SVB 2011-2012 Wine Industry Report

2011-2012 State of the Wine Industry Dr. Rumack: You’d better tell the Captain we’ve got to land as soon as we can. This woman has to be gotten to a hospital. Elaine Dickinson: A hospital? What is it? Dr. Rumack: It’s a big building with patients, but that’s not important right now. The 1980 spoof classic Airplane was a critical success, well, it was if you didn’t listen to the critics, but that’s not important right now. The movie introduced us to the lighter side of long-time character actor Leslie Nielsen who played the part of Dr. Rumack. Nielsen, who passed away in November of 2010 followed that “hit” with forgettable roles in The Naked Gun series, The Scary Movie series, and Police Squad. I think we should now pause to remember just what Leslie meant to each of us … OK that’s enough. Maybe that’s not important either.Written ByRob McMillanFounder, Wine Division707.967.1367rmcmillan@svb.comAPRIL 2011 1

º Slightly too much wine at the producerThe movie Airplane was about a The industry has soared from being levelflight where both pilots died of food a cottage-based industry, into a jet-poisoning. Fortunately, the plane was fueled growth business in which U.S. º Too much wine at the distributor levelcarrying our reluctant hero Ted Striker. consumption alone is projected to º Most growers supplying fine wineA former combat pilot who had lost his increase by 9 percent to $23.8 billion producers would get less for their grapesmojo to fly, Ted along with his lost love by 2014.1 on expiring contractsinterest Elaine Dickinson, together finda way to land the plane and save the day, Flight Log With the exception of our overlythus triumphing over their own fears Looking back at the State of the Wine bullish guess on the timing of anyand personal tragedy. Too bad about Industry flight log from last year (2010), improvement in discounting, we believethe pilots, but that’s not important right we forecasted improving conditions in our predictions were largely quitenow. What is important is Airplane is the fine wine business2: accurate. In fact, we saw fine wineour canvas for painting a picture of the º Improving consumer climate sales come in right in the middle of ourwine business this year with all of the forecast range of 8-12 percent. º The end of the trading down trendups and downs, misunderstandings anddrama. Besides, it was really funny and º Growth in $20+ price points ending the 2011-2012 Cautious Optimism?might help you read this to the end. But year 8-12 percent higher year-over-yearfor those needing more entertainment, º Revenue growth in fine wine to outpace Rumack: Can you fly this plane, andin the electronic version of the report growth in lower price wine segments land it?you will find links to clips from themovie. To co-opt a line from an airline, º Improving affluent spending, corporate Ted Striker: Surely you can’t bewe know you have many choices in spending and restaurant sales serious.banks. So thanks for flying Silicon º Prominent level of discounting continuing Rumack: I am serious ... and don’tValley Bank! call me Shirley. into Q3 º Improving distributor purchases for the year as depleted wine is reorderedExecutive Summary Could you be cautiously optimistic if º Positive momentum in the adoption of you were Dr Rumack? I hate that termThe wine business has long been a direct-to-consumer sales tactics. when it comes from an economist.sanctuary for the creative soul seeking How does a winery owner plan withrefuge in a rural lifestyle, with an … but we noted several drags on a cautiously optimistic outlook fromadditional twist of elegance and producer performance: an expert? It’s like a pilot announcingoccasionally, for some lucky souls, the º Persistent financial and economic over the cabin speaker, “Ladies andpromise of semi-retirement. Today, hurdles nationally gentlemen, we’ve started our finalthe U.S. wine industry has taken full descent. I’m not sure exactly when º Fine wine sales would not return to theflight, respected for the quality of its we are landing. Hopefully our angle high point of the past decade anytimeproduct, domestic consumption and its won’t be too steep and it won’t be our soonimpressive international market share. final-final descent. But I’m cautiouslyBut sadly in the process of climbing to º Downward price pressure in all but those optimistic about our chances.” Well,cruising altitude, the industry hit heavy wineries selling on allocation, large scale that’s comforting!turbulence in the form of short-term producers, or established brands in widecyclical and economic shocks to its distribution Following several years when we feltbucolic roots along with longer-term more like a coroner than a cheerleader, º Wineries selling sizeable productionstructural changes driven by distribution this year we are happy to declare above $50 would find it a difficult timeconsolidation and the digital revolution. we are off the bottom of the wineNo longer is the wine business a game º Producer profitability in family wineries industry down cycle and we are solidfor amateur pilots flying a Piper Cub. would be negatively impacted optimists for the industry looking out2 APRIL 2011

