click here to download the pdf — it is well worth reading if you are interested in this issue.  Jim concludes that

The U.S. wine market will look different in 2030. On the demand side, per capita consumption will increase as acculturated Hispanics adopt wine and as wine becomes a more integral part of the American culture. Increased per capita consumption combined with population growth could quite possibly increase total table wine sales to 3.60 billion liters.

California will remain the dominant producer within the United States, but it is likely to lose market to inexpensive bulk-wine imports. These wines are likely to be marketed as global brands, with the location of grape supply of little importance to consumers. This article has also discussed the supply and demand picture for higher priced wine for which location of production is a dominant marketing attribute. These wines, which are largely produced from coastal grapes, face quite different economic drivers on both the supply and demand sides of the market

Jim’s analysis is more sophisticated than what I have posted on The Wine Economist, but we see many of the same factors at work.  I see the global integration as being a more powerful factor, but maybe that’s because I’m a globalization expert and pre-disposed to see globalization wherever I look.

Another set of reader comments essentially argues that I am too influenced by recent events and conditions — the relatively weak dollar, for example, the recent surge in bulk wine trade and current supply-demand balance trends and conditions. All these factors could and probably will change. Will they change enough to alter my conclusions?

Good point. They might! But I’m not convinced they will. I guess we will have to wait and see, but in the meantime I don’t think if would be a mistake to get ready for the increasingly global future of U.S. wine if  and when it comes around.

What’s the best strategy for the U.S. wine industry as it enters the increasingly global market environment that I’ve described in my two recent posts on Juice Box globalization and the prospect of a coming 50-50 import-domestic split?

I’ll use this post to make a few observations inspired by the buzz at this year’s Unified Symposium and then return to the topic again next week to synthesize the emails and comments I’ve received on this topic.

Whenever I think about strategy I always ask myself “What would Machiavelli say?” because the famous Florentine’s advice has held up pretty well over the years.  Since, as the sage Jon Fredrikson likes to say, “there are no one-liners in wine,” here are three elements of a Machiavelli-inspired battle plan.

“Wisdom consists of knowing how to distinguish the nature of trouble and in choosing the lesser evil.”

Machiavelli seems pre-occupied with trouble, which is both good and bad when we try to apply his insights to the changing global wine scene. The wise part of this saying is that the nature of trouble may not always be obvious and you’ve got to be careful not to jump to conclusions.

The continued growth of the imported wine category in the U.S., for example, isn’t simply a matter of lost market share, as I suggested in my last post.  The whole business of wine is changing and rising imports are only  part of an emerging syndrome that  presents both challenges (trouble for the Tuscan strategist) and also opportunities for the thoughtful entrepreneur.

“It is better to do willingly what you will otherwise be compelled to do.”

The idea of course is that if resistance really is futile, then you may be able to get better terms through cooperation. I think this rule might apply to the basic wine category in the United States, which faces double jeopardy from competition at home and abroad. Although wine imports are likely to increase in all market segments, the biggest impact may be for inexpensive “bottom shelf” wines, where the combination of bulk shipping economies and “drawback” credits are most significant.

Basic wines will also face competition on the input side. Nut crops promise higher profits than wine grapes for some farmers, especially at the low price part of the grape market. Many wine growers will need to move up-market if they want to stay in the wine grape business and this has implications for bargain basement wines. If you want to know why Two Buck Chuck has raised its price to $2.49 in its California home market, this is part of the answer.

Where will these trends lead us? Well, if I wanted to shock you I’d say that California will be forced to retreat and to concede the bottom shelf of the wine wall to imports.  Basic wines won’t come mainly from California as they have for decades, but will adopt a modified version of the “juice box globalization” mode, where branded products are sourced from all around the world as needed to minimize cost for standard quality.

This is vision of the future is actually current practice in the “premium box wine” segment, but I think it will appear in even sharper focus among in the basic wine segment.

If “retreat” is inevitable, Machiavelli suggests that U.S. producers embrace rather than resist the trend — and I think this is already under way now, too. Some wine companies are seizing the initiative to make sure that the brands that the imported wine goes into are theirs and not those owned by foreign producers and of course a retreat in the basic category is not a defeat if it can be leveraged into an advance in higher margin categories.

The transition will be difficult, but less so if U.S. producers plan for it rather than just watching it happen to them. I’m reminded of what happened in Washington State when the California Wine Bill was passed in 1969. Cheaper California wine flooded into the state, crowding out the cheapest Washington products and forcing Washington to become much more tightly focused on premium products. A tough transition in the short run, but it’s been great for Washington wine in the long run.

“It is better to be feared that to be loved.”

It’s not about love or hate, it’s about control. It is better to be feared than loved, Machiavelli said, because you can control if you are feared far better than you can control if others love you and controlling your own destiny is the key.

Hence the sentiment I heard on several occasions in Sacramento that U.S. producers need to take command of the import levers so that the bulk wine imports go into their brands rather than foreign brands. The goal is to defend hard-won territory on wine walls and distributors’ lists. Although many of the people who talked to me would rather have American wine sold in American brands, they could live with imported wine in American brands if that’s what is necessary.

Perhaps Machiavelli is a control freak and exaggerates its importance, but I think the control issue is worth considering. Certainly there is some concern among New World wine exporters about lost control of quality and reputation when wines are shipped in bulk versus packaged goods. Shipping wine in bulk to yourself in foreign markets and bottling there (to gain economies but preserve control) is a rising trend.

