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.

Big Trouble Down Under: Crisis in Australian Wine

Most people find it hard to imagine that the Australian wine industry could possibly be in trouble. Isn't Australia the great success story of wine's current globalization era? Australian wines are the #1 imports in Great Britain, having overtaken the French, and they may soon replace Italy as the #1 wine import in the United States. Where is the trouble in this?

And aren't Australia's best wines, like the iconic Penfolds Grange shown here, recognized as among the finest wines in the world? Australian Shiraz has set a high standard and its popularity has ignited interest in Shiraz and Syrah around the world. What's wrong with that?

And yet big trouble there is for Australia's wine industry and it is important to understand the situation both to appreciate the forces at work in Australia and to recognize their impact on the rest of the wine world.

First, however, we have to understand how Australian wine really works. Although famous brands like Penfolds Grange established Australia's reputation for fine wines, they are a small and limited segment of the market. The evolution of Australian wine during the 1990s has produced an industry dominated by a small number of very large producers focused on branded products for export to Great Britain and the United States (about 75% of Australian wine exports are aimed at these two markets).

The bulk of Australia's exports are inexpensive bulk wines, like the Yellow Tail brand that sells so well in the U.S. In fact, Yellow Tail wines account for nearly one-third of all Australia's exports, making the industry incredibly dependent upon market conditions at the bottom end of the market. And those market conditions are not favorable: price competition is fierce. Penfolds Grange is the sophisticated image of Australian wine, but Yellow Tail, with more than 10 million export cases per year, is the inexpensive "critter wine" that pays the bills.

Or doesn't pay the bills. Three years of rising harvests from 2004-2006 left Australia awash in bulk wine and the market worked just like the textbook says: prices dropped. The fact there is surplus wine, at least for now, in many parts of the world made the situation worse, of course. Bulk wine export prices are now less than 85 cents per liter, an unsustainable level.

I have read some reports that suggest that cheap French wines are part of the problem. The wine industry in the South of France,the Languedoc, is badly fragmented, with tiny family vineyards that can undercut new world wines because they do not count the cost of inherited capital (the vineyards) or family labor. And, of course, there are those EU subsidies, at least for now.

The wine world has become very small and Australian bulk producers compete head to head with those from Chile and France in the main global markets. And this creates a problem, too, because there is only so much demand to go around at any given time. If Australia exports a bit more to the U.S., for example, it pushes that extra U.S. wine into an export market, where it undercuts existing Australian sales. The result, once again, is falling price. Australian wine producers are on the lookout for new markets, focusing on Russia, China and South Korea. I would guess that these are not the easiest markets to enter except through the undesirable bulk wine route.

The problem is compounded by the fact that Australia's big brands seem to have hit a wall in the export markets. Everyone has "critter" wines, now (or haven't you noticed) and the competition among branded wine products has become positively frenzied. Sales of some of the Australian "popular premium" brands have actually declined for the first time, with these wines pushed down into the bulk market, pulling prices even lower there. More and more, Australian wines compete in a single category and market conditions on that part of the wine rack have deteriorated.

There is good news, but even the good news is bad. The good news is that the Australian wine surplus is shrinking and supply is becoming more closely aligned with demand. The bad news is that this isn't because demand is rising, but rather because 2007 was a disastrous vintage. Grade production fell by 30% due to disease, frost and especially drought. Drought conditions are projected to continue into 2008, so there is not much hope of a quick recovery. Bad news is sometimes good news in agricultural markets, where bad crops push up prices and make people rich. But Australia's bad crop won't do much to push up global bulk wine prices. The only good news is that the surplus stocks that Australian producers have been holding can be used up at last.

What can be done? The Australian Wine and Brandy Corporation (a government marketing agency) has released a study titled Wine Australia: Directions to 2025 that presents a plan to turn the troubled industry around without ripping out vines the way that they did in Canada and New Zealand during their wine gluts in the 1980s and the European Union proposes to do to shrink their wine lake now. The key to the plan is to "re-brand" Australian wines using a market segmentation scheme described in the report and then to move up market and away from bulk wines with more innovative brands and an attempt to focus on distintive regional terroir.

The logic is simple: move from the bottom shelf in the supermarket, where prices are unsustainable in any case, into the middle and top shelves, where consumers are willing to pay higher prices. The problem? Well, changing consumer expectations isn't easy, although it is possible. But isn't everyone trying to do that? It seems like every winemaker is trying to move upmarket. Gallo and Constellation have dozens of brands in these market segments, with more coming every day. (Just this week, as it happens, Gallo announced a partnership with Martha Stewart to produce a Sonoma-sourced Martha Steward Vintage brand wine to sell for $15 in select markets!)

The Wine Australia report is a good beginning. They recognize the current crisis and they know what to do. But can they do it?