OVERSUPPLY/GLOBAL TRENDS: Too much to drink?

Wine oversupply continues to be a serious concern and has driven prices of quality offerings down to unsustainable levels. Can the industry seize the opportunity to correct its market position?

Billy Connolly once quipped that his ambition was to ski down the butter mountain and plunge headfirst into the wine lake. A wonderful image courtesy of the Big Yin, but at the time the European wine industry had a serious problem on its hands with heavily subsidised oversupply fuelling financial problems and political tension. France and Italy were swimming in surplus wine and the situation had to be brought under control. The problem, pain and rooting out excess European production continues to this day but the wine world has dramatically changed and oversupply has become a global issue.

Consider that the global trade in wine has risen 80% in the last 20 years with exports now accounting for 28% of world production and 33% of global demand according to EU figures. And, while the “traditional” European producing countries have been slow to address a largely fragmented and relatively unbranded industry, the New World “newcomers” have seized the initiative. Strong brands, consumer-friendly styles, generic marketing and a big bang for your bucks mentality in terms of over-delivering on a quality/price ratio have seen the well documented rise and rise of Australia, California and others on UK and US retail shelves.

But all the while world demand has been falling with dramatic drops in consumption in traditional European wine drinking countries, down from 100 litres to 50l per head annually. This, of course, has been balanced to a degree by emerging and still developing wine drinking markets (eg the UK, US, Australia and other rising economies) and after falling to a recent low, global consumption is gradually creeping up again, rising 1.4% in 2006 to 241 million hectolitres (according to the OIV). The net result, though – with plantings continuing apace by New World countries buoyed by recent successes – has been a global wine lake lapping at the feet of less than thirsty drinkers.

Too little too late?
In the UK the double-digit volume growth experienced in the 1980s fell to single figure growth during the 1990s before tailing off into this century. For the past 18 months the market has remained stable but flat, with the only growth in higher price point wines. Against this background the two major movers, Australia and California, have driven impressive growth against rival countries through an essentially limited number of big volume brands. So far, so good. But, to sustain this momentum, heavy discounting has become the norm, possible to a large degree because of cheap surpluses of juice in Riverina, Central Valley and elsewhere.

Low cost wines can and do create a competitive edge but over time – as brands owners are only too aware – discounting jeopardises market position in several ways. Image of quality suffers and with it the ability of a country to maintain a high median price point in the market. Consumers may also tire of overly generic wines and brand loyalty becomes ever harder to maintain if competing brands “taste virtually the same”.

Julian Brind, the widely respected ex-head wine buyer and now consultant for Waitrose, recently spoke out on the subject in the national press. He agreed in a Guardian interview that discounting is ultimately damaging for the trade and even went as far as accepting some responsibility, having been one of the first supermarket buyers to recognise the potential and introduce discount offers on wine.

Australia, with its long-term industry vision, realises that it has become too reliant on discounted wines and needs to revamp its image and positioning in the UK. To a degree California needs to do the same. Good news then for both that vintage shortfalls and moves to reign in over-production are helping to rectify oversupply of cheap wine. The problem is, though, it may be too late for these countries to return to business as usual and, especially in Australia’s case, the days of oversupply may come to be seen as a golden era.

“With Australia and California coming out of surplus and the market flat in UK, plus most of their recent growth being on the back of cheap surpluses, there could be a very sizeable impact as supply hardens from these two,” warns Richard Cochrane, off-trade director at Bibendum. “The issue is that discounting erodes the bottom line and long term reduces the amount customers are prepared to pay for a wine or a country’s wines.

“If you look at the major players in the off-trade, there is a big churn rate among buyers and category managers which leads to a short-term mentality, but retailers still have to show growers year-on-year growth,” continues Cochrane. “It’s like being on a train where everyone can see the buffers at the end of the track but no-one has bothered to tell the driver.”

Redressing the balance
Last year the Australian Wine & Brandy Corporation (AWBC) calmly estimated that the balance of supply would be redressed by 2009-2010. At that time Australia was sitting atop a wine lake of between 700 and 900 million litres, more than its annual export volume and double the annual domestic consumption. However, such is the severity of the continuing drought Down Under that Australian Prime Minister John Howard recently announced that unless rains arrive there will be no allocations to draw water from the major Australian water systems. Around 60% of Australia’s vineyards are in the Murray Darling basin and irrigation is essential for their commercial survival. The AWBC forecasts that this year’s harvest will be down 30% and many growers are close to the wall. To say that the knock on of two and maybe more severely short vintages will rapidly redress the oversupply issue is to put it mildly.

