California’s wine industry will continue to split most of its sales above and below the $10-per-bottle mark, enjoying a rise in overall consumption and a growing emphasis on premium wines, according to wine industry leaders who participated in a 2015 survey of CEOs conducted by the University of California, Davis.

 

Results from the survey of wine executives were presented Sept. 22, during the Wine Industry Financial Symposium at the Napa Valley Marriot in Napa, Calif.

Challenges remain in the form of consolidation in the distribution and retail arms of the industry as well as in water and other environmental issues, the survey respondents noted.

“The good news is that as consumers ?become more knowledgeable about wine, they are trading up for premium wines and pulling the entire wine market up with them,” said Robert Smiley, professor and dean emeritus of the UC Davis Graduate School of Management.

“This means that, more than ever, competing wineries need to be investing in their quality lines and in branding,” Smiley added. “This could be challenging for some companies because the cost of land and grapes is now higher than ever, partly due to a recent wave of outside investors who have set their eyes on the wine industry.”

Survey of wine executives
The 13th annual survey of wine executives reflects the opinions and projections of the heads of 24 wine companies. Those firms include 15 California wine producers, two global wine companies and one Washington state producer. Four distributor/wholesalers, one wine broker and one vineyard-investment firm also participated.

Most of the executives surveyed noted a definite “premiumization” trend among wine consumers, who are buying more of their wines above the $10-per-bottle price point. “The market is moving upward; it is enormous,” said one respondent. “It is growing very fast.”

Consolidation among distributors and retailers
The wine executives expressed concern about the effects of continued consolidation among wine distributors and retailers.

Since the federal repeal of Prohibition in 1933, state-by-state regulations have generally required that wine move through three tiers on its way from the cellar to the consumer. Wineries make up the first tier, wholesale importers and distributors the second, and restaurants and retail stores are the third tier. Direct-to-consumer (DtC) wine shipments have presented an alternative, although relatively minor, way for producers and consumers to connect.

In recent years, there has been an increasing consolidation in the second and third tiers, creating greater competition among wine producers as they jockey for shelf space in retail outlets. With continued consolidation into fewer retail chains, some wine executives reported that it was becoming more difficult to place all of their brands in stores, especially for small producers.

“We grew up in an age where we worried that the manufacturers had monopoly power,” said one respondent. “Today, monopoly power is at the retailer. Now they are doing private labels that are disenfranchising our national brands.”

Environmental challenges
The wine industry will face continued challenges related to environmental issues, the executives predicted. As winery footprints expand and intensify, the impacts on water resources, air quality, traffic and the surrounding communities, it will likely be more difficult to produce grapes and wine, many added.

“We are going to be scrambling for water and grape supply,” said one executive, predicting that many Central Valley growers would switch to other crops, further limiting the supply of wine grapes.

The five questions submitted to survey participants and their responses follow.

Q. Are you concerned about the continued consolidation at the distributor and retailer level and the impact it will have on your ability to get your products to the end customer? Is direct-to-consumer selling (DtC) a viable alternative?

“Twenty years ago we had Albertson’s, Lucky’s, Alpha Beta, Safeway and Von’s. They were all separate entities. If you missed an advertisement in Albertson’s, you could make it up in an Alpha Beta or a Lucky’s. If you miss an ad today with Safeway or Albertson’s you can’t make it up with any other business. The answer is yes, we are concerned.”

“It is less to me about the consolidation as it is the attitude and business approaches that will come with whomever survives the consolidation. It is about their approach to the business.
We have approached the business for a long time—we being the collective industry—as kind of a brand equity investment to build brands and relationships with consumers. There are a couple of reasonably strong players in the consolidation world that really treat the wine category like much more of a commodity than a branded business.”

“Often in a positive way. If we have a wine with one (distributor/retailer), then we tend to be in all locations. The retail consolidation can be very positive, because many of them are very professional in how they operate their organizations and how they train their people.
At the distributor level, we partner intentionally with the same distributor in every state. For us, if they continue to consolidate and bring on more markets, that is a good thing, since we are intentionally and strategically aligned with them.”

