The Evoultion on the Wine Supply Chain

In the last 79 years since prohibition ended, the beverage alcohol industry in the United States has grown by leaps and bounds, contributing an estimated $380 Billion to the U.S. economy in 2007.  Roughly a third of that figure comes from wine, with the U.S. consuming nearly 3.96 billion bottles of it in 2010 alone.  Producing about 61% wine sold in the U.S. (199.6 million cases of the 330 million case totals), the estimated retail value of California wine sold in the U.S. in 2010 was $18.5 Billion.  With more than 42 million cases shipped abroad, that total is well over $20 Billion worldwide. 

So why does it cost more to distribute wine than virtually any other product segment in the US?

The US Wine supply chain is comprised of 3 parts; the producer, the distributor, and the retailer.  Under this structure, the producer and the retailer are strictly prohibited from buying and selling directly to each other – this is why (for the most part) every transaction legally must go through a licensed distributor. 

Since the implementation of the 3-tier system across the US following the repeal of prohibition, a protected and regulated industry has evolved into an anti-competitive market environment within the middle distribution tier.  This is a model that was developed for the distribution of beer and spirits in the 1960’s, and has yet to evolve to support the now substantial wine industry that is required to go through it. 

For the most part, the high volume major wine labels run through the major six or seven distributors.  With the mid and small sized wineries forced to run through smaller and less capable wine distributors to move their brand, this industry trend has actually been labeled ‘The missing middle.’  Basically, the small boutique wineries (<5,000 cases/year) can survive through direct to consumer shipments and tasting rooms.  The large wine producers (>500,000 cases/year) have the interest of the major national distributors because they can provide volume and consistent sales year round.  The producers who fall in the middle (5,000 – 500,000 cases/year) are too large to survive selling one bottle at a time, and too small to draw the interest of major distributors.  This is where smaller, regional distributors come in.  These distributors lack the volume and network to be very competitive from a pricing standpoint, and their lack of reach creates a very inefficient sales channel, as mid-sized producers are forced to run though countless different distributors in order to reach retailers and ultimately consumers in different markets. 

The overall relationnships between the wine producers and the distributors who handle their products could be described as amicable at best. The driving dynamics within this industry have created an environment of distributor dominance, and only those that prove the most profitable to the middle tier benefit. Because of this, there is growing frustration from many of the groups involved.

“Small suppliers and large retailers express dissatisfaction with the current three-tier system regulating alcohol sales in the US.  Retailers’ main concern is the added layer of costs that the system creates, while small suppliers express frustration with the system’s role in limiting access to market.”

Long story short, the distribution tier is inefficient because the system that insulates their position in the supply chain has removed many of the factors that drive competition.  As we all know – competition is what drives evolution. 

I recently brought my young nephew to zoo and was taken aback by the sheer size of the Lion standing on the other side of the glass from us.  My nephew pointed out his massive teeth, huge jaw muscles, full mane, and paws the size of a catcher’s glove.  As this Lion stood up and walked away from us, I couldn’t help but be impressed by the way he carried himself – Confident that his place on top was undisputed.  Something dawned on me then – This Lion would likely not survive if he was released into the wild.  Born and raised in captivity, he had never fought for its territory or been forced to protect himself from outside threats.   He had never chased down a zebra, or known what hungry felt like.  As sure as he was in his dominance, he has never been forced to better himself to survive – and because of that, he would stand little chance of surviving if not surrounded by the walls that protect him. 

It is easy to blame the structure of the three tier system for the inefficiency and added cost needed to get wine from the barrel to the hands of the consumer.  Thus, the natural reaction is to try and remove those walls – As was learned with the passing of I-1183 in Washington a few months ago, this is a very complicated and expensive undertaking. 

Many in this industry have been banging their heads against these walls, hoping they will fall down. . . The fact is, this is making us all dumber.  Instead, let’s accept the walls as they are, (they are not going away any time soon) – and start finding ways to encourage the evolution of the business that lives within them . . .

The Wine Industry – Taking a step back

There are a number of key topics that shape the landscape as well as the future of the wine industry here in the US.  We dissect the numbers, analyze the trends, stare at the clouds, and kick the dirt – all in hopes that we might gain an inside track on what lies ahead for this perplexing industry.  The critical error made time and again, is that the interconnected dynamics that shape the business of wine are analyzed as though mutually exclusive from each other, and from the influence of constantly shifting macro and socio-economic factors.  Sure, many of us can make the connection of how the price of an Oregon Pinot Noir can be affected by the declining value of the Euro.  But how will the differing purchasing tendencies of generations and cultures play into the complex relationships of the three-tier system?  And how will all these dynamics shift as the wine retail model continually evolves towards more non-traditional retailers, and as new models of wine is production and distribution are introduced?

My hope is to bring the expertise and foresight of many people much smarter than I am, together.  It stands to reason, if we all take a step back to look at the bigger picture, the seemingly random swirls of paint we all have been staring at will make a lot more sense . . .