2012 – The NZ Wine Industry, Not the Disaster Movie

At the beginning of any year there is a surfeit of reviews of the year past (2009) and forecasts for the year ahead (2010).  As I personally tend to perceive 2010 and 2011 as still highly transitional years for the global wine market, with discounting and stock reductions likely to continue for a time, uncertainties in terms of pricing, values and consequently financial support, I have instead shifted my focus ahead to 2012. This is the closest thing to a shift to a “new normal” (give or take six months or so).  As global economic conditions are likely to be more stable (rather than the present mix of positive and negative factors), consumer behaviour and market structure are more likely to settle, at least to the extent that this ever really happens for the wine industry!

What has happened?

2007-2010            Global recession and its impact on wine demand (with some something of a lag?)

2007-2011            The “credit crunch” and its impact on capital financing

2008-2010            High levels of discounted exports of bulk wine

2009-2010            Heavy domestic discounting/de-stocking

2010-2011            The bumpy, uneven process of finding the new “normal”

In recent years the failure of some existing offshore distribution networks, including the fact that for most (but clearly not all) brands this has not created defensible brand loyalties in the face of discount pressures, has been a significant driver of the level of volumes directed to bulk exports.

The Impacts

Consumers

Consumers have gone cheaper.  In part this has been because of the sheer weight of discounting in much of the retail world (itself often reflecting the power of the retailers to dictate to over-stocked producers); but also, and quite related, is the tendency of consumers to tighten belts and trade down in price points.  The extent of the discounting has simply allowed consumers to maintain (and sometimes upgrade) quality of purchases at the lower prices.

The big question on everyone’s lips is: if the major economies are healthier, job worries have eased, incomes are stabilised where they were for many consumers and the array of labels available is closer to what it was before the crunch (i.e. most of the short-term discounting brands have disappeared), will consumers revert to earlier purchasing behaviour or will they adopt a new normal of lower prices and reduced demand for wines representing conspicuous consumption?  Will the shape of the pyramid have changed, with a smaller tip and fatter low-end footprint?

Of course, one of the related issues is whether consumer tastes have changed in the interim and, if so, will it affect decisions regarding price or other factors?  By 2012, the period of the crunch, of the global transition that I have referred to here will have been five years.  Five years is a long time in a fashion sense, especially for certain wine styles. 

The New Age Global Consumer

The next generation of wine drinkers is on its way.  The same as has always been the case.  This next generation will have cut its teeth on cocktails, spirits, RTDs or beer, just as previous generations have done.  Wine as a beverage has never appealed to everyone.  It has long appealed to a small number of early drinkers (late teens and early 20s), to a growing number of drinkers in the mid to late 20s, and found its way to become beverage of choice to a steady core of drinkers from the late 30s on when other demographic factors become more significant.

… and the New Temperance

Given the unavoidable effects of the New Temperance movement, wine more than any other beverage has both an opportunity and an imperative to both differentiate and distance itself from other alcoholic beverages.  In particular it must fight to avoid being associated with beverages that are themselves associated with binge drinking.  To date wine, across the world, has singularly failed to send an unequivocal message that it stands for moderation, for consumption with food, for traditions that are not a threat to health and safety of consumers or society.  If it fails to do so by 2012 it will experience the economic consequences of the tool of choice for legislators around the world that are determined to place all alcoholic beverages as a category of ethical problem on a par with tobacco: materially higher excise or taxation.

Red or white or rosé?

Will the wine market become more like the beer market?

Anyone who follows the beer market in different parts of the world will be aware of the impact that the weather has on beer consumption.

The more that wine displaces beer as a beverage of choice in certain markets, does it mean that wine may also slowly assume some of beer’s characteristics?

Similarly, if climate change ultimately means warmer weather, will the wider wine market (as distinct from the fine wine sub-set) tend to shift towards styles that may be regarded as more “refreshing”, featuring the cut of acidity over “fatter” or more overtly wooded styles, for example. 

It is far from a secret that climate and temperature influence the styles of wine grown and consumed in many parts of the “Old World”.  Is it therefore a coincidence that as the world has experienced what the WMO has cited as being the warmest decade since temperature records have been kept globally, the post-“French Paradox” swing to red wines appears to have stalled or even reversed in many markets, and sales of rosé wines have surged?

Will this have reversed in the face of a string of long and bitterly cold northern hemisphere winters?