“Even for companies that do our volume, we are being forced by distributors to pick our priorities. You just can’t have multiple brands anymore. On the retail side you are seeing stores consolidating, but the chain calls are decentralizing. The decentralization of chain-buying as an experiment is over for most people, now replaced by regional buying.”

“We are affected by it. I have some concern—not so much about consolidation at the distributor level, but about consolidation at the retail level. I am concerned about the disappearance of the independent retailer.
The chains are a more difficult place to build a luxury wine brand. We do not sell much in chains, and with the independent retailers going away, what do they leave? That is my concern. Is my only point of distribution going to be DtC? Or will I have to do some limited distribution to chains? Which ones? How do I judiciously select the chains that can help me build a luxury brand?”

“Gallo and Constellation are not only the most important supplier to the wholesaler, but they have become very important category captains. Their power just makes it difficult for anybody smaller than that without 60 salespeople in the field to penetrate.”

“It is a very strange thing. You would almost question whether (retailers handing over category control to the big wineries) is legal, because you are not supposed to give anything to a retailer. Yet, you go to Kroger or Wal-Mart, the big suppliers probably have 10 to 20 people helping set. It is a way for a retailer to enhance margins by having someone else do all the work, but it has been out of control. At some point, somebody—and a smart group of wineries—are going to get together and ask, ‘Wait a minute, is this really fair?’”

“It has not affected us negatively. In some ways there are some benefits to it when you are a large producer who has some leverage. Most distributors look at the priority brands that pay the rent. That is not necessarily a challenge for us. But when you look at most distributors, the number of brands they have continues to increase, and the number of suppliers continues to increase.”

“There is development of a new tier of distributors: the small/mid-tier distributors who will merge over time. I do see a continued consolidation at the top, but I also see a very grassroots, small, micro-retail wholesaling specialty distribution/retail sector opening up at the same time.
This generation is willing to pay a premium for food and spirits. At these price points, you do not have to do a lot of volume to be sustainable. The same thing with these mid-retailers. They work on sometimes 50% margins and do not need the volume. I see consolidation continuing to get bigger, but I do see this niche thing growing.”

“There will continue to be some consolidation at the distributor level. It is providing an opportunity for new distributors to open up and acquire the brands that the big distributors are putting less emphasis on. It is a major change we are going through, but it is a new opportunity for wonderful, small state distributorships.”

“I do see that getting product to my end customers is going to be increasingly more the responsibility of the producers. I do not believe distributors or retailers will build brands like they did years ago. Now they play a role, but the market is changing their responsibilities.”

“I do not see DtC as a viable option for companies that are anything above 100,000 cases. That is not significant enough business to offset the U.S. trade business. It is all part of a general bifurcation that is occurring in the industry, in that a bulk of the industry will settle into large players. Then you will have those traditional, high-end, small producers of 1,800 cases to 15,000 cases, possibly which can survive on DtC either through brand prestige or location.”

“DtC is not a viable alternative for $10 to $12 and under. For the producers with over $20 (per bottle) retail wine, everyone is doing that. Most people are shooting for 40% to 50% DtC, and (they) are having a hard time getting distributors to work on the $40 to $50 Cabernet that sits on the top shelf of a grocery store.”

“Some of these consolidated retailers are more interested in promoting private-label brands. The other part of that question as relating to DtC—we are going to see a brand-by-brand migration.
There is going to be a division of brands into DtC-type brands that will be more retail-friendly. We see many more consumers becoming comfortable purchasing wine on the Internet, but we are fortunate to be in a position where our distributors have put our wines on sale day to day. We see an ever-increasing piece of the business moving to DtC, however.”

“At some point, if you want to grow to something more than a 4,000- or 5,000-case winery, you are going to need the traditional three-tier markets to help grow your brands.”

“DtC is a viable alternative, especially for new wineries starting up and building their networks. We also focus on DtC at the winery level—especially for our more luxury and limited wines.”

