Wine’s New World

It’s unlikely that Maurice Large, a winemaker and president of the Union Interprofessionelle des Vins du Beaujolais, a professional organization charged with overseeing one of France’s most popular wine regions, will be welcomed back in Australia any time soon. Touring the heart of Australian wine country last summer, Large likened Australian wine, now among the world’s most popular, to Coca-Cola. He has also called the consumers who purchase it "philistines."

Who could blame Large for his pique? Recent events in world wine markets have shocked even the French from long-held complacency. "Until recent years wine was with us," concluded a report commissioned by the French Ministry of Agriculture in 2001. "We were the center, the unavoidable reference point. Today, the barbarians are at our gates: Australia, New Zealand, the United States, Chile, Argentina, South Africa." In the last 30 years, France and other Old World European producers — namely, Italy, and Spain — watched per capita consumption roughly halve in their domestic markets, while wines from New World upstarts suddenly invaded the Old World’s traditional export markets. Even winemakers in the United States are beginning to worry. In the late 1980s, less than 4 percent of wine imports to the United States came from the Southern Hemisphere. Today that figure is around 30 percent, more than half of which is from Australia alone. For the first time, Australia surpassed France last year in the volume of sales to the United States and is now second only to Italy in the U.S. market. Those who bought Napa Valley land for more than $100,000 an acre in the late 1990s now wonder if they will ever see a return on their investment.

Traditional consumers, the drinkers of super premium wines, are concerned, too. They worry that what for centuries has been characterized as a largely cottage enterprise — with colorful, passionate personalities and a wide variety of wines that differ across regions from year to year because of the vagaries of weather or the vigneron’s experimentation — will soon be indistinguishable from any other globalized industry. With this fear comes concern for ancillary industries like wine tourism, since small boutique wineries are the lifeblood of such tourism.

Wine is not a big industry. In fact, wine accounts for just 0.4 percent of total household expenditures globally, and vineyards make up only 0.5 percent of the world’s cropland. Moreover, the industry’s aggregate output hasn’t grown for decades. However, consumption patterns have changed tremendously in recent decades. Sales of commercial premium bottled wine (which retail for $5 to $8) are growing at dramatic rates compared with super premium wines (those costing more than $8), while sales of previously popular jug wines (less than $5) have plummeted. The shift in demand toward low-end premium wines and away from nonpremium wines is forcing changes in the fortune of Old World (that is, European) versus New World producers, sparking fierce commercial and bureaucratic battles in the process.

But will the New World really send wine the way of colas and hamburgers? Will a small number of large winemaking firms dominate global markets by churning out ever larger volumes of standardized products under their own brand or that of large supermarket and discount chains? If so, will that drive small winemakers and wine retailers out of business?

SUPERMARKET MANIA
What first triggered growth in export demand for New World wine was a change in British liquor licensing laws in the 1970s, allowing supermarkets to retail wine to baby boomers. The new upwardly mobile middle class that arose from former Prime Minister Margaret Thatcher’s economic reforms was eager to experiment with posh products like wine that had hitherto been the preserve of the upper class. By the mid-1980s, supermarkets — dominated by Sainsbury’s, Marks & Spencer, Waitrose, and Tesco — accounted for more than half of all retail wine sales in Britain.

Given Australia’s close historical ties with the United Kingdom, Australian companies not surprisingly responded to this new market opportunity first. The timing of the initial export surge was helped by a significant devaluation of the Australian dollar in the mid-1980s. Rampant food-safety scares also accelerated the swing away from Old World wines. In 1985, for example, the United States banned Austrian wines when the country’s winemakers used diethylene glycol, a deadly chemical found in antifreeze, as an artificial sweetener. Chernobyl amplified food-safety fears in April 1986. And when it was discovered that same year that methanol was used in Italian wines to raise their alcohol content, exports of Italian wine plummeted 38 percent in one year.

Australian success in the U.K. market, where per capita wine consumption has doubled each decade since 1960 to 16 liters per capita, is now legendary. So dominant was New World expansion that since 1990 only 29 percent of the United Kingdom’s increase in wine imports have come from the European Union (EU).