Weather and climate does influence consumer behaviour.  What will the weather be like in 2012?

The stalled hunt for a Plan B white

In Australia the Alternative Varieties Show has served as a showcase for the ongoing moves to diversify the varietal scope of the Australian industry, highlighting and promoting new grapes and winestyles.  Whether those varieties are even truly at home in some of the very warm, dry climates they are being planted in is not the point.  The Australian industry has identified the need to develop alternatives and actively supports this, resulting in quite disproportionate media coverage, for example.

The same cannot be said for New Zealand.  There have been voices for several years promoting the need to find varieties that can serve as foils in case sauvignon blanc slips out of wider market favour. However, unlike Australia, the tendency is to look at varieties already growing in New Zealand as candidates for “promotion” (e.g. pinot gris), rather than to find and experiment with new varieties.  There are exceptions, of course, with companies such as Coopers Creek and Trinity Hill actively marketing new alternative varieties. 

It is arguable that far more attention in the last 10 years has gone to finding alternative red varieties, rather than whites, for experimental purposes.  This may, also arguably, be something of a lingering consequence of New Zealand’s subconscious tendency in the past to perceive itself as an inferior or marginal producer of red wines (in contrast with its growing tendency to regard itself as a world-beater with almost all white grapes).

Of course most of the world’s wine consumers are more likely to want to drink either a white or a red as a separate preference, so the chance of consumers fleeing sauvignon blanc for pinot noir or for syrah is very low – these are completely different markets. If sauvignon blanc were for any reason to go out of favour with consumers, the majority of those consumers would be expected to migrate to other white wine flavours and styles.  This has the potential to expose not just New Zealand sauvignon blanc, the vast majority of which is made in a very specific style, but also all of the producers of copy-cat sauvignon blanc styles elsewhere around the globe.  Of course if a drinker buys a Marlborough sauvignon blanc today, the chances are that they will get a wine in a style they are quite familiar with, just as a buyer of an Italian pinot grigio would generally expect, for example.  On the other hand, as it is often commented, buy a New Zealand riesling or pinot gris and there is considerable doubt that the same can be said given the relatively wide variety of sweetness levels and styles in which these wines are made.

During 2009, the year Australia found out its albariño grapes were in fact savagnin blanc, the first commercial plantings of albariño occurred in New Zealand. Given that the fruits of these first plantings will be on tasters lips in 2012, are they likely to inspire dramatic expansion in the future if people like what they taste – a maritime grape being grown in a very maritime country that, arguably, has its own unique characteristics (and winemaking technology) to bring to the originals?

Increasingly the answer looks like no.  Growers are paring back yields all over the country.  There is now something akin to a stigma attached to new plantings or to replanting when the industry mantra is balancing supply and demand – never mind the fact that the new can create its own demand if it is good and distinctive enough.  New Zealand’s attitude to trialling the new and different is much more tentative than Australia, which may even manage to have more real albariño planted by 2012 than New Zealand, despite its 2009 setback and despite the avoided question mark over why such a grape is even grown in Australian conditions.

The Role of the Multinationals

Inevitably the role of the large multinational wine and liquor companies within the New Zealand wine industry has become the subject for increased scrutiny given both the degree of importance these companies have in terms of the industry as both buyers of grapes and sellers of wine to both the domestic and export markets; combined with the wider implications of sales statistics suggesting increased discounting during 2009.

By and large the large companies, most of whom are multinationals, have been good corporate citizens in New Zealand.  There is, of course, the risk of over-generalisation since many overseas investors in New Zealand have much more limited scope and scale than some of the larger global wine companies.  Overall, however, they have mostly tended to reinvest profits back into their New Zealand investments.  They have generally been good employers and trainers, as well as active sponsors and benefactors of the community and the arts.  They have brought both structure and management disciplines, often lacking in smaller companies, to the industry.

Of course they have also made significant investments in the industry, both in vineyards and also in processing and marketing infrastructure.  In support of this investment they have actively promoted New Zealand wines offshore.

As a further generalisation, they have tended to emphasise larger volume production and volume-oriented strategies with a relatively token investment at the boutique or ultra premium end of the market, where New Zealand has only rarely succeeded in replicating the sort of icon-centred marketing strategies employed by several companies in Australia.

Accordingly, the multinationals have for the most part been good for the industry and the economy, that is while the global economy and global demand has been strong, but the market changes of the last couple of years have exposed certain weaknesses of the multinational model. 

