Sunday, September 30, 2012

Part I: The Long Term Future of US Wine Sales

Don Draper, the Middle Class, and the Mad US Wine Consumer



Economically speaking, a luxury good is one with a demand curve that's straight up and down and a commodity has a horizontal demand curve. Practically speaking there's a lot of gray between the two and Luxury for American's is easier to segment into "need to have" (a vacation camping close to home) and "want to have" (a vacation at the Hilton in Rome).

There was a time when luxury goods were that: Custom goods manufactured for the wealthy. Mass Luxury? At best that was just an oxymoron. Back in the day, lettuce was not a luxury good. It came in fresh iceberg or older iceberg. There were no field greens mixed in a gas sealed bag replete with mustard greens and escarole. But when the boys came home from a World War and the Boomers started popping out and growing up, America grew a large appetite for something more than 'need to have' products. We desired, wanted and coveted the Jones' stuff next store. An exploding middle class was the catalyst that gave the Mad Men out there license to pitch our wildest needs and wants, and we consumed our way to prosperity.

Today with a shrinking middle class, displays of wealth politically incorrect, a waning Boomer, and a $9 trillion dollar hit to the net worth of America's consumers in real estate losses, can we still have Mass Luxury goods like we used to and more important, will we be able to afford them, and even more important still, what does that mean for wine?

Mass Luxury is now a heavy component in consumer spending and our GDP. Wine is positioned as more of a luxury or a lifestyle enhancement, even in the lower price points. Its that explosion in marketing, along with the rise in wealth of the Boomer that has allowed the huge growth in the wine business in the past 20 years. Problem is, the average age of the Boomer is now passing the prime spending years of 35 -55. In fact, 10,000 Boomers a day are now passing 55. That is a headwind for wine producers that is structural. Its one the Millennials wont solve anytime soon no matter what else you read, simply because they lack wealth and they aren't yet at their prime spending years.

US$ Versus EUR, JPY, GBP, CAD, CHF and SEK
The other thing that has positively impacted the US Consumers ability to slide up on the demand curve in the past 50 years has been the abject strength of the US Currency itself. We have been able to buy the worlds goods at discount since the end of WWII when the rest of the worlds industrial infrastructure was destroyed. The dollar post war became so strong when Paul Volker raised the prime interest rate past twenty in the mid-eighties, the world powers made a concerted effort coming together for the first time in the Plaza Accords to deflate the dollar and transfer wealth to other countries. That pattern continues to this day with the Dollar weakening over the long term against world currencies. Where will that put the Middle-Class consumer in the next 20 years?

The quick answer is the Middle-Class can't return to what we've experienced in the last 20 years. The US has major structural problems to overcome starting with the Government's ability to Govern as reflected in the downgrade of our debt rating. But there's more. The lingering impact of foreclosures will continue to dog our consumer. The problems with the Federal Debt and the dynamic and growing impact of the Boomers on Medicare and Social Security payments will slow our GDP growth and threaten our currency if interest rates precipitously rise. The middle class which dominated consumption over the past 50 years is shrinking. The 80's and 90's which saw growth in real estate and allowed consumers to spend ahead and refinance their current spending with Home Equity loans, wont repeat for at least the next 15-20 years both because of the hang-over on underwater homes, and the lack of a proper mechanism to securitize, bundle and sell those loans off as securities. Finally, Banks now with greater regulation and higher capital requirements, will earn lower returns going forward and that will force them, perhaps properly, to take lower risk. That said, the US is still the greatest democracy and strongest capitalistic economy in the world.

That sounds like a mixed bag, kinda like a clown with a knife. With the Boomer and all that cohort's wealth now just starting to edge out of the picture and the Dollar slowly sailing out of its long-held position of world dominance, we can say with confidence the Middle-Class wont spend like it did before and we aren't going to have the same kind of wine consumer spending as we've come to expect over the past 20 years. But the great news is, they will want more wine.

Is wine a need or a want? Consistently, the answer ends up being that it is a need more than a want. Stacked up against other grocery goods in the Great Recession, wine sales ended up performing the best overall. By all measures, consumers in the US continue to grow in their affinity for wine and that appears to only have upward momentum.

There is a difference between growth in volume and growth in price however and that leads me to conclude we will see growth in volume of wines consumed, but more or less stagnation of the real price paid for wine. What does that mean and how that will impact the long term structure of the business is the topic for next week in SVB on Wine. But what do you think? Are you more of an optimist about the prospects for higher real prices for wine, the middle class, and the time-line for a recovery? Join the community here, sign in and sound off.