Competition from other New World producers was slow in coming. South Africa initially posed little threat to European vintners because of anti-apartheid sentiment. Argentina and Chile lagged because their domestic and trade policies discriminated against exportable agricultural products. (And the Argentine wine style was less attractive to Northern Hemisphere palates.) Nor did U.S. exports emerge as rapidly as Australia’s in the later decades of the 20th century. U.S. viticultural land was more expensive and the country’s currency stronger. In any case, the U.S. domestic market grew faster than domestic supply. This consumer trend received a boost in the United States and in Asia from a 1991 report by CBS television’s investigative program 60 Minutes on the so-called French paradox — the apparent health benefits of (especially red) wine consumption in moderation.

Despite the growth in U.S. and U.K. demand, European suppliers failed to respond due to numerous regulations — such as restrictions on which grape varieties can be used in each appellation, on maximum yields and alcohol content, and on vine density and vine-training systems. As well, Old World producers were insulated from market forces by price supports in Western Europe and, until the fall of the Iron Curtain, socialist planning in Eastern Europe.

Exploiting the rapidly growing markets required large volumes of consistent, low-priced, easily approachable (fruity) premium wine and mass marketing. Large wine companies in Australia had both. And the export growth prospects — highlighted in a highly publicized 1996 vision statement, "Strategy 2025," released by the Winemakers Federation of Australia — stimulated a boom in new plantings that has doubled Australia’s vine acreage since the mid-1990s.

Export growth and new plantings, together with low domestic prices for red grapes in Australia in the mid-1980s due to a local fashion swing to whites, increased the incentive for wine companies to consolidate, thus reaping the economies of scale necessary to invest in developing mass markets abroad. A number of Australian mergers and acquisitions followed, including spirits giant Pernod Ricard’s 1989 purchase of Orlando Wyndham Wines, owners of the Jacob’s Creek label. Jacob’s Creek’s production has trebled since 1995, with sales growing at double-digit rates. Orlando Wyndham currently sells more than 170,000 bottles of wine worldwide under the Jacob’s Creek label every day — enough that two wine bottle-making plants in southern Australia (ACI and Amcor) are now the world’s largest.

NEW WORLD REALITY
For some, the result of wine’s globalization has been devastating. The situation in Italy is so bad that a 15 percent fall in domestic wine sales in 2001 left an excess stock of 37 million liters. Shortly after Maurice Large returned to France in the summer of 2002, wineries in Beaujolais found they had 10 million liters of unsellable wine from the 2001 vintage. The selling price of ordinary wine grapes fell by up to 40 percent in southern France in the 2001 vintage, prompting violent protests there in early 2002. But the French are not alone in their bewilderment. Producers in Central and Eastern Europe, despite market reforms, have watched their wine exports grow no faster than Western Europe’s over the 1990–2001 period (4 percent per year, compared with 20 percent for the New World).

Making matters worse for small European producers, New World wineries are internationalizing their production and distribution, forming alliances with foreign companies to enjoy economies of scale. West European firms are investing in Eastern Europe, South America, Australia, New Zealand, and China. U.S. firms are investing in France, Italy, and South America. And Australian firms are investing in North America and Europe.

Since only one quarter of global wine production was exported in 2001 in volume terms, one might conclude that wine is not highly traded. But that proportion compares with just 15 percent in 1990 and less than 10 percent in the 1960s. More significantly, in value terms, the share of global wine production exported is nearly 40 percent since most of the cheaper jug wine is not exported. Further, the pace of wine’s globalization shows no signs of abating. With the selling of wine in supermarkets becoming more common, and concentration of ownership of groceries increasing, the competitiveness of firms able to supply large shipments to such markets will only strengthen.

MAKING A MARKET
In the face of declining domestic demand in Europe and increasing market pressure from the New World (including firm concentration), Old World producers are looking for prospective markets elsewhere. So, too, will New World producers as their exportable volumes grow. The Middle East has the affluence but not the inclination to drink wine, thanks to the Prophet Mohammed’s decree against alcohol. Africa and much of South Asia are still too poor to provide mass markets any time soon. But do rapidly rising incomes elsewhere in Asia offer prospects?

