| February 2007 | The Industry's Leading Publication for Wineries and Growers | www.winebusiness.com |
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As part of our review of the wine industry, Wine Business Monthly compiled its fourth annual ranking of the Top 30 U.S. wine companies by U.S. case sales. These companies represent more than 90 percent of the U.S. wine market. In exclusive interviews with WBM, leaders of these companies spoke about where they are heading, how they plan to get there and about the challenges they face today. The landscape continues to change because of consolidation among the larger wine companies. This year was no exception as Phillips-Hogue disappeared from the Top 30 list when it was subsumed into Constellation Brands. Constellation purchased Vincor International, the largest wine company in Canada and the owner of Phillips-Hogue. Bonny Doon Vineyards fell off the list because it sold its popular Big House and Cardinal Zin brands to The Wine Group. Two companies appearing on this list for the first time are 585 Wine Partners and Purple Wine Company, two fast-growing wine companies with brands that were featured in WBM's Hottest Small Brands List for 2004. While the number of large wineries has declined in recent years because of consolidation-2004 and 2005 saw many changes-the number of new wineries opening for business continues to increase. According to WBM's proprietary database, nearly 300 new U.S. wineries opened for business in 2006. There are now 5,970 wineries in the United States (see "Number of U.S. Wineries Tops 5,900" page 64). The wine industry is vibrant and continues to change. Profiles of the largest wineries that start on page 30 include updates about what these companies accomplished in 2006 and expect to accomplish in 2007. Industry Outlook and Trends The last several years have been challenging for the wine industry overall. The industry has faced oversupply, discounting, economic uncertainty and a surge in imports. Yet the industry grew at a healthy rate in 2006. Industry executives contacted for this article said that they expect the wine sector to continue to grow in 2007 and expressed optimism about the future of the U.S. wine business. All were quick to point out that demand for wine is growing. The positive health benefits associated with modest consumption of wine, particularly red wine, have been news mainstays that continue to bolster overall wine consumption. Simultaneously, younger consumers are becoming more interested in wine. The huge United States market, considered the world's most profitable, is fueling competition from imports. Producers from around the world see the U.S. as a target market. Competition is fierce from Australia, Italy and Chile. Even France is making a comeback, and sales of imports are at an all-time high. A Healthy Industry "The wine business is going very well," said Diageo Chateau and Estate Wines president Ray Chadwick. "The consumer demographics are good, and it's a growing market." "It's been a good year for the wine business," Constellation Wines U.S. chief executive Jose Fernandez said. "We've seen overall growth in wine volume in the U.S. between 4 and 5 percent this year, and the dollar value is growing. By any measure it's a healthy business to be in. We're continuing to see consumers trading up, which is good for companies involved in premium wine." Fernandez was among those to note that younger consumers are embracing wine to a much greater extent than preceding generations did. "Attitudes about wine and the way wine fits into their lives are different than those of preceding generations," he said. "Younger consumers like to experiment and enjoy the whole discovery process of wine, and it fits into the things they're looking for, so I think that bodes well." "The consumption numbers are up, and the other thing is that people seem to be moving up in price point," Ironstone Vineyards president Steven Kautz said. "There are great wines at $7.99 and less, but customers are moving into that $10-$12 category." "The California wine business is pretty healthy," Wine Group president David Kent said. "The price of California wine recovered in 2004 and has stayed stronger. Consumption continues to be positive." Consolidation Continues Consolidation of the industry continued in 2006 (see the consolidation chart, page 68, for a look at how the landscape has changed in the last decade). Smaller wineries must compete against larger ones that can provide a one-stop shop and better deals. Some of the larger wineries support their wine portfolios with revenue from distilled spirits, making it even tougher for others to compete. "Consolidation of all tiers of the business is continuing to define the landscape and is accelerating among suppliers like ourselves, as well as among distributors," Fernandez said. "The retailer consolidation with more and more business going through chains will also continue to define the landscape. We're still in a very fragmented industry relative to other industries our size, and I think we'll see that continue." "We continue to see consolidation and a shakeup of the retail chains." Kautz said. "There are so many wines out there, and with the overall consolidation of the industry, these big guys are looking at who can supply at all price categories." However, some, including Delicato Vineyards chief executive Chris Indelicato, said distributor and retail consolidation have largely run their course and expect the wine business will remain highly fragmented. A Return to Classicism In recent years, wineries have been making their labels more accessible. "Critter brands" and "adventure wine brands" carved out a huge segment of the market, becoming an entry point for many wine