º Low adoption rates in the use of digitalseveral years. Based on our outlook most importantly, individual skill in marketing toolsfor the economy and our knowledge executing their sales strategy. A wideof the wine business, we believe we º High fixed costs to produce wines with disparity between winery businessare at the beginning of another long- lowered and reset price points models continues to exist, making theterm steady growth pattern in fine º Slowly improving economy, but several “average winery” even more difficultwine sales. We are off the tarmac and issues that hold back the recovery: to find today. What might be aare predicting growth rates for the defined risk for one winery could be º Euro zone challengesfine wine segment in the range of 11 strength for another. This increases- 15 percent this year, albeit with only º State, municipal and large pension both the opportunity to redefine andmarginally improving profitability. 3 funding/budget problems differentiate a given winery and brand, but also raises the risk for owners, º Geopolitical risk in oil-producingWe are predicting: investors and lenders alike who might countriesº Growth in luxury goods will outpace the otherwise act on instinct, patterns and rest of the economy º Surging commodity prices act like a rules of thumb. tax on consumptionº Trading up trend will accelerate in higher º Federal spending: to spend or not to The dominant question for the fine priced wine spend? wine business today is: Who are yourº Marginally improved pricing power at the customers and what do they want? producer level º Inflation in emerging markets and the EU To answer that question, wineriesº Boomers and Gen X, not Millennials, will º Increasing domestic interest rates should consider the following issues. support most of the fine wine recovery Do customers want cheap wine and º Quick swings in the FX markets is it really all about price? Are they allº Improving restaurant sales, specifically in º Balancing a weak dollar against smartphone-carrying Millennials who full-serve restaurants inflation, recovery, huge debt burden talk in 140 characters or less, have noº Producer level inventory closer to and rate hikes land phone and never check e-mail? balanced than most seem to think Are they arthritic Boomers or mid-º Sales growth in fine wine of 11-15 percent Despite the concerns mentioned, output career Gen-Xers distracted by young with marginally improving profits from the SVB Wine Conditions Survey kids and with no time or money for shows winery owners believe 2011 will affordable luxuries? Maybe they want be a better than average year on most to be part of your wine club, or maybe “We believe we are at the beginning fronts, and the industry is becoming they hate your idea of a club? Did of another long-term steady growth more convinced that there might be you ask if they had any suggestions pattern in fine wine sales.” some smooth air ahead. While we to make your program better? Maybe generally support their increasingly they are green and want somethingSpoiling what otherwise is a smooth optimistic view, we suggest there is still that is authentic and environmentally-takeoff, we note the following a fair bit of headwind. As we’ve said friendly? Maybe you are sending themheadwinds: for the past two years, it’s unlikely we red wine, but they only like whiteº Continuing distribution issues/changes will experience price levels or see price wine? How would you know? If your increases similar to those that existed customer’s attitudes are changing,º Shifting threats to the legal landscape for prior to the crash anytime soon. what will you do to stay relevant with direct shipping them? Are you one of the approximateº Flat or declining pricing on grape That said, it’s important to realize that 3 percent of wineries who actually use contracts except in best properties the obstacles wineries face continue CRM and can answer those questions to be winery-specific depending on or are you in the 97 percent who haveº Decline in the number of affluent several factors, including grape made little investment in answering spenders between the ages of 35-54 contracts, price points, brand strength, that most basic of questions: Why do appellation, volume produced, and people buy my wine?4 2011-2012 State of the Wine Industry 3

