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The Turrentine Outlook©

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Some prophets go into a deep trance to discern the future. Others read the entrails of sacrificial animals or the flight of birds or tea leaves or they peer into crystal balls. Less mystical forms of assessing the future are also available. They usually involve the detection of patterns that have existed in the past and include speculation about how the dynamics that have created those patterns might be expected to play out in the future. The newly revised Turrentine Wine Business Wheel of Fortune is all about understanding the patterns evident in the wine business and considering how the dynamics involved are likely to develop in the future. The updated Wheel (see facing page) has been produced in conjunction with a new subscription service that Turrentine Brokerage will soon offer its key clients, providing the best information available about the past, current and future supply situation of the California grape and wine business. Turrentine Brokerage first began to describe the dynamics of the cycle in general terms when the wine business was in excess in 1992 and 1993. The first edition of the Turrentine Wine Business Wheel of Fortune was published in January of 1996. It gained fame because it accurately described and predicted the often violent supply cycles that have long characterized the wine business.

Predicting the future by any method is a tricky business. Those who live by the crystal ball must occasionally eat broken glass. But the fact is that all business people must predict – and bet money on – how they think the future will develop. During my 30 years in the wine business, I have observed how hard it is for people to look beyond current conditions. When demand gets ahead of supply and the wine business is doing well, people get excited and focus on the positive factors that are driving success. These can seem unstoppable. When the wine business is flooded with excess supply, most people become gloomy and focus on the factors that are depressing the business. These factors appear insurmountable. In the past, however, each phase of the cycle has created the conditions for the next phase. Shortages, for example, have raised prices, which have stimulated new planting. New plantings have eventually surpassed demand and once again created excess. Excess supply has depressed prices, stopped new planting and created opportunities for creative marketing. Creative marketing has increased sales, which have used up excesses and produced shortages.

That was the past. The future will be different – and full of surprises. No one can predict something like the 1991 Morley Shafer 60 Minutes television segment, called The French Paradox, that associated red wine with longevity and gave sales a huge boost at time when wineries were overflowing with multiple vintages of red wine. No one can predict something like the September 11, 2001 terrorist attacks, which reduced demand for wine just as new acres from the planting boom of 1996, 1997 and 1998 were coming into production. The amazing impact of the movie, Sideways, is another example of the kind of surprises that have a huge influence on the business as a whole or on one segment of the business. These kinds of surprises can determine how fast we travel through the phases of the Wheel and on how extreme the changes are from one phase of the Wheel to another. As long as demand keeps growing – and the demographics for demand growth look good – external factors are unlikely to completely overcome the basic dynamics of the cycle.

So let’s take a spin around the Turrentine Wine Business Wheel of Fortune and see how the wine business fares, Phase by Phase. Then we will examine our current location on the Wheel and what that means for the future.

Phase I – Emerging Excess

We last entered Phase I in 2000, when many acres of wine grapes planted in 1996, 1997 and 1998 were coming into production. Unfortunately, the Dot Com boom went bust at around the same time, slowing the rate of premium wine sales just as the tons of wine grapes harvested began to escalate. Many brands were eager to preserve the good margins they had achieved during the boom years and they were willing to sacrifice market share in order to preserve margins. But the fact is that trying to preserve margins in an excess market is usually an impossible dream that delays action while conditions worsen. The few companies that foresaw the coming excess, of course, were in great shape because they had already cut back on commitments and were now able to source grapes and bulk wine at much lower prices than their competitors. With a lower cost of goods, they could pass on savings to wholesalers, retailers and consumers in order to gain market share while still keeping fairly reasonable margins. The majority of companies, however, were locked into high priced, long term grape and bulk wine contracts that increased in volume over time. The companies found that their inventories were ballooning while their existing casegood market share was being stolen by brands that were willing to aggressively discount. They turned for relief to the grape and bulk wine markets and discovered that these markets do not work very well when almost everyone wants to sell. Moving excess inventories into export markets or through the domestic bulk wine market proved difficult and required taking large losses. Eventually, many companies found that they needed to discount their brands and to increase marketing expenses and many of them still needed to accept low prices for excess grapes and wines in bulk.

Phase II – Acute Excess

This difficult situation was exacerbated in 2003, 2004 and 2005, as vineyards planted in 1999, 2000 and 2001 started coming on line. Through this period, a number of wineries took huge write-offs on sales of grapes and wines in bulk, but they did make progress in working down excess inventories. The huge harvest of 2005 reversed much of that progress and flooded the wine business once more with excess inventory.

Strong sales growth for wines over $10.00 a bottle retail helped the higher end of the wine business deal with excesses. The removal of an estimated 50,000 acres of wine grapes in the southern end of the San Joaquin Valley, along with strong sales for the Charles Shaw brand, helped to stabilize the value end of the business. But strong competition from imports has constrained sales growth for many of those California wines in between the high end and the extreme value brands. Further inundated with an above average crop in 2006, the wine business overall remained in a state of excess supply into 2007.