consumers. In 2006, major wineries even created separate divisions to launch "fun" labels aimed at the younger demographic. Adventure brands, particularly attractive to young adults, do away with traditional wine pomposity and eschew typical place names, family names or chateau names, instead using clever names and visual cues that tie in to tell a story. While this trend continues, industry executives interviewed by WBM said they are seeing interest fade for whimsical labels, and many feel the "critter label" trend has run its course. "I was just asked how I'd summarize the changes to the wine business this year," said Jay Shoemaker, chief executive of The Coppola Companies. "I think we're returning to classicism. Lots of new wine drinkers have come into the category, attracted by bright labels and funny names. Now they're migrating to more classic varietals and labels, and I think that will continue." "I think the excitement from Australia, and some of the creature labels and innovative products, brought a lot of new drinkers to the category, specifically younger ones," Shoemaker continued. "Now those people are getting experience with more premium varietals and brands." Many new wine consumers who started with novelty wines have now moved to more traditional wines, Ste. Michelle Wine Estates president and chief executive Ted Basler said. "I think we're seeing a resurgence in classic wine labels that have authenticity. I think people are willing to pay a slight premium to have something seen as more authentic." "There will always be a market for critters and novelties and all that," Baseler said. "What we're seeing is a correction toward classic and traditional. Chardonnay is a great example. Two years ago people said Chardonnay was dead, but it is a very healthy market. Even Merlot, which people had declared dead, is seeing sales increases." Consumers Win: More Wines, Better Wines and Better Prices While consumers are buying more wine, they're clearly buying it at more attractive prices and have more options than ever. Industry executives seemed to agree, though, that pricing has been relatively stable in the last year or so; a couple of them even said they'd taken prices up this year without sacrificing volume. Virtually all said, however, that they see competition getting stiffer in general. "I'm very optimistic about the industry in the U.S., but that optimism is wrapped up in a very realistic perspective on how hard the business is," said Fosters Wine Estates chief executive Scott Wiess. "The business in total will continue to grow and will outpace growth in many other consumer categories. Americans are aging, have more income and are growing into the category. We, as an industry, are learning to market our wine to be more inclusive. There isn't a demographic group in which the trends aren't positive for wine or where there isn't upside potential. That said, it's harder today and will be harder in the future. We need to be good business operators." "The wine market is every bit as competitive as it has ever been," 585 Wine Partners chief executive Dan Leese said. "But I don't see lower prices than I did a year ago. And imported wines have the biggest share they've ever had, but that seems now to be moderating. California producers aren't going to give the market up. They will always fight for their piece of it. But the market itself is good. If you talk to retailers, they're very positive." Precept Brands chief executive Andrew Brown cited maintaining margins as being the biggest challenge facing the U.S. wine industry: "The challenge is that the United States is one of the last places where you can make margin as a wine business. Everywhere else in the world it is pennies. With consolidation, it will continue to become more competitive. People like Fred Franzia (Bronco) and Don Sebastiani (Don Sebastaini & Sons) are saying we've got way too much overpriced wine. That gets to the consumer public, and then key accounts ask the questions, and it trickles down." "The wine business is starting to become a much better understood business from an economic perspective," said Andrew Varga, Brown-Forman's senior vice president and managing director for Foundation Brands. "We all learned quite a bit the hard way in the late 1990s and early 2000s about some of the things not to do if you're in this for true economic reasons," he said. "I think in the past many of us tended to pay attention to the consumer and distribution pieces, and not as much attention to the supply and production pieces. When oversupply hit, it bombarded us. We are really managing the supply and production pieces a lot tighter; we know what we can and can't do, and it's really allowing us to build brands in a much more realistic fashion." Grape Supply, Imports and the Hangover from 2005 After four consecutive years or so of market imbalance and thousands of acres of vineyard pullouts, most California growers thought in early 2005 that the market for their grapes was improving. Bulk market activity was picking up, more wineries were offering contracts and there was a sense of optimism. The supply picture seemed to be moving back into balance. But the grape market in 2005 and 2006 remained very difficult. The expected correction, once started, seemed temporary. While demand for grapes and bulk wine had been increasing, and consumption of wine was up, 2003 and 2004, on a yield-per-acre basis, had actually provided short-yielding crops. The 2005 crop, though, was a whopper-the largest in history-and tanks were still brimming with 2005 wine during the 2006 harvest, killing grape demand. At the same time, imports continued to make inroads in 2006, with imported bulk wine readily available at unbelievably cheap prices, which