Wine companies largely are caught between escalating costs of production and mixed perceptions of how much of the rising costs the market for finished wine will bear.

Those are among the topics five of the Bay Area’s innovative wine entrepreneurs are set to tackle at the Business Journal‘s Wine Industry Conference on April 18.

Cameron Hughes in 2001 co-founded Cameron Hughes Wines, a negociant wine producer. He took advantage of an ocean of wine available for purchase from wineries in bulk after ample plantings in the late 1990s and again as wineries shed inventory after the most recent recession to buy luxury-tier wine and create lower-priced brands.

Tom Klein has led Rodney Strong Wine Estates since his family purchased the winery in 1989. He took production upscale, shifted to Sonoma County grapes and acquired the Davis Bynum winery.

Alex Ryan has been guiding the flight of Duckhorn Wine Co. since 2000 and was promoted to the top spot in 2005, just two years before GI Partners acquired a controlling share. He was key to the launch of estate brands Paraduxx and Goldeneye as well as the launch of the Decoy label.

Christopher Silva in 2003 became president and chief executive officer of St. Francis Winery & Vineyards, which focuses on Sonoma County chardonnay, cabernet sauvignon, merlot, and “Old Vines” zinfandel.

Hugh Thacher in 1975 started San Francisco Wine Exchange. Arguably the oldest U.S.-based independent wine marketing company, it has a network of more than 125 regional sales managers, brokers and wholesalers.

They talked with the Business Journal about key drivers of cost and retail pricing, how they and markets are responding, and pricing impacts for exports and alternative sales channels.

 

What’s most affecting your costs and consumer prices?

Cameron Hughes: Right upfront is the three-tier system. Its labyrinthine inefficiencies are the greatest contribution to consumer pricing. Next biggest would be grape and bulk wine prices, which have risen unnecessarily high due to a perceived “shortage.” We believe it is in actuality a balanced market, not a short market.

Dry goods have not changed much. Glass prices have moderated actually. Though transportation costs have increased significantly in the last five years, probably up 40 percent or more.

Tom Klein: The biggest factor that affects us is raising grape costs per ton on the production side, and on the sales-and-marketing side it is the discounts and allowances to distributors, restaurants and retailers. For consumer prices, the biggest issue has been the desired margins retailers hope to make, and there remains a wide dispersion of targeted gross profit margins across the retail environment.

Alex Ryan: The biggest factors affecting costs are labor and vintage grape-yield variations. 2012 was a high-yielding vintage, following 2010 and 2011, which were two consecutive low yielding vintages.

Consumer prices are driven by a desire to ensure that our consumers are able to get great luxury value in keeping with our competitor’s prices. Consumer prices are also designed to guarantee that each wine hits its appropriate consumer price tier. Decoy resides on the entry-level luxury tier, while Duckhorn Vineyards core wines rest in the mid- to upper-level luxury tier.

There is also a need to provide restaurants and retailers with an enticing but fair margin. The increasing power of select wine buyers and their relentless focus on higher margins are driving up prices.

Christopher Silva: A highly competitive marketplace doesn’t change the fact that our biggest cost factors are the investment we make in grapes and in winemaking. Because our business is both agricultural and involves a product that doesn’t hit the marketplace for at least a year or two after we begin making it, our costs of goods don’t necessarily correspond with the current pricing paid by consumers.

That being said, wineries are still expected to — and must — deliver products that meet the expectations of their audience. For a lot of us, that means settling for slimmer margins in exchange for the loyal customer, who is still very much alive, and who will keep buying your wine if the perceived value is there.

This is why St. Francis has not taken the price increase we otherwise would have in a better economy — a decision that kept us ahead of the game in allowing us to be both profitable, albeit at slightly slimmer margins, and current on inventory.

Hugh Thacher: The market changed radically after the end of 2008. The combined forces of consolidation at many levels, especially the wholesaler side, has challenged us all. Wholesalers ARE, in many ways, the key to our collective success. Consolidation has made their lives very difficult too. Freight, taxes and a larger average margin for most wholesalers are part of that mix.

Consolidation among the big conglomerates aggravates the situation.

The era of allocations is over. Price points are critical. The national accounts and chain business have become more important than ever. Direct-to-consumer business, even with its heavy restrictions, is a source of significant growth.

 

How have cost and price factors changed recently?

Mr. Hughes: Quite simply, we are flush again with excess wine. Prices have come back to Earth somewhat but are still too high, in our opinion.