If you wants to see where the control trend might lead, read this article about China’s Great Wall brand wine’s global strategy in on TheDrinksBusiness.com.  Great Wall seems to be going beyond purchasing foreign wine to fill their domestic brand bottles — they are actually buying the foreign vineyards themselves and securing the production facilities!

“We will announce that Great Wall is not only China, and we will make a French Great Wall, a Chilean Great Wall and an Australian Great Wall,” he said.  …  “You will probably find these wines in the market next year… Great Wall will use global sourcing for the Chinese domestic market.”

Now that’s control! Machiavelli would be pleased!

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I’ll consider alternative viewpoints and try to sum up next time.

Will half the wine sold in the United States in 2025 be imported? No — that’s crazy talk. But 40 percent seems very likely and 45 percent isn’t out of the question. The trend towards half imports is fairly strong even if the day we hit the 50-50 import – domestic milestone is likely to be a bit further down the road.

Not a River in Egypt

I want to talk about the forces that are driving the 50-50 trend in this post and then focus on changing U.S. strategy next week.

Imports accounted for about 35 percent of U.S. wine sales in 2012 — enough of a jump from previous years to get everyone’s attention. And even though it is easy to say that this is just a short term blip that will disappear now that 2012’s big vintage is in the tank, I think that we need to take the trend seriously

As I tell my students, Denial isn’t just a river is Egypt. It’s a good idea to face the facts. Here are five reasons for the rising import trend.

Five Steps Toward 50-50

1. The U.S. is now the world’s largest single wine market and continued growth is likely, but not guaranteed. Macroeconomic uncertainty is still high and competition from ciders and craft beers could certainly eat into wine’s expanding market. The trend is up, but lots could still go wrong.

2. Because the U.S. market is growing (and Europe continues to stagnate), we are clearly in the cross-hairs of every wine producing region on earth. Everyone wants to get into our restaurants and onto store shelves and many will succeed, which is where the 50-50 trend begins.

The Almond Alternative

3. U.S. wine producers will find it difficult to meet all of the rising domestic demand, which will create an opening for imports. Yes, great efforts are being made to expand vineyard capacity to make up for the many years when such investments were uneconomic. But it might not be enough. Water availability and cost will limit expansion at some point, for example.

What economists call “opportunity cost” is a more immediate factor in some parts of California — vineyard land in some areas could be more profitably used to produce almonds and pistachios and that’s what will happen if current trends continue. The competition isn’t domestic wine versus imported wine, as you might expect, it is profits from wine grapes versus alternative crops. And wine grapes no longer have the upper hand in many cases.

4. So domestic wine demand may grow faster than domestic wine supply. Can imports fill the gap? Yes, now more than ever. The surge in global bulk wine trade over the last five years — bulk wine shipments now account for 45 percent of all New World wine trade — convincingly demonstrates that global wine production has become a tightly integrated industry. As one wine executive told me a few years ago, it’s a small world after all. Very small. And it’s smaller still today.

Pull Ahead then Draw Back

5. U.S. wine exports are likely to add to the trend, but not necessarily in the way you might suspect.

U.S. exports have risen and although  this is a difficult sector to forecast because so many factors (such as exchange rates, foreign economic trends, etc.) are involved, I think growth will continue. Higher exports increase the import ratio both directly (selling the wine at home would crowd out foreign sales) and indirectly through import duty and excise tax drawbacks. (Click here to read a 2012 UC/Davis report on the drawback program.)

The wine drawback program allows a refund of 99% of import duties and excise taxes on wine for which the importer has matching exports of commercially “interchangeable” wine. Because per-unit import duty and excise tax rates are substantial compared to the price of bulk wine, use of the program is high for bulk wine imports, which compete with wine from low-price Central Valley grapes. Bulk wine exports dominated imports until 2009 and the program stimulated import growth. Now, with imports and exports roughly in balance, the program stimulates both exports and imports—leaving net trade in bulk wine roughly in balance.

— Summary of the U.C. Davis Report

Now I know what you’re thinking: who’s going to import wine and then export it — that’s nuts. Ah, but it doesn’t have to be the very same wine — you can import Moscato from Argentina, for example, and export a different variety to Britain or somewhere else and so long as certain rules are respected, the drawback will kick in. The focus is on inexpensive bulk wines, as the report suggests, because that’s where the relative impact of both duties and drawbacks is greatest.

Unexpected Consequences

Getting the full advantage of drawbacks requires a careful balancing of imports and exports by individual firms. If you import a lot, then you have a strong incentive to export to get the tax paybacks. And if you increase exports as I think U.S. wine producers will, you have a strong incentive to import more, too. If both imports and exports increase, as the UC/Davis report cited above suggests, then import market share rises.

How strong is the import incentive? Well, it depends on the particular case of course, but one of the speakers at the Unified cited a case where the drawback payment was almost equal to the price of the wine being imported. For a firm that was already exporting, the imported wine was nearly free. (I don’t have details of this transaction, but the source of the story is completely reliable; I wish I had been there when the deal went down!)

Bottom line. More and more of the wines on store shelves will be imports as the U.S. wine market continues to expand and evolve. What will this mean for domestic producer strategies? Come back next week to find out.

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Note: this is the second of three posts where I try to make sense of what I learned at this year’s Unified Wine & Grape Symposium. Thanks to everyone I met at the Unified for giving me their views about current wine trends and future prospects.