We hope you will find the following and go. Even into late Q3 there was still thus sealing the extension of the Bushhelpful in sorting through some of your discussion of a double dip mirroring era tax cuts. Maybe consumers weretop-level thoughts, and that exercise will the business cycle from the Great just tired of earning less than the costassist in your decision making and drive Depression. Some even put the odds of inflation for their savings and weregreater success for your business in 2011- as high as 50/50.5 Clearly, wineries had ready to take on more risk. Whatever2012 and beyond. no upward pricing opportunity against happened, by Q4 2010 business was that backdrop. good — not great. But it was at2011-2012 State of the Wine least good again, and that was greatIndustry Then one day in Q4 an almost palpable news for the producer. That change in change came about. It seemed the fog fortune is reflected in the ECRI LEIContrails on the deck cleared, traffic patterns chart (Figure 1), and also in Nielsen opened, giving way to VFR6 for the Scan Data (Figure 2) that showedSteve McCroskey: Looks like first time since the market meltdown. the strongest price point growth inI picked the wrong week to quit Maybe it was the addition of QE2, the $20+ category last year. And withdrinking. or perhaps the investing community many fuel tanks at bingo in Q4, a little approved of the gridlock in Washington, in-flight refueling was much needed.With an Airplane theme, maybe we Figure 1: ECRI Weekly Leading Indicator Indexshouldn’t talk about “The Crash.”Steve McCroskey did what a lot of 140people did in late 2008: quit drinking. 135Well they didn’t quit really, they 130traded down to cheaper wines andglue. (Trust me, you’d have to see the 125movie clip.) Anyway, in 2008 with the 120economic hardships surrounding us, 115the foul mood of the U.S. taxpayer, 110and resultant inventory bulge ensuing 105from slack retail sales, many thought 100the luxury goods business was dead. May-08 May-09 May-10 Nov-08 Nov-09 Nov-10 Aug-08 Sep-08 Dec-08 Aug-09 Sep-09 Dec-09 Aug-10 Sep-10 Dec-10 Mar-08 Mar-09 Mar-10 Mar-11 Feb-08 Feb-09 Feb-10 Feb-11 Jun-08 Jun-09 Jun-10 Jan-08 Oct-08 Jan-09 Oct-09 Jan-10 Oct-10 Jan-11 Apr-08 Apr-09 Apr-10 Jul-08 Jul-09 Jul-10Gone were the vestiges of conspicuousconsumption and public celebrations. Source: Economic Cycle Research InstituteConsumers were trading down to lowerprice points and producers capitulated,discounting their wines to meet the Figure 2: Trading Down?consumer’s price expectation. Volume% Chg Volume% Chg Lat 52 $ Share Price SegmentMoving into 2010, the fine wine Lat 52 Lat 26 Lat 52 Lat 26business started to show a pulse early 100% Ttl Table Wine +4.5% +4.8% +3.2% +3.5%in the year, but the summer was touch 8.4 $0-$2.99 -1.3 -2.5 -2.4 -2.6 29.3 $3-$5.99 +4.4 +4.2 +4.8 +4.9 20.2 $6-$8.99 -3.4 -3.3 -1.0 -0.9 20.8 $9-$2.99 +10.0 +10.5 +12.4 +12.5 “Even into late Q3 there was 10.0 $12-$2.99 +7.8 +8.1 +10.3 +10.2 discussion of a double dip mirroring the business cycle from the Great 6.2 $15-$2.99 +7.0 +9.4 7.7 +10.3 Depression.” 5.0 >$20 +11.4 +11.8 +9.2 +11.0 Source: Nielsen Beverage4 APRIL 2011

Ascent Figure 3: Price Changes in 2011Roger Murdock: Flight 2-0-9’er, 70.00%you are cleared for take-off. 60.00%Captain Oveur: Roger! 50.00%Roger Murdock: Huh? 40.00% 30.00% 20.00%The fine wine industry is taking off 10.00%again. The real question is in whichdirection. It’s a little confusing to find 0.00% Reduce the shelf Reduce the shelf Hold my shelf Selective price Shelf price increases onthe right vector, Victor, especially when price significantly price a little price increases most or all wines.it comes to pricing decisions. So, inSVB’s Wine Conditions Survey, we Source: Silicon Valley Bankasked wineries what they intended to dowith their pricing in 2011. The responses Since the press has been full of stories have evolved and the affluent consumerare reflected in Figure 3. Roughly 25 in the past year of cult wineries cutting is back spending, while the middle classpercent of the 598 respondents said price, finding this result seems a little makes some inroads as supported withthey thought they would have selective like expecting a lead airplane to fly — lower unemployment rates and higherprice increases in 2011. In fact, by although technically lead planes could levels of job creation. In addition, it’sa small margin, the responses again fly with the right wind speed and lift. the job of every producer to balanceindicate we are past the bottom of Obviously, the luxury end of the fine inventory and many times that meansthe recession and trending up. But wine business has gotten lighter; the blending down to lower tires. So thein our current view of the industry, news isn’t as bad as we think; or the chart really is reflective of the drying upwe see only very limited upward economic atmospherics have changed. inventory bulge and a very positive signpricing prospects considering inventory foretelling the end of this down cycle.balance, distributor challenges and From our desk, we would vote forthe enduring, soft economy. The fact the latter. Although the economy as The economic recovery has not beenthere is any upward pricing pressure, a whole still works to avoid financial equal across all income groups. Untilhowever, is noteworthy. wind shear, the consumer atmospherics 2011 the growth in sales came largelyJust where is the pricing opportunity? Figure 4: Price Changes by Price PointSurprising to many perhaps, it’snot with $20 wines. It’s with more 35%expensive wines. 30% 25%Figure 4 compares by average pricepoint, those wineries who believe 20%they could increase prices from those 15%who said they needed to reduce it 10%further. From that, we are able to seewines selling over $41 show a greater 5%likelihood of increasing price in 2011, 0%compared with those wines priced >$15 $15-$20 $21-$25 $26-$30 $31-$40 $41-$70 >$70 Reduce Prices Increase Pricesbetween $15 and $40. Source: Silicon Valley Bank 2011-2012 State of the Wine Industry 5