Mr. Klein: As I mentioned, grape costs have begun to rise with the 2012 vintage, and the market will only tighten as grape supplies remain steady and the wine market continues to grow. It will take several years for any new plantings to come into production and dramatically increase supply.

Also, the agricultural community has enjoyed very attractive profits growing other commodities. This will continue to make it difficult to get significant increases in wine grape plantings. The biggest Central Valley areas and northern coastal regions are beginning to reach the limits of their plantable potential.

In the sales-and-marketing area, wineries are beginning to claw back marketing discounts and allowances to retailers as well as sales incentives for distributors to attempt to bring margins back in line with historical averages.

Mr. Ryan: The supply cycle shift has had a huge impact on our activities. While wine is ultimately a consumer-driven industry, the supply cycle generates a significant number of new wines, brands and even business models during every shift.

Mr. Silva: In recent years we’ve seen a hyper- competitive market, with new labels and wines from all over the world crowding retail shelves and restaurant wine lists. I recently ran into a wine executive who only half-jokingly told me that, “We just went back to 1988…. Classic brands are everywhere, and retail pricing is awfully close to what it was in 1988.” The big difference from 1988, he noted, is the existence newer brands competing for shelf space and market share.

Frankly, there is a renaissance going on right now in our industry, and we need to embrace the fact that never in our history has there been a better time to be a wine consumer — that guy or gal you and I are here to serve. Look around, on wine lists, store shelves, the Internet, food shows on television. People are celebrating and talking about wine, and at the same time expecting to pay the same or less for it than just a few years ago.

Each of us needs to figure out a way to deliver that compelling bottle of wine at even better quality and greater value than our friendly competitors who are reading this same article. No easy task — but what an exciting, dynamic time to be doing this for a living.

Mr. Thacher: Transportation and storage costs have gone up. This affects pricing on many levels, especially imports where FOBs out of California must be $2 to $4 lower per case than they were even three years ago. Despite these challenges, the interest in wine continues to grow. The world of the “millennial” is full of new opportunities with concepts and packaging and taste profiles.

Even though the gatekeepers — wholesalers, retailers and restaurants — continually and wisely warn us about pricing, wine clubs and DTC groups have learned that there is serious interest at wines that cost over 40 dollars. Buyers want variety and are wary of too many “big brands”.

 

What changes do you foresee?

Mr. Hughes: No changes are written in stone, but should we make it through April and early May with little or no frost activity, prices for grapes and bulk wine will need to come down to find buyers. Everyone is again flush with inventory.

If Euro zone problems metastasize and the euro weakens alongside normal or plus-normal global harvests, then look for increased pressure and lower prices from imports. The southern hemisphere 2013 harvest is already coming in big.

Retailers will continue to strongly resist price increases, as they have done mercilessly the last two years.

Mr. Klein: I see the U.S. wine market continuing to grow in the 3 percent to 4 percent annual growth range. It will remain the most profitable wine market in the world. Exporters from other countries will continue to target the U.S. market with their wines, and the market will remain as competitive as ever. However individual, highly regarded brands can increase prices based on quality and packaging improvements.

Mr. Ryan: There will be a challenge for Napa luxury vintners to hold their short vintage price increases from 2010 and 2011 in the midst of the abundant supply brought by 2012. It will be interesting to see how vintners try to use this long vintage to reconcile the much shorter previous vintages. Successful vintners will be able to deplete the supply with more of an “invisible” trade spend, while unsuccessful ones will have to peel back prior price increases to the consumer.

Also, long-term demand is forecasted to exceed supply for a number of years in the future. It will be interesting to see how this is handled by vintners as well.

Mr. Silva: I foresee a retail market that will stabilize at some level in terms of new SKUs. I am perceiving consumers to be more seasoned and better informed and increasingly aware that price does not necessarily equal value, which explains somewhat less crowding on shelves of novelty and other new labels in recent months.

As to price vs. value, my very favorite wine is our St. Francis Sonoma County “Old Vines” zinfandel. It is widely available and can usually be purchased off premise for $20 or less. I think it offers tremendous value at $20 a bottle.

We also make a 400-case wine called St. Francis “Anthem” Meritage at $60 per bottle. A much higher price than the $20 zinfandel, but I think people who taste it, hear the story and read the scores will agree that it is also a great value.

While a lot of people tell me that $30 a big cliff in terms of bottle price, the market will continue to bear wines people tell each other are amazing, including those well above the super-premium and ultra-premium levels. Indeed, more people are “celebrating wine,” as opposed to celebrating “with” wine.

