Perfect storm forming - Scion Advisorsregional, national and global in scope. They include legal, political, and cul-tural developments. The speed of change is accelerated by economic

BY John Hinman, Hinman & Carmichael LLP, San Francisco, CADeborah Steinthal, Scion AdvisorsNapa, CA

Today’s wine industry in the U.S.is at a juncture in history unlikeany it has ever experienced, fac-ing complex challenges that are

regional, national and global in scope.They include legal, political, and cul-tural developments. The speed ofchange is accelerated by economicdrivers, technological innovation, andforces of globalization. One thing issure — by year 2015, the wine andalcoholic beverage distribution systemwill be more efficient, and more unfor-giving of failure, than it is today.

Each tier of the entire “drinks”industry will be impacted, includingwine, beer, spirits, ready-to-drink

(RTD), carbonated soft drinks (CSD),energy drinks, premium water, andjuice. Tomorrow’s successful industryparticipants will be proactive. Newbusiness models will emerge inresponse to market challenges, andsuccessful operators will effectivelyleverage new opportunities.

Five interrelated dynamics are hav-ing a cataclysmic impact on all industryparticipants — a perfect storm is gather-ing and generating monumental changein all tiers of the industry as the playersposition themselves for growth andprofitability. Industry participants willneed to develop essential, focused, anddisciplined strategies to weather thisstorm and prosper. Ultimately, con-sumers will benefit — from the innova-tion created by the forces of competition,from better access to higher qualitywines for the price, and from increasedretail resources available to incentivizecustomer purchase behavior.

What are these five interrelated dynamics?1. Supply and Demand Pressures —The sheer volume of global wine sup-ply is massive and provisioning a con-stantly expanding multibillion-dollarconsumer market. The net results ofindustry growth are supply-chainpressures, which force producers tocontinually improve wine quality andproduction efficiencies, and demand-chain pressures, which drive produc-ers and retailers to apply innovativepractices and produce more customer-focused and differentiated products.2. Producer Consolidation — Largeproducers are getting larger and areprimarily publicly held companies, astatus that provides better access tocapital sources for funding growth.With two notable exceptions (E&JGallo and Kendall-Jackson, which areprivately held and only in the wineindustry), the largest “drinks” produc-ers are dominant merchandisers in allthree major alcoholic beverage productmarkets — spirits, wine, and beer.

The inherent motivation behind pro-ducer consolidation is to achieveeconomies of scale in production anddistribution, which equate to profitopportunities, market power, lower perunit administrative and delivery costs,and more sales and marketing clout.These billion-dollar, mass merchandisersare forcing mid-size ($60 million to $500million) and small (less than $60 million)producers to become more focused andspecialized and better differentiated. Theoutcome is a widening chasm in howwine is sold — separating the billion-dollar, mass drinks merchandisers fromall other segments.3. Distributor Consolidation — Thestrong are getting stronger. In the U.S.,the alcoholic beverage distributor, orwholesaler, has benefited from a pro-tected business environment, as a resultof the legal and regulatory system cre-ated by the repeal of Prohibition.

The mandatory three-tier system,which still exists in most states, is acomplicated weave of restrictive regu-lations (cash laws, credit restrictions,primary source laws, at-rest laws, fran-chise laws, product registration, price-posting, and prohibitions on directretail sourcing from out-of-state).These regulations were designed toprevent brand movement between dis-tributors and assure comfortable dis-

NOVEMBER/DECEMBER 2005

M A R K E T T R E N D S

2

U.S. wine market liberalization by 2015

Perfect storm forming

Year 2015 — The consumer has MORE!More brands to choose from, more innovative products and packaging, morespecialized experiences with smaller wineries, and more quality for the price.

2005 2015

1. Supply & demand pressures2. Producer consolidation3. Distributor consolidation4. Retailer consolidation

5.Market

liberalization

1. Retailers / producers share more profits2. Widening chasm between the very large and the small3. Large drinks houses “selling” direct to very large retailers4. Small, specialized wineries selling direct to niche retailers

and consumers5. Distributors, as logistics providers — not sales force

Five interrelated dynamics force monumentalchange enabling wine (and drinks) wholesalers,retailers, and producers to compete on theirown merits by 2015.

21⁄2 tier distribution system=

$1 billion per yearLess profits for wholesalers



tributor margins regardless of the eco-nomic climate.

Over the last 10 years, wholesale con-solidation has been accelerated bywholesale margins being squeezed withnew overhead costs in technology,retailer-required merchandising, andadvertising. Consolidation is not abating.However, margin squeeze is causingwholesalers of alcoholic beverages toincreasingly focus on doing what they dobest — transporting and delivering prod-uct — and requiring producers to mar-ket, sell, and merchandise themselves ifthey want their products to move.

Modernization of the alcoholic bever-age distribution system is being drivenmore by economic factors than by legalaction. This is apparent in the reductionin the number of wine and spirits whole-salers. This tier has shrunk, from approx-imately 2,400 wholesalers in the mid-1980s, to approximately 250 today. Thisreduction occurred even without thespur of current legal decisions adverse tothe distribution tier.

The expansion in size of distribu-tor networks is another sign of thestrengthening storm. Southern Wineand Spirits spans the U.S. from Cali-fornia to Massachusetts. NationalDistributing Company (NDC) isexpanding its base in the south andsoutheast. Glazier’s is growing byaggressively acquiring distributors inthe midwest. Young’s Market Com-pany is a force in the west andHawaii, and the Charmer group(Charmer, Sunbelt and Premier,among other companies) is powerfulin the northeast, south, and the west. 4. Retail Consolidation — Whenwholesale margins are squeezed, theopportunity exists for large retailers tocapture a significant portion of wholesaleprofits, sharing these with producers andusing them to compete for consumerattention. This is happening today.

The retail wine industry is segment-ing into two broad categories — on oneside are wines sold in restaurant chainsand broad market off-premise retailerswith good price-to-value ratios (includ-ing private and controlled labels). On theother side high-end and scarce winesfrom high-profile producers are posi-

tioned as “luxury goods.” These winesare sold to customers on allocated lists,and they are located on wine lists inhigh-end restaurant accounts and avail-able at specialty alcoholic beverageretailers and in secondary markets, oftenat prices above $15 per bottle MSRP.

Implications of this “divide” areimportant. Positioning within onecategory or the other has a hugeimpact on the ultimate potentialvalue of a brand.

Development of on-premise andoff-premise, multi-outlet and multi-state retailers has driven much of theproducer and wholesaler consolida-tion of the last 20 years. This retailmodel exists to service a highly identi-fiable, targeted, mass customer baseand relies on controlled margins.Participating vendors must play a vol-ume game.

Wine is an attractive product forthese retailers, because it both exertsa pull on customers and providesmore profit per unit of cost than gen-eral merchandise or food. Thesetypes of retailers will continue toexpand globally and are likely tobecome even more focused on tar-geted customer segments. Someexamples include: Chevy’s and otherMexican restaurant chains, special-ized pasta chains, or groups of white-tablecloth restaurants that share acommon management and adminis-trative structure. Competition in thisarena continues to intensify, follow-ing today’s mantra of “driving costsout of the system.”5. U.S. Market Liberalization —However it comes to pass, whether byopening or restricting the flow of goods,in the wake of the Granholm decision inthe Supreme Court, the states (slowlyand one-by-one) will have to repeal ille-gal laws that discriminate in favor oflocal interests to the detriment of com-petitors in other states.

It is our view that, by 2015, whole-salers, retailers, and wineries increas-ingly will be operating in an environ-ment where they will have to competeon the merits of their wines, theirprices in relation to the entire market,and customer service.

The May 16, 2005, Supreme CourtGranholm decision is the most importantdevelopment in the industry in the last40 years. This decision is the culminationof a decade-long legal battle over theright of wine producers to ship out-of-state directly to consumers in states thatpermit their wine producers to ship toconsumers within their state.a TheGranholm decision supports the moregeneral conclusion that no state law canbenefit a private in-state interest againstan out-of-state interest in the same line ofcommerce, absent a compelling stateinterest (or when the state itself is theactor, such as in control states).

The Granholm decision will create adomino effect in the long term, acceler-ating the purging of state-level dis-criminatory laws that currently pre-vent direct shipment of wine. Firstaffected will be laws as they pertain towineries, and then as they pertain toother industry members.

The immediate state-level directshipping disputes will be legislativeand political in nature. They willinclude attacks against the right of in-state wineries to ship directly to in-state retailers as a defensive mecha-nism on the part of wholesalersconcerned about losing business.These attacks will ostensibly furtherthe goal of equality on the anti-alcoholtheory that everyone should be prohib-ited from shipping in order to protectminors and entrenched state interests.This has already happened in NewJersey, been threatened in Michiganand Indiana, and has been ordered as aremedy by a Federal District Court inVirginia in a follow-up case there.

21st Amendment jurisprudence hasevolved from the late-1930s cases thatallowed a state to regulate alcohol anyway it wanted, without regard to therest of the Constitution. A subsequentseries of cases moderated that position:a state cannot affect another state’scommerce;1,2 a state cannot violate anti-trust laws,3 a state cannot impose dis-criminatory taxes;4 and a state cannotviolate the First Amendment.5,6 Thiscontinues to evolve right up to today’sGranholm decision: a state cannot dis-criminate against out-of-state interests.

a. The Supreme Court in Granholm v. Heald, 544 125 S. Ct. 1885, May 16, 2005 found that the 21st Amendment did not authorize discrimination betweenin-state products and products from out-of state. Justice Kennedy held for the Court, “The Amendment did not give States the authority to pass nonuniformlaws in order to discriminate against out-of-state goods, a privilege they had not enjoyed at any earlier time.” This is the key holding in the opinion andrepresents the beginning of a clear line of authority (Authors).

The five essential dynamics describedabove are catalysts for change, conse-quently producing new global oppor-tunities and challenges.

Supply and Demand PressuresOPPORTUNITIES

New customer segments are evolvingboth in the U.S.and globally.More than 70million consumers from the millennialgeneration will be the single most signifi-cant factor affecting U.S. market demandin 2015. This generation appears to bewine-savvy at a much earlier age thantheir parents were, and early studies pre-dict they are likely to appreciate qualityproducts and brands.

This phenomenon is equivalent tothe post-WWII boomer explosion andis double the number of the millen-nial’s older Gen-X brethren. Earlyadopters in this generation also appearto be large consumers of high-end spir-its products, energy drinks, and pre-mium water.

As developing countries are industrial-izing and acquiring expendable income,new, untapped regional wine markets areemerging in China, India, and easternEurope. Although U.S. wine producersface global competition in these markets,well-positioned luxury goods and mass-marketed wines that leverage local cul-tural differences and values willencounter growth opportunities as thesenew wine consumers expand exponen-tially in volume.

One country’s mass-producedwine and beer are often anothercountry’s luxury products, andmany multi-national producers arecurrently capitalizing on that phe-nomenon.

Improvements in bulk transportationtechnology are now supporting growth ininternational bulk wine shipments. Bulkwine increasingly is shipped betweeneastern Europe and South Africa,between California and the UnitedKingdom, between South America andCalifornia, and between Australia andChina. This is a trend that will persistand will play an important role by year2015, enabling significant growth innegociant trade and private labeling,and smoothing out price differentialsbetween regional markets. Mostimportant, large global wine compa-nies will be able to optimize their costof goods in every market they chooseto enter.

CHALLENGESGlobal wine supply is perhaps too

abundant? Wine is produced in almostevery developed country in the world.India, China, and several easternEuropean countries are becoming wineproducers. Countries with excess winesupply, such as Chile, Argentina,Australia, New Zealand, South Africa,Georgia, Moldavia, and the traditionalEuropean producers (France, Italy,Spain, Germany), are hitting the worldmarket. In order to compete more suc-cessfully, many are replanting to takeadvantage of new production technol-ogy and soon will present more com-petition for California winemakers.