from the affluent because the impact Figure 5: Dow Jones Luxury Index vs. S&P 500of accommodative policy and low rates 1600has floated the stock market again 1500where they had investments. On the 1400other hand, for the middle class whohave little stock investment and more 1300of their wealth tied to their homes, life 1200has not been close to being what it was 1100pre-crash. As of this writing, about 23 1000percent of all homes in the U.S. have 900equity that is less than the mortgage 800amount. That’s not only a drag on the 10 10 10 10 10 10 10 10 10 11 0 0 0 01 01 01 20 20 20 20 20 20 20 20 20 20 /2 /2 /2 1/ 1/ 1/ 1/ 1/ 1/ 1/ 1/ 1/ 1/healing economy, it’s a drag for that /1 /1 /1 1/ 2/ 3/ 4/ 5/ 6/ 7/ 8/ 9/ 1/ 10 11 12 Dow Jones Luxury Index S&P 500percentage of the population who arein a bad spot and unlikely to spend Source: Bloomberg and SVB Financial Groupmuch on luxuries. But the start of2011 has started with real job growth middle class more forcefully join the teachings stick with us. One that manyaccompanied by the first decline in the recovery, specifically with respect to of us might hold to is a long-held beliefjobless rate in some time. Consumer housing. Regrettably, most economists that if you drop your price on a SKU,confidence is improving and we expect point to a further decline in U.S. you will train consumers to pay less forto see the start of a healing middle class home market prices in 2011 with new better wine and then play hell raisingthat will have a positive impact on fine housing inventory still higher than price back later. Reading the presswine sales. what is needed for a healthy balance we constantly see the statement that of supply. In addition, the summer wineries have trained the consumers toBut the reality is the affluent have a prospects for the continuing pace of believe that they can find better winesdominant role to play in retail sales in job creation to continue are clouded at at lower prices. Is that true? Our belief isthe U.S., especially for fine wine. It’s the best as of this writing. that if your wine is truly a luxury good,recovery of the affluent consumer that that kind of thinking is fraudulent onis moving the luxury end of the wine Flight School its face.market forward. This can be seen inpart by the divergence of the Dow Jones Captain Oveur: You ever been in a “When wine inventory goes backLuxury Index from the S&P in Figure cockpit before? to a balanced state, price can and5. While the middle class in America is Joey: No sir, I’ve never been up in a will rise.”making slower progress in recovering, plane before.sales of higher-priced wines are weightedto the affluent and, as such, a reduction Consumers of fine wine in anin the unemployment rate won’t have the We all have long memories of our information age are far more aware ofsame impact as improvement in major foundations in the wine business, what they like and don’t like. Whilestock indices. But it’s another good sign our first sip of wine, first taste of a there are wide substitutions availablethe industry is recovering and moving wine grape. Like our movie theme, we — especially in lower-priced wine —on. The declining unemployment rate probably have had a mentor of some sort high-priced wine as a luxury whenwill support some level of increased who gave us guidance and asked us the the business is in balance or in shortpurchases. difficult questions in life such as, “Do supply has fewer pure substitutes you like movies about Gladiators?” and and carries more of an up and downFor there to be upward pricing maybe the occasional misperception demand curve.8 That means recoveringopportunity in all luxury price points, such as Kareem never playing defense in price is quite realistic under the rightthough, we are going to need to see the the regular season. Some of those early circumstances. Those circumstances are6 APRIL 2011

a healthy, affluent consumer and wine of paying the same money for lesser Then once you get it, sometimes yousupply that is not long. Consistent with quality wine in the bottle, or have to be need a translator because it can soundthe winery owners’ views that there are willing to price up slightly to find the like straight out jive talking. Even ifselective price increases available, we quality they want. someone can read the tea leaves,believe we are moving in the direction there can still be misunderstandings.that will firm pricing up this year. We So, with cost-conscious consumers It’s something we struggle with everyanticipate that we will begin to see feasting on values over the past two day in our jobs. So, trying to sort outupward movement in price in future years, we predict the trend will end this inventory in last year’s