Mr. Thacher: More growth and competition in the $16 to $19.99 category. Consumers are looking for vineyard oriented wines, that are estate grown, estate bottled and sustainable. They are open to new ideas and new packages. They are learning about the great vineyards of Washington State, Chile, Argentina, Spain, Portugal and New Zealand as well as the their old favorites from France, Italy and Germany and Australia.

 

How are costs of goods affecting retail pricing? What adjustments are planned?

Mr. Hughes: We have held pricing in some areas and taken pricing up in other areas through expanded distribution. Our product mix is highly variable versus other wineries, so our prices ebb and flow with assortment. We launch anywhere from 60 to 100 Lots each year. In general, our prices have risen slightly, but we also have the unique opportunity to reprice with each unique Lot.

Mr. Klein: We raised our prices across most of our product line in 2012 and now foresee limited price increases until 2014. The 2012 crop was a very good quality crop but also a large quantity was harvested and it will be difficult to adjust prices until the market digests this 2012 vintage.

Mr. Ryan: There are no plans to make adjustments in prices due to changing cost of goods, nor have there ever been. Ultimately, we must be consumer driven or we will fail.

Mr. Silva: We have no immediate price increases planned. As I said above, our cost of goods continues to rise, yet consumers expect that same quality bottle at the same or an even lower price. We have been successful in both maintaining quality and staying current on inventory by operating on slightly thinner margins than before the economic downturn. A goal here is to get people to taste our wines.

There are two critical moments of truth between a winery and a possible consumer. The first moment is when a person becomes our customer by actually deciding, in either a retail setting, online, or in a restaurant, to purchase that bottle of wine. This decision is made for one or several different reasons, including word of mouth, price, score, label, image, and effective advertising.

The second moment of truth is when the customer drinks and hopefully enjoys that bottle of wine — the moment that the customer determines, based on the quality of what is in the bottle, whether he or she will purchase our wine again or buy it just that once. If people taste what’s in the bottle and like it so much that they tell people about it and buy it again — we’ll keep duplicating the first moment of truth described above. As long as we keep making that happen, our pricing will follow.

Mr. Thacher: Pricing continues to be the front line of marketing wine. Getting distribution for wines that cost more than $20 retail is not easy. Incentives are often in play to attract “a share of mind”.

 

How elastic are price and demand for your wines? How have your consumers and account buyers responded to price changes?

Mr. Hughes: Depends on the venue. Online, we see higher-priced items selling faster than lower-priced items, however there is clear pushback over higher-priced similar items.

Retail buyers are using the threat of alternative wines in each category to keep price increases in check. I am not aware of any successful price increases amongst brands retailing under $25. In fact, the price increase barometer brand, Kendall-Jackson, is seeing increased discounting activity.

As an observation, during the height of the perceived “shortage” and throughout 2012, we saw increased programming and discounting activity amongst many major brands.

Mr. Klein: The elasticity of demand is dependent upon your brands, quality in the bottle, packaging and brand image in the market place. If all of these factors exist price increases can continue but fewer people will be taking them in 2013. Our brands’ demand elasticity proved to be positive, as overall sales volumes increased despite our price increases.

Mr. Ryan: We are fortunate enough to have tremendous brand equity. For this reason, our recent price increases have been absorbed without issue from both consumers and trade.

Mr. Silva: As consumer optimism seems to be replacing panic and uncertainty at many levels, we are seeing that consumers have slowly gravitated toward higher priced wines over the past year. This explains growth well in excess of ten percent last year on wines priced at $9 and above.

Based on what I have seen in the marketplace, this is more a result of “trading up” to higher-end wines than buying the same wines with a price increase. I keep hearing about all the supposed price increases that many people have been predicting for many months — the ones that everyone is talking about but hardly anyone has seen. I think this is because we are seeing a lot more caution on wine pricing across our industry than originally predicted, again, to the benefit of our customers.

Mr. Thacher: It is still a buyer’s market. Even high-scoring wines are discounted. Some larger chains are working on the assumption of 40 percent margins.
How is your company approaching exports and pricing in foreign markets?

Mr. Hughes: We are investing in Canadian exports, but other than that have little export business.

Mr. Klein: Exports are an important market for our company. We focus on Canada, Caribbean and Mexico as our most important export markets. We also sell in Europe and Asia, although China has not become a major factor for us yet. Looking at the California industry in total we will continue to see a good demand for California wines in export markets around the world.

Regarding pricing, we sell our wines at our full US price per bottles after subtracting discounts and allowances.