A lot of the industry export growth expectations have been predicated on the strength of the networks built up over the last 10 years, including those of the multinationals. These have been found wanting.

In particular, the New Zealand arms have become subject to global weaknesses.  Should an overseas parent have financial imperatives (and this is not to speculate or to state that New Zealand winery parent companies have been in financial distress) that dictate global requirements for cost controls or for balance sheet restructuring, by way of examples, the investment heavy New Zealand operations may become subject to pressures not necessarily created by domestic performance.

Now it is the multinationals that have ended up most obviously exposed to excessive stock levels and difficulty moving them since they have been more reliant overall on exports than most of the smaller players.  Yet they have also been more limited in terms of bulk export options (owing to the risk of cannibalising the offshore networks) and so have had to discount domestically to aggressively drop stock volumes.  Cutting contract exposures means that they will end up with a smaller overall share of the pie by 2012 (maybe as much as a 5-10% smaller share of production/sales in 2012 than 2007).

Moreover, New Zealand is often perceived as a product slot in a global portfolio, serving a very particular purpose.  This is often not conducive to product evolution – a particularly important issue with respect to Marlborough sauvignon blanc; and can also become a serious handicap when competing with products from other countries in the same stylistic slots within the portfolio.  When competing within one’s own portfolio in any given country within a company’s sales system, the decision of which product to back locally can become a complex issue, often decided by the local profit margin.

With respect to sauvignon blanc, provided sales continue to flow this is rarely a problem as the product tends to have a priority position.  If sales fall below projections, resulting in a disproportionate increase in current or forecast inventory levels, the financial pressure to discount in order to reduce stock levels increases.  Despite the 66% production increase in 2008 from 2007, and the similar level of production in the clearly superior 2009 vintage, the domestic and export statistical evidence is of a greater increase in overall sales volumes driven by discounting as well as market growth.  Consequently, the experience of the last two years suggests that the level of de-stocking may have been even greater, suggesting cash flow pressures have been an equal or greater driver behind discounting behaviour if bulk sales might otherwise have been sufficient to shift the volume increment.  In this context New Zealand’s small overall size is such that its total bulk wine sales are relatively insignificant against those of other large producers.

As a consequence, there are grounds to believe that should New Zealand producers move beyond the current cash flow driven discounting imperative, the country could be closer to finding the supply/demand balance than many think to be the case.  The question then is whether by 2012 the key brands will have survived intact, or whether they will have been compromised by discounting behaviours.

Mergers and acquisitions occurring offshore have sometimes proven detrimental, even if the consequences have rarely been understood within the country.  Such acquisitions frequently result in the realignment of offshore distribution networks, sometime causing dislocation in the transition process and disruption to existing end customer relationships over and above the issues that new brand managers may have fitting acquisitions into their portfolios.

The current wine glut in other product areas has more severely exposed the impact of intra portfolio competition as a serious constraint.  In styles such as sparkling wine and varieties such as chardonnay there has been a clear lack of willingness to necessarily promote some NZ wine styles against those of other countries in the same portfolio, notwithstanding the efforts of New Zealand management to make headway within the international systems that they work in.

Perhaps ironically, the outcome is a reinforced, excessive and arguably unhealthy default focus on sauvignon blanc.

Similarly, New Zealand has traded heavily on the quality of its pinot noir credentials. While justifiable in many respects, the risk that has been exposed is that of limiting the global exposure of other New Zealand reds, and of reducing their market access, despite simultaneous growing international acclaim.  The generally smaller independents are left to try and push this opportunity.

The other key issue with regard to the multinationals is the degree of influence they hold over grape growers.  The multinationals have been by far the largest buyers on a contract or spot basis from the grape grower section of the market.

In recent times, when either offshore indebtedness or other cash flow pressures have forced rapid heavy discounting to reduce stock levels, it has been the multinationals that have led the way – especially in domestic supermarket sales.  Other domestic producers have been forced to match discounts or else experience diminished sales and stocks languishing on shelves.

In a 2012 future where global price points have shifted downwards for the long haul, the large companies have limited scope to gain sufficient additional economies of scale or other opportunities to reduce production costs – so logically the long-awaited squeeze on grape prices, showing signs of appearing in 2010, will be in full “new normal” mode over the next 2-3 years.

