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.

Costco and Global Wine

Costco is the largest wine retailer in the United States and I think it is worth thinking about the Costco model and what it has to say about the globalization of wine.

Costco’s approach to selling wine is different from most other U.S. retailers, such as supermarket chains. Most supermarkets offer a surprisingly large selection of wine. The Metropolitan Market (an upscale grocery store in my neighborhood) has more than 1500 different wines on its shelves. The Tacoma Boys farm store down the road has more than 3300 different wines – an incredible selection. A typical Costco store has a rolling inventory of only about 100-120 wines at any given time. Selection is obviously much narrower at Costco, so value and quantity sales are the key. If you’ve shopped for wine at Costco, you already know that you can spend as little as about $5 for a bottle of wine and as much as … well, as much as you want, really. I have seen Dom Pérignon on the Costco rack as well as a Heitz Cellars Martha’s Vineyard Cabernet Sauvignon as few years ago. If you go to the website you can even purchase Bordeaux futures!

One way that Costco reflects wine globalization is obvious: they bring global wines to the American market by offering products from France, Italy, Spain, Chile, South Africa, Germany, Portugal, Australia, South Africa and New Zealand (those are the countries that I can remember from my last visit – I haven’t tried to make a complete accounting).

Costco distributes the wines of the world to America and America apparently snaps them up. A good example is the red wine shown above, a 2006 Kirkland Signature Central Otago (New Zealand) Pinot Noir that I found on my most recent Costco expedition. Pinot Noir is hot these days (the Sideways fad continues) and Central Otago Pinots have developed something of a cult following. So it is very interesting to find this wine in a warehouse store, where volume sales are key.

The Kirkland Signature label first appeared in 2003. The wines are relatively small lots (around 2000 cases each -- large for many wineries but small for Costco -- according to a 2006 Costco report) specially created by chosen winemakers. The wines are scattered out among the warehouse stores and when they are gone they're gone. New wine releases are staggered throughout the year so that serious (or curious) buyers have reason to check back frequently to see what's new.

I found an Oregon Pinot Noir a few years ago and went to the trouble of tracking down the maker. This isn't always necessary any more -- some Kirkland Signature wines, like the Marquis-Phillips made Shiraz we had on Monday, proudly list the winemakers. The Oregon Pinot's maker was the same company responsible for the A-to-Z brand. A-to-Z are negociants who own no vineyards. Negociants typically purchase wine from other makers and blend, age and market it. A-to-Z is know as a great value brand and so a good potential Costco supplier. Interestingly, the Costco Pinot had the same price as the A-to-Z Pinot in my local store.

Now we can begin to appreciate why Costco is so successful as a wine retailer. Their list of wines is not large compared to other retailers, but they provide a rolling selection of pretty interesting and sometimes unexpected wines (at good prices, but that goes without saying). Costco buyers suspect that it must be a good value to get on the Costco shelves and know that any particular wine might not still be there next week or next month. Better run back and buy more now if you want it. So people keep coming back.

There is another aspect to Costco’s wine story that interests me and that is its house brand, Kirkland Signature wine. Kirkland Signature wines reflect the complex nature of wine globalization in ways that you might not suspect.

There are basically three models for wine marketing in the world today that correspond to the three largest import markets for wine: the U.S., Germany and Great Britain.

The U.S. model is built around brands owned by wine companies. Winemakers big and small seek to establish a brand or reputation that will help them sell their wines to consumers who need a trustworthy indicator of value and/or quality. Building reputation is complex and brands are part of the process, but not the whole story, of course. Americans typically look to brands for quality/value information when shopping in general and so it is natural that wine brands are so important here. Because there are lots of market segments for wine and many competing brands within each segment, American retailers stock a lot of wine.

Then there is the German model, which is all about low prices. The average “bottle” of German wine is sold in a discount store, often with a house brand name, and costs about a Euro per liter. I put “bottle” in quotes because sometimes it comes in a juice-box type container. Decent quality for less is what the German market seeks and the discount chain’s reputation for value seals the deal.

Finally there is the British model. Britain is by most accounts the most important wine import market in the world and the key players there are the supermarkets such as Tesco and Sainsbury’s. Because this market is so important to wine exporters, you can find wine from every nook and cranny of the global market in British stores. But because this huge selection can be confusing to consumers (especially French wines) and discourage them from making a purchase, the stores themselves (not the wine producers) have launched their own brands, like the Tesco’s Finest Bulgarian Cabernet Sauvignon or, for example. Or the Sainsbury's Marlborough Sauvignon Blanc shown here, which offer a limited range of global wines under the store’s own label. The Tesco brand gives consumer confidence to try an unfamiliar foreign wine (a Central Otago Pinot?) that they might otherwise avoid. Tesco and Sainsbury’s don’t make the wine, of course. They contract with local winemakers to supply the product. The stores add value to the bottle by lending it their reputation through the store brand label. And, of course, they use their efficient distribution system to get the bottles into consumer shopping baskets.

Now a quick field guide to globalization and the U.S. wine market. You can find the American wine marketing system in your local supermarket: dozens of different brand-name wines in all the major price segments.

You can find the German wine marketing system at Trader Joe’s, where people who would never spend three dollars for a bottle of wine at Albertsons (how could it be any good?) confidently pay as little as two bucks for a bottle of Charles Shaw (how could it be bad?).

I think that Costco’s innovation is to bring the British wine market system to the United States. Costco’s wine aisle reminds me of Tesco’s in Britain. And the Kirkland Signature line reminds me of Tesco’s or Sainsbury’s house brands. Even the labels bear a family resemblance if you compare the Costco Marlborough Sauvignon shown here with the similar Sainsbury's wine above. (Interestingly, they are both priced at about $9 per bottle.)

Bottom wine. Costco is a success in the wine business because it sells global wines to Americans using the British wine market system. That's globalization!