Driven by forces of good and bad,consistent growth in demand may still betentative. Population growth, increasingworldwide income held by the middleand upper classes in developed anddeveloping countries, higher-qualitywine at reasonable prices, and improvedmarketing and advertising are fuelinggrowth in consumption. However, grossdemand is slowed by unfriendly legalclimates (Russia and much of easternEurope), counterfeiting and other illegaltrade practices, decreased consumptionby historically high-consuming nations(Italy and France particularly), the anti-alcohol movement, and religious andcultural practices in many parts of theworld.

Global consumer perception ofUnited States’ wine quality is varied,inconsistent, and complicated by politicsand currency fluctuations. Aside fromE&J Gallo, very few U.S.-based winecompanies have shown the stayingpower and commitment to profitablydevelop global wine products and mar-kets. Untapped global markets may beprice-constrained and become thedomain of globalized mass merchandis-ers, such as Diageo, Fortune Brands, andConstellation, since these large-scale,multi-national business models arelargely impervious to currency fluctua-tions and have the budgets to establishand maintain market share. Smallerplayers export when the value of the dol-lar is weak and retire from global mar-kets when the currency pendulum shifts.

Producer ConsolidationOPPORTUNITIES

Large wineries can become moreprofitable through vertical integration of

their distribution systems and aggres-sively segmenting their products andservices to take advantage of marketopportunities. From a distribution per-spective, drinks are all liquid (also heavy,usually fragile, and must be protectedfrom temperature variations) and needto be properly stored, delivered on time,and managed in accounts.

More and more beer distributorstoday are multiple-line houses han-dling many products, and many arealso moving into wine distributionbecause it’s simply another box on thetruck. This is a trend that is inevitableand impacts every drinks marketbecause it makes economic sense toconsolidate as many products as possi-ble on the same truck for delivery tothe same accounts. For this reason, themajor consolidated marketing compa-nies are increasingly focused on pro-ducing premium products in almostevery beverage segment. For example,Constellation has Corona and Diageohas Guinness. These same companiesare also active in the RTD categories.

Examples of well-managed, largeentities include E&J Gallo — with over70 million cases shipped in 2004, theindustry leader in wine depletions —and Anheuser Busch (AB) — the indus-try leader in beer with more than a 50%market share. E&J Gallo and AB are cat-egory leaders, function as “categorymanagers” for many major off-premisechains, and are expanding product offer-ings to capitalize on the “premium is bet-ter” marketing climate.

E&J Gallo has segmented its productsmore than any other company in thewine industry and is capitalizing on thecurrent popularity of low-priced brandsfrom other countries (such as Yellow-Tailfrom Australia) with its launch of RedBicyclette from France. E&J Gallo ownsits distributors wherever possible, forexample, G-3 in California, and is anassertive partner in other U.S. markets.AB owns distributors wherever it is per-mitted to own them, rewards loyal man-agers with franchises, and has adopted adistribution agreement that provides anadditional margin on sales to compen-sate distributors that focus on AB prod-ucts to the exclusion of competitiveproducts.

A “two-and-a-half” tier systemcould eliminate between $1 and $5 bil-lion per year in distribution inefficien-cies by year 2015.7 Large producers



4



and large retailers increasingly workdirectly with each other on pricing,market positioning, advertising, andmerchandising. They do not rely ondistributors for these functions. Rather,they inform the distributor what theterms are and then pay for servicesthey actually receive (transportation,storage, billing, timely delivery ofproduct, and local market informa-tion).

If distributors provide extra serv-ices, such as merchandising support,they are paid for those services. Thisleaves more money in the hands ofretailers and producers, to apply todeveloping consumer awareness andloyalty and fewer profits in the handsof wholesalers. The Diageo distribu-tion agreement institutionalized thesepractices more than two years ago, andit is now being emulated by other verylarge producers through special pro-motional programming to encourageproduct movement at the retail level.

At the same time, large retailers areincreasingly embarking on selling theirown private, proprietary, and con-trolled-label brands, which affordthem larger margins. Sales of theCharles Shaw brand at Trader Joe’s is aperfect example. This new dynamicprovides distributors no effectual roleother than to deliver product.

Beer industry analysts have coinedthe phrase “two-and-a-half” tiers todescribe this trend and ascribe a billiondollars per year to the expected annualefficiencies extracted from the distribu-tion tier. These cost savings are splitbetween producers and retailers asadditional margins.

We believe that similar cost savingsexist within the wine industry becauseindividual unit values in wine aremuch higher than in the beer industry.Therefore, higher cost savings per unitare more likely to occur when the realvalue of services provided is substi-tuted for a distributor margin. Our pre-liminary calculations leads us tobelieve the wine industry stands toearn $1 billion to $5 billion per year incost savings once the wine marketbecomes fully liberalized. In responseto market dynamics, the modern dis-tributor is certain to provide more cost-effective local services, such as mer-chandising and product servicing, inan attempt to recoup lost profits.

Smaller and mid-size wineries thatsurvive consolidation will grow in valueand observable brand equity by becom-ing specialists. Concentrating on whatthey do best, these producers areinvesting in transforming their busi-nesses through more professional anddisciplined product portfolio and cus-tomer-based management practices.Many wine consumers are looking forunique experiences or luxury goodsthat do not fit the mass merchandisers’business models; they get that uniqueexperience from feeling that they arepart of a winery “family,” and thatonly comes from personal relation-ships built-up over time and main-tained.

By 2015, most successful smallwineries will be 100% customer-focused — with consumers and retail-ers being the customers. To the extentthat traditional distributors are reliedupon, it will be for the purpose ofservicing high-profile or importantaccounts in regions or areas wherethere is a large base of existing cus-tomers. High-profile account relation-ships provide a venue for obtainingand tasting wine, and thereby drivewinery direct sales and build smallwinery brands in the marketplace.

The next 10 years will be marked by atrend toward large wine producers col-lecting smaller, more specialized brands.The market is rewarding significantmergers of specialized mid-size winer-ies, such as RH Phillips and HogueCellars, under the management ofVincor from Canada; the Icon Estatesportfolio of brands, under the manage-ment of Constellation; and significantinternal growth through the develop-ment of multiple stand-alone brands,such as the brands produced by E&JGallo (both in Healdsburg and Modesto,CA).

The business models that will winare those that allow each specializedbrand to maintain its separate, butstrong and consistent relationship withits consumers. Kendall-Jackson’s Artisans& Estates are a good illustration of thisstrategy.

CHALLENGESExcept for the few top (A) brands,

most smaller and mid-size wineries arebeing locked out of the current three-tier distribution system. The cost of

marketing and sales has escalated formost wineries to upwards of 25% to30% of sales; consequently, manybrands are not realizing their goals.

Many expect that relief is on thehorizon from the three-tier systemitself, because the Granholm SupremeCourt decision is expected to liberalizestate shipping laws and potentiallyopen new consumer-direct channels.This is false hope for many, because itwill take a long time for changes to befully processed through each state leg-islature, and it will still be necessary topenetrate local markets to createdemand-pull.

Timing is important because thewinners will be the first to market —with the right wine, story, communica-tions structure, and customer service.The window of opportunity is now,because successful brand buildingtakes years, requiring a serious com-mitment of time and focusedresources.

In order to survive and grow, small-and mid-size wineries must already bebuilding the infrastructure capable ofcapitalizing on these opportunities.Brand building over the long term willbecome more and more difficult, as largeproducers segment their brands to fillavailable niches and well-positionedsmall wineries use their agility to capturethe consumer’s share of mind.

Distributor ConsolidationOPPORTUNITIES

In most of the world, the middle tierof the drinks industry exists as a serv-ice provider or as an adjunct of largeproducers. The distribution tier hasalways performed a valuable functionin assuring proper product storage,delivery, and merchandising whereand when required by producers andcustomers. An essential component ofthese relationships is the mid-tierinvestment in vehicles, warehouses,and transportation technology — off-set by a concomitant return on theinvestment. This is understood bybeer, RTD, CSD, juice, and energydrink segments of the U.S. market.Participants in these segments, seekingimproved efficiencies in their distribu-tion systems, are consolidating prod-ucts for storage, shipment, and deliv-ery on a common base of trucks,warehouses, and personnel.

As the wine industry follows inthese footsteps and our laws continueto change, the large U.S. distributionhouses should evolve from sales man-agement to fleet management, leavingmore money in the hands of the wineretailer and producer to build brandswith consumers and less profit in thehands of wholesalers. In doing so, theindustry becomes a two and one-halftier system, and the projected elimina-tion of in excess of $1 to $5 billion peryear in inefficiencies becomes morelikely.

Investment in more efficient deliv-ery technology is supported by largesuppliers and retailers. Examples offunctional, vertical integration arecommonplace in the non-alcoholicbeverage drinks segment, primarilyachieved through shared investment,brand equity, and regional distributionnetworks. Driven by technology andeconomics as much as by legal chal-lenges, the development of large pro-ducer networks and large retailer net-works inevitably will spur thedevelopment of large, coordinateddelivery networks.

CHALLENGESU.S. distributors are being forced to

invest in new technology and systemsnecessary to serve today’s customers,especially large multi-state retailchains. Without the scale necessary toefficiently compete, many old-line dis-tributors are selling to larger competi-tors rather than invest in the requisitetechnology and systems. Regardless ofthese economic developments, as longas the current wholesale tier is able toprofit from the protectionist legal sys-tem it created, change will be slowerand more incremental than it would bein a non-regulated product market.

With considerably more wine beingsold through fewer distributors, onlymass merchandisers and a few top (A)brands are getting properly serviced inexchange for a large share of theirprofits. New, specialized distributorsand brokers are emerging to supportsmaller brands. As laws continue tochange, new specialized shippingcompanies will emerge to fill the gapand facilitate direct shipping from pro-ducers to their retail customers andtheir consumers in return for a market-based service fee rather than a margin.

Retail ConsolidationOPPORTUNITIES

Large consolidated producers andwholesalers are becoming categorymanagers for certain large retailers.The large national retailers share acommon growth strategy. Examples ofthese include: grocery store chains(Safeway, Albertson’s), the super-premium grocers (Andronico’s, WholeFoods), the specialty food and beveragechains (Trader Joe’s, Cost Plus WorldMarket), the super retailers and ware-house stores (Costco, Wal-Mart, Target,K-Mart,), the chain restaurants (OliveGarden, Red Lobster, Chevy’s), and theconvenience store operators (7-11).

These retailers are centrally man-aged and are committed to vigorouscompetition (which means low-mar-gins) and good pricing to consumers,efficient and cost-effective customerservice, and limited SKUs (StockKeeping Units or brands), which areeasier to manage and have a high turn-ratio — usually better than 10 times to12 times per year. They are alsoexpanding into every geographic mar-ket that they can reach.

As they expand into these markets,the natural inclination is to implementcentralized, regional product fulfill-ment at the lowest cost for every prod-uct they carry, including beverageproducts. This model emulates a “two-and-a-half” tier system, because theretailer hires the distributor to providea delivery service for a fee rather thanto be paid a margin for product.

Retailers are already favoringselected (large) wine producers thatdemonstrate the ability to analyzeprofit opportunities and assist theretailer in making difficult decisionsamong an ample supply of productscompeting for scarce shelf and winelist space. These (large) mass mer-chandisers also have the scale to pro-vide advertising support, anothercritical component to category man-agement.

A growing number of luxury wineproducers are tapping into other large,more specialized, retailers. Specialtyalcoholic beverage retailers service amore specialized domestic retail winemarket. Examples include multi-outletretail chains, such as Beverages &More in California and ABC Liquors inFlorida, and smaller but high-volume

specialty retailers, such as Zachy’s inNew York, Sam’s in Chicago, Wally’sin Los Angeles, and K&L Wines andthe Wine Club in California. Theseretailers are heavily invested in inven-tory at higher price points and multi-ple SKUs and are increasingly manag-ing a multi-market customer base withstate of the art customer-relationshipmanagement systems. The hallmark ofthese retailers is customer-handhold-ing, education, and service, particu-larly in the above $15 wine categories.