Skeptics question whether wine goes with Asian food, yet the wealthy in China and India have consumed wine from grapes for centuries. China produced, consumed, and traded wine with Persia as early as the first century B.C., and Venetian adventurer Marco Polo noted that excellent wines were produced in Cathay’s Shanxi Province for exporting all over the country. The Mogul Empire in 16th-century India, meanwhile, was supplied with wine from the High Indus Valley and Afghanistan. Can interest among elite classes be a springboard for converting expanding middle classes in Asia to a traditional European product — just as Japan was able to export sushi to the rest of the world?

As incomes rise, and with them access to refrigeration, a gradual expansion in wine promotion into food-revering Asia could well yield a high long-term payoff. Recent efforts by wine marketers in Japan and Southeast Asia to match food with wine have been highly successful, with both Old and New World suppliers hosting promotional tastings and the like. A speech by then Chinese Premier Li Peng in 1997 affirming the health virtues of red wine helped consumption skyrocket in cities on China’s eastern seaboard. In Asia as a whole, wine sales have more than doubled in the last 10 years. Japan and China are responsible for 80 percent of this growth.

Sales growth in Asia will accelerate further if import and consumption taxes on wine fall. That is already beginning to happen. Due to China’s accession to the World Trade Organization (WTO) in 2001, the nation’s wine import tariffs are scheduled to come down from 65 percent to around 10 percent by 2006; the regulation of its distribution and retail channels should be relaxed over the next two or three years. Elsewhere, India succumbed to pressure from the EU in March 2003 to lower the country’s wine import tariff, albeit only from 199 percent to 166 percent.

Meanwhile well-targeted information and promotion efforts will alter Asian sales patterns over time, especially while per capita consumption is still low and easily influenced. (Per capita consumption is currently less than 3 liters per person in Japan and less than half a liter on average in Asia’s developing countries, compared with 8 liters in the United States and 34 liters in Western Europe.) Strong marketing may even lead eventually to China’s elite consumers refraining from the practice of diluting $200 bottles of wine with 7-Up to make the beverage sweeter!

But who will supply this emerging market? Old World producers hope to fill the gap by holding on to their historically high market shares. Of the current imports reaching Asia, 80 percent of the volume has come from France in recent years — even though France supplies only 25 percent of total global exports and is farther away from Asia than both Australia and California.

It may be that French wines are preferred initially for reasons of snobbery, but as new Asian consumers experiment with wine, they are more likely to be seduced by the fruit-driven, lower-priced wines of the New World. Furthering Europe’s frustration are the long-term chances that China’s wine industry will remain close to self-sufficient. The country’s vineyard area and winery capacity have grown in parallel with domestic consumption in recent years. But room for joint ventures remains. Currently, more than 20 such alliances reportedly exist in China. In Japan, the high price of cropland means imports will continue to dominate. But most imports come in as bulk wines that are blended with local wines, then sold as "Product of Japan." Arcane labeling laws allow such a claim even if only a small fraction of the product is derived from domestically produced grapes. The main beneficiary is the domestic producer whose poor value-for-money product may otherwise be unsellable.

CULTURE CLUB
If regulatory quirks are being used to bolster local producers in Japan, they are used even more heavily in Europe, ostensibly to preserve a cultural heritage. After successfully securing protection via trade agreements for geographical names such as Champagne (France), Sherry (Spain), and Port (Portugal), the EU now plans to introduce a new regulation on August 1, 2003, that demands recognition for so-called traditional expressions. Despite the everyday use of terms like tawny, ruby, vintage, classic, and cream in English-speaking countries, the EU wants only wine labels from the specific countries concerned to carry these terms.

Since such protectionist measures create another technical barrier to imports of wine from the New World (adding to the existing sea of paperwork required before wine is imported to the eu), New World countries are taking the matter up in the current WTO trade negotiations. U.S. lawmakers have put forward the Miscellaneous Trade and Technical Corrections Act of 2002 by way of retaliation. If implemented by January 2004, as proposed, the act will subject all nations that are not signatories to a Mutual Acceptance Agreement with the United States (the EU is not) to similarly onerous paperwork requirements when exporting wine to the country.

