Warren Buffett and the four horsemen of the apocalypse

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.


3 thoughts on “Warren Buffett and the four horsemen of the apocalypse

  1. Great post Mike. I mostly agree, especially in regards to niche marketing, however I’m not sure I agree with the part where you take an economics view of a branded good. Sure, bulk wine is affected by supply and demand and all those low-value high-volume no-name brands will no doubt suffer at the hands of the mighty UK supermarket buyers.

    But a branded good that is sold at the about same price every year should be able to weather downturns. (Financially speaking whether they purchased land at a high price with high debt will probably have more influence on financial survivability than bad economics.)

    If you take water as an example. It comes from a tap, is easy to produce and from a consumer, not industry or environment point of view, it should therefore be a dead industry due to oversupply. Yet despite bad economics the industry thrives – branding and distribution being the heart of its success.

    Building value with oversupply exists. Economics be damned. Shoot that horse ;). Leave the economics to politicians, commodity industries and liars. Premium branded goods markets should be concerned about other more important drivers. Like niche marketing.

    • Thanks for this, Bruce. You make some interesting points.Firstly, let me say I totally agree that strong, well distributed, brands will be more resilient in the face of economic issues.As an example I’ve always been very impressed with how Jacobs Creek seems to have sailed fairly serenely through the storms of the last decade.And I accept too that internal financial weaknesses (not to mention fluctuations in the FX ) may well be of much greater concern than bad economics in individual cases and\or at certain times.

      I’m afraid however I do have a problem with your water analogy. Brand owners in the water category certainly have an infinite supply but,quite literally probably, in the vast majority of cases they can turn it on and off with a tap! They are thus able to manage supply and demand pretty effectively- like most FMCG brand owners in fact. I accept that their success in brand building has been remarkable (and worth studying ) but that’s a different point.

      Imagine,however, a parallel world in which branded water companies could only get water from their springs once a year and the quantity varied annually.Imagine too that to avoid financial penalties they were forced to store all the water from these springs.Finally, imagine that for the last few years supply has been significantly greater than demand.Even the most marketing oriented producers would be forced therefore to get rid of stocks in order to make way for the next ‘vintage’.The stronger one’s market power and breadth of distribution the less difficult this is, but at the very least it’s a serious distraction.

      Consider, in the wine world, the example of Australia.In the 90’s it became I would suggest a role model for how to brand wine and make relatively high returns.However a rapid move into oversupply, driven by over-optimistic forecasts from people like me, implied that the marketing oriented hero of the 90’s became the production oriented villain of the noughties.Yet the skill sets in the industry were probably greater. What changed ( at the risk of over-simplying the issue ) was that the need to move large quantities of wine, for which there was no profitable market, became,of financial necessity, a priority over building brands.

      • I may sound like an economics atheist (guilty) but I do accept the oversupply of Australian wine (and recent high forex issues of low priced wine) as a major issue for the industry. My disagreement is that good brand management leading to higher prices can hold back the bulk-wine tsunami disaster – the micro over the macro. It may also be I am more interested in the small and the premium than the large and mainstream.

        Great blog BTW.

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