Wine.com may be most technologi-cally sophisticated of these retailers,serving 35 states through a legallycompliant combination of ownedlicenses and marketing partnershipswith other retailers. These retailers usethe three-tier system where possiblebut do not wholly depend on it forproduct relationships. Rather, theybuild relationships with high-end pro-ducers and importers and sophisti-cated customers.

Subsets of these retailers are alsoinvesting in “collector,” luxury wines,purchased on the secondary marketand sold through to high-end users.This would include the auction houses(WineBid.com, Christies, Acker Merrilland Condit, Butterfield’s and Bon-ham’s, etc.) and a host of smaller inter-net-based retailers. These channels arebecoming increasingly important forthe luxury wine segment, because theyprovide both a source of mature,investment-quality wines and an out-let for selling those same wines.

CHALLENGESWine — two markets: The widen-

ing chasm between large mass mer-chandisers and small to mid-sizeproducers is most obvious at theretail level. Mid-size producers areeither merging or being acquired and get-ting larger or specializing and gettingsmaller. More than ever before, small- andmid-size producers are carefully develop-ing key retail relationships based on thevalue they are able to provide to theserelationships, in terms of merchandisingsupport and profit dollars.

Small producers are becomingeven more specialized, selling to spe-cialized wine shops and restaurants.Specialization requires improvedcommunications; more effectively dif-ferentiated brands — through packag-



6



ing, quality distinctions, and morefocused product portfolios; and acommitment to working more closelywith a smaller number of importantretail relationships.

The reality is that all wine produc-ers are seeking to become stronger atpositioning their brands and arelearning from each other in theprocess. Jug and the emerging “box”wine segments are now using varietalidentifiers and upscale packaging.Through specialization and nichemarketing, many winery — and retail— operated, proprietary wine clubsare growing in the U.S. and elsewherein the world.

Larger retailers are not only look-ing to manage fewer SKUs, they arealso launching their own, more prof-itable private labels in all price tiers.Retailers are attempting to buildvalue by creating their own brands,to help build their reputation andgenerate stronger return on brandequity. Private, proprietary, and con-trolled-label brands are each strate-gies for achieving higher retail prof-its where the margin is essentiallyspilt, after transportation and deliv-ery expenses, between producer andretailer.

Typically focused on wines in thelow- to mid-range price tiers, this fastgrowing, global market is now movinginto the luxury tier. Costco carries a$60/bottle Kirkland (private label)brand. In the last two years, multi-statewine distribution projects have beeninitiated — out of California to servicethe western states, out of Illinois toservice the midwest, and out of Floridato service southern states.

These projects involve private andcontrolled labels or mid- to low-pricenational brands that are centrally pricedand managed. Many wineries areactively specializing in supplying wineunder these special labels, and they arean important outlet for excess produc-tion. Others, selling their own brands,compete with retail private labelsdirectly for floor space.

U.S. market liberalizationOPPORTUNITIES

Wholesalers will most likely NOTbe successful in maintaining the statusquo. The depth of the wholesalers’ anx-iety is demonstrated by Wine and SpiritsWholesalers of America joining forceswith the conservative, religious right(Ralph Reed and his Christian Coalitionfiled an Amicus brief in support of thewholesalers in the Granholm case) andthe traditional anti-alcohol forces.

At least four dynamics are prevent-ing wholesalers from holding back thestorm: 1) wholesaler consolidationreduced the number of wholesalers —diluting their historic power. They willbecome even weaker over the nextdecade as they join consolidated sys-tems.; 2) winery trade associations aremore effective than in previous eras; 3)the Granholm decision truly exposesthe vulnerability of traditional special-interest legislation; and 4) special-interest legislation is an enormouspolitical risk that benefits one tier atthe expense of putting another tier outof business. Wineries can generatevotes, the real currency of politics.

A victory by Costco will reverberatethrough other states and lead to directshipment from producers to retailers.The Costco case is the 800-poundgorilla behind the door of the directshipping lawsuit, and Wal-Mart isright behind Costco. Costco filed suitin federal district court in Seattle,WA, in September 2003, seeking toinvalidate the following Washingtonstate laws: 1) distributor price post-ing; 2) minimum wholesale markups;3) credit law (Washington is a cashstate, requiring retailers to pay cashon delivery for alcoholic beverages);4) prohibition on quantity discountsand cumulative quantity discounts;5) prohibition on direct delivery fromout-of-state wineries to Costco ware-houses.b

Given that Costco is fighting soshipments can be sent directly fromout-of-state producers to its Washing-ton warehouse,c the interests of both

wineries and Costco should bealigned. The wholesaler’s legislativeresponse to a Costco victory is certainto be an attempted repeal of in-stateprivileges held by local wineries. TheWashington wine industry is also cer-tain to resist encroachments upon theprivileges for which it has battled solong. We predict that Costco will pre-vail in the courts and the Washingtonwine industry will prevail in the legis-lature.

If Costco establishes that it legallypossesses the privilege of receivingdirect shipments from out-of-state pro-ducers, then any retailer in any statewhere in-state wineries have a right toship directly to retail accounts in theirown states should possess the sameright.

California has the same restric-tions as Washington state and thesame privileges for its domesticwineries. If challenged, Californiarestrictions on out-of-state shipmentsto California retailers will also fall.This is certain to be a contentious andheavily litigated issue that will bebattled first in the large coastal con-sumer market states, such asCalifornia, Florida, Texas, and NewYork. State by state, legal action willeventually move to smaller marketsas consumer and business pressuresrise over unjustifiable price dispari-ties that become transparent becauseof better consumer and retailer accessto market information.

CHALLENGES (OR OPPORTUNITY?)The most significant court cases

will come from the retail tier. Changewill be slow, since regulators are dis-inclined to enforce laws that theybelieve may be discriminatory andsubject to challenge. However, it ishighly likely that the retail tier willbuild its case and win it — dramati-cally accelerating liberalization of thenational wine market.

If an in-state retailer can ship throughcommercial delivery services to a cus-

b. The Costco action survived 2004 cross-motions for summary judgment and was stayed pending the U.S. Supreme Court decision in Granholm. The caseis now going back for trial in March, 2006. Of note is the fact that in 2003, the Washington Supreme Court itself expressed hostility to the state regulatoryscheme when it invalidated the Washington franchise laws on the basis that they were discriminatory because Washington wineries were excluded. Mt.Hood Beverage Co. v Constellation Brands, Inc., (Supreme Court of the State of Washington, No. 72882-8, Feb. 20, 2003).

c. Equal treatment with in-state wineries that can ship direct to retail accounts, or with consumers in Washington who are also defined as “people” forlegal purposes and who can receive goods directly from out-of-state.

tomer, we believe that there is no validbasis for denying that right to an out-of-state retailer. Many states permit theirown retailers to ship directly within thestate, clearly discriminating againstretailers out-of-state.

Judging from the momentum of thelast several years and driven by retaillegal action, major legal hurdles will beovercome by 2015. While the economicand technological factors are the mostpredictable drivers of change, definitewild cards exist , including the potentialimpact of the anti-alcohol movement(which is currently focused on “youth”advertising and reduction in the avail-ability of product through retail outletcontrol), positive or negative develop-ments in health research, and the conse-quences of religious-based legislationprohibiting alcohol consumption inmany parts of the U.S. and the world.

The “Perfect Storm” is alreadybrewing with a two-and-a-half tier sys-tem operating with controlled-label orprivate brands that are deliveredthrough distributors at rates that areessentially transportation and admin-istration costs. As technological andregulatory breakthroughs occur, thistwo-and-a-half tier system will expandto broadly sold national brands overthe next 10 years.

On the global scene, major super-retailers have been expanding world-wide for several years. These includeTarget, Costco, and Wal-Mart. It is likelythat the major super-retailers fromEurope — Tesco for example — mayexpand into the U.S. or may acquire (orbe acquired by) their U.S. counterparts.

Because of globalization, we believethat the world in 2015 will comprise a

dozen super-retailers operatingthroughout the developed world, whowill be working primarily with theirworld-wide producer counterpartsand less so with smaller, national pro-ducers. In 2015, the average retail winebuyer program will most likely consistof a limited number of well-segmentedSKUs purchased from the top 20 wineproducers.

The big will get bigger. However,highly specialized retailers and produc-ers will continue to grow through nichemarketing, because of the adventurousnature of the high-end wine consumer,who constantly seeks new experiencesand education; many consumers willpersist in their quest for undiscovered,still higher-quality wines.

New wineries will continue toemerge; but the strong that survivewill go about marketing and sellingtheir wines in a more focused, seg-mented, and disciplined manner overthe next decade than they have overthe last. The consumer will get more:more brands to chose from, moreinnovative products and packaging,more specialized experiences withsmaller wineries, and more qualityfor the price. ■

Deborah Steinthal is the foundingpartner in Scion Advisors, a professionaladvisory firm focused on finding creativesolutions to the toughest problems of familywine businesses. Scion helps wine familyleaders transform their companies into moreprofitable organizations with obvious brandequity. Seasoned executives, Scion’s threepartners combine a unique perspective of thewine business with general managementknow-how from across several industries.

For more information visitwww.scionadvisors.com; or call or emailSteinthal at 707/258-9130, [email protected].

John Hinman’s experience spans themodern history of the wine industry andincludes regulatory defense before stateand federal government agencies, distri-bution litigation throughout the U.S.,arbitration and mediation of relationsbetween grapegrowers and wineries, anddeep involvement in the direct shippingbattles from the very beginning. Hinman& Carmichael LLP provides expert cor-porate, administrative, and regulatorylegal services exclusively to the alcoholicbeverage and hospitality industries andassists other law firms and in-housecounsel as special counsel on alcoholicbeverage issues.

For more information visit www.beveragelaw.com; or call or email Hinman at415.362.1215 x101, [email protected].

References1. Brown-Forman Distillers Corp. v. New

York State Liquor Authority, 476 U.S. 573(1986 and United States Brewers Association v.Healy, 692 F.2d 275 (1982)

2. Hostetter v. Idlewild Bon Voyage LiquorCorp., 377 U.S. 324 (1964)]

3. California Retail Liquor Dealers Associa-tion v. Midcal Aluminum, Inc., 445 U.S. 97(1980)

4. Bacchus Imports, Ltd. v. Dias, 468 U.S.263 (1984)

5. 44 Liquormart, Inc. v. Rhode Island, 517U.S. 484 (1996)

6. Cooper v. McBeath, 11 F.3d 547 (5th Cir.1994)

7. Prudential (Kantar) January 11, 2005Report — Future Shocks, page 4



8

Reprinted from:

58 Paul Drive, Ste. D, San Rafael, CA 94903 • 415-479-5819 • FAX: 415-492-9325

Visit our website:www.practicalwinery.comto learn more about PWV.

JANUARY/FEBRUARY 2010

BY Deborah Steinthal, Scion Advisors®,Erica Valentine, Scion Advisors®,John Hinman, Hinman & Carmichael

Over the next 24 months, con-sumer demand for wine willcontinue to grow globallyand the U.S. consumer will

lead the way. Industry advisorsSteinthal, Valentine, and Hinman pre-dict, “However, the wine industry willsee the fallout of weak players as thestrong get stronger.”The Great Recession has acceler-

ated the professionalization of thewine industry. Figure 1 illustrates howwine industry A-players are adoptingnew business practices at a faster rate,managing more strategically, andbuilding more financially viable busi-nesses.In November 2005, co-authors

Deborah Steinthal and John Hinmanpublished a groundbreaking article:“U.S. Wine Market Liberalization by2015: Perfect storm forming,” in PWVjournal, defining a ten-year frame-work for change. We predicted thatinterlocking dynamics — the forces ofglobalization, consolidation, and winemarket liberalization — would drivechange in all tiers of the wine industry(see Figure 1).By 2015, U.S. wine consumers

would benefit from better access tohigher quality wines for the price, dra-matically accelerating innovation cre-ated by the forces of competition.Four years later, as we move into

2010, we are exploring what has reallychanged. The purpose of this article isto challenge our assumptions and ask

ourselves: What is ahead for winebusiness leaders? How do we preparefor future opportunities and chal-lenges? We also want to revisit ourpredictions in the context of what weare now calling “the New Road.” Thestate of the world economy and itsimpact on the wine industry can nolonger be referred to as a “bump in theroad.”