Phase III and Phase IV – Emerging Shortage & Shortage


In the past, the period of shortage has been very good for most segments of the California wine business. In this phase, growers experience increasing demand and improving prices. Wineries usually get stuck with higher grape prices but, as long as the whole market tightens up, they are usually able to increase casegood prices to more than compensate for higher grape prices.

It appears that demand for premium wine in the United States is relatively price inelastic. That means that, when the whole market is increasing prices because of shortage, demand does not fall off as much as one might expect. This is very positive for the wine business during times of shortage. Many wineries discover that demand remains strong even though they increase FOB prices and they are able to achieve the kinds of margins that justify a complicated, capital intensive game like the wine business. These good times typically attract large amounts of new capital and fuel a boom in planting and in winery expansion.

Where Are We Are Now and Where Are We Going?

Past history, as well as the dynamic of the Turrentine Wine Business Wheel of Fortune, would suggest that growing sales for premium varietal wines will drink up most of the current excesses over the next 12 to 24 months and that the California wine business will enter a period of emerging shortage. But the past is no guarantee of the future and there are experienced players who are skeptical about this prediction, so let’s review the factors, pro and con, for a developing shortage:

Pro

1. Essentially no new bearing acres of any major variety except Pinot Noir and Pinot Grigio.
2. Strong sales growth for most varieties, especially for wines retailing over $7.00 and even more for wines retailing for over $12.00. Most wineries think the demographics are good for continued premium sales growth.
3. Potential new plantings are restrained by high land and development costs and by ever higher regulatory hurdles.

Con

1. Current lingering excesses still need to find routes to market.
2. Intense international competition, driven by more adventurous consumers and improving quality from many established wine regions, some of which have much lower costs and export subsidies.
3. The entry of China and other areas with very low labor and other costs into the international wine business.

There is no question that global competition, over the long term, will continue to intensify. American consumers, especially younger consumers, are increasingly willing to try wine from anywhere. On the other hand, most regions of the world that make wines that have been competitive with premium varietals from California have also been through a number of years of excess supply and they also have not been planting significant acres of new vineyards. If worldwide sales of premium wines continue to grow, it will take producers some time to develop new vineyards or to re-tool existing vineyards to effectively compete in the expanding world market.

The size of the 2007 California harvest, which is still hard to predict, will be crucial for the timing of a definitive transition from Phase II excess to Phase III shortage in California. And, of course, every varietal is in a somewhat different position. Pinot Noir and Pinot Grigio are way ahead of everything else. They entered Phase III two or three years ago and they have already stimulated their own grafting and planting boom so that there are significant non-bearing acres of these varieties. You could say that, for Pinot Noir and Pinot Grigio, a race is on between supply and demand. Demand is still in the lead but supply is now coming on fast. But this race is not easy to handicap because demand is still growing rapidly from a relatively small base and demand could continue to grow for quite a while, possibly taking market share from other leading varieties, such as Merlot (for Pinot Noir) and Chardonnay and Sauvignon Blanc (for Pinot Grigio).

Chardonnay and Cabernet Sauvignon are a long way behind Pinot Noir and Pinot Grigio, but they are approaching a critical change point. Chardonnay has sustained an actual decrease in the number of bearing acres, while casegood sales have been growing at a slow but steady rate on a large base. Cabernet Sauvignon has been in serious excess, but it is experiencing a healthy rate of casegood sales growth that is likely to soon drink up the excess. Merlot is bringing up the rear, with a serious excess of wine from both the 2005 and 2006 vintages. Few wineries need much Merlot from the 2007 harvest. Casegood sales, however, have experienced a bit of a recovery. The potential long term problem is that many growers are likely to graft or remove Merlot vines because of several years of dismal markets. By the time these vines have been removed over the next year or two, wineries will probably have used up their excess bulk inventories and will be needing to purchase grapes to sustain growing programs. A year or two from now, the Merlot market could come around with a surprising shift into shortage.

Though the future is always hard to discern, those engaged in business must consider and act upon the probabilities as best as they can understand them. This is especially challenging in the grape and wine business, which depends upon grapevines for supply and fickle consumers for demand. Grapevines are expensive to plant and slow to develop. Consumer preferences, on the other hand, often change quickly. This means that proprietors and executives in the grape and wine business must make expensive decisions, with long term consequences, based on their evaluation of the probabilities of the future. Furthermore, there is less data on both supply and sales trends in the wine business than in most businesses. The big dollar amounts, the long timeframe and the paucity of data make every bit of useful data and of sound analysis extremely important. The Turrentine Wine Business Wheel of Fortune is a time-tested tool to understand the essential patterns of the wine business and to apply those patterns to an analysis of the probabilities of the future. It is our goal to provide the best information in the grape and wine business to help guide critical decisions.