Mr. Ryan: We have been exporting wines for well over 20 years and are seeing steady growth in the export markets; particularly in Canada and Asia. It is quite gratifying to see demand for our wines (and California wines in general) increasing overseas.

Currently, 5 percent to 6 percent of our wholesale sales come from export. The export market demands some flexibility on products and pricing due to competition, culture, taxes and exchange rates. For this reason, we must devote some additional resources to this channel.

Mr. Silva: We haven’t spent as much time as I would like on exports for the simple reason that we have been selling out of our wines here in the U.S. While that may be a good problem to have, the bigger picture requires us to pay more attention to the positive impact in terms of brand imaging and exposure we receive by high-end placements overseas. I know first-hand that American business travelers often purchase high-end American wines and other products when overseas, particularly in hotels and restaurants, which further supports and reinforces our brand image and sales here at home.

I am traveling to Asia this month to visit distributors and consumers, and to get a better idea as to both the stability and viability of sales channels and points of distribution there. Our focus in Asia, both during and after my visit, is to fine-tune what we have been doing here in the U.S. for over three decades: trying to effectively bring our wines to market in a manner that allows them to be recognized, purchased and enjoyed by consumers there.

Mr. Thacher: Our firm is not an exporter.
How have alternate sales channels affected your pricing?

Mr. Hughes: Our website is one of our largest channels for sales, accounts for about 30 percent of our bottom line, and it continues to grow. We have successfully taken our prices up to the $39-a-bottle mark from a high of $28 a year ago.

That said, we feel the competitive activity in the space has definitely increased and can’t help but wonder what our growth would be without the additional noise.

Mr. Klein: We specifically try to avoid online telemarketing organizations, “flash” pricing marketing tactics, or other such vehicles that rely on dramatically reduced prices as we think it hurts brand equity. We are very careful who we sell to in order to avoid this risk to our own brand equity.

Mr. Ryan: Flash sales and telemarketing have not affected our pricing at all. Flash sales came to be when supply was abundant and have now dissipated in the face of short supply.

It is true that telemarketing has become a potent source of consumer outreach and sales. However, only a small incentive has been necessary in recent months to entice consumers to buy. The message of scarcity has been a far more powerful motivator.

Mr. Silva: Alternative marketing channels have not directly affected our pricing. With that in mind, brands needing to be very cautious about how their wine is sold, as first impressions and other perceptions are created in the minds of both consumers and trade as to each brand sold via alternate channels.

While the goal here is to get the wine in people’s mouths so they like it and buy it again, we know that brand image is often affected by how and where a wine is sold. Brands today are often confronted with the conflicting goals of moving inventory vs. maintaining a healthy brand image. These are among the big challenges of the past few years in our industry.

Mr. Thacher: Flash websites have become very significant sources of volume. Pricing is a very sensitive issue and needs to be carefully coordinated so that it doesn’t interfere with your existing club, retail or wholesale business.
Anything else on this topic?

Mr. Hughes: Wine pricing has increasingly moved away from everyday low pricing towards a model of false front line with deep discounts 9-10 months out of the year. Perceived discounts are, unfortunately, the name of the game in today’s market. Current grape prices are not sustainable as they appear to be based on a short term shortage driven as much by quality shortfalls of the previous vintages as it was actual quantities of fruit harvested. Now that inventories have been more than replenished grape and bulk prices will most likely moderate. Napa Valley pricing has not moderated and is seriously in danger of pricing itself out of the marketplace. Consumers are more than ever willing to drink outside the box and try new countries or chase the value equation over the border. California growers and producers need to work together to stay competitive in what is now the #1 global marketplace for wine.

Mr. Klein: Raising prices or lowering marketing discounts and sales incentives is a very tricky & complex issue, and it is critical to do it right. Most smaller brands cannot compete with Gallo, Constellation, The Wine Group, Beringer, Kendall-Jackson, and Delicato. Smaller wineries have to be careful to continue tip-toeing around the footprints of these giants, which include raising prices or reducing discounts when these large wineries as a group are not. Every winery must decide for itself its own brand strategy. Just be careful that when price increases are passed through that the quality is in the bottle when you do so. Consumers are willing to pay for noticeably improved quality.

Mr. Thacher: The wine business is cyclical. The world of wine critics domination is in transition. We foresee healthy growth ahead for those with sound marketing programs.

Source: North Bay Business Journal

https://www.northbaybusinessjournal.com/71463/questions-for-2013-wine-industry-conference-pricing-panelists/

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