Last 24 months: New realityBy December 2007, when we pub-

lished our update, A Perfect StormRevisited (II), in Wine BusinessMonthly, the industry’s largest playershad continued to grow through acqui-sition and global sourcing.Globalization was helping to mitigateproduction over-supply.

More states were open to interstateshipping. Regulators, driven bywholesaler trade associations lookingto control market access, were at thesame time making it more complex tomarket and ship wine direct, legally.This was inhibiting wineries and logis-tics providers from building profitablenew direct-shipping business models.Over the last 24 months, notwith-

standing the new legal complexities,winery direct-ship permitting andthree-tier delivery models havetapped into consumer markets for pre-mium and super-premium wines thatwere nonexistent even four years ago.The net effect has been to limit growthin this segment to those marketers andwineries who have heavily invested inthe new technology, while alsoempowering consumers to demandaccess to premium wines in the mostrestrictive states.An unexpected Great Recession

has had the net effect of acceleratingsome of our predictions and slowingdown other predictions. Although thereal ramifications of theGreat Reces-sion are still unknown, many areexpecting a long recovery period, withlong-term impacts on consumer pur-chasing behavior. Some impactsinclude:• The recession, interstate logisticshurdles, and a concentration of winesabove $50/bottle have put small

1

W I N E B U S I N E S S

Predicting future trendsand opportunities

PART THREE

PERFECT STORM REVISITED

2009 Globaliza on of supply and demand

Producer consolida on

Distributor consolida on

Retail consolida on

Wine market liberaliza on

2005–2015

1. Globaliza on of supply and demand

2. Producer consolida on

3. Distributor consolida on

4. Retail consolida on

5. Wine market liberaliza on

More consumershave better

access to high quality wine.

Figure 1: Five interlocking dynamics continue to have a dramatic effect on the wine industry.

Practical Winery and Vineyard


wineries in a perfect storm predica-ment, many reporting sales down asmuch as 40%.• Big players have been reconfigur-ing and trimming their portfolios togrow profits organically instead ofgetting larger through acquisition.• SKU rationalization is hitting eventhe smallest players.• Thousands of white-tableclothrestaurateurs have closed their doors,heavily impacting the luxury sector.• Luxury consumerism is considered“un-American” as consumers globallystruggle to keep their jobs and feedtheir families.• Distributor consolidation has esca-lated as that segment struggled to sur-vive in this economy, essentially shut-ting smaller players out of nationalwholesale channels.• Worn down by industry phases andeconomic cycles, many more winebusiness owners are looking to exitsooner through sale to third parties orto the next generation (February 2008joint report published by ScionAdvisors/ Silicon Valley Bank: “Own-ership Transitions in the WineIndustry.”)Most importantly, the pendulum

has shifted and the industry is morecompetitive and polarized than it wasfour years ago. Figure 3 illustrateshow the large, billion-dollar producersare more aligned with the very largedistribution companies and the smallproducers desperately need new oralternative marketing and distributionsystems.The U.S. wine market is undergo-

ing its most difficult cycle in 30 years.As large wineries are dominating andcontrolling a more limited number ofwholesalers, small wineries are liter-ally being locked out, unable to sellprofitably through existing nationaldistribution channels.Many wholesalers are heavily cash-

flow-constrained due to the globaleconomic downturn and/or debtincurred during recent consolidationdynamics. Given economic and com-petitive pressures, this market phasecould last for two to three years.The long-term impact of these

forces is dramatic on under 250,000-case wineries, especially those with

portfolios in categories above $30msrp/bottle. Even A-players, unableto move inventories, are down 30% to40%, and are discounting heavily.We expect a wave of foreclosures

and bankruptcies among wineriesmost dependent on national channelsand unable to cover cash requirementsover an extended down-cycle.Figure 4 revisits six key predictions

from our 10-year framework for U.S.wine market liberalization (WineMarket 2015).Little has moved the business of

producing, marketing, and sellingwine forward more efficiently than theeconomy.Wine producers have not yetbeen able to quantify the impact totheir balance sheets of either thehealth effects of wine or the greenmovement, but they are continuing tobenefit from the impact of wine con-sumption by millennials.

Key predictions in next 24months:“The new road?”Inspired by the Granholm Supreme

Court judgment, the dream of deregu-lation has not played out in exactly theway the industry has anticipated.We predict that by 2012 stronger

players will emerge with more finan-cially viable and technologicallysophisticated wine businesses. Theywill provide better quality wine evenmore suited to today’s emerging con-sumers, and will be positioned to take

advantage of emerging marketingchannels.Rob McMillan (founder of the Wine

Practice at Silicon Valley Bank), fore-sees rough seas through mid-2010 forproducers with cash flow issues orstrictly luxury-priced portfolios. “Forthose willing to do the hard workrequired to sell-though inventoriesover the next six months, their busi-ness should begin to stabilize by theend of 2010,” predicts McMillan.Rather than struggle through the

current economic and industry chal-lenges, more first-generation, luxury-brand owners will seek exit strategiesby selling their businesses and proper-ties rather than weathering the storm.The biggest industry challenges are

still ahead. At greatest risk are winer-ies without scale in the national mar-ket (under 250,000 cases) and continu-ing to depend on traditionalmarketing models that rely on distrib-utor sales forces. The primary hurdlefacing these small wineries is assess-ing how to profitably build sustainednational sales volumes, with grossmargins at least at 50% of sales rev-enues.“National sales channels that con-

tribute less than 50% margins are mostlikely not sustainable, especially sincemost wine business models are sodependent on capital-hungry assets,”says Hank Salvo (Scion AdvisorsPartner and former Robert MondaviWinery CFO).

2


Figure 2: Over the next 24 months, ‘A’ players arebuilding more financially viable businesses

STRONG WILL GET STRONGER WEAK WILL DROP OUT

Pruned, profitable product portfolios >$50 category takes long term hit

Focused, differentiated brands >100 ‘hobbyists’ quietly close doors•Wine culture shifts as consumers seek closer socialconnections with their favorite brands

Stronger, leaner teams Thousands of jobs lost

Cash becomes king Hundreds of equity lines close down

More diverse sales channels Thousands of brands drop out of• Hundreds of new retail private and control labels launch national distribution• Hundreds of new consumer channels launch

Selective growth thru acquisition Hundreds of properties sell• Excess grape supply gets absorbed by Hundreds of properties go into$12–$25/bottle wine categories, driving category foreclosurequality up

Next generation owners step up Next generation owners drop out



Some will survive and potentiallyprosper by tightening their productportfolios, improving branding, andupgrading their teams and businesspractices. Those most likely to prosperlong-term will radically change howthey sell to the trade and consumers.Looking ahead to 2012, five inter-

locking dynamics continue to beincreasingly important for wineryCEOs. These dynamics are strainingboth large and small players, forcingmajor operational changes along withnew modes of marketing and distribu-tion to better engage with consumers.

Global grape supply pressureswill exist: There is no substitutefor brand strength.A-brands are defined by increas-

ingly efficient supply chain practices;established, healthy distribution chan-nel management; and strong cash flowdisciplines. Global procurement man-agement by large wine companies, intandem with crop reductions causedby Mother Nature, have put grapesupplies more in balance with normalmarket trends. This will help the pathto stability for growers who are posi-tioned to weather the drop in demandfor the 2009 and, possibly 2010, crops.Contrary to industry predictions

less than six months ago, oversupplyis a reality everywhere — a trend thatis expected to persist throughout theworld. Pricing will likely continue totake hits. Growers that have catered toluxury wineries are facing drasticdrops in demand. Over-leveragedgrowers will be in trouble when theirgrapes go unsold.Large wine producers with global

sourcing options will profit from theresurgence of the popular premiumprice point segment and are using newinventory tracking and transportationtechnology to profitably shift suppliesfrom market to market. Small playerswill experiment with new sales chan-nels that will maintain image anddrive cash flow from higher volumeand lower-priced offerings.Banking pressures and cash-con-

strained businesses will limit thelaunch of secondary tiers, while fuel-ing the production of private or con-

trol labels, a common trend duringperiods of excess supply.

Consolidation will likely continuein all three tiers: Margins shrinkon all sides; 85% of retail spacewill be occupied by 10 winecompanies.a. PRODUCERS will learn to navigate

a polarized wine market landscape:comprising the large, multi-billiondollar corporations on the one handand the small to large privately heldwine businesses on the other (seeFigure III) — each operating quite dif-ferently and playing to different mar-gins.Major players Diageo and Constel-

lation will continue to pull back fromacquisitions, seek synergies frommerging their multiple operating unitsin 2009, and focus on gaining greatercontrol of their distributors and mar-ket efficiencies.The top 20 wine brands will use

their market presence and line exten-sions (and new brands) to reinforcetheir value to national distributorportfolios.Chris Indelicato (CEO, Delicato

Family Vineyards) says, “Wine is ahard sell because of the requiredknowledge base: larger wineries that

can afford to field sophisticated mar-keting and sales teams will continue togain market share.”The cost of promoting small pro-

ducers is simply too steep for largedistributors to afford. This is also thereason for the resurgence of spirits as adriver of distributor profit margins.Spirits are an easier sell and demand isdriven by substantial producer invest-ments in advertising and marketing.Seeking national distribution mus-

cle through an acquisition strategy,portfolio builders such as Bill Foley(see www.foleywinegroup.com) orJean-Charles Boisset (seewww.deloachvineyards.com) and focused privateequity players such as The VincraftGroup will buy more wine brands.According to Pete Scott (Vincraft

CEO), “The acquisition of KostaBrowne Winery is just the beginningof a wine portfolio comprising small-scale ultra-premium or luxury-tierCalifornia wineries.”Competition for consumer “share

of mind” will intensify in the U.S.market:1) Wineries in every state will cre-

ate new tourism opportunities andreach more consumers with educa-tional experiences;

3


Larg

ew

iner

ies

getl

arge

r

WHOLESALERETAIL PRODUCER

Club stores

Chain stores

Distributors Large (>$1B)producers

Largemarketingagencies

Move fromMove from sales force tosales force to !eet drivers!eet drivers

Move fromsales force to!eet drivers

Large retailers

Small retailers

New specializedlogistics

companies

New consumernetworks

Mid-sizewineries $60M

to $500M

Small wineries<$60M

WIDENING CHASMSm

allw

iner

ies

are

spec

ializ

ed

Figure 3: Pendulum shifts — small producers (under 250,000 cases) need a new distributionsystem.



