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.