14 comments:

  1. I'm not sure whether to laugh or cry. So, I think I'll go home and have a glass of wine.

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    1. The clown with a knife syndrome in action. The good news in an alternate future view is that the US$ can depreciate more than the major wine producing regions making US wine competitive here and in the growing export countries..... then again, that will raise the costs of all our imports and drive inflation up. There is no perfect outcome that I can see, but optimistically I do believe we as an industry will fare better than most in the US.

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  2. From the supply side of the equation, I see the the US winery business model adapting to support a higher volume/lower price wine. Think less "Chateau's" and more custom crush production methods, ala Cameron Hughes business model, etc.

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    1. Interesting perspective .... perhaps. Why do you believe that? Where will those grapes come from?

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  3. I agree with Anonymous. You can already see Australia and Argentina Bulking out much of their grapes that can't be sold at the high prices they used to command. I think that value wines will increase in volume with wineries going farther a field in sourcing. Perhaps you will even see Australian Juice in the American market and sold under, who knows what designation. There is a shortage of grapes, but there is also a shortage of buyers in the mid-premium line, i.e. $35 to $60. Unless you are an established brand with a reputation, I believe many will struggle and have to be willing to either lower their price or cut production.

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  4. Thanks for weighing in Mark. It would be great as an industry if we could actually quantify 'premium, super-premium, mid-premium' etc. It would lead to more complete discussions but - I doubt we see that happen.

    I agree foreign sources - bottled and bulk - will change the dynamic of the business. Its a little harder for today with the world wide balance/shortages that are beginning to emerge. Argentina which I just came back from last Monday has one of the larger supplies and man can they produce beautiful wines. But their Government is so fickle in their decision making it makes it hard to predict anything for them. That said, there is a need and the large wine producers here are bringing out the wines and filling their domestic brands.

    Next week in Part II of this two part series, I'll discuss some of the wine specific changes I expect, given these observations.

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  5. I know several producers in California that continue to raise their prices incrementally each year. What used to be a wonderful bottle of wine for $28 btl is now retailing at $40-45. When I asked how they can continue to do that in a down economy the overall response is, "I'm not worried about it, they'll buy it in China". I myself have shifted my buying habits to different varietals like Ribolla and Cab Franc. I simply think a $45 price tag is insane for something whose quality is consistent rather than noteworthy.

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    1. Thanks Chrissa
      Price/Quality is what consumers look for (value). Small very high-end producers will continue to do well because there will alwauys be someone willing to pay a high price for a limited bottling. But I do agree, its hard to see how a higher production wine can attract a $45 price in the present revovering economic conditions.

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    2. Sometime around March 2012 you forecast the U.S. Wine consumption for 2012 would exceed 2011 by somewhere between 7 and 11 percent. Now that we are three-quarters of the way through 2012, how far off from that prognosis is the U.S. wine market?

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    3. Thanks for keeping me honest Rich. The forecast was for the fine wine side of the business since that is our main focus. We describe that as wines selling over $20 a bottle because we have several databases from which we can draw that information at that price. I haven't checked since May but last I checked, that segment was showing about 10% growth and the growth rate was dropping. I expect we will finish within that range.

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  6. I've been sharing links to the recent report from the Manhattan Institute about California's fiscal, demographic, population, and economic deterioration. I've noted in prior research that the popularity of CA wine is higher nowhere than in CA itself.

    Therefore, is it possible that using national stats in understanding demographic trends may result in understating the risks to CA producers as CA sheds productive citizens to neighboring states (at a decent clip)? http://www.manhattan-institute.org/html/cr_71.htm

    The gap between CA unemployment vs. national unemployment alone is material and probably has some effect. If things deteriorate worse in CA wine's best market, maybe we just have to start advertising in TX more?

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    1. Thanks for contributing Nick. Thats a good and valid observation. California is an expensive state in which to live, has the highest State tax rate, and who wants to live in the smog and density in LA with the Dodgers? Not many since that MSA leads CA in the exodus. I don't quite know how to vailidate the conclusion though. If people have a hard time living here financially, they move leaving arguably thte more wealthy people who are better able to afford the wine produced here.

      That is by no means a happy conclusion. I suspect with the growth in the internet, wealthy people will more and more be able to work outside of the state ... maybe Nevada and pay no tax at all. Fiscally speaking, its a conundrum without question.

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    2. Hey if your sick of the Dodgers, send them back! You can have the Mets now.

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    3. We would gladly send you back the Dodgers, and you can keep the Mets. Go Giants!

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