By Laura Ness
This article is part of the Bold Predictions series.
Michael De Loach of Michael De Loach Brands, acts as a broker and marketing consultant for many small-to-medium brands, like Selby Wines, Bucher, Davis Family and Bennet Lane. Like many market observers, he says we’re right in the thick of a major correction, something the wine industry goes through every 8 to 12 years. He attributes it largely to “overly optimistic assessments of future grape needs.” The bulk market is currently swimming in inventory and prices are declining, with spot market prices down 25% to 50% plus, depending on region and variety, according to De Loach.
De Loach says to look for the correction to intensify in 2020. “It’s a ‘chicken and egg’ affair for the most part, but it certainly starts with greatly increased consumer demand for premium wine at the very beginnings of this cycle, somewhere in the late 1970s to early 1980s. It’s a vicious cycle ending with a collapse of pricing for grapes and bulk wine, which we are experiencing right now.”
He sees two phases to the cycle: phase one is premiumization, where growth at upper wine price levels gets producers giddy with excitement about the future. They increase production targets to meet sales growth, often driven by perceived additional demand. “Contracts are written whereby growers are encouraged to grow certain varieties in certain areas, e.g. Pinot Noir in Russian River, and necessarily eliminate other plantings, e.g., Gewurztraminer, once widely planted, now almost non-existent in Russian River,” notes De Loach.
Phase two brings price collapse, when producers have access to so much supply at attractive prices; they find themselves in an overcapacity situation. De Loach points to a winemaker who recently had to sell nearly 50,000 gallons of premium wine in tank for $1 a gallon, so that the tank space could be available for other supply. “The wine’s assessed value only a few months ago (before harvest estimates firmed up) was well over $20 per gallon. The conversion cost for making the wine (excludes the price paid for grapes) is a minimum of $5 per gallon. This is a terrible loss for the winemaker, but a fantastic opportunity for buyers, such as negociants and private-label buyers. But while negociants win in this phase, they lose later when supplies evaporate.”
In the excess supply market, as we are experiencing now, De Loach likes to quote his friend Brian Clements of Turrentine’s popular Wall Street phrase, “There’s a thin line between greed and fear.”
Oversupply adds to sales woes for producers of all sizes. Gigantic private-label buyers like Costco, BevMo, Trader Joe’s, Safeway, reduce shelf space for their usual suppliers, and replace SKUs with their own lower-priced, higher-margin goods.
“When growers and producers can’t make money, they pull out grapes or bud-over to other varieties and make less wine. Their annual gross revenues decline significantly. Growers are reluctant to plant new acreage until buyers are writing lucrative contracts again, which will be another four-to-five years. Medium-to-large producers will lower prices to move excess inventories, thereby lowering the average price point in the market for at least two years, and making business difficult for small producers who could not take advantage of price drops in bulk and grape supply. Inevitably, some producers are forced to sell to larger producers, or to get out of the wine business entirely,” says De Loach.
It usually takes another two years to move lower-cost and reduced-price wines through the system, at which point we’re back to a short supply situation. Prices go up to cover the greater cost of bulk and grapes, and lower-priced negociants get squeezed out of the market as prices go up. “Then, you guessed it, the reports of ‘premiumization’ once again appear, because prices went up! Back to Phase One!” says De Loach.
Will we eventually reach a steady state? De Loach thinks the US market has grown to about 30% of potential consumption, after 40 years of rapid growth, beginning in 1980. He believes we have another 40 years to go before we start to even out and become more stable. “The industry would be wise to hedge its bets in the meantime by cooperatively negotiating capacities and opportunities with at least a ten-to-fifteen year outlook. So far, even with great technological advances in IT, agricultural techniques, and production, grapes, regionally, can’t be grown fast enough to meet emerging demands, leading to shortages, in turn leading to major market corrections and instability (oversupply), then onto another cycle.”
Still, he likes to take the long view. One cold rainy day while pruning his family’s vineyard, which was planted in the late 1800s, and later sold to Williams-Selyem, he had an epiphany. “I realized that the vineyard had survived many things that wiped out other farms and crops. Prunes, once dominant in our area, were all but gone. The only reason you’d know hops had been a big crop here was the old, crumbling, but still architecturally striking hop kiln barns. There had been two devastating world wars, a great recession, and, worst of all, 13 years when commercial wine production was illegal. Most of that all happened in a 30 year span. And yet, the grapes were still here. The farmers and grape marketers figured out a way to make it through, unlike other long-gone crops. We tend to work together to find solutions and help each another out. And I think that tradition carries on.”
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