The Changing Structure Of The Global Wine Industry

This paper examines the distinctive economic structures that exist in the wine industry in various regions of the world, and it identifies the critical forces driving changes in the structure of this industry. The paper accomplishes these objectives by applying concepts from industrial organization economics, agency theory, and the field of competitive strategy. he economic structure of an industry affects the intensity of competition and the average profitability of firms in a particular market. While strategy scholars have debated the extent to which industry structure explains differences in firm profitability, virtually no one disputes the idea that structural forces have a sizeable impact. More recently, researchers have demonstrated that industries exhibit substantial structural differences across various geographic markets around the world. These structural differences are driven by institutional heterogeneity and contrasting patterns of historical development. Over time, the structure of a global industry can change dramatically. In particular, many industries have experienced consolidation in recent years. Industry consolidation raises several important questions for scholars and practitioners. First, why do these structural shifts take place? Second, do structural differences across geographic markets persist as consolidation begins to occur? Finally, do firms that actively pursue global consolidation strategies create value for their shareholders? The wine industry offers a unique opportunity to examine these questions. There are substantial differences in the structure of the wine industry around the world. For instance, there are 232,900 wine producers in France and the top 10 brands control only 4% of the market. In contrast, four firms control over 75% of the Australian wine market. Overall, one can see a marked difference in industry structure when comparing the “New World” producers (e.g. Australia, Chile, United States) to the “Old World” firms (European producers). These structural differences are driven by institutional heterogeneity and contrasting patterns of historical development. However, they are also driven by the competitive strategies employed by particular firms. This latter point is extremely important. Differences in industry structure are not purely exogenous; they are also a product of the strategies employed by firms in the industry. The structural differences have become more substantial recently, as industry consolidation has accelerated in some regions, particularly in New World markets. Why is consolidation taking place rapidly in an industry that has remained highly fragmented for centuries? Two sets of explanations exist. One set consists of rational economic (profit-maximizing) drivers of consolidation. For instance, the market power of the distribution channel is rising dramatically, and there are increasing scale, scope, and learning economies available to producers. A second set of factors may be driving consolidation, though this may not be profit-maximizing behavior. Firms in other segments of the alcoholic beverage industry (i.e., beer and spirits firms) are acquiring wineries and driving consolidation because their own markets are maturing. They see entry into the wine business as a mechanism for reenergizing revenue growth. Of course, the motives and behavior of the managers in these firms may not be consistent with shareholder value maximization (i.e. there may be agency problems). Nevertheless, this behavior is fundamentally altering the economic structure of the global wine industry. Thus, we see that not only do firm ___________________ Readers with comments or questions are encouraged to contact the author via email. T International Business & Economics Research Journal Volume 2, Number 9 2 strategies shape industry structure around the world, but the behavior of particular executives, who may be pursuing their own interests at the expense of shareholders, can also alter industry structure over time. Overview of the Global Wine Industry There are over one million wine producers worldwide, and no firm accounts for more than 1% of global retail sales in 2001. However, market concentration differs substantially by country. Four firms account for 75% of the Australian market, while the top 20 firms control 75% of the U.S. wine industry. In contrast, the European market remains highly fragmented (See Table 1 below). Table 1: Market Concentration in Selected Countries – 1998 Nation # of Primary Producers Hectoliters (HL) per Producer (000s) Mkt. Share of Top 10 Wine Brands US 4,500 4,200 37.6% Australia 3,000 2,500 24.3% South Africa 4,654 1,750 24.7% Germany 68,500 160 8.0% Italy 275,000 200 6.0% France 232,900 220 4.3% Source: Adapted from Morgan Stanley Dean Witter Research Though its market is highly fragmented, Europe still dominates the global wine industry. 75% of the world’s production and consumption take place in Europe, with three countries alone (France, Italy, and Spain) accounting for one-half of the world’s supply of wine. Industry observers often distinguish between these “Old World” producers in Europe, and the “New World” wineries in countries such as Australia, Chile, South Africa, and the US. The “New World” increased its share of the global market in the past two decades, while wine production declined dramatically in Europe. Global consumption has followed a somewhat similar pattern, with overall growth of 1-2% per year since 1994 (Exhibit 7). Demand has increased for premium wines, while consumption of inexpensive, lower quality wine has fallen. Industry analysts expect the demand for premium wines to grow at 8-10% per annum for the foreseeable future. These changing consumption patterns have created a great deal of excess capacity in Europe, while New World wineries continue to increase vineyard acreage in response to strong demand for high quality wines. Wine-making in the New World differs from the Old World in many ways. Small family-owned vineyards produce most of the wine in Europe, while many larger publicly traded firms compete in New World markets. European governments often provide subsidies to these small vineyards. Moreover, many European families continue to make their own wine for household consumption, while Americans and Australians purchase nearly all of the wine that they drink. The New World producers invest much more heavily in technology and automation. These investments and innovations enable them to enhance the consistency and the quality of their wines and to reduce operating costs considerably. For instance, New World producers rely increasingly on machines to harvest the grapes in their vineyards, while most European wineries continue to hand-pick their entire supply of grapes. The New World also has more extensive and well-developed markets for grapes, making it easier for wineries to find multiple avenues for sourcing their most critical inputs. The level of outsourcing differed markedly by region. California wineries outsource 70-85% of their grapes, while French winemakers grow nearly all of their own fruit. 7 In Europe, strict regulations control many aspects of winemaking including planting, irrigation, classification, and labeling. The French government imposes the most severe restrictions. Often, it takes legal action to protect the nomenclature created centuries ago. For instance, wineries only can designate sparkling wine as “Champagne” if they produce it using three grape varieties grown in the region with the same name. Fewer controls constrain production in nations such as the US, Chile, and South Africa. The Australian industry has International Business & Economics Research Journal Volume 2, Number 9 3 particularly loose controls. The producers can label wines based upon the sourcing of grapes from broad geographical regions. They also can identify the wine by the year it was bottled, rather than when the grapes were harvested. This enables them to combine grapes from different vintages to make a particular wine. The European wineries also engage in very little consumer branding. Instead, the wines are known primarily by their appellation (region) – Bordeaux, Burgundy, Chianti, etc. The New World producers tend to classify wines according to the variety of grapes used to make the wine (Chardonnay, Zinfandel, etc.) Inexperienced consumers find it much easier to associate the flavor of the wine with a particular variety of grape rather than a geographic region. New World wineries invest heavily in activities designed to educate consumers about wine. They hope to raise per capita consumption by enhancing the level of product knowledge among New World consumers, and by removing some of the “mystique” associated with winemaking. They also spend more money on advertising and promotion in order to build brand equity. After developing a well-known name, many firms extend the brand to an entire line of products, each serving a different market segment. Structural Differences: Old World vs. New World Clearly, the New World is much more highly concentrated than the Old World. However, the structural differences go far beyond market concentration. Each of the principal competitive forces differs as well when comparing across geographic markets. In general, the New World appears to have a slightly more attractive industry structure than the Old World.