also kept some California buyers from being aggressive about buying 2006 California grapes. Because of a relative scarcity of certain varietals such as Pinot Noir and Riesling, a number of wine companies chose to source some of their U.S. brands with imported bulk wine. When the numbers are finally counted, 2006 will probably turn out to have been an "average" crop, yet it will also likely be the third largest winegrape crop in history. Thousands of tons went unpicked in 2006, and many growers are expected to pull out excess vines. Still, most industry leaders expect demand for grapes to increase and the excess supply to wane. "When I look at the demographics, it all looks good," Hess Collection president Tom Selfridge said. But he noted a couple of things that cloud the picture. "We had a huge 2005 harvest, and we have lots of excess wine all over the world. Everybody wants to sell wine in the U.S. Even though demand is steadily going up, because of the supply situation it doesn't feel like it's gone up. You have to be on your toes, but it's an expanding market." Selfridge said the bumper 2005 harvest got people into an "excess wine mentality" in California but predicted that 2006 will turn out to have been a lighter crop than many expected. He said shortages of some varietals would come sooner rather than later. "Frankly, I'd rather live in a marketplace with a shortage than an excess, which is what we're headed for in California," Selfridge added. Fernandez of Constellation said he thinks the relatively short 2006 crop will balance out the huge 2005 crop. The 2005 crush was 3.8 million tons in California, and 2006 has been estimated to be 3.0 million tons (final numbers will be released by the California Agricultural Statistics Service in February 2007). Averaging the two numbers, Fernandez said that 3.4 million tons is roughly equivalent to the underlying demand for California winegrapes. "Take the two years together and I think we'll be largely in balance with the demand for wine," he said. "There's plenty of sourcing available," Leese said. "It's getting the right sources and securing those for the long haul. There's plenty of production capacity out there, but storage continues to be a problem." "I think the biggest challenge that the industry faces is that the South (Central) Valley farmers pulled so many vines during the grape glut of 2000-2003," said the Wine Group's Kent. "They have not had sufficient supply to meet consumer demand in years like 2004. One of the great challenges the industry faces is that the federal government is unfairly taxing the South Valley farmer relative to the rest of the industry. Thirty-three percent of the price a consumer pays for a South Valley wine is the federal tax and the distributor retail margin on that tax. That figure is 3 percent or less on a wine from Napa-because it is gallon-based, not value-based. Small producers have a tax exemption. Low-cost wines carry the burden of the taxes, which cuts deeply into what wineries can pay farmers for grapes, which prevents them from replanting their fields," he continued. "Certainly in the $10 and up super-premium area, business continues to do well," said Beam Wine Estates chief executive Bill Newlands. "It will be interesting to see what pricing looks like going forward, given that with some of the core growth drivers like Chardonnay there's not a lot of un-bearing acreage. If demand continues to grow as it has, it could push some price points up." "Based on the large size crop last year, it seems like there's an awful lot of wine in the world that needs a home," said Rodney Strong proprietor Tom Klein. "What's been made in California is nice wine. It's a good time to be a consumer, but we're not that far from shortfall. We're going to need these good growers going forward." "Wine has been in surplus around the world forever, and that's not going to change," he added. "But I don't see us in a long-term overly long situation for good wine. I think we'll end up being in short supply. Imports are going to be here. Wine drinkers want new things and want to experiment. They should. New Zealand Sauvignon Blanc has been healthy for the growth of the category. Good wine will get sold. It's healthy for the industry." Working the Trade, Working the Market Clearly, the wine industry is maturing and becoming more sophisticated. Wheeling and dealing on price still drives sales, but outreach and education of key trade buyers is even more essential. "From retailers to restaurateurs, everyone is becoming more wine savvy," Sebastiani Vineyards & Winery chief executive Mary Ann Cuneo said. "Lots of these people have sommeliers, master sommeliers and masters of wine. These are the people you want to get in front of and tell your story to-because they will or won't recommend your wines." "It's definitely more competitive," added Cuneo. "We pride ourselves on offering value and even though we've improved quality, we haven't gotten cocky on price. I think there are a lot of great values on the market." "There's a lot of potential out there, but there are somany brands and so many new brands out there that it's tough to find shelf space and even to find distributors," said Ironstone's Kautz. "The distributor network is to the point where they are throwing up their hands and saying, 'we don't want to see any new brands, we're so overloaded.'" "You have to be positioned properly in terms of quality to the marketplace, with an honest simple story and focus on quality." Selfridge said. Indeed, another of the key challenges facing wineries today is standing out from the crowd. "As an individual winery, the challenge is making sure you're differentiated with a clear and direct story because there's so much clutter out