| February 2006 | The Industry's Leading Publication for Wineries and Growers | www.winebusiness.com |
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What a difference a couple of years makes. The continued consolidation of the industry almost goes without saying, but the pace of change has been breathtaking. Five of the Top 30 companies merged into other companies in the last 24 months. Three blue chip wine companies—Robert Mondavi, Allied Domecq Wines and Southcorp of Australia—were purchased and combined into other global wine companies. Robert Mondavi is now part of Constellation Brands; Allied Domecq Wines is part of Beam Wine Estates; Beringer-Blass Wine Estates parent Foster's bought out Southcorp to form Foster's Wine Estates. In addition, Chalone Wine Group was integrated into Diageo Chateau & Estate Wines. E&J Gallo purchased Barefoot Cellars, and Constellation purchased the 500,000-case Rex Goliath brand from Smith and Hook/Hahn Wine Estates. Cline Cellars would have made the top 30 list for the first time this year, but in late 2005, the company sold its high-volume Red Truck label to Axiom Wine Company, a new venture launched by former executives of Beringer-Blass Wine Estates. "Who would have thought this year would see the changes it did with Mondavi, Beringer and Southcorp, Allied Domecq disappearing and Constellation continuing to grow?" asked David Dearie, president and chief operating officer for Brown-Forman Wines. "I don't think we could have guessed." While the number of large-volume producers has dropped, new wineries open virtually every day. According to WBM's proprietary database, there are now 5,364 wineries in the United States, up from 4,740 one year ago (see "Number of U.S. Wineries Tops 5,300," page 46). "There are now four producers that do two-thirds of the volume and half the dollars in the industry while at the same time, at the artisan level, the market for handcrafted wines continues to fragment," observed David Kent, chief executive of The Wine Group. "There's an interesting paradox going on," said Jose Fernandez, who runs Constellation Wines U.S. "You have this dynamic that you see in a lot of industries with a consolidation of suppliers, but at a consumer level there's interest in variety, and people are looking for interesting wines to discover. We're seeing a consolidation of suppliers but not of brands; there's probably more variety and fragmentation of wine styles and brands than there has ever been." "I'm just lamenting the tremendous consolidation of the industry and the difficulty for a mid-sized winery—you either have to be very big or very small," said Randall Grahm of Bonny Doon Vineyards. Despite this consolidation, several executives said the wine industry has a long way to go before it resembles other consumer goods categories. Beer and laundry detergent, for instance, are dominated by less than a handful of players. "We've talked a lot about consolidation, but when you look at the wine industry compared to any other industry, it isn't that consolidated," David Dearie said. Industry Outlook & Trends In addition to listing this year's Top 30 U.S. wine companies, we have interviewed executives from each of the 30 companies. These industry leaders share their views on everything, from imports, pricing and consumer interest, to the general health of the industry. In general, the executives were a little more optimistic than last year. But while the industry is becoming healthier, it has also become tougher and more competitive. This competitiveness is primarily due to increased consolidation, an influx of new brands and inexpensively priced/high-quality imports, all of which have put many wineries at a disadvantage as they strive to get their voices heard and their brands recognized in this "global category." As a result, the rules on how to compete in today's market are in the midst of being redefined. Foremost, many leaders suggest that wineries gain a better understanding of how to build and differentiate their brands. As for this year's large, high-quality harvest, some feel that while we won't soon be seeing the oversupply of 2000, this harvest will help the U.S. better compete locally and internationally. However, others remind us that it is not permanent and that a shortage will likely come again in a few years, especially if consumer demand continues to increase. What follows is an overview of what industry leaders, at the end of 2005, had to say about the state of the wine industry. The Turnaround Continues The last four or five years have been rough for the wine industry, which has faced oversupply, rapid discounting, economic uncertainty and the wrath of Two Buck Chuck. Every industry executive contacted for this article said the industry continued to recover and grow in 2005, and expressed cautious optimism for the future. The factor cited most often was growing consumer interest in the category, especially among twenty-something consumers. "The wine market has improved dramatically," said Ted Baseler, chief executive of St. Michelle Wine Estates. "We don't expect the same kind of dramatic increase next year, in terms of the rate of improvement, but a continued positive atmosphere for wine, in spite of large harvests in Australia and California." "The wine industry is getting healthier," Kendall-Jackson president John Grant said. "It enjoyed unprecedented prosperity through the 1990s. The bubble burst early in the new century, led by a convergence of domestic oversupply, growth in international product and a turndown in the economy. I think we're through a lot of the negative impact of those elements." "Consumption has been robust in the U.S. since 2001, and it's driven in part by low absolute pricing," said David Kent of The Wine Group. "When the price of wine goes up, consumption begins to curtail. We'll see what the next few years will hold. The absolute price of wine is very critical for the American consumer." Kent said that in the late 1990s, when California grape prices escalated, the domestic market "stalled out." Wineries had to pass through the high cost of grapes in 1999 and 2000, and there was no longer any domestic consumption growth, he said. "There was some imported wine consumption growth based on weak foreign currencies and their ability to hit price points that the California producers had abandoned, but with the cyclical nature of the grape crop, grape prices came back in line, and wineries adjusted their prices, and consumption has been growing again." "We had some glory days, then it deflated dramatically," said Don Sebastiani, chief executive of Don Sebastiani & Sons. "Clearly it's come back but in a different way. You're seeing prices deflated now, but they're also more real." Despite the optimism and sense that the industry is on the upswing, a number of industry executives said they see business being more competitive. "I see the industry getting tougher and tougher," said Stephen Kautz of Ironstone. "The consolidations, the new brands being introduced and the sheer lack of shelf space are really creating some hardships for a lot of companies. In 2006, I see the promotions being harder and harder to compete against. Big spirits-driven companies with huge portfolios have a marketing advantage and a louder voice in front of the retailers." "I think the industry has never been tougher," Jay Shoemaker of the Coppola Companies said. "The Australians have proven to be incredible competitors making low cost wine, coming in with decent labels that have staked out their territory. The good news is that the children of the Baby Boomers, the younger generation, have finally embraced wine. It's a rising tide that has floated all boats." "A question on a lot of people's minds is what's next after this critter craze," Vincor USA president Mike Jaeger said. "I think the growing reliance on private-label brands will force wineries to be even better at brand building. To compete with (private labels) you will need to understand your brand equity and how to better differentiate in an already highly fragmented industry." The Supply Picture and Bountiful 2005 Harvest The California Agricultural Statistics Service predicted a crush of 3.15 million tons, 14 percent larger than last year and the second-largest grape crush on record. That number will be revisited and may be revised higher when the annual crush report is released this month. Industry executives had somewhat differing perspectives on how a large 2005 harvest—high in quality and enormous in size—will affect the market. Some see the burgeoning supply pressuring prices lower. Others see the 2005 harvest as an aberration and foresee a looming grape shortage that will result in higher prices. The 2005 California grape harvest could be a "defining moment" in the wine business for both consumers and the industry, according to Fred Franzia of Bronco Wine Company. "This doesn't mean there is too much grape acreage planted," Franzia said. "Mother Nature just gives us extra in some years, and this year's extra-large crop should mean a double bonus for consumers. "The large crop brought down grape prices, and now it will have the same effect on future wine prices," Franzia said. "Wine drinkers should now know beyond any doubt that good wine does not have to be expensive. For the industry, it's Economics 1A. As inventories go up, prices come down. "There will be a one- to two-year delay before this year's wines come to market," Franzia said, "but pressure on inventories should accelerate declining prices very soon." Chris Indelicato of Delicato Vineyards said the quality of the 2005 harvest will help American wines compete domestically and in export markets. "Most wineries went into the harvest short on inventory, so a lot of the extra grapes we were getting were welcome. We certainly won't return to the oversupply we saw in 2000. It was a good time to have a big harvest." Other industry executives, however, cautioned that California vintners may soon be short on grapes. "People should not be lulled into thinking (the oversupply) is permanent," Hess Collection president Tom Selfridge said. "If demand keeps going the way it is, we'll see shortages in two or three years." "Looking at vineyard plantings—what's in the ground, what is producing and non-producing—it looks like the overall tonnage over the next five years will be relatively flat," said Peter Mondavi Jr., vice president and treasurer of C. Mondavi & Sons. "As the consumption side grows, the sourcing side in California will be relatively static. That's good for the California wineries; it will shore up pricing, but on the flip side, it will let in more imports. Clearly, it's going to allow some of these imports further access to the market. As the demand grows, the supply side is not necessarily growing that fast in California, so demand will be met from imports." "One of the things people are going to have to start paying attention to is the mix of grapes produced each year," Indelicato said. "There's a difference between Lodi and Central Coast Merlot. A ton of grapes here is a lot different than a ton of Thompson Seedless grapes from Bakersfield. In Napa, good quality grapes will be available for good prices. That's different than having an undersupply of icon quality Cabernet Sauvignon. The market is stratified by wine quality, and we're going to be short on some varieties, but that's not a bad thing." "I think the 2005 vintage will be a bit of a blip," said Jose Fernandez, "but in general, inventories are pretty balanced. The key thing driving the market is consumer interest in wine. We expect that to continue." Changing Demographics "The demographic and physiographic trends are all very positive when you consider the key wine consumption age is 40 to 65 and that 5,000 Baby Boomers move into that age group every day," John Grant said. "I think that during the next 15 years or more, the wine industry will enjoy organic growth. There are not a lot of industries with such positive growth dynamics in play." Vintners are optimistic because of the widespread perception