Recent government subsidies aimed at helping wine producers in EU countries upgrade their wine industry are reportedly worth more than $1.35 billion per year. If such subsidies were to encourage structural adjustment toward producing what the market wants, then the Old World could gradually claw back some of its lost market share from Australia, New Zealand, the United States, and other New World producers. But past experience suggests subsidies encourage complacency more than entrepreneurship, particularly when they are supported by other forms of government protection. A French court recently fined a Lyon-based magazine $375,000 for publishing "denigrating" statements about Beaujolais wine.

THE MYTH OF McWINE
So far, the increasing globalization of the wine trade has not resulted in the homogenization of the world’s wines, despite Maurice Large’s claims. After all, firm concentration within the global wine market started from a very low base, at least compared with other beverage industries. The world market share of the three largest wine firms in the late 1990s was just 6 percent, compared with 35 percent for beer, 42 percent for spirits, and 78 percent for soft drinks. The share of national wine production held by the five biggest producers is around three quarters in the United States and Australia and just half in both Chile and Argentina. In Europe, the share is far lower, even where large cooperatives operate.

The French and other Old World winemakers are right that the New World’s low-end commercial wines sold in supermarkets are not sophisticated, but the Europeans ignore two key points. First, New World commercial wines are certainly more in demand than the low-end wines produced by countless cooperatives in southern Europe. Hence, the former will continue to take market share from the Old World in the segments of the market that seek low-priced bottled wines. Second, Old World producers need to wake up to the increasing range of sophisticated wines being produced in the New World. Volumes are not yet sufficient to make an impact on the Old World’s shelf space in the fine wine outlets of Europe, North America, and Japan, but continuing growth in super premium New World wine production will have a discernible impact before the decade ends.

With increasing affluence comes an increasing demand for many things, including product variety, the spice of life. Over time, consumers will gradually differentiate more between grape varieties and between not just countries of origin but regions within them. With the help of wine critics such as Hugh Johnson in Britain and Robert Parker in the United States, the "philistines" will increasingly discriminate between brand names and labels within brands. The preference for differentiated products, and the infinite scope for experimentation by vignerons, will ensure that there will always be small- and medium-sized wineries — like California’s Ridge Wines and Australia’s Petaluma — alongside the few large corporate labels like E.&J. Gallo, Robert Mondavi, and Orlando Wyndham.

The forces of globalization, together with the expansion in premium wine-grape supplies as winegrowers upgrade, may spur more mergers, acquisitions, or alliances among wineries across national borders. Nonetheless, the success of corporate wine labels in the global marketplace will provide a slipstream in which astute smaller operators can also thrive. Plenty of New World wines from small wineries, including California’s Screaming Eagle, are now going for fantastic prices — in some cases over $1,000 a bottle — thanks to high scores from Parker’s tastings. One of the best known "cult" red wines in Australia, Henschke’s Hill of Grace, is from a small family winery in the Adelaide Hills that crushes well under 1,000 tons of grapes per year (compared with Orlando Wyndham’s 200,000 tons).

The popularity of cult wines shows that small and medium enterprises can do well in the age of mass marketing and consolidated winemaking giants, provided small wineries work hard on marketing and distribution to ensure their differentiated product is in demand. Generations of traditional knowledge and skill at grape growing and winemaking, the marks of distinction for many Old World producers, are both necessary and admirable attributes. But these traits are not sufficient for survival. Mastering the formation of alliances with quality marketers and distributors also is essential, as is searching out and developing new markets, including in such places as East Asia.

Who will get all those ingredients right? At a 2001 conference in Italy, Australian wine critic James Halliday was asked the question: What country will dominate the world’s wine markets in 2100? Leaving aside the fact that, in a world of multinational corporations, the more pertinent question might be which firms will dominate, Halliday answered that Australia will be in a similar position then to that of France today. Given that Australia has been exporting wine in commercial quantities for barely a century, his answer is consistent with Madame Rothschild’s oft-quoted claim that winemaking is easy once you learn how — it’s just the first 200 years that are difficult.