Sunday, June 23, 2019

How Much Did Wineries Really Make in 2018?

      The Wine Industry Shares Most Information


Unlike most of the business world, there's a sense in the wine business that sharing is part of community, and your neighbor is part of your support mechanism. They are not a rival nor are they a competitor. Everyone freely offers support in the form of information and time. If you need a tractor because yours is mired in a soggy field, no problemo! Need a little welding and custom fabrication on a pump? I'll be right over with a welding rig. Stuck fermentation? I'll send over a portable heating unit.

That kind of sharing happens all the time. But ask your neighbor for your wine club list, or ask "Can you show me a copy of your financial performance so I can compare my winery to yours?" The answer is always just < ..... crickets ..... >. 

When it comes to that type of question you'll just get a mixture of liars dice, false bravado, partial truths. The following cartoon I put together is the best explanation of how that game is played with your neighbors in wine country...

    

      Sales Growth in Premium Wine has been Slowing



In the 2019 SVB State of the Industry Report released in January of this year, we said 
"2018 was a good year for wine. Total wine sales for the year set a record, restaurant sales of wine were higher and premium wine sales were up as well. Strong consumer confidence and a healthy US economy contributed to the improved performance, but changes to long-term trends are telling us that we

are at a transition point as an industry."  
We need to stop and note that 2018 showed a small uptick in performance, but that was only in the Premium Wine Segment as you will see below. The under $9 categories continue to disappoint and dragged volume sales negative, but there were some positives in the year and we have to be grateful for that, despite longer-term negative trends.


      A Look Back at Growth


We've gotten used to premium sales growth rates averaging 13% since 2000, and in the wine industry as a whole, 3-4% sales growth and 2% case growth was the norm. 


Going back, the upturn started in 1994 with premium wine sales growth in the 1990s typically above 20%, and even that was stunted by short supply. 1994 was the year the median boomer turned 35; typically the beginning of peak retail spending.

Starting in the early 2000s traditional three-tier wholesale distribution started to fail for the small producer, leading to a scramble to push direct sales. That move progressed very well until the past four years when three-tier sales went through another down phase, and tasting room growth couldn't replace losses in three-tier.



Wine sales are still growing today but as you can see in the nearby slide titled US Wine Consumption Volume, volume growth with the rectangle highlighting the present period, is flattening. As alarming, total volume through retail grocery and drug; the orange line in the nearby slide, has turned negative for the first time since 1994.




      Major Trends Impacting Wine Sales


3 years ago in the SVB Annual State of the Industry Report, I forecast a decline in per capita wine consumption; the result of flattening sales volume and only a slightly larger adult population. That was a directionally correct call but slightly premature. If we've not already arrived there, we are getting closer to that today.




The issue the Premium Wine and Luxury Goods industry faces in the US is shifting demographics. The boomers who have driven the growth in premium wine are moving to retirement age. In 3 more years, the median Boomer will hit the full-benefit Social Security Retirement age of 66. The good news is they will work longer than expected, but spending will be muted particularly on luxury goods and alcohol.

With over 50% of the country's net wealth and a dominant share of discretionary income, there is no question the headwind of boomers moving to a fixed income will continue to impact spending on premium wine. And that ignores the reality that boomers will also be buying less volume as they age. 


      The Missing Millennial


While it would be natural to think the slightly larger millennial cohort should replace the spending of the boomers, that's not the case. The Indulgence Gap; an economic confluence of the Great Recession's echo, reduced financial opportunity for millennials compared to generations past and burdensome college debt are some of the factors that make those younger consumers an uneven financial consumer trade out for retiring boomers. 



But finance is only part of the issue. The troublesome confirmation brought out in the Annual SVB Wine Report this past January is that while the boomer is still drinking, the millennial is making no greater advance into premium wine and has stalled out at 16% of total consumption, as noted in the nearby chart. The outside edge of the cohort today is already 38. We should be seeing growth from that consumer, but as I've written in several other places including the annual report - the cumulative negative health messaging is taking its toll in consumption patterns, and having an even larger impact on the under 25-year-old age group.


  Wine Segmentation



Averages can be deceiving. Critical information is lost when we don't segment and in this case, there is a clear demarcation of winners and losers by price point. While total volume growth through May 2018 is negative 1.3%, it's clear all of the declines are showing up in the $9.00 and under wines. Bottles above $9.00 have both volume and value growth. 

The sweet spot for growth today is in the $12 - $30 price segments, with $12 - $15 showing the best patterns of both value and volume growth. Though total growth is muted, the consumer continues to seek premium wine today and there are pockets of good opportunity still.

    How Much Do Wineries Really Make?


It's easy to see growth rates and profits from public companies, but there aren't many public companies in the wine business. How do you get consistent financial benchmarking? 

SVB collects financial information every day and at any given time can present many different views of winery performance using our own proprietary database of actual winery financial statements. Our database now goes back decades which is pretty helpful for trending.



The chart nearby is one I present each year in the State of the Industry Report and use in many of my speeches. It represents a benchmark of performance for the average winery in the US.

In the chart, the red bars represent gross margin (total sales minus the cost of goods sold, divided by total sales and expressed as a percentage), and the green line is the pretax profit margin. Pretax profit margin is calculated after deducting interest and all other expenses, except tax. The blue line is the industry sales growth rate. You can back into total operating expenses if you are interested, by adding the pretax profit margin and the gross margin, then subtracting the sum from 100%. 

When the statements were all collected and input this year, because of the impact of US tax reform and added discretionary income in the pockets of consumers, wineries ended up having an improved 2018, with sales growth rising to 5.3% compared to 3.1% in the prior year. It's not growth in the teens as we've seen as recently as 2014, but it's better growth than the prior period. 

Gross margin started to have a more obvious DtC impacted result starting in 2013 but was flat in 2018.

On the cost side, winery owners have seen labor availability and grape costs escalate markedly in the past five years, though we are in an oversupply situation on grapes and juice at present, which is reducing grape costs off their highs. On the three tier side of the business, there has been an increasing request for added discounts and allowances. That said, wineries are finding increases difficult to pass on cost increases to new consumers who are signaling they have a lower indulgence ceiling. Those higher grape costs are presently all embedded in inventory waiting to sell.

Pretax profit trended higher in 2018 finishing the year at 10.6%, slightly higher than the 9.9% figure from the year prior. We'll take these results!


    Shoveling out Tanks


I don't have all the answers, but I know the business is changing rapidly and that requires a response. 

It's critical we address the hijacked science that is producing preposterous conclusions about the negative health consequences of moderate wine consumption. That's something all of the alcohol beverage industry needs to take on. 

We need to evolve the way we sell and market wine to include the young consumer as well. There is no choice. We can't hold on to the aging consumer or expect the seldom-mentioned GenXers to continue to produce 75% of the current growth rate in wine. That's not sustainable.

We need to be more thoughtful of changing the current tasting room and wine club model and define scalable methods to create an experience and build brands remote from the winery.

The wine business is not something you do as a gracious retirement anymore, which was the case in the '80s and '90s. The business, like all of life now, is churning faster and those changes will require a little bravery to face and adapt. But I also am convinced when presented with a clear challenge, the wine business will respond. Well ... the challenge is clear!

I encourage you to read the Annual SVB Wine Reportdig in deeper to this discussion and help create the dialogue below.



What are your thoughts? Are you feeling the sales slowdown? How are you passing on higher grape costs? What strategies are you using to operate in the evolving consumer environment

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