that wine is aligned with cultural trends in America, including a renewed focus on family and tradition. For the first time since Gallup began measuring Americans' drinking preferences in 1992, wine passed beer in a 2005 survey as the alcoholic beverage adult drinkers consume most often. That data came on the heels of anecdotal evidence and other research indicating that so-called "millennial" consumers (between 21 and 30 years old) are taking a strong liking to wine. "The watershed is that Gallup poll," Jose Fernandez said. "Increasing per-capita consumption and continuing the move away from beer is terrific for the industry and has great potential," Peak Wine Estates' chief executive Bill Newlands said. "If what occurred in the UK and Australia happens in the United States, it will be a boon for the wine industry. They were heavy beer cultures, but wine has been added into the normal consumption mix of alcoholic beverages." "Conversion of beer consumers to wine is accelerating and may have a dramatic impact on the future of the wine industry," said Ted Baseler. Imports, Competition Focus Vintners on Costs One of the trends seen in the last few years has been a shift where control of the $3 to $7 per bottle "fighting varietal" category has shifted from large domestic producers to importers or import companies. This has been driven particularly by Australian imports. The flow of inexpensively priced imports has pressured prices lower. "Whether we want to admit it or not, we are in a global category," Trinchero Family Estates president Bob Torkelson said. "There will be a glut somewhere in the world every year. The consumer has a lot of choices these days." "The Australians have pulled prices down and quality up. They've stolen our sheet music, and they rewrote it better," Don Sebastiani said. "Shame on those of us in California who opened the door and let Australia in here to eat our lunch. We opened the door with a sleepy presentation to market, fighting yesterday's war over again, with not good enough quality for the dollar and a lack of willingness to experiment with anything, from closures to different wine styles." "Those low price imports are beginning to assume captaincy of the ‘fighting varietal' price segment," John Grant said. "That seems to be a sustainable long-term trend. We are ceding the ground at the low end. Now, ironically, the majority of the growth in the industry is coming at price points above fighting varietals, so those domestic players that have positioned themselves above the fighting varietal fray should be doing well. Those caught up in those fighting varietal segments with a domestic cost base are likely to have a tougher time." Jose Fernandez, whose company sells vast quantities of wine from both California and Australia, said the success of Australia puts good healthy pressure on California to improve quality, lower costs and operate in a sustainable way. "Like other industries, competition from imports has caused everyone to hone their skills and sharpen their game," he said. "We get in these discussions about the total U.S. industry versus the total Australian industry," said Jon Moramarco, who runs Constellation's Icon Estates' division. "The reality is industries don't work in lock-step. If you look at individual companies, California can compete. It comes down to individual producers and what they're capable of doing. The reality is we live in a global marketplace, not just for wine but anything." "Competition in an evolving global wine industry will be the key challenge for all producers," said Scott Weiss, the chief executive of Foster's Wine Estates. "Quantity and quality from around the world continue to increase dramatically, and the U.S. is a very attractive market for imports. Scale and relevance will become more important in a consolidating supplier, retailer and distributor environment." "Costs are going to go up everywhere around the world," Chris Indelicato said. "The Australians have the same issues we do. Environmental laws are increasing costs. Not all of that is a bad thing. The U.S. will be able to more than compete with everybody around the world, especially where it counts: in wine quality." "California can stay competitive," Dearie said. "The Australians and South Africans have cost advantages, but you have so many other factors: exchange rates, supply and demand, and the size of harvest. This industry will continue to move and shape itself year to year. That's one of the joys of having Mother Nature as a business partner." "As an industry, things are moving forward smoothly; not as quickly as people would like but I think we're all spoiled from the 1990s," Moramarco said. "We may never get back to the rate of growth in either volume or pricing that we had in the 1990s; we were spoiled. "The things I look at right now are—with the movement in oil pricing, natural gas pricing and other similar issues—is that we are going to see more pressure on our costs, and I think, as an industry, I don't think it's a major issue, but it is going to put more pressure on margins," Jon Moramarco said. "In the last few years, we've been squeezed, in terms of being able to take a lot of price increases. We have to get back to how we look at pricing and use that as a tool in the economy we have to live with. I think we may see more inflationary pressure because of fuel prices than we have in the past, and we have a lot of people in the industry that really have never dealt with an inflationary cycle." Indeed, some winemakers warn of complacency and believe a long road still lies ahead, in terms of producing even better fruit and meeting the demands of today's market. "The turnaround hasn't quite come yet," J. Lohr proprietor Jerry Lohr said. "We have got a long way to go to get where I think we need to be. We need to do a better job at almost everything, from growing grapes to understanding consumer preferences. We're still production-oriented rather than market-oriented." wbm | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||