SVB Wineyears as the consumer is healing and year (lower-priced and higher quality). Conditions Survey (January 2010),inventory is close to or in balance, The next most obvious question is it was a bit of a surprise to us thatdepending on varietal, price point and when wineries will stop blending down 35 percent of respondents said theyappellation. their good juice into less expensive still had too much wine on hand wines. Knowing that answer gives a in the cellar. That number seemedIn practical terms, it’s important to good indication of where we are in the high because we had seen clients andremember that when a shock hits the inventory-balancing cycle, as well as an prospects aggressively discounting,economy, there is a predictable reaction indication of how likely discounting blending down, and selling bulk,from distributors and producers. is to continue at the distributor level. taking their first loss and positioningDistributors, when confronted by a When wine inventory goes back to a for the future. After discussions withchange in demand or supply, stop balanced state, price can and will rise. brokers, we decided to predict aordering while they work down their balance in wine supplies aroundstocks.9 Once they reach their optimal Fuel Q3 2010 and a gradual ending toinventory level, they start ordering discounting.10 We were wrong and,again to match depletions. The same is in fact, discounting continues to thistrue for restaurants and even consumers First Jive Dude: I say hey, sky... day for many labels. subba say I wan’ see...with cellars. Second Jive Dude: Uh-huh. Maybe we’ll make the same mistakeIn reaction to a shock, producers blend again, but from all we see right now,down reserve wines into lower-priced coming off a slightly small harvestofferings, and sell off bulk supplies. The Inventory and Appellations we think inventories are now, or veryhigher-quality bulk is then purchased Getting good information is really close to being, in balance this year.by other wineries, oftentimes for less difficult in the fine wine business. Survey responses show that wineriesthan the cost to produce, and put intoless expensive SKUs. The end result is Figure 6: Current Inventory Positionsthe value-conscience consumer can findbetter value at lower prices. But thattrend is not sustainable because it’s not 3% 4% 14%economically viable. 25% 25% We have way too much wineThe production of fine wine is an We have too much wineexpensive, lot-by-lot and barrel-by-barrel We are roughly in balanceundertaking. Wineries won’t produce Are short on wineuneconomically for much more than Are very short on wineone to two years as they balance theirsupplies. Once inventories are corrected 54%in the cellar, wine consumers whodiscovered great values in a disjointedmarket are presented with the choice Source: Silicon Valley Bank 2011-2012 State of the Wine Industry 7

reporting long positions have fallen to Figure 7: Ranked Inventory Imbalance29 percent (Figure 6). That still seemsintuitively high, so we took a look atinventory sorted by case production to 47.37%see if we could spot an anomaly. Butthe responses are only slightly skewed to 27.27%smaller wineries, so that was not a help 18.49% 18.18%in explaining the intuitive and survey 14.44% 13.70% 12.82% 11.11% 10.00%differences. The only conclusions we 5.80% 1.85%can come to are that we are wrong 0.00% ty y y(which of course is impossible) or the nt le no un a on r ll y y a n l e ra nt nt di m ap to ou Va th Co ci g ve Lo ou ou no ng N re l O C do tra O C C So a O hi yrespondents are less optimistic than we ar en re as n ke o rb te Ce sp M W La Ba on bi O a Mare for 2011 and expect lower growth t is an Lu S n -23.08% Sarates. Source: Silicon Valley BankLooking purely at a net long/short forthe fine wine industry doesn’t give all is Lodi. While that may be an accurate since 2006 to understand the impact onthe information we would like either, assessment, it should be noted that it is evolving and changing tonnage fromas fine wine is appellation-based (if a a small sample set and, as such, more the vineyard and bulk markets. As wewinery needed Russian River Pinot prone to sampling error. have said in the past, the best thingNoir, it doesn’t really matter that the about the just completed recession (itSanta Rita Hills have an excess). To The clear message to us is that while is over in theory) is that we are largelybetter understand the appellation prices have reset lower, we will continue not in a position of over-supply andpositions, we netted out the responses to see less true discounting in 2011. this downturn hasn’t had the trailingof those wineries that reported excess There will still be some good value impact of non-bearing acreage, makingpositions against those reporting short wines available to the consumer for part the current imbalance worse.positions, ignoring those who said they of 2011. Snap them up, though, becausewere in balance. Figure 7 shows that those kinds of uneconomic buys will This year, with the slightly smallMendocino has the largest imbalance soon come to an end. harvest, there are only two varietals weand the appellations that produce wines view as long: Syrah and Chardonnay,in higher-scale and in lower price points Varietal Inventory with the latter probably a tweener. Evenare the closest to being in balance. The We have monitored the level of bulk with the recession, we are closer to beingregion reporting the only net shortage and grape supply by varietal in Figure 8 in balance than many may believe. But Figure 8: Bulk Wine Positions 2006 2007 2008 2009 2010 2011 Chardonnay Sauvignon Blanc Short Cabernet Short to Balanced Merlot Balanced Pinot Noir Long to Balanced Syrah Long Zinfandel Overall Premium Source: Turrentine Wine Brokerage, Silicon Valley Bank Proprietary Research8 APRIL 2011