“It is a good thing. For example, with distributors that are multi-market, a supplier can obtain greater attention because the distributors have a larger footprint and can take care of them. The larger the chain is, it ends up helping with total distribution. Meanwhile, great independents are necessary to nurture brands, and they are stronger than before because they are trying to do the very best on a personal basis for their customers.”

Q. What is the impact of the arrival of large, acquisition-minded institutions (pension funds, university endowments, family wealth groups) on the wine business?

“I see the effects, especially on the Central Coast between some of those big guys buying things. We have actually done deals in the past with some big institutional investors like that, or they can buy a vineyard and you can lease it back.”

“My biggest concern is sustainability: ?How long do they plan to stay in the business? Obviously the terms in buying vineyards in particular, prices are up particularly in Napa. Is that sustainable? How long will they stay in based on returns?
This kind of money comes in about every 10 years. Then they find this is a lot more difficult than it was on paper. It is a classic cycle. Anytime the industry has outside investment it is a good thing, but I really question whether they will stick to it or not.”

“If you go to the American farmer, what is the average age? Sixty at least. What is going to happen to all that farmland? Consolidation is occurring in agriculture across the U.S.; the vineyard business is no different. ?A lot of that has to do with the intergenerational change that is occurring. Not everyone wants to take over the family farm from dad and run it the same way.
We are talking about very big capital dollars these days. Investors play a role in providing some liquidity. Most of them hire professional management; many of them are family farmers who have expanded their operations to include management so they can spread their cost among a greater number of acres. It is happening in the almond and nut business. It is happening to the vineyard as well.”

“It is better than someone buying it as a hobby. They are buying it like they buy a bond. They are buying it for the long-term land investment and the ultimate payoff and some return in between. We have seen that for 20 years. David Freed was one of the first people who started doing that. It is a good thing since there are people who are investing for the long-term who have an understanding of the value of land and the wine business is very asset heavy.”

“In the state of Washington we are seeing tremendous investment really for the first time. We are seeing big tracts of land being sold to plant vineyards. Frankly we are happy. In California there has not been ?a rush to plant vineyards recently as ?much as in the past. There is definitely no shortage of business in the North Coast.”

“None really, but we have seen a lot of Asian investors come in to buy winery properties. But it does not really affect me for what we are and what we are doing. It is more of an opportunity for those first-gen, second-gen investors that are only going to be in it for four or five generations. It gives them a way to get out in time.”

“It just simply creates a bubble and makes assets impossible to purchase. There is a real bubble out there on vineyard pricing. ?I do not see the prices coming down.”

“More are coming. The industry and the communities need to understand it and need to work with them. A good outside investor will reinvest with the community if they are smart. It shows the health of the overall industry.”

Q. Has the strength of the U.S. dollar affected your wine sales, either import competition or exports?

“Yes, we saw that first in Western Europe, where we distribute our wines very strongly. There was a little pushback on the value of California wine there. Of course, the first guys to get pinched were the agents and the distributors there. It was difficult for us to maintain pricing in that area. We were forced to take prices up a little bit in the local currency.
The other thing of course, as you start to talk about dollars, is the port strike that hurt us in 2014. If you look at the dollar, we have not seen an increase in the amount of imported wine here in categories that were already hot.”

“The port strike hurt us as both exporters and importers. We could not export wine for our customers and had a problem getting dry goods in. We had problems importing some of our wines that were bottled offshore.”

“It has a huge impact on our cost of goods with barrels alone. If we figure to save 20% on the barrel purchase, that is achieving almost $1 million in savings. From that standpoint it has been really helpful. It is early to tell what is going to happen to us on the international market. So far our markets have held pretty well, but international sales are not nearly as important to us as our cost of goods. If I had to take one or the other, I would take cost of goods.”

“The area where we saw it more pronounced was in Canada, where we sold quite a lot. It is already difficult to obtain the right prices in Canada. To put it another way, you generally have to accept their margins in building business in Canada. That coupled with a strong dollar made the last year quite difficult.”