At the same time, California’s harvest is down 20% to 3.5 million tonnes, helping balance out recent bumper crops. While there is little suggestion that California is in the same fix as Australia, it is worth remembering that water and environmental issues are becoming ever more pressing concerns in its industry. The main point is that shortfalls from both these countries will surely collectively hit the ability of both brand owners and retailers to fund heavily discounted promotions.

Australia, to its credit, has already been making tracks to reposition itself in the UK, its major export market. Recent focus has been on pushing the quality and individuality message, centred on regional identity, on-trade oriented and cooler climate wines. “There are great opportunities, especially with the surplus of cool climate fruit, but much of this is currently being undersold in over-delivering, bigger volume wines,” says Paul Henry, general manager, market development, at the AWBC.

To put this into figures, cool climate fruit represented 40% of Australia’s production in 2006, but only an 18% share of exported wine. “There is a need to persuade customers to trade up and across to individual wines and pay the full value for these expressions of high quality cool fruit,” says Henry. “Australia has been woken up rather rudely after its apparent free run of the past two decades, but I am confident about the future.”

John McLaren, UK director of the Wine Institute of California, is cautious in his assessment of how much knock-on effect there may be from Australia’s plight. “When the last California vintage came in the feeling was that it would meet our market requirements without either price rises or falls,” he says. “However, that was before the Australian shortage and there is a possibility, at the lower end, that there will be moves by some to plug the holes.” McLaren stresses that it is not in California’s interest to “fill gaps on retail shelves just because they have run out of cheap stuff from elsewhere”, but admits the large players are a law unto themselves.

“The heart of our marketing strategy is to address the £5-10 sector and redress the lingering image of California as either cheap end or high faluting Napa wines,” he says. “There has been a shift towards better quality fruit, with lower quality vineyards grubbed up in the Central Valley and the balance made up with new fruit from the coastal regions and this has boosted the quality of the branded wines.”

Though neither may be able to express the opinion quite so plainly, McLaren and Henry recognise the impossibility of a situation where the general quality of raw materials has been upped while prices have been driven relentlessly down. Drain the surplus out of the system and one is reminded again of Cochrane’s image of the buffers and a fast approaching train.

Rising prices

The thing is, marketing can drive change only so far and the retailers driving discounting may find South Africa, Chile and even recently regenerated regions in the Old World countries willing to fill the gap. It is worth remembering, though, that a proposal currently doing the rounds at the EU agricultural department recommends uprooting 40,000 hectares of vines between 2008 and 2013, representing 12% of current vineyards, in a dramatic move to quash lingering European oversupply and improve quality. Couple this with the very real likelihood that global wine consumption will continue its tentative recent expansion – think China, South East Asia, India, Brazil, Eastern Europe, America’s Mid West and a host of other developing regions – and long term the picture begins to suggest that demand and prices for grapes will inevitably rise.

The big Australian brand owners insist that it’s business as usual – for the moment. As do most retailers. Jason Godley, category manager for wine at Tesco, believes the current Australian difficulties will not impact at the moment because there is still a lot of wine left in tank from the previous vintage.

“The next vintage will be the crucial one if it proves as poor as the last,” predicts Godley. “This is an incredibly competitive market anyway but it has become even more so in the last six months because not enough people are buying wine, so of course there is the danger that Australia’s good, or bad fortune, depending how you look at it, will pass on to South Africa and Chile.”

The big question
Tesco does not buy Australian wine on the bulk market, but for those competitors who do, prices are already rising. The question is how long it will be – if, as feared, the next vintage is short – before this price increase knocks on the door of the big players.

“Australia has strong brands and it is likely that many consumers will remain loyal to these should prices rise or discounts and promotions become less frequent,” suggests Godley. “But ultimately this lies in the hand of the consumers.”

Consumers love discounts and promotions. What South Africa and Chile have to ask themselves is, regardless of their own current surplus situations, whether it is in their long-term benefit to plunge further down the discount road. Because factors such as the effects of global warming, tighter global management of production and the growth of emerging markets are likely to diminish the global wine lake in the medium term. And then who wants to be left with the bargain basement baton?

© db June 2007