By John Kiernan
In this edition of our “Ask the Experts” series, we examine how the wine industry operates as well as how the Great Recession affected it with wine economists Dr. Tony Lima from California State University, East Bay and Dr. James Lapsley from the University of California, Davis.
To own a vineyard is to possess a status symbol that rivals the famed Centurion “Black Card” from American Express. Both signal immense wealth, carry quite the price tag, and are staples in the rarefied air of CEOs, actors, athletes and musicians. After all, Johnny Depp, Francis Ford Coppola, “Brangelina,” the Beckhams, Mike Ditka, Gerard Depardieu, Martha Stewart, Steve Spurrier, Nancy Pelosi, Olivia Newton-John, and many other notable public figures are involved in the wine business in one way or another (and most probably have Black Cards too).
The wine industry is also surprisingly important to the U.S. economy given that we’re the world’s fourth leading producer – after France, Italy, and Spain – and wine sales account for 34% of our annual alcohol expenditures. What’s more, all 50 states actually produce wine, though California has a 90% share of the market.
Well, we all know what effect the recession had on the overall workforce and the economy at large, but it’s fair to wonder how the wine industry fared. Drinking wine is clearly one of our favorite pastimes, but is it one of those things that we forgo during tough times or do stresses serve as the impetus for an industry boom, thereby contributing to the billions we rack up in unpaid credit card balances? Might prodigious debt figures be at least somewhat a result of struggling vineyard and winery owners relying on credit cards to stay afloat financially?
Effects of a Recession
In order to answer the questions laid out above, we turned to two of the foremost experts on the business of wine: Dr. Tony Lima from California State University, East Bay and Dr. James Lapsley of the University of California, Davis. Interestingly, both of these wine economists say the recession actually had minimal impact on the industry as a whole.
“Wine drinkers tend to like wine,” said Lima. I’ve heard the arguments in the past that people will switch from beer and wine to vodka because it’s cheaper to get a good high that way. I think a lot of wine drinkers drink it because they like it. In terms of the number of gallons purchased per household per year, I don’t think that changes very much with the business cycle.”
Indeed, the annual consumption of wine has grown for at least the last 20 years, but that doesn’t mean the industry was completely unfazed by our recent economic struggles. Consumer purchasing habits did change, but not as a result of the common notion that increased stress equals more drinking.
“What happened during 2008 to 2011 was that people who were fairly rich and who had seen their portfolios decline suddenly tightened their belts and said, ‘I’m no longer buying $60 Cabernets, I’m buying $30 Cabernets.’ And people who were buying $15 wines said, ‘I’m now buying $7 [wines],’” said Lapsley. “If you were a winery producing inexpensive wine – which meant you were a very large winery because this is where you really need to have economies of scale both in production and distribution – you did really well.”
On the other hand, smaller upscale producers who were counting on being able to sell their product for somewhere in the $60-per-bottle range were “totally screwed,” according to Lapsley. Things didn’t necessarily get to the point where producers were going out of business left and right, but they certainly experienced severely distressed sales. Before you start feeling too sorry for them, though, consider the type of person who owns a winery.
“I think that in many cases, people who are starting these small little deals are buying a lifestyle,” said Lapsley. “Economists talk about utility, and utility is the personal satisfaction you get from something. Being able to say that you have a winery and being able to serve your own wine and go into a nice restaurant that is serving your wine … is satisfying for some people, but it doesn’t necessarily mean that it’s a profitable business.”
How the Industry Works
I don’t know about you, but I come from a family of “winos” and hearing Lima and Lapsley discuss how different segments of the industry fared during the recession really piqued my interest. Indeed, there are a number of really interesting dynamics in play, not the least of which is the fact that the specter of prohibition still hangs over the industry.
You see, the modern wine industry really took shape with the passage of the 21st Amendment. The states and the federal government had to make a number of important determinations at that time, including how exactly to define wine in terms of alcohol by volume, how to tax it, and how to ultimately control distribution. Remember, booze is technically a “drug” and some form of regulation is needed to prevent abuse.
What resulted is the three-tier system that’s currently in effect. The first tier – the producers – develop the product and sell it to distributors. The distributors, who act as middlemen and comprise the second tier, collect excise taxes for the states and sell the product to retailers. The retailers, which make up the third tier – in turn bring the supply to consumers while often implementing mandatory mark-ups designed to ensure minimum margins for the different players in the process.
The reliance on middle men would seem to be a glaring inefficiency, but in reality they’re far from arbitrary.
“Distributors actually do serve a great consolidation function, especially for inexpensive wines, by moving these cases of wine in full trucks,” said Lapsley. “It costs pretty much the same to move a truck that’s half full from California to Ohio or Washington as it does to move a full truck, but obviously the cost per case if it’s half full is going to be twice as much.”
One potential downside to all this, depending on your perspective, is that large companies able to efficiently distribute large quantities have come to dominate the market.
“What we’ve seen in the last 20 years is a consolidation of distribution in the alcoholic beverage industry, which means then that in many states, you only have two major distributors. You might have some other specialty guys, but what this means is that for the producer, if I want to sell [wine] in Washington State in any volume, I’m going to have to go through a wholesaler. The wholesaler may or may not want to take my good, in which case I’m out of luck and in which case if you wanted to buy my wine in Washington, you’re out of luck. If I do get distribution, I’m one of literally 500-1,000 other products.”
You know what that means? We finally have a rationale for all the crazy labels we see in the liquor store as well as the role alcohol company reps actually play: the need to differentiate and lobby in order to survive.