"It definitely has affected us in our imports. We import quite a bit of wine and it has helped us, but it is a major factor. A net positive, since we import more than we export.”

“When the exchange rate goes from 1.3 to 1.05 for the euro, yes that is a big deal. We have actually had to discount to maintain our momentum in a lot of countries. We do not import enough to offset that. I am concerned about too many imports. In America we are a very heavily regulated business—higher costs and taxes. Imported brands, if anything, have government subsidies, and we let them into America almost for free.
I am in the American wine business in the big picture, and we are a California grapegrower. That would concern anybody out there. However, in short years we offset the supply by bringing in imports. Not at the high end, only at the low end. I am concerned about too many imports getting too strong in America.”

“Looking at imports in the bulk world, if we had not had three huge crops in a row we would probably see more bulk imports than we have. Cased goods being brought into the U.S. are going to continue to grow, and the strength of the dollar is one of the major factors.
But you are also going to see a fair amount of European wines that come in and go to market that are above the $10-tier segment. You will see some guys start to bring in more French, Italian and Spanish reds to hit the price points that will be above that value.”

“We see an impact that is just beginning. If you look at Italian imports, which we are quite close to, you really see a decline in the value even though the volume is growing. It appears that we are seeing discounting by Italian producers and that they are taking the exchange rate savings and plowing them back into lower prices. I do not know why they would do it, but they are taking advantage of the strength of the dollar and then discounting their product.”

“On the export side it has been affected quite a bit. We do a fair amount of bulk wine exports, and the competitive nature of that has gotten tough with other currencies being so weak and ours being very strong. That has had an impact. It has forced us to really push on quality and to kind of dig our heels in and say, ‘Look, while it is a commodity, we are not going to be a cheap commodity.’
On the import side, it has affected us a lot less because it has made it really hard for folks to come here and compete too.”

“About 30% of our total volume is export. We have seen a little of that impact in the past couple years. In Canada, even though we have had double-digit growth, the Canadian dollar versus the USD has hurt our margins a bit. But the port closing was the big problem on the export side, just getting wine shipped out of there.”

“It is hurting exports pretty substantially. The currency is brutal. Volumes are still decent, but the currency exchange is brutal. I do not see anybody lowering prices at all.”

“It has had virtually no impact on our business. We thought on the import side that imports would be a better value. We have not really seen that yet. On the export side, we as a company took the position that those clients are really terrible. A) They are fickle. B) They pay slowly.
We have a strong domestic market. We really shifted our gears where we are about 95% domestic because this is the best market in the world to sell wine. As long as we have domestic margins that outperform imports, it is just a question of allocating resources.”

Q. There seems to be an increasing bifurcation of the wine market for brands above and below $10. Will this trend continue? How have you responded?

“Absolutely. The market is moving upwards, it is enormous. Growing very fast. We predict the same thing of, say, $12, $15 and $20 wines in the next five years. There will be enormous growth. Below that there is not going to be any growth.”

“We have a very strong foothold in the under-$10 economy section, especially at the lower end. But the future is definitely above that. We are trying to get more balance into our portfolio: diversifying that whole portfolio and realizing that while we are strong under $5, the $5-$10 is not that strong. I am not too anxious to invest because I do not see it as very strong. We will try to really diversify and balance our portfolio by looking at the $10-plus category.”

“It is not just in the wine business, but also in the spirits business. People are trading up for more premiums and people want better, whatever that means. They continue to explore merchandise that may be more expensive because they are more knowledgeable.”

“In 2007 we looked at the landscape, and Gallo, Constellation and The Wine Group owned that space. There is nobody that can come into that market and take those guys’ volume. We could not be in that space anyway. We built our entire infrastructure around the $10-$15 range. Fortunately the bites we are taking are relatively small, but they are significant for us. The margins are much more enhanced above $10 than they are below $10.”

“All of the action has been above $12, and some of the fastest growing categories are up around $20. We see the consumer shifting in some direction there. A lot of it relates to baby boomers and who is consuming wine. It really is on us to try to diversify the portfolio to make sure we offer what consumers want.”