2) Companies like Crushpad inSan Francisco (soon to be inManhattan along with City Winery),are building on a “consumer as pro-ducer” trend, offering hands-on wine-making experiences;3) Global competition from

Australia, Chile, and Argentina willonly be tempered by a weakening dol-lar.Many more wineries will experi-

ment with evolving direct-to-tradeand consumer channels and will con-tinue to develop brands that are rele-vant to a new generation of con-sumers. NewWeb 2.0 tools will enablewine brands to connect to new con-sumer networks, build awareness, andengage consumers — and learn tostaff, drive strategy, and ultimatelymonetize “social networking.”Rachel Dumas-Rey (CEO of

Compli, a leading beverage compli-ance services company) says: “Overthe next 24 months, wineries thatintend to survive and prosper willinvest in the most efficient and pro-

ductive direct shipping logistics solu-tions. Regulatory compliance is amoving target and so key to both top-and bottom-line growth.”b. DISTRIBUTORS have consolidated

from five to four major distributorhouses, leaving most mid-size winer-ies in a worst-case situation. Over thenext 24 months, the three-tier distribu-tion system will become even lessavailable to small players. Small winebusinesses will continue to seek outalternative paths to market.State regulators will invest in tech-

nology to enforce existing regulationsrather than making access for con-sumers easier. Renewed competitionfrom spirits and craft beer will cut intothe wine category’s “share of mind”with large distributors. Pre-packagedcocktails will infringe on wine sales,with TV ads driving consumer pull atretail and eroding market share forwine.Anti-trust will become a new legal

battle front. Consolidation couldencounter a backlash on both sides —

wholesale and retail. Demand willincrease for integrated logistics mod-els. Consolidation among these mod-els will blur the lines between logisticsproviders and agency or e-retail mod-els: mywinesdirect.com; wine.com;Adams Wine Group; Inertia BeverageGroup; Winetasting Network; Copper-peak, and Provino, among many oth-ers.c. RETAILER business models will

also undergo dramatic change. Overthe next 24 months lawsuits currentlypending in the federal court systemwill force regulators to revisit discrim-inatory regulations that impact retailermarkets. Retail powerhouses willexpand very profitable private andcontrol label offerings, and will add tothe competition for the consumer“share of mind.”Brick and mortar stores such as

Safeway and Beverages & More(BevMo) will be selling more winedirect than they have in the last twoyears. Retailers who jumped in overthe past few years with direct ship-

4


Figure 4: 2009 Reality CheckRevisiting predictions from 2007

PREDICTION: Global wine consumptionwill grow from $107 billion at 5% per year(Wine Institute, December 2006).2009 REALITY CHECK:• 2008 U.S. Wine consumption grew for the15th consecutive year. Through April 2009,total wine shipments in California increasedabout 5 percent by volume. Millennialconsumption grew by 23% in 2008.• Wine Market Council 2008 report, andJon Fredrickson in September 8, 2009, PressDemocrat article: Makers of high-end winescaught in ‘dead zone.’PREDICTION: U.S. will become the world’snumber one consumer of wine by 2010(Wine Institute, Dec. 2006).2009 REALITY CHECK:• For the first time, the US surpassed Italyin total wine consumption in 2008 — with27.3 million hectoliters vs. 26 for Italy.(International Organization of Vine andWine — VinExpo, April 2009)PREDICTION: Small wineries’ wine sales,shipping direct, will grow from $2 billion toover $5 billion (MKF Mar. 2007).2009 REALITY CHECK:• 2009 sales should be up overall with newDTC launches from major players such asQVC, New York Times, USA Today, and theWall Street Journal.

PREDICTION: U.S. wine industry will beappreciably deregulated by 2015.2009 REALITY CHECK:• We now know that the pendulum hasshifted, and wine direct sales have become abureaucratic regulatory licensing bonanzafor many states. By September 2009, it hasbecome more complex to ship wine acrossstate lines.• Although winery direct sales data isnot available, more consumers are buyingwine directly from online marketers,telemarketing merchants and cataloguersthan ever before. Notable: TV’s QVCchannel is marketing wine, WSJ.com isselling >$90 million in wine; New York Times,USA Today (and many more) are makingtheir consumer database available tosophisticated wine merchants with theability to direct ship in all channels.PREDICTION: U.S. wine trade policy andregulations will encourage innovationand participation.2009 REALITY CHECK:• Many initiatives are in play, and we assertthat the recession will become the mother ofinnovation as a critical mass of smallerplayers struggles to succeed.

PREDICTION: Integrated distribution modelswill serve large and small players, aidedby new technology — driving efficienciesin production and distribution.2009 REALITY CHECK:• Larger players, more able to invest intechnology, are moving into integratedinventory management platforms with keydistributors and customers.• Smaller players are struggling to keepinventories on distributor floors as non-performing SKU’s are dropped.• Filling the void, new distributionbusiness models are investing in technologyenabling smaller producers to find newpaths to market and ship direct to tradeand consumer.• Integrating with communications,ecommerce and fulfillment systems,experienced compliance solutions suchas E-Compli are positioned to support legalshipping direct to trade and consumers.• Now in development throughout theindustry is the “integrated” businessmodel, where one business entity combineswinery, import and retail operations (legalin California), and utilizes both directshipping and three-tier delivery to fulfillnational market orders obtained fromdifferent marketing sources.



ping across state lines will take cau-tionary steps in anticipation of a moreopen (but still complex) state directshipment permit system.As regulatory bodies continue to

clarify and interpret state law, we willcontinue to see more integrated newbusiness models enter the wine indus-try over the next 24 months. Morecompliant e-retailer models, trustedmerchants, and third-party marketingagent businesses will emerge — on theback of a new generation of wine clubsand hundreds of new consumer net-works such as Snooth, Wall StreetJournal, Sunset Wine Club, New YorkTimes, and winestilsoldout.com.

Slow economic recovery will slowwine market liberalization:Producers and retailers willscramble to understand andposition for a new generation ofwine consumers.The Great Recession has cat-

alyzed a consumption shift: a largelyBaby Boomer-driven wine economywill soon be supplanted by Millen-nials. Baby Boomers, driving growthin wine consumption for the past 30years, will enter retirement in droves.As they adjust to fixed incomes, theywill consume their cellar reserves and“downsize” their purchases, both byvolume and price point.Millennials, who will become a

larger consuming population thanBoomers, will pick up some of theslack. Some are already adventurouslyseeking out imported wines and newwines.Nutrition, wellness, and green

planet movements (biodynamic,organic, sustainability practices) haveyet to prove to be growth drivers forthe wine category. Consumers willcontinue to seek quality regardless oforigin, and more than ever before,they will demand value.ENGAGEMENTdb, a July 2009

report published by Wetpaint andAltimeter (available online atwww.engagementdb.com/downloads/ENGAGEMENTdb_Report_2009.pdf) indicates thatthe most valuable brands in the worldare experiencing a direct correlationbetween top financial performance

and deep social media engagement.Social media already allows wine cus-tomers to share their preferences inreal time, as aging media punditsbecomemarginalized and irrelevant totoday’s consumers.Over the next 24 months, wine cul-

ture will shift as consumers seek closersocial connections with their favoritebrands and continue to rapidly adoptsocial network technology to sharetheir authentic stories.One great example is the Benziger

Winery (Sonoma, CA) 2009 harvestvideo, which has attracted wine tweet-ers and drives people to theirFacebook fan page. Imagine — a GaryVaynerchuk for each winery!Social media could make direct-to-

trade programs even more viable ifwine fulfillment and distribution chal-lenges can be worked out cost-effec-tively. Liberalization will open upslowly as permits get easier to acquireand as states understand the tax valueof eliminating caps on consumer ship-ments.Wine has become mainstream and

is now an American tradition. Whilemany wine industry leaders wouldsay that today they have a “tiger bythe tail” and chaos prevails, we stillhold by our analogy:

“A perfect storm gathering hasgenerated monumental change,and by year 2015, the wine andalcoholic beverage distribution sys-tem will be more efficient, andmore unforgiving of failure, than itis today.The challenges are now multi-

faceted and more complex thanever before: regional, national, andglobal in scope. They include legal,political, and cultural develop-ments. The speed of change isaccelerated by economic drivers,technological innovation, and theforces of globalization.”

How to prepare for opportunity:Strategies strong players areadoptingRather than just “battening down

the hatches,” well-positioned winebusiness leaders are supporting theircrew with tools, training, and otherlifeline supports to ride out the storm.

Strong and strategically focused lead-ership is vital in steering wineriesthrough these challenging times. Hereare some important practices andstrategies to consider:

Everyone on deck. Everyone atsmall and mid-size wineries should beactively selling, on the road and inperson, in constant communicationwith the trade, brokers, distributors,consumers, and the media, throughtraditional means and the rapidlyexpanding online network communi-ties that includes social media andbloggers.

Increase productivity by develop-ing your team.With more talent avail-able during this recession phase, con-sider hiring stronger, more productivepeople; investing in better communi-cations and systems; and developingimproved execution practices.

Drive cash flow and profits. Largeor small, every business team shouldconduct an annual objective review oftheir product portfolio strategy,aligned with market opportunity.Each wine must be rationalized withan understanding of cost of goods,margin and overall performance toensure it is delivering a sustainablereturn — or phased out if it is not.

Grow your competitive advan-tages. In a highly competitive market,most wineries need to assess andimprove customer/consumer relation-ship management systems and disci-plines; expand use of market and cus-tomer information; and supportconstant improvement processesaround production, packaging, distri-bution and supply chain.

Investigate new ways to convertyour customers to brand advocates.Every brand needs to figure out howto engage consumers differently andto experiment with emerging socialmedia tools more effectively. Ratherthan an ad hoc approach, implementa-tion should be founded on a morecompelling and authentic brand strat-egy, clear goals, and relevant con-

5




sumer value propositions deliveredconsistently. �

About the authorsDeborah Steinthal (deborah@scion

advisors.com) is the founding partner ofScion Advisors, a Napa-based wine busi-ness advisory firm that enables clients tobuild more financially viable businesses.She has been an executive across a varietyof industries globally and helped compa-nies transform from startup through highgrowth, restructure due to poor perfor-mance, and integrate new acquisitions.

Erica Valentine ([email protected]) is a senior associate of ScionAdvisors. With over 15 years as a market-ing executive at Constellation Wines andSeagram Chateau & Estates, and 10 yearsconsulting with privately owned wineries,

venture capital, and web-based businesses,Valentine advises companies on how todifferentiate and compete successfully in acomplex marketplace, creating and imple-menting marketing and sales programsthat work.

John Hinman’s ([email protected]) experience spans the modern his-tory of the wine industry and includesregulatory defense before state and federalgovernment agencies, distribution litiga-tion throughout the U.S., arbitration andmediation of relations between grapegrowers and wineries, and deep involve-ment in the direct shipping battles fromthe very beginning. He is founder ofHinman & Carmichael LLP.

For further questions please callDeborah Steinthal (Scion Advisors): 707-246-6830.

6



1 | Fall 2011 Journal

William Goldring (chairman of the Sazerac Company and the Crescent Crown Distributing Company,

(Louisiana and Arizona) warned a crowd of mostly wholesale distributors at the 2011 Wine & Spirits Wholesalers of America (WSWA) convention in Orlando, FL that the three-tier alcoholic beverage distribution system was in danger from suppliers and retailers battling to under-mine it. “Should any one of the tiers get greedy ― and we do not hang together,” Goldring said, “we will hang separately. I caution our supplier-friends here today about slicing the pie too unevenly.”

Outside the convention center the sun was shining. The balmy April weather gave no hint of the storm within the alcoholic beverage industry itself ― and in the last 24 months that storm has picked up speed, intensity, and power.

The authors of this report predicted in 2005, and again in 2007 and 2009, that a perfect storm was generating monu-mental change in the alcoholic beverage industry. The forces of globalization, consolidation, and market liberaliza-tion have been converging and bringing cataclysmic changes to the industry, producing an alcoholic beverage dis-tribution system that will ultimately be more efficient – and more unforgiving of failure – than it is today. As the lead-ership at the WSWA convention recog-nized, only those industry participants who develop winning strategies will weather this storm and prosper.

Figure 1 shows how key industry participants at every tier will need to develop such strategies. In Figure 5, the authors provide readers with actionable insights to consider.

What will change over the next 24 months?

We offer new predictions for the next 24 months regarding five interlocking dynamics that are game-changing to the wine industry: 1) globalization of supply and demand, 2) producer con-solidation, 3) distributor consolidation, 4) retailer consolidation, and 5) U.S. market liberalization. Figure 2 shows how these dynamics continue to have a profound effect on all tiers of the U.S. wine industry.

In 2011, the storm is brewing at near-tsunami level, and we maintain that by 2015 a very different industry from that of 2005 will have emerged. The U.S. wine market is undergoing its most exciting and dynamic cycle in 30 years.

As large wineries and producer groups dominate and control a more limited number of wholesalers, smaller wineries are being locked out, unable to sell profitably to traditional retail

outlets through existing national distri-bution channels, at least until pre-Pro-hibition-era laws are changed to enable a fully liberalized market.