that is an average and there will be some Figure 9: Grape Purchases vs. Price in 2011vineyards this next season that maystill find it hard to get a contract, while 40.00%others in higher demand will have their 35.00%choice of suitors. 30.00% 25.00%While as an industry we have been 20.00%doing a good job of discounting and 15.00%moving wine to clear the runway for 10.00%takeoff, the price that vineyards ownerspay for grapes has continued to be 5.00%pressed downward. 0.00% More Grapes at a More Grapes at a Fewer Grapes at a Fewer Grapes at a Lower Price Higher Price Lower Price Higher PriceIn reality, the vineyard owners are thelast ones to feel the pain in the supply Source: Silicon Valley Bankchain, in part because they are underlonger-term contracts that producers Atmospherics really have the position and negotiatingare faced to honor or renegotiate even power with the sales channel, leavingwhen grape prices drop. So wine-grape Morphing Models the craft manufacturers to find theirgrowers are the last entities in the way to clear skies.supply chain to see price recover. Striped controller: Bad news. The fog’s getting thicker. When SVB began its dedicated wineTo get a handle on what wineries were practice in the early 1990s, it was Johnny: (jumps to an overweightexpecting to do with their purchases of controller) And Leon is getting common to see successful businessgrapes in 2011, we asked them simply laaaaarrrrrger. models in nearly all volume segmentshow much they expected to buy and at and price points. Small brands makingwhat relative price. The answer is about a few thousand cases of super premiumwhat we would anticipate in that 56 The wine business has evolved almost wine seemed to thrive right alongsidepercent of respondents say they expect imperceptibly, as if in a fog, first with estate operations making 10,000 cases,to buy more fruit in 2011 over last year, the rapid growth of small wineries. But or negociants making 50,000 casesbut 64 percent said they also expect to in the end, it’s the larger wineries that of popular premium wine, larger-scalepay less (Figure 9). Figure 10: Business ModelsIt’s a time where perceptions maynot necessarily be reality in the field. 90%Wineries with relationships worth 80%protecting may want to consider Small Integrated 70%extending important contracts out, and Gross Margin Direct Modelnegotiating to lock in price at 2011 60%levels because per ton prices will start 50% Stuck In The Middleto reverse once bottle prices start to 40% Distributor/Negociant Eff Model icieinch back up. If sales of premium wine nt Fro 30% ntie Large Scalegrow as we expect this year, and the r High Volume Low Costharvest isn’t large, perceptions of what 20% 1,000 10,000 100,000 1,000,000 10,000,000is available and at what price should Case Sizeschange to the positive from the growerperspective this next year. Source: Silicon Valley Bank 2011-2012 State of the Wine Industry 9

wineries making 100,000 cases and Figure 11: Restaurant Segment Growth Ratesmore. Each had a very similar selling 8.0%strategy: they moved wine through anationwide distribution system and sold 4.0%a little in their tasting room. A verysmall winery might not make a lot of 0.0%money, but it could at least break evenand find several distributors willing to -4.0%work with them. -8.0%The foundation for selling has been -12.0%morphing for 20 years — slowly Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3until recently when we now witness 2006 2077 2008 2009 2010 Qsr - Specialty Full Service Specialty QSR Casual Dining Family Diningthe almost complete consolidationof both the distribution system and Source: Demeter Groupthe large retailer accounts for chainsand restaurants. Now, the relationship shift to more at-home entertaining. is sold (Figure 11). Examining thebetween distribution and the family When negative press about the big NRA Current Situation Index,11 wewinery can kindly be described as in bonuses for CEOs and Wall Street note that as of this writing the indextransition. bankers collided with news of bailed- has been above 100 for the fifth time out insurance giant AIG’s lavish in six months driven by improvingSVB has been underscoring the trend spending on corporate retreats, same-store sales, growing customerillustrated in Figure 10 for at least the