there," Selfridge added. "I'm reminded every time I go to Safeway. It's overwhelming, especially with all the competition from overseas. Have a clear message and stick to it." "With the number of wineries that there are now compared to the number of wholesalers, how to get attention and placement is an issue for everybody," Jackson Family Wines president Clay Gregory said. Global Sourcing Throughout 2006, WBM highlighted the huge industry topic of global sourcing. California growers are talking about putting together a public relations campaign to educate consumers and key trade buyers about California winegrapes. There's an oversupply of bulk wine in most wine-producing countries, much of it of reasonably good quality. To the extent that consumers buy wines based on brand, grape variety and bottle price, the country of origin is not seen as being as important at lower price points. "You can either embrace reality or sit around and complain about it while everyone passes you by," said Chris Indelicato of Delicato. "The economics are going to drive the market. You have to find the profitable niches in the business and work it hard. This whole globalization thing will make it more difficult for wineries to compete. We haven't felt the last of it yet. There's a global oversupply that will drive down pricing, and how it will manifest in the U.S. is to bring in more SKUs and wines that compete for the same shelf space. That tends to drive pricing down." "I feel like California, in many ways, has abdicated the under $10 (per bottle) market and it bugs me," Wimbledon Wine Company chief executive Bill Leigon said. "We shouldn't. Imports are nearly 40 percent of the market, and you hear writer after writer saying these bottles of wine from California under $10 aren't very good. There's no reason for that. We can produce high quality wines at $10." "What's going to drive what people drink is the best wine for the price, so the days of hiding inferior quality wine behind good packaging or strong distribution and promotion are numbered," said Indelicato. "The consumer is not as concerned about where it comes from as opposed to how good it tastes and at what price, and the chain buyers and retailers know it," Indelicato added. "That doesn't suggest the demise of the California wine business. Lodi, the Central Coast and Napa can easily compete with any Old or New World wine regions around the world. You just have to figure out how to do it profitably." Kent of The Wine Group noted that much of the global sourcing has been driven by "consumer-focused" wineries and a scarcity of certain varietals. "There's global sourcing at the low end because there's insufficient grapes in the field because of this tax situation," he said. "Whenever the industry wants something like Pinot Grigio or Shiraz-grapes that were virtually unplanted in the U.S. 10 years ago-the wineries that are consumer-focused go out and get those varieties. In the past, the farmers may not have been that forward-thinking, but they reacted and planted. Now California has abundant amounts of Pinot Grigio and Shiraz. Now we have it with Pinot Noir and Riesling, the principal grapes being imported. They're underplanted in California." Kent predicted that when ample domestic supply of those grapes comes on line, certain brands will move back to domestic sources. "The freight implications of importing wine will always favor the domestic sources," he said. "To me, the question is: what kind of quality do you put in the bottle, and what is the right price point?" Diageo's Ray Chadwick said. "If you put good quality in a bottle, the consumer is going to like your wine. If you over-deliver against quality at a given price point, you are going to have happy consumers." "Global sourcing isn't something that's being discussed for the first time, but this is the first year we've really seen it manifest itself," Fernandez said. "There are a number of brands in the market that have traditionally been domestic wines that are now being sourced fairly discreetly with imports, particularly in the value segments. I think we are in a global marketplace for wine; people are much less focused on appellation and enjoy trying wines from around the world." "Frankly, it's driven by scarcity in the U.S. and also by this big excess in Australia, but there are signs that will correct itself," Fernandez said. "They are having the worst drought in 100 years, and the projections are that 2007 will be considerably down from a normal year. With all the restrictions they're putting on irrigation, it's safe to say the 2008 harvest will also be small. There's less than half the normal amount of water available. And they have had some pretty severe frost damage. Over time, nature has a way of balancing some of that out. "I think the sourcing has been driven by shortages in the U.S. and the Australian wine lake, and I think over time both things will correct themselves. "There is a structural change, and there will continue to be global sourcing," said Fernandez. "So for a lot of value wines, people will be able to shop the world for the best quality-price relationships. But I do think some of the dynamics driving the big increases in bulk imports from Australia are cyclical rather than structural." Dan Leese from 585 Wine Partners observed that California growers are concerned about global sourcing. "They should be," he said. "If they're not concerned, who's going to be?" Gary Heck, chief executive of Korbel Vineyards, takes the issue in stride. "My advice to growers is to relax," he said. "We've been here for 124 years-nobody is running us out of here. The industry has been here even longer than that. We can weather the storms." wbm
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