Ultimately, consumers will benefit ― from better access to higher quality wines for the price, and from increased retail resources available to incentivize customer purchase behavior. Over the next 24 months, we will see the follow-ing developments:

1. Capital investments driving new marketing and distribution systems will continue to be slow, impeding inno-vation and limiting growth for smaller wine businesses.

2. Polarization, more than a chasm between the large and the small, will increase as the U.S wine industry splits into two different distribution systems, driven by very different margins.

3. Figure 3 illustrates how billion-dollar producers will continue to align with the very large distribution compa-nies, while small producers seek new or alternative marketing and distribu-tion systems. The long-term impact

predicting trends and opportunitiesBY Deborah Steinthal, Scion Advisors,

John Hinman, Suzanne DeGalan, Hinman & Carmichael

PART FOUR –

PERFECT STORM

MORE CONSUMERS HAVE BETTER

ACCESS TO HIGHER QUALITY WINE

Figure 2: Five interlocking dynamics continue to have a dramatic effect on the wine industry.


EXCERPTED FROM

FALL 2011READ MORE & SUBSCRIBE

www.practicalwinery.com

Fall 2011 | 2 Journal

of these shifts is dramatic on under 250,000-case wineries, especially small wineries with portfolios in the above $30 msrp/bottle categories.

Supply and Demand pressuresIn July 2011, economies are slowly

rebounding from the recession, and wine sales have improved; only grape supply is short again, driving prices up. Emerging markets in Asia and Eastern Europe continue to grow, although they are not expected to match the top Western markets in value and volume for the foreseeable future.

Consumer choice itself, and the Millennial segment specifically, have the potential to reshape what the wine busi-ness will look like over the next quarter-century. Despite this potential, there is a lot more competition for the American wine consumers’ share of pocket.

Short supply cycle again driving higher grape prices – Short global supply will make it harder to serve growing U.S. market demand as the economy slowly expands again.

“The world has moved from a very ‘long’ position to a very ‘short’ posi-tion ― in no time at all,” says Steve Dorfman, partner at Ciatti Company (San Rafael, CA), a leading wine indus-try brokerage firm.

The weakness of the U.S. dollar is keeping foreign bulk wines at bay, which allows Americans to “drink” their way through any excess in American Chardonnay and Sauvignon Blanc. Experts are concerned about access to enough supply to cover growth in future market demand, due to inad-equate planting in California.

Growing the United States wine market – America has become the world’s

largest wine-consuming nation by vol-ume and value. “Overall, Americans spent $30 billion on wine in 2010, with the average American drinking only 2.6 gallons annually,” says Jon Fredrikson of Gomberg, Fredrikson & Associates, a wine industry consulting firm. “With the average Frenchman drinking 12.3 gal-lons per year, the U.S. market still pres-ents huge future growth opportunity.”

1. The short-term future for the U.S. wine industry looks rosy, with sales growth for the fine wine segment fore-casted to be 11% to 15% higher year over year, and for winery profits to margin-ally improve.1

2. U.S. off-premise wine sales were up 4.1% in volume in 2010 and 4.7% year-to-date through May 15, 2011. Anticipate sales to increase 21% over the previous year in the priciest wines ― in the $20+ categories.2

3. While on-premise numbers lag behind those of off-premise, growth is also returning to the restaurant market.3

4. Total imports in 2010 were 107.5 mil-lion cases, including 20.2 million equiv-alent cases of bulk wine, not all shipped into trade channels, notes Fredrikson.

5. A weak U.S. dollar at press time means imports are down, especially from Australia and Chile. But while bulk wine imports were down 23% by volume in 2010, imports are up over 50% from 2008 numbers. There are 25 countries that ship at least 50,000 cases of wine to the U.S.

6. While bulk wine imports are down, bottled wine imports continue to climb ― by more than 7% in 2010.1 New Zealand, Argentina, Germany, and Spain led the pack in terms of per-centage increases, and only Australia showed a decrease (2%) among the top

10 importing countries. Other countries increasingly want a share of the U.S. wine market ― witness the 2011 pur-chase of Fetzer Vineyards by Chile’s Concha y Toro.

Increasingly global, savvy, and younger Americans consume wine – With more and more Americans choosing to drink wine for lifestyle and health rea-sons, the potential to reach these mil-lions of consumers is irresistible. U.S. wine producers will face increasing competition from other countries. The producers that survive and thrive in the global marketplace will do so by deter-mining how to appeal to the globally savvy American consumer.

“The Millennial generation2 offers the wine industry the kind of growth potential not seen in more than 30 years,” noted the Wine Market Council in its 2009 consumer tracking study.

1. “Many [Millennials] are well-trav-eled, Internet-savvy, and total network-ers, encouraging and sharing wine, beer, and cocktail favorites as never before.”6

2. Although beer remains the bever-age of choice for this group, accounting for 42% of their alcoholic beverages, wine captures 20% ― up from 13% for GenXers when they were a similar age 10 years ago,” according to Danny Brager (VP Group Client Director, Beverage Alcohol Team, The Nielsen Company).

3. “If the usual pattern holds true for Millennials [of drinkers shifting from beer to wine and spirits as they get older], wine will account for 26% of all alcoholic beverages consumed by all U.S. generations by 2020, up from 24% today, while beer will fall from 41% to 38%,” according to Nielsen.

Giant wine producer Constellation Brands, appealing to this critical market segment, has introduced more “whim-sical” brand ideas at lower prices to capture this market. The company’s Rex Goliath brand, sporting a large rooster on the label and selling for less than $10 per bottle, is an example, which Jay Wright (Chief Operating Officer) says has “been on fire” with Millennials.

Long-term impact of discounting and flash sales – The big question of whether pricing has taken a permanent reset with the recession and the shift in con-sumer demographics is a major concern among producers.

The CEO of one large wine com-pany asks: “Will the value system of

Figure 1: All three tiers need new strategies to stay ahead of a growing number of traditional and non-traditional competitors

• Short global Supply will make it harder to serve growing U.S. market demand as the economy slowly expands.

• producerS will focuS on growing top / bottom line again.

• economicS are changing the diStributor powerbaSe, and new distributor solutions may dissolve traditional models.

• riSe of billion-dollar retailer is increasingly important to consumer choice, and is changing relationships among the three tiers.

• conSumer choice itself (Millennial segment specifically) has the potential to reshape the wine business over next 25 years.



the Millennials ever permit them to embrace luxury/icon wines to the same degree as Baby Boomers did, or should the wineries who depend on these price points focus more intensely on China, as the French have done?”

1. In just a few years the “flash wine market” grew to about $100 million in annual sales, fueling new wine sales models including WinesTilSoldOut, Invino, Lot18, Cinderella Wines, Groupon, Gilt Group, and ideeli.

Tim Bucher (founder and CEO of Tastingroom.com, an innovative online marketplace that enables wine consum-ers to “sample before buying”), asks: “What is the long-term impact [of flash sites]? Are we educating consumers that the Internet is the discount channel for wine? Or are consumers learning they can buy wine online ― opening up this channel to innovative marketers looking to capture consumer share of wallet?”

2. “The high-end market was extremely volatile in 2010,” notes Christian Miller (Research Director of Wine Opinions, a leading wine research group). “Substantial numbers of high-frequency and high-end consumers are still reducing their purchases of over $30 wines (msrp), especially clas-sics such as Napa Valley Cabernet and Bordeaux. Yet there were strong posi-tive trends for wines from Oregon, Washington, and South America, and for Zinfandel, Sauvignon Blanc, and Pinot Noir.”

Wine is mainstream in America – Wine Opinions’ in-depth analysis of wine con-sumption at home and on premise shows strong signs of the increasing incorpora-tion of wine into everyday life in the U.S.

“Fully a third of all wine that high-frequency wine drinkers consume is on Monday through Thursday,” says John Gillespie, Founder and CEO of Wine Opinions. “Not only are we seeing more wine being enjoyed on a casual, everyday basis, but significant amounts of wine are being consumed without food at all, or while preparing a meal, or with snacks. The proportion of red wine consumed without food is astounding.”

Producer consolidationOn the back of more cautious strategies

formulated during the economic down-turn to meet more conservative share-holder demands, as the U.S. economy recovers all producers will be focused on

how to grow top and bottom lines again. They face decreased consumer demand for higher-priced wines, increased com-petition from bottled imports, and the loss of branded shelf space to large retailers’ private label products.

While the large producer is ostensi-bly king and the small producer fights to survive, both segments have their own challenges and opportunities as consolidation within all three wine industry tiers intensifies. Increasingly, large producers with greater market share will compete with well-posi-tioned small and mid-size wineries that have learned how to capitalize on brand building to capture the consum-er’s share of mind or have formed into brand groupings to capitalize on multi-brand distribution efficiencies.

Large producer challenges – After sluggish activity during the recession, the pace of acquisitions is increasing in 2011, and the market is far more active now than it has been in recent years. Privately owned wine companies such as Foley Family Wines and Boisset Family Vineyards are increasingly buy-ing up standalone wine brands, and even the Chinese are entering the action with the recent purchase of Rutherford-based Sloan Winery. Answering to stockholder expectations for return on assets, large publicly-traded wine com-panies are offloading subsidiaries and brands that drag on investor returns:

1. Constellation Brands sold its Australian and U.K. operations to an Australian private equity firm for $290 million, shedding its value brands (wines that sell for $3/bottle or less).

2. In 2011, Brown-Forman Corp. sold Fetzer Vineyards and a portfolio of other brands to Chile’s lead producer, Concha y Toro.

Also in 2011, the expected demerger of Treasury Wine Estates from Foster’s Group became a reality, with speculation that the stand-alone Treasury may in turn sell some of its wine brands in a fur-ther effort to increase shareholder value.

large producer opportunitieS: Reducing cost of sales through outsourced services – With traditional wine distributors no longer being paid for in-store support for many of the products they deliver, potentially hundreds of millions of dol-lars will stay in the hands of the pro-ducers or at the retail tier even after taking merchandising fees into account.

One of the biggest developments in the last twelve months has been the rise of alternative distribution services, potentially driving improved margins for producers and retailers though logistical service providers such as Warren Buffet’s McLane Company4 and Core-Mark, as well as third-party mer-chandisers such as Advantage Sales & Marketing and Daymon Worldwide Inc.

1. Logistics companies such as McLane Company have improved economies of scale largely through centralized ware-housing and vast transportation fleets, potentially resulting in lower costs for producers. Large producers that work directly with retailers on private and con-trol label brands (PL/CL) and do not need the in-store product management that traditional distributors provide are in a better position to take advantage of these non-traditional distribution channels.

2. Alcoholic beverage merchandisers are helping producers manage product at the retail store level. Unlike tra-ditional distributors, these unlicensed third-party merchandising companies do not negotiate sales, are paid a flat fee for their services, and are more afford-able. Large producers that deal directly with stores’ category managers and do not need a distributor to facilitate sales at the retail level are able to benefit from these services.

large producer opportunitieS: Capitalizing on technology and social media – Wine market leaders are using data to tailor products and customize direct marketing campaigns with cus-tomer information. Winning business models are those that allow each brand to maintain its separate and strong con-nection with customers. Developments in technology are increasingly facilitat-ing this strategy.

While the rise of social media has pro-vided unique opportunities for small producers, large producers also are capitalizing on this direct route to con-sumers. Constellation, Diageo, Kendall Jackson, and Treasury Wine Estates all have special teams of Millennial mar-keters to work on digital media adver-tising strategies.

One Constellation campaign includes a Facebook page for Arbor Mist, which reputedly has developed into the largest wine social network site. Another cam-paign includes a YouTube video contest for Constellation’s Black Box line of wines.



Small producer challenges – Increasingly, smaller wineries complain they have no voice within the national distribution channels. Small and mid-size wineries will be hard pressed to survive in today’s competitive environ-ment, as they are unable to compete against large producers through the current three-tier system or build alter-native sales channels.