“I see the trend continuing, and we feel it very strongly. We have been trying to raise prices and to push into the $15 and $30 price segments, and we play it fairly strong there.
We are trying to get out of any $10 and under branding for wine labels. For us, given where our grapes are grown, we just cannot compete down there at the margins that we like to enjoy. It caused us to really evaluate our portfolio and where the opportunities are at $15 and above.”

“It will continue to impact the wines below $10 because a lot of that market is dying out. Most people are focusing on the $15 price point, which seems to be the new version of the $12 point. The issue there is that the cost of goods is very high for wines over $15. That it is going to be difficult for people to scale a brand of that size and buy the grapes. You really have to own the vineyards in order to scale a brand in that range.”

“The fact that other guys want to go into our business, it just shows you that the American consumer is willing to trade up. It shows they are an aspirational consumer. Yes, it concerns me a little bit when Gallo is now in my back yard.”

“Many people are talking about premiumization in this industry. This is still not played out properly, because all that is occurring now is people trying to shift the same product up the ladder. The consumer is not going to be fooled by that, and ultimately you have to premiumize through pure investment.”

“I firmly believe that the wine industry is as well-posed as any in the world to play the trade-up game. Most happy consumers love to try the next best thing. It is just human nature. If they try a $5 wine, they just want to know what a $10 wine tastes like, and then a $15 bottle. Nobody trades down unless they have to.”

“We have talked about this over many years, and there is no question that we see growth in the high end. Growth mainly coming in wines in the $11-$20 retail price segment. We are experiencing double-digit growth there. We are pretty happy with the premiumization category.”

“A little, but it has had no effect. Every time the big competitor tries to jump into my category or buy someone within my category, they destroy the brand they bought. Those brands are no longer my competitors. When corporations come in and buy upscale brands, they tend to devalue them.”

Q. What will be the hottest issues ?during the next five to 10 years?

“The big issue is going to be, in my opinion, the grape wars south of Modesto, south of Lodi, that are going to have alternative crops that they want more than growing grapes. You are going to see a gradual, fairly rapid to medium transformation from grapes to other crops, big crops. That is going to mean, to obtain the quality wine that you need at that price point, they will have to go to South America to import it.”

“In North America today, there are more imported products authorized in America than there are American products. The avalanche of new products and imported products continue to dilute this marketplace. Maintaining brand equity and brand strength is a concern with so many new products in the marketplace.”

“In the North Coast you will continue to see anti-development, a difficult environment to do business. We are by no means certain that our water woes are going to go away, but we may have El Niño this year. The whole western United States is struggling with water—and just struggling with the general political environment that climate centers on—is going to be huge.”

“Winery footprints: the impacts on water, traffic and the overall community. As people try to get bigger or try to add, there is going to be more pushback just to try and determine the impacts of water, traffic and your neighbors.
Then the evolution of DtC—I do not know what it is going to be—is going to evolve from where it is today. It is the small guys relying on the system even more because they will not have another option as an outlet for their wines. As the customer evolves, they will get used to that as well. It will just be another way to buy wine. For anyone making 5,000 cases or less, it is difficult.”

“We are going to be scrambling for water and grape supply. The cost of growing grapes in California—and the competitive crops such as almonds—are going to make fruit really tight in (California’s) Central Valley. Most of that is going to be imported. Regulation is also approaching out of control. You have air credits now, and they do not even want to honor the air credits from when you settled in the last time.”

“Private label is probably one of the hottest, most daunting challenges in the wine business. We grew up in an age where we worried that the manufacturers had monopoly power. Today, monopoly power is at the retailer. Now they are doing private labels that are disenfranchising our national brands. That, to me, is one of the greatest challenges.”

“I see continued trending toward private label, but also there is going to be the need for authenticity and transparency. When you look at the use of social media to find out about wines and their authenticity, that is going to increase. Therefore, private labels will have a harder time.
When someone walks into a big store where all the staff is incentivized to move to the store brand, someone will look at their smartphone and say, “What is this brand?” and find out the producer and if it is an imposter. While retailers are going to make more store brands, there is going to be a counter impact through social media, which will slow the growth.”