corporate T&E and conspicuous traffic levels, mounting optimism,past eight years and encouraged both consumption of all types was snuffed and expectations for staffing growthclients and prospects to consider their out. According to The National that is now at the highest level inplace with this chart as a backdrop for Restaurant Association and the nearly four years (Figure 12).a discussion of their business model. Demeter Group, the most impactedWe realize that when the business is part of the restaurant trade had been According to Malcolm Knapp, presidentworking, it’s hard to change, although the higher-end, full-service white of the New York-based consulting firmonce it’s not working, it could be too tablecloth restaurants — precisely the bearing his name, sales at full-servicelate to take corrective action. target accounts in which fine wine eateries, will rise 0.7 percent in 2011Restaurants Figure 12: NRA Current Situation IndexMost wineries selling fine wine 104move between 20-30 percent of theirproduct through restaurants. So, the 103changes that have taken place in 102restaurants subsequent to 2009 have 101been of particular interest to thefine wine business. That said, the 100changes really started in early 2007 99when the restaurant industry began 98a contraction phase according tothe National Restaurant Association 97(NRA). That downward trend was 96 Jul- Jul- Jul- Jul- Jul- Jul- Jul- Jul- Jul- Jul- Jul- Jul- Jul- Jul- Jul- Jul- Jul- Jul-later magnified by cuts in corporate 20 03 03 04 04 05 05 06 06 07 07 08 08 09 09 10 10 11T&E budgets and a recession-based Source: National Restaurant Association10 APRIL 2011

after adjusting for inflation — the Figure 13: Wine Industry Financial Performancefirst year-over-year increase since 2007. 70.0% 59.0%That’s more good news for the wine 60.0%business and again indicative of higher 57.0%year-over-year wine sales. 50.0% 55.0% Sales Growth and Pretax Profit 40.0% Gross Margin 53.0%Financial Performance of Wineries 30.0% 51.0% 20.0% 49.0% 10.0%(reading newspaper headlines) 47.0% 0.0%Rex Kramer: Passengers certain to -10.0% 45.0%die! 12/31/2002 12/31/2003 12/31/2004 12/31/2005 12/31/2006 12/31/2007 12/31/2008 12/31/2009 12/31/2010 Gross Margin 51.5% 50.2% 51.5% 52.8% 54.5% 57.1% 55.3% 52.4% 53.70%Steve McCroskey: Airline negligent. Sales Growth 5.2% 17.6% 25.5% 19.4% 21.2% 22.3% 2.0% -3.8% 10.80% Pretax Profit 3.2% 6.3% 7.6% 12.6% 11.3% 16.3% 9.5% 2.2% 6.70%Johnny: There’s a sale at Penney’s! Source: Silicon Valley BankWe have good news and bad news as we gross margins, sales growth and pretax or positive growth with most reportinglook at the financial position of wineries profit (Figure 13). It should be noted growth in the 5-15 percent range andthis past year. The bad news was last that the information is sourced largely few reporting declines (Figure 14).year had higher-cost trailing inventory from company-prepared and unauditedpass through the balance sheet, which financial information. Year-end tax Examining gross margin and pretaxlowered profits. The good news is there planning will likely reduce gross and profit, in the prior full year endedwas still a sale on fine wine ... Wait, is pretax profit somewhat. Nonetheless, 2009, the fine wine segment had cycledthat good news? Maybe if you were a it’s a great sign of emerging health for back to the lowest levels of profitabilityconsumer, but there is good news for the industry. since 2002 — the bottom of the techwineries when you look at the growth in recession. Some might want to lookfine wine sales this past year. Sure, there Confirming the positive year-end back and try to predict that this timewas still a wine sale and discounting, but results, in the conditions survey we we’ll have the same type of recovery offthe industry is gaining altitude again asked wineries to estimate their full year the bottom of the recession, but there iswith improved gross margins. 2011 sales growth. The overwhelming a difference in the recovery compared majority of respondents reported flat to the recession experienced in the early “What is nice to see in this data is a Figure 14: Winery Estimated Sales Growth for 2011 firm bottom noted in the improving gross margins, sales growth and 35.00% pretax profit.” 30.00% 25.00%Reports using proprietary but stillunaudited financial information from 20.00%SVB’s PGA12 showed full-year sales 15.00%growth through Q4 about 10.8 percent 10.00%for the year versus 11.8 percent fromNielsen scan data — roughly in line 5.00%with our 2010 producer-level sales 0.00% >20% 5 -15% Relatively 5 -14% 15 -24% 25 -49% >50%forecast of 8-12 percent for fine wine Negative Negative Flat Growth Growthlast year. What is nice to see in this datais a firm bottom noted in the improving Source: Silicon Valley Bank 2011-2012 State of the Wine Industry 11