Even with DTC (direct to consumer) or DTT (direct to trade) opportunities, smaller producers still face the huge logistics challenges of getting their products to market on time, affordably, and with minimal wine damage.

1. Direct to trade strategies may not solve the small winery distribution dilemma. Many believe an elimination of the distribution tier would help their businesses, but there may be no easy alternative, according to a 2011 sur-vey by Steven Rannekleiv of Rabobank. Retailers told Rabobank they would not add shelf space any time soon to make way for small producers’ products sold outside the usual distribution channel.

2. The legal and regulatory hurdles facing any concerted DTT effort are sig-nificant. Truman Reynolds (VP of third-party order fulfillment company Pack n’ Ship Direct) says: “Regulatory chal-lenges still dominate as we tiptoe through the legalities of clearing prod-uct through customers in many mar-kets.” Pack n’ Ship Direct (www.packn-shipdirect.com), Wineshipping.com, and Winetasting Network are three dom-

inant third-party logistics providers ser-vicing the California wine industry.

3. With Washington and Oregon cur-rently the only legal direct to trade states from out of state, huge hurdles must be overcome before direct to trade becomes a viable channel for smaller wineries ― including how to reach and sell to trade customers.

4. Margins will continue to suffer in a market where consumers expect deep discounts, and short supply is driving increased cost of goods. Rachel Dumas Rey (CEO of Compli Beverages, a lead-ing beverage compliance services com-pany) says: “I am surprised we have not seen more small producer consolidation into business models where front end [market muscle] and back end [econo-mies of scale] are leveraged more ― for example, administrative, purchasing, and licensing economies.”

5. Overwhelming challenges may tempt many producers to sell out. Top properties with stellar reputa-tions, valuable brands, and winning management teams will always be attractive to buyers. However, this does not make for a practical exit strat-egy for a majority of small and mid-size properties. While private equity remains interested, the asset-intensive nature of the wine industry is not a top investment choice when times are tough, except for the rare occasion where family succession dynamics push top brands to sell, as in the recent sale of Seghesio Family Vineyards to

the Crimson Wine Group.5Small producer opportunitieS: Wine

purchasers are shifting to the digital world – U.S. wineries are expecting the DTC channel to be their fastest grow-ing sales channel for 2011, especially online sales. The savvy small producer is already engaged with consumers and learning the best ways to use social media, making this a key part of its marketing strategy. Figure 4 shows how social media, with its promise of direct conversations and meaningful exchanges between customers and pro-ducers, fits perfectly with these trends.

Some observations about wine DTC:1. U.S. consumer direct wine sales ―

online, wine club, tasting room, and event sales ― grew 12% in 2010 to $3.4 billion.5

2. Online wine sales alone grew 38%, and projections for 2011 are even higher.

3. Many expect online sales to speed up, doubling by 2012 to a $500 to $600 million channel (depending on the rate of growth of flash sales as the economy improves).10

4. Big upside with focused resources: Online sales are constrained by inad-equate strategy, resource commitment, and tools/platforms. “Only 25 to 30 U.S. wineries have a full-time dedicated ecommerce staff person,” says Paul Mabray (founder and CEO of Vintank, the leading wine industry digital mar-keting think tank). Most ecommerce staff are still wearing multiple hats (wine club, tasting room, ecommerce).

5. Flash sales grew to become a $100 million digital retail channel. Since many of these transactions are accom-

Large

become

larger

WHOLESALERETAIL PRODUCERClub stores

Chain stores

Distributors Large (>$1 billion)producers

Large marketing agencies

Move from sales force to fleet drivers

Large retailers

Small retailers

New specialized logistics

companies

New consumer networks

Mid-size wineries $60 million

to $500M

Small wineries<$60 million

WIDENING CHASMSmall

become

specialized

Figure 3: Under 250,000-case producers need a new distribution system to grow profitability.

60% of core wine drinkers and 40% of marginal drinkers use the Internet to get information about wine.

Wine Opinions’ 2011 Consumer Trends Report

shows that wine consumers

increasingly tune in to their favorite passion through

social media.

• 38% of core wine drinkers use social media to discuss wine.

• 45% who use Twitter “follow wine people” on Twitter.

• 46% Tweet family or friends about wine.

• 41% are Smart Phone users. Among these Smart Phone users 39% use wine/food/restaurant applications.

Figure 4 - Wine consumers are heavily engaged through social media.



plished through the three-tier system, producers do not always benefit from a direct sale margin.

6. 13 to 14 million conversations were about wine online in 2010 ― predicted to grow to 20 million by 2012. “This provides wineries with intelligence and visibility to mass consumers and means to sell product,” adds Paul Mabray.

7. Consumers are increasingly enam-ored of artisan, handcrafted products in a world of mass production.5 Wine consumers are engaging with produc-ers directly in the tasting room and through social media channels, or indi-rectly through shopping for wine online or at a bricks and mortar store.

Consumers are heavily engaged through social media – Both small and large wine companies are now engag-ing with consumers. Social media is no longer just the turf of founder-run smaller artisan businesses. This is both an opportunity and a competitive chal-lenge for small producers.

“Social CRM (customer relationship management) is a critical tool that win-ery marketing and PR departments need to effectively leverage and convert into online sales,” says Paul Mabray. Over the next two years, we will see maturing industry skills and platforms, enabling these social connections to convert to commerce.

Small producer opportunitieS: Retailers are positioning uniquely with consumers – On- and off-premise retail physical and Internet outlets (see Retail con-solidation, below) are blurring the lines between winery tasting rooms and sampling at home and in stores.

1. Sample sizes or tastes of differ-ent wines (www.TastingRoom.com), beers, spirits, and sakes are being offered online and in wine bars, stores, restaurants, and hotel lounges. Small producers who participate are build-ing customers faster and more afford-ably by getting more people to sample their products, telling their unique story through more outlets and offer-ing educational experiences that build meaningful memories and more loyal brand ambassadors.

2. Wineries are seeing a surge in local and regional restaurant chains cater-ing to consumers’ heightened drive for taste adventures. Top restaurants have become much more creative with their beverage programs, inviting distilleries

and wineries around the world to give customers more choices than ever before.

3. Specialized retail grocers offering ethnic foods or local artisanal products are faring well even in the aftermath of the economic downturn. Small produc-ers who might otherwise get lost in the mass of products at mainstream super-markets now have more opportunities to hand-sell through specialized retail outlets where customers are more likely to expect to pay for quality.9

There is no question the big will get bigger. But small, highly specialized wineries can survive and even thrive through quality product, untraditional trade channels, and niche marketing.

Distributor consolidationThough distributors have increasing

clout, economics are changing the dis-tributor powerbase, and new distribu-tor solutions may change traditional models. In late 2010, Wine & Spirits Daily speculated that Buffett’s McLane entry into the alcoholic beverage dis-tribution business meant more mergers and acquisitions, as distributors seek improved efficiencies in a changing marketplace. Since that article was writ-ten, more distributor consolidation has indeed occurred.10

As the legal battles over maintain-ing the three-tier system demonstrate, distributors worry about maintaining their protectionist system. Their con-tinuing efforts to strengthen legislation already favorable to their tier point to their discomfort with the economic and social forces that question the value of the current system. Big forces of change at this tier include:

1. Increasingly, distributors are express-ing concern over the rise of big retailers.11

2. A growing market share of private and control label products (PL/CL) is driving much lower distributor mar-gins, with distributors acting essentially as delivery services for PL/CL.9 Experts estimate PL/CL has grown from 22% to comprise 30% of the market today;9 other large producers speculate PL/CL represents up to 40% of total wine sold on the U.S. market.

3. We noted back in 2005 that by 2015, large retailers would increasingly work directly with large producers on pricing, marketing, and merchandising, with distributors no longer getting paid for these services – moving potentially

$1 to $22 billion in income to the pro-ducer or retailer side of the ledger.

diStributor challengeS/opportunitieS: Economics are transforming the power-base in the middle tier – With new logis-tics providers ready to step in and offer delivery services at lower (often fixed) cost and greater efficiency, and with third-party merchandisers dedicated to providing producers with in-store dis-play and related services, where does this leave the middle tier?

1. Margin squeeze is one result. Some distributor margins are starting to resem-ble those of spirits distribution margins (18% to 20%), and the PL/CL dynamic may be pushing these margins much lower. The modern wholesaler is measur-ing productivity by margin contribution and less by case volume. The prolifera-tion of PL/CL may in fact re-incentivize wholesalers to pursue more branded products with higher margins, such as brands in the under 250,000 case range.

2. Some speculate that beer distribu-tors ― traditionally used to lower mar-gins ― may step into this changing landscape, where unrealistically high fixed distributor margins (25% to 35%) are no longer the norm.

3. We foresee a new generation of smaller regional and specialty whole-salers emerging to serve small to mid-size producers. These niche product specialists, often veterans of large dis-tributor organizations with specialized product knowledge, will market to on-premise and specialty retail chains, and independents. Their challenge is build-ing a strong enough balance sheet to afford inventory and pay suppliers.

The recent TTB approval of bailment warehouses9 (essentially consignment facilities where suppliers continue to own their own inventory until orders arrive, at which time inventory is transferred to the wholesaler) may strengthen this channel further in the near to mid-term future.

Distributors are still a powerful group responsible for selling more than 300 million cases of wine in 2010, and federal and state laws still protect their power base.

Retail consolidation“The growing pace of retail consolida-

tion in the U.S. may be the most signifi-cant dynamic over the next 24 months,” says Danny Brager (VP Group Client Director, Beverage Alcohol Team, The



Nielsen Company). Large retailers are growing larger, in part spurred by PL/CL products. The rise of the large billion-dollar retailer is of increasing importance to consumer choice and is changing the relationships among the three tiers.

One example of the giant retailer trend is Total Wine & More, the larg-est privately owned, multiple-state alcoholic beverage retailer in the U.S. Co-owner David Trone predicts that 2011 revenues (chain-wide) will be more than $1 billion. Private label is an important part of Total Wine’s business, although the company has declined directly to give numbers.

retail opportunity: National retail chains see significant growth through Millennials – Successful large-scale retailers are capitalizing on current trends and opportunities by catering to the choices, experiences, value, and convenience customers now expect, and tailoring products and marketing efforts toward Millennials.

“We are targeting Millennials because they like convenience and to try new products,” says Jesus Delgado-Jenkins (7-Eleven’s Senior VP – Merchandising and Logistics).

A November 2009 Symphony/IRI Group report, “Winning with Millennial Women Shoppers,” assesses Millennial psychographics:

1. Millennials are eight times more likely to relocate than Baby Boomers in the next few years, mostly to emerging cities in the Southeast, Southwest, and the Rockies.

2. Demographic shifts, especially among Millennials moving from north to south, favor the large chains. They expect the level of service and variety of products they experienced in one state to be available in another.

3. Millennials tend to shop less and spend more when they do shop, prefer big box stores, and are believers in pri-vate labels.

4. 70% of those surveyed in a Symphony/IRI Group report think store brands represent high quality.

retail opportunity: Retail players find creative ways to engage customers – Some U.S. airports now allow liquor to be sold around the clock. A few provide tastings at terminal locations. Upscale locations at airports where passengers can drink while waiting for flights are on the rise. Vino Volo was launched in


Figure 5: Next 24 moNths – Seven winning strategies to leverage trends and overcome hurdles

1. Win share of mind by develop-ing strategic marketing and sales programs. • Target the growing casual, everyday wine drinker, and consumers having wine without food, while preparing a meal, or with snacks. • Develop unique digital media advertising strata-gies: Experiment every week with affordable Facebook and YouTube tactics. Track results.• Understand how new integrated, cross channel, go-to-market strategies will drive consumer awareness and sales. (See PWVJ, Summer 2011: Winning consumer share of mind.)• Populate the Internet with information and stories about your wine brand – more than half of all U.S. wine drinkers are on Facebook, and 25% also use MySpace, YouTube, and Twitter.