“There is a consolidation of retailers and category managers by some of the larger suppliers that will reduce our opportunity to get wine on the shelf. They completely control the shelves. It seems that the TTB or somebody has to step in and say there is a restriction of trade occurring. That is the hottest issue for me: the ability to get on the shelf because of control by the major companies.”

“One thing that keeps me up at night is the private-label business. Total Wine’s influence on the industry is all about control and about selling people into their store on name brands, but trying to direct them to private labels once they are in the store.”

“I see a lot of loyal clientele developing. There is no indication that the millennials are going to be as brand-loyal as baby boomers and to a lesser extent gen-Xers were. There will be a quickening of trends, and brands can be hurt by trends going in different directions. That is going to keep speeding up, and you’d better be willing to move as fast as other parties. That is going to be a challenge for wine. There is going to be that focus on how do we tell our story as the ultimate craft product?”

“As the population gets older, we will see continued growth in wine consumption. It is interesting, too, since everyone has done a lot of study on millennials. First off, we see pretty clearly that they are somewhat fickle consumers, jumping from one thing to another. But that is good, because baby boomers 25 years ago were not drinking wine. Now, based on a certain occasion, we are seeing good wine consumption—even at higher prices. This is positive, and then as they mature they will select wine more frequently. I believe they are comfortable with it, for one thing.
Remember 30 years ago, the biggest topic was how to mainstream wine when it is seen as an elitist beverage only for wine snobs. There was one winery that was running a lot of advertising that wine is not for wine snobs, which actually becomes a reverse problem. Today—and to some extent thanks to Starbucks, where people order complicated drinks—simply asking for a glass of Chardonnay or Pinot Grigio is a common task where it was not 30 years ago.”

“Declining consumption. All of these models on increasing consumption—I lived through the 1980s, when I saw declining consumption for a decade. Then, I keep wondering, what is to say we are not at the high? Rather than in a cycle, we need to make wine exciting again. With millennials, there is an increase in consumption of craft beer and craft cocktails, plus this whole fusion of food to wine. Now we talk about beer in wine/bourbon barrels.
It used to be that you had the wine guy who was the “sophisticated” guy, and the spirits guy who was the “Vegas” sales guy, and the beer guy who was the “football” guy. Well those days are gone. These are sophisticated sales now at all three levels. That puts us in direct competition with beer and spirits in a way that we, as an industry, have not seen before. We have to look at that.”

“More engineered wines versus naturally made wine. Where is that fine line where people are sort of manufacturing for taste profile instead of naturally moving toward a taste profile? People are going to say that there is real value in engineering these certain taste profiles, and they might get the right profiles and it may not matter how they got there at a certain price point.”

"We are going to see a beverage alcohol business with more cross-marketing and mixing of different flavors. You can even go back to where you have beer now being put in wine barrels or bourbon barrels and being marketed together as a product. You can see some of these ciders as well. How is wine going to play in that?
We are going to have to continue to cross-market. The wine industry has got to continue to look to different alternative packages. Maybe some smaller single serves, wine in cans, etc.”

“As more young people travel around the world, they are being exposed to wine and seem to be experimenting and trying. That trend is going to continue.”

“Young people are truly getting into sparkling and bubbly wine more and more. They enjoy it; it is refreshing, and once they get into it they will continue to trade up. Of course they will be moving more toward Champagne and the fine wine business, the super-premium levels—people are constantly craving to drink better as long as our economy can afford it.”

“One of the biggest threats that the California Cabernet probably has is from Washington state. It does not take the American consumer much to translate from California to Washington. As cost of goods rise here—either through water or land scarcity—we will struggle to keep our prices down and eventually they will calibrate through supply and demand.”

Robert Smiley, Ph.D., is the director of wine studies, management professor and dean emeritus at the University of California, Davis. Albert Vontz IV is a graduate research assistant in the University of California, Davis, Graduate School of Management.