Wine’s bad economics: What does the future hold?
If I had the talent of Hieronymus Bosch I would paint an apocalyptic scene, at the centre of which would be four horsemen pausing for a moment to survey the result of their labours. They would represent the devastating combination of structural oversupply; a highly fragmented producer base; an agricultural ethos; and a global recession.
If you compare the return on investment of wine with that of its direct competitors – beer, spirits and cider – it is critically low. If you then consider the relative amount of effort that goes in to producing a bottle of wine and the fact that wine, as a generalisation, has greater aspirational values and a relatively affluent consumer franchise, then this lack of return is all the more remarkable.
To believe, as some appear to, that the disparity is down to our relative lack of marketing skills and/or the activities of those “beastly” retailers around the globe is, I feel, to comprehensively miss the elephant in the room.
Warren Buffett once said that “when a management team with a reputation for brilliance tackles a business with a reputation for bad economics, then it is the reputation of the business that will remain intact”.
His point is that economics is a more powerful force than effective business management. Looked at another way, if the economics are “bad” then one is marketing with at least one hand behind one’s back. And in the wine business the economics are not just bad, they are awful.
Are we all doomed?
Even pessimists would have to admit there are currently many producers doing very well: those that have a niche, a specific formula for success, or perhaps a short-term competitive advantage. In addition there is, at least in theory, plenty of room for expansion, even if one’s traditional markets are no longer profitable. World consumption is increasing and Asia is opening up.
Looking long term, however, they might argue that there will always be far too many producers, and new markets will eventually dry up. Therefore the power will always be with the retailers and the consumer, while the production process will always be relatively complex and inefficient. Then there are the additional challenges to be faced around climate change and government intervention.
Aside from a few niche producers, they might conclude, producers will struggle harder and harder to escape the quicksand of declining returns. Great marketing will just keep one’s feet dry a little longer.
The perils of oversupply
Well fortunately I am an optimist. What is not apparent in my fake Hieronymus Bosch is that one of the horses has a hamstring problem. There exists the tantalising prospect of an end to a decade of chronic oversupply.
At a basic level it is pretty impossible to build value when you have oversupply, either as a company or as a category. This applies in principle to Coca-Cola or Apple as well as to the most unsophisticated wine producer. Producing more than one can sell is an own goal of classic proportions.
Just look at New Zealand as a case study: the marketing success story of the last decade. Yet grape prices are below the level they were before the boom. Consumers were quite happy to pay premium prices, but then discovered they didn’t need to – how wonderfully altruistic we are as an industry! The retailers, of course, got much of the blame for driving the price down, when all they were actually doing was using their power. As Dan Jago once said in exasperation: “If I’m offered a large quantity of NZ Sauvignon at half the price of the previous vintage, do you really expect me to tell the producer to chuck it in the sea?”
But by the same token, at the other extreme, we find producers also using their power, including, ironically, some from New Zealand. Creating a demand for something which is in short supply – or perceived to be – is arguably the best way to build value.
In our category, therefore, scarcity and oversupply co-exist, it is just that the pendulum has swung too far in one direction. Now it is moving back in the producers’ favour.
Cause for optimism. The end of oversupply?
It is, I accept, dangerous to consider the supply position too broadly, but a shortage, however inconsistent across the globe, may well change our culture. If producers and retailers know there is a shortage, the relationship changes, even if the shortage is not of the particular wine being discussed. As somebody said recently, “buyers are actually having to buy for the first time in a decade, as opposed to selecting from a multitude of options”.
It is, of course, not that simple; my apocalyptic horse’s hamstring problem may well not be that serious. For a start, producers have to take advantage of this change and not await the point when they have absolutely no choice – which tends, unfortunately, to be the norm in our business. More importantly, the dramatic move from surplus to shortage could well be weather-related. A bumper crop in Europe this year, and the light at the end of the tunnel will prove to be a mirage.
Of potentially greater importance is the proposal in front of the EU to remove all planting constraints by 2018. I am all for a free market, and for successful producers being allowed to expand, but the implications of this proposal, both for premium regional brands such as Burgundy or Rioja as well as more generally, would be profound.
So, what of the other horsemen?
Well, the one representing “recession” will assuredly come a cropper at some stage. One can debate the timing and the longer-term consequences, but I don’t think it’s too trite to say that all recessions end, and this one will be no different in that regard.
This leaves “fragmentation” and “agricultural ethos”: two horsemen who will assuredly always be with us. With the other two out of the picture, however, their influence is arguably less serious. It’s certainly more complex, as both are linked to some degree to wine’s inherent aspirational values.
In optimistic moods I can even envisage these horsemen becoming benign forces. Wine’s diversity is surely a fundamental advantage when marketing premium wines; we just need to harness the potential. In addition, we are making progress across all sectors of the category in terms of becoming more consumer-facing. It’s just that progress is painfully slow.
I do accept, however, that this is rather a rose tinted view. I do have serious concerns that there will always be too many producers chasing too few profitable consumers, however sophisticated their marketing becomes. And, in particular, I just can’t see a way forward for any producer whose business model is predicated on making a “normal” return on large volumes of mainstream wines marketed in traditional ways. There’s too much competition from similar operations, some of whom are not just not driven by the same success criteria. There’s therefore less and less margin to invest in adding value, which implies increasing pressure to drive volume simply to stand still.
The recession has highlighted the fragility of our industry. It’s highlighted how much we are at the mercy of our ‘bad’ economics. To succeed longer term we of course need to strive to be brilliant as individual producers, but let us also understand the value of generic efforts to mitigate the effects of oversupply, the only element of ‘bad’ economics which is at all within our control.