2. Differentiate or die! • Carve out a niche to maintain a separate and strong brand connection with customers. • Find niche retailers, such as wine bars, where consumers can sample your wines and hear your story.• Initiate direct conversations and meaningful exchanges between customers and your company through social media and other tools. Think conversations, not sales pitches.

3. Grow online sales by converting social conversation to social com-merce (sales).• Develop an integrated sales and marketing strategy, and detailed plan.• Dedicate experienced staff full-time to the ecom-merce channel.• Invest in the platform: Use data and CRM tools to tailor products and customize direct marketing campaigns with customer information.• Connect website information to travel and blog-ging (biggest digital categories).• Make website information and technology work with mobile applications (50% of Internet conversations).

4. Tailor new products through non-traditional retail channels.• Sell sample sizes or tastes of different wines online (www.TastingRoom.com), in wine bars,

stores, restaurants, and in hotel lounges.• Develop local and regional restaurant chain relationships, with venues catering to consumers’ more adventurous tastes. • Focus on specialized retail grocers with a niche offering, such as ethnic foods or local artisanal products, where customers are more likely to expect to pay for quality.

5. Service retailers better: they want to sell a lot of wine, too.• Teach retailers about your business: Share goals, strategies, and tactics, and do a better job of mak-ing recommendations suit those goals.• Show objectivity: Put the category first, and have a professional sales process focus on the customer rather than your portfolio.• Deliver insights/answer the question “So what?” If you have data, explain why it is useful.• Share post-program analysis – help retailers learn what went well and what did not. • Make every seller a fan of your wine.• Keep products streamlined to avoid sales staff retraining. • Find your segment, establish your message, and educate about how you distinguish your brand.

6. Assess alternative distribution services, third party merchandisers, and regional wholesalers.• Experiment with alternative distribution strate-gies that are better aligned with target markets, or provide more control over margins and pricing.• Find ways to collaborate with distributors or brokers who are more aligned with your goals.• Build a meaningful distributor relationship through innovative brand building, partnering, or acquisition strategies.

7. Manage and control supply sources and costs more tightly.• Consolidate back office support, especially mixed, decentralized vineyard and wine opera-tions.• If market demand is there, secure growth financ-ing or capital to support growth strategies.• Negociant brands: Secure access to the right balance of supply sources through acquisition or strategic partnering.


September 2005, bringing high-quality wine and food to airports. “Vino Volo has grown rapidly,” says CEO Doug Tomlinson, “with 17 stores in operation by Spring 2011 with plans to grow to 50 stores within the next three years.”

retail opportunity: Wine bars are the coffee bars of the 21st century – Wine and beer bars at grocery stores and cof-fee shops may become the wave of the future.6 The retail wine industry is tak-ing advantage of the same trends that are hitting beer and tea. Whole Foods is experimenting with this concept in some stores and, if successful, will roll it out on a wider scale. Starbucks may begin serving regional wine and beer in at least some of its 16,000 stores around the world if the idea meets with customers’ approval in the company’s Seattle home base, where the concept is being tested.

Wine bar concepts in general are exploding around the country, with multiple bottle lists, themes, and many wines by-the-glass (50 to 100 offerings are common).

Online retailers, despite legal issues that vary from state to state, continue to grow. Leveraging more than 10 million online viewers who tune in to their TV programs, the Food Network launched an online wine club in July and could soon become the largest online retailer in the world.

U.S. market liberalizationThe influence of the retail tier on wine

market liberalization is significant. This tier has 90% of wine inventories and is energizing an increasing wine-savvy customer base ― including a grow-ing number of Millennials. Increasing consumer demand ― for variety, con-venience, value, personal experience, and communication ― is distinctly at odds with three-tier alcohol beverage distribution. How the law evolves to reflect this rapidly transforming mar-ketplace will, in part, determine the pace at which the wine industry itself can change to meet consumer demand.

We are halfway to 2015. What effect has the U.S. Supreme Court Granholm decision had?

Two steps forward, one step back – Litigation and legislation continue to shape this dynamic.

1. The CARE Act, intended to legisla-tively reverse the Granholm decision, is a sign of the desperation of the wholesale

tier attempting to hold the line against modernization of the industry. Backed by the Wine & Spirits Wholesalers of America and National Beer Wholesalers Association and roundly condemned as cynical and unnecessary by every U.S. producer-organization in wine, spirits, and beer, the CARE Act has yet to find a Senate sponsor in spite of a record level of political spending by distributors hoping to influence politicians.17

We predict the CARE Act will fail, and that failure will accomplish exactly the opposite of what was intended by its authors. It will show the American con-sumer the inability of current delivery systems to provide the products they want when they want them.

2. The retail tier lost its effort to apply the Commerce Clause principles of Granholm to interstate shipping by retailers when the Supreme Court declined to hear the Wine Country Gift Baskets case19 in March 2011. The Supreme Court’s denial of cert leaves retail-based wine clubs, flash market-ing sites, marketplace sellers, specialty wine clubs, and auction houses and specialty stores holding older vintages and rare wines vulnerable to state laws challenging their right to ship wine directly to consumers.

3. Consumer refusal to accept the restrictions of the three-tier system is confounding regulators across the country, whose only recourse is to arrest their own consumers for unlaw-ful importation of alcoholic beverages, something they are loath to do.

The loss of the retail case served to drive more commerce underground. Some determined collectors are using every tool at their disposal to obtain wine they want regardless of where they live, and others are purchasing their wine in the state of the merchant and importing it themselves.

We expect the ultimate winner will be the consumer, and breakthroughs within the next two years will include development of legally compliant ship-ment systems, using new technology to decipher the complexities of the three-tier system and 50 different state laws. Consumer demand justifies the cost of system development.

4. Retailers are using their clout with consumers to fight back. Battles over selling wine in grocery stores are raging in New York, Tennessee, and

Kentucky, and fights over retail license limits have been placed on the ballot in Massachusetts and are the subject of legislative hearings in New Jersey.

New tactic: the initiative process – First with court battles20 and in 2010 with its failed Initiative-1100, big-box retailer Costco has attempted to over-turn laws in Washington state that uphold restrictive alcohol regulations. In 2011, Costco introduced another measure, Initiative-1183. Potentially less objectionable to anti-alcohol forces, the new measure would allow quantity discounts and central warehousing for wine and spirits (although not for beer), and privatizing liquor sales in this cur-rently control state.

Will Initiative-1183 be successful? In 2011, Costco is NOT being opposed by a competing initiative, as was the case with Initiative-1100, but rather by a combination of wholesaler, public entity unions, and anti-alcohol forces who have, thus far, not stepped in with any-where near the funding opposition that Initiative-1100 faced.

If Costco wins, this may establish the initiative process as the tool of choice to change laws and reform systems, in spite of entrenched (and immovable) political interests in state houses all over the U.S., where wholesalers have their power base.21

Winning strategies and actionable insights

Over the next 24 months, all three tiers need new strategies to stay ahead of a growing number of traditional and non-traditional competitors, and win consumer share of mind. Figure 5 illus-trates how small and large producers can use winning strategies to leverage trends and overcome hurdles. n

About the authors:Deborah Steinthal is Managing

Director of Scion Advisors LLC, a lead-ing business and strategy consulting firm with a proven approach that helps business leaders “get to the next stage” ― reposition to grow or prepare for exit. Achieving results across 100 com-panies and several industries, Scion Advisors comprises seasoned execu-tives with established track records in the food and beverage industry and emphasis in the premium wine sec-tor. For more information please see www.scionadvisors.com.


Fall 2011 | 8 JournalW I N E B U S I N E S S

John Hinman, a wine industry vet-eran with 35 years of experience rep-resenting wineries, retailers, wholesal-ers, and importers, is a graduate of Columbia University School of Law, and a senior partner of the San Francisco alcoholic beverage industry law firm Hinman & Carmichael LLP. Suzanne DeGalan, a graduate of the University of California, Berkeley School of Law (Boalt Hall) and a corporate, business, and intellectual property lawyer with prior experience at Skadden, Arps, Slate, Meagher & Flom LLP, and at Shartsis Friese LLP, is an Associate at Hinman & Carmichael LLP. The firm specializes in 21st Amendment-specific law; alcoholic beverage licensing, mar-keting and distribution counseling; and the regulatory defense of alcoholic bev-erage industry members throughout the U.S. For more information please see www.beveragelaw.com.

References/Footnotes1. Silicon Valley Bank’s 2011-2012 Annual

State of the Wine Industry Report.2. According to Symphony IRI Group

(Chicago, IL).3. Wine Market Council’s 2010 overview

of the industry.

4. Impact Databank.5. Millennial cohort: 50 million between

the ages of 21 and 30 in the U.S., and another 25 million turning 21 in the next few years.

6. Scion Advisors’ Trend Watch 2011 report.

7. McLane is a U.S.-wide grocery and food service supply chain business, that has entered the alcoholic beverage distribution business by buying existing distributors in Tennessee, South Carolina, and elsewhere, and applying for state wholesale licenses across the U.S.

8. www.pressdemocrat.com/a r t i c l e / 2 0 1 1 0 6 0 1 / B U S I N E S S / 1 1 0 6 0 9985?Title=Napa-wine-group-acquires-historic-Seghesio-winery. [Press Democrat, June 1, 2011]

9. VinterActive LLC 2011 report10. Online wine sales have only doubled

in the last 10 years, to $200 million in 2010.11. In Texas, the large South Texas

Anheuser Bush distributor and L&F Distributors (20-million case wholesaler), entered an agreement to purchase Avante Beverage, a statewide wine distributor based in Dallas. Young’s Market Company and Republic National Distributing Company recently combined forces to create a single alcoholic beverage distribution company in Arizona.

12. Community Alcohol Regulatory Effectiveness Act, HR 1161, currently stalled in the House of Representatives.

13. 2010 Rabobank survey.

14. Including Charles Shaw and Oak Leaf Vineyards as control labels.

15. Estimated by owner of Total Wine when speaking to 2009 WSWA conference.

16. See TTB guidance on bailment ware-houses, available at: www.ttb.gov/main_pages/bailout-warehouses.shtml.

17. Specialty Wine Retailers Association cites public records showing that distribu-tors spent $82 million between 2005 and 2010 on contributions to federal and state politi-cal campaigns and federal lobbying efforts. SWRA Report, “Toward Liquor Domination” June 2011.

1 8 . w w w . f a c e b o o k . c o m /AmericanWineConsumerCoalition

19. Wine Country Gift Baskets.com v. Steen, 612 F. 3d 809 (5th Cir. 2010).

20. Costco’s initial victory in the Washington district court was largely over-turned by the Ninth Circuit, when it upheld the state’s laws regarding uniform pric-ing, minimum markups, quantity discount, credit, and central warehousing bans. Costco Wholesale Corp. v. Hoen, 2006 WL 1075218 (W.D. Wash. April 21, 2006), overruled by Costco Wholesale Corp. v. Maleng, 522 F. 3d 874 (9th Cir. 2008).

21. During the past three election cycles, wine, beer, and spirits wholesalers have contributed more than $58 million to state political campaigns, and spent countless mil-lions in lobbying efforts at the state level. [SWRA Report]

Reprint From:

subscribe today at www.practicalwinery.com; or tel: 415/479-5819.

• Identifyingreserve-qualitysoilsinvineyards WINTER• LessonslearnedinCalifornia—Invasiveinsectspecies SPRING• Definingsustainableviticulturefromthepractitionerperspective SPRING• TheScienceofGrapevines:AnatomyandPhysiology(bookexcerpt) SPRING• Differentialharvestinginwinegrapevineyards SUMMER• Vinevigoraffectsfruit/winechemistry FALL

MORE OF OUR IN-DEPTH CONTENT FROM 2011:

READ MORE AND EXPLORE AT:www.practicalwinery.com

Documents

Perfect storm forming - Scion Advisorsregional, national and global in scope. They include legal, political, and cul-tural developments. The speed of change is accelerated by economic