M& A and Industry Structure

In a world where debt is severely constrained, even merger or acquisition (aka M&A) options that make excellent commercial sense may not be feasible. By 2012 the new normal will still be a far more conservative lending environment than that of 2007.  However, the extreme risk aversion phase of the bank economic cycle will have started to pass so that the issue for most banks will still be that of capital rationing.

In this environment the past perceptions of the wine industry as being riven by glut and discounting will not be helpful to the lending process essential for much M&A activity.

Even for those with the necessary resources, there are concerns around the three key rationales for operational expansion of wine businesses through acquisition:

  1. operational improvements,
  2. security of supply, and
  3. brand expansion.

The concerns surrounding these three factors are:

  1. Without adequate controls the operational improvements may exceed the costs;
  2. Cancellation of existing contracts plus the sharp drop in the price of grapes means this will no longer be a key issue; and
  3. brand expansion may not be a universal or fashionably desirable strategic goal, especially for larger multinationals (as compared with brand profitability).

So, those second tier firms with a shareholder value strategy based on being taken out by a global player have: (a) lost value; and (b) a serious need for a plan B.

M&A in the smaller end of the market will continue, with a mix of new entrants and mergers among peers. Transaction rationales will vary considerably, as they have always done.

In 2012 the historic normal will continue: some firms will get bigger and others will get smaller.  In terms of industry structure, the main growth will be in the middle.

It is already apparent from NZ Winegrowers data that for the first time in several years the number of wineries has declined slightly.  NZ Winegrowers classifies its members within three tiers: Category 1 small wineries with sales up to 200,000 litres; Category 2 with sales up to 4 million litres; and Category 3 with sales above that level.  At the time of writing there are 6 Category 3 members (three locally owned/controlled and 3 offshore owned),  61 Category 2 members and 608 Category 1 members.  Numerically it has been category 2 that has grown most quickly, doubling in numbers over the last 5-6 years as a number of smaller companies have taken the opportunity to expand export sales.

It is in terms of share of volume that most changes will take place between 2009 and 2012.  During that time it is likely that total Category 3 and Category 1 litreage volumes will decrease, in relative share terms if not also in actual amounts, meaning that the present Category 2 members will expand volume and share of production and sales. (Note that the list of 61 Category 2 wineries includes 34 Marlborough-based, 9 Hawke’s Bay-based, plus 6 Auckland-based companies, all of whom draw more grapes from Marlborough and/or Hawke’s Bay than from Auckland).

Between 2012 and 2020, at least 3 to 5 of the current Category 2 companies will expand into Category 3.  The question is therefore whether this happens through brand and sales growth, or through acquisition.  It should not be ignored that there are companies within the higher tiers that have expanded aggressively in recent years through asset or business purchases, have higher than advisable levels of debt, and that have constrained cash flows and limited asset sale options with which to materially reduce debt gearing.

Land values

The overhang of properties for sale tells its own story.  In the period to 2012 the trend in land values will be downward.  To the extent that high sauvignon blanc yields and grape prices together justified the value of Marlborough land, together with the shortage of grapes when demand was rising, the logical effect in a world of yield limits and lower prices is a fall in both economic and actual values.  This has already happened but the real fallout will be when cash flow pressures force more sales at lower prices, since these factors rarely hit “overnight”.

Overall the impact may well be greatest in those vicinities where viticulture has become a monoculture, i.e. where grape growing has in recent years become a significantly higher value land use than alternative crops or land uses.

The silver lining?  The pressure will increase for greater production efficiencies, and the viticultural contracting sector, able to dictate pricing in recent years, will be under greater pressure although grape buyers will ensure that this does not mean short cuts and diminished quality.  The days of taking the comfortable easy options are over.

The Rising Regional Imperative

The other story that will gain strength by 2012 will be the increasing importance of the regions as the heart of the new New Zealand industry.

The history and development of the wine industry in Marlborough, Central Otago and Hawke’s Bay over the last 5 years is the key indicator of this trend.

Each of these regions has developed a regional story and identity to take to export markets.  Once New Zealand’s geographic indications system is bedded in place, regional identity, which has been the essence of “brands” such as Marlborough Sauvignon Blanc and Central Otago Pinot Noir, will become pivotal to the attempts of other regions to establish, define and protect their identities.  The regional story will become more important to export producers than the New Zealand story, although this process will take a lot longer than 2012 to fully mature.  Some regions will lack the identity to develop further in this environment, accepting that their place is more about a largely local niche market.

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