2000s. That was an isolated, shallow Figure 15: Current Financial Healthand fast recession. We were led out of itby increasing home values bolstered by 35.00%a massive amount of liquidity looking 30.00%for an investment. We also didn’t see 25.00%the same level of price resetting we see 20.00%this time. The slower recovery this time 15.00%around will continue to produce a drag 10.00%on the financial performance of family- 5.00%owned wineries and make price recoverya multi-year task. 0.00% Very Slightly Very On Life Rock Solid Strong Good Dead Strong Weak Weak Support Overall 9.24% 13.11% 31.60% 22.69% 16.47% 4.54% 2.02% 0.34%How do winery owners view their ownfinancial health? That’s a question that Source: Silicon Valley Bankwe posed in the conditions survey andagain surprisingly there was little year- Sometimes the simplest answer is the Understanding who is buying your wineover-year change between the results right one and sometimes it’s not. Take and knowing why they buy is far morefrom the 2010 survey and the 2011 off the sunglasses and you still get the important than trying to categorize agesurvey. The good news is that about 70 same look. The case being made for groups and looking for generalizationspercent describe themselves in the range Millennials this second is overblown so you can sell a luxury good. Why? It’sfrom “good” financially, to “rock solid.” if you believe they are the group to not age that matters. It’s discretionaryAnother 7 percent describe themselves chase and you sell a $30 bottle. They income that matters, no matter if youin the range from “slightly weak” to are not the dominant consumers of are 21 or 101. Keep in mind that you“dead.”13 That percentage is more than fine wine. In fact, they are barely on aren’t just selling wine, you are selling anlikely the un-bankable segment and the map. That’s obvious when you experience: what the wine does for youragain about the same percentage as last consider most are not of legal drinking consumer. Affluents more than any classyear (Figure 15). age, have the highest unemployment of consumers can have any “thing” they rate, aren’t established in careers with want. It’s an experience they desire, andWhat we have observed is small wineries discretionary income, and have the those wineries that focus on the brandhave been amazingly resilient in this smallest amount of wealth of all the and experience will have more successdownturn. Time and again, they find demographic tiers. than those who don’t.ways to cut costs to survive and holdon. That said, the majority of those will Figure 16: Dow Jones Luxury Index vs. S&P 500need to be recapitalized or sell soon. It’sunlikely a winery in that situation — 1600losing money and unable to get more 1500debt — will find a way out of the high 1400fog without changing pilots or refueling. 1300 1200Demographics, Affluent Consumers 1100and Luxury Brands 1000 900Rex Kramer: Alright Steve let’s face a 800few facts. (Removes his glasses to reveal 0 0 0 0 0 0 0 0 0 1 10 10 10 01 01 01 01 01 01 01 01 01 01 20 20 20 /2 /2 /2 /2 /2 /2 /2 /2 /2 /2glasses) 1/ 1/ 1/ 1 1 1 1 1 1 1 1 1 1 1/ 2/ 3/ 4/ 5/ 6/ 7/ 8/ 9/ 1/ / / / 10 11 12 Dow Jones Luxury Index S&P 500 Source: Bloomberg and SVB Financial Group12 APRIL 2011

Affluents represent a much smaller salvation of the business. That will the expensive wines and a lot of lesspercentage of the consumer by number, be true someday, but not this year. expensive wine as well, driving downbut have far greater impact on retail Examining Figure 17 from Nielsen, their average purchase price.spending. Pam Danziger of Unity the 55 and above crowd is responsibleMarketing points out the top 20 percent for 44.1 percent of purchases — more Work from Unity Marketing supports aof U.S. households14 represent: than double that of the Millennials. concept that resonates with us. It pointsº 50 percent of the nation’s income Not to undercut all the positive notions out a “Window of Affluence,” a prime- of Millennials being more wine savvy time window of spending. That windowº 40 percent of all consumer spending than their parents at similar times for retailers selling luxury goods is theº 90 percent of discretionary income left in their lives, but we need to put sweet spot for luxury consumption. It’s over after the necessities are paid a dose of reality into the discussion. a period where careers are a little more The under 34-year-old age group has established and there is more disposableº 80 percent of all premium wine sales15 a very high unemployment rate and, income and a willingness to take onNot unlike the full service restaurant as we demonstrated last year in the debt because of increased expectationssector, luxury retailers took a pretty State of the Wine Industry report, of higher personal cash flow in futuresteep nosedive when the markets a miniscule percentage of consumer years. That window is between thecollapsed, but results began to change net worth. No job and no wealth ages of 35-54. Today, that spans thein the 2009 holiday sales period. By makes it hard to buy luxuries. On the trailing edge of Boomers and Gen X,mid-2010, performance in luxury other hand, in reviewing confidential which if you look at Figure 17 frombrands started to pull away from lower retail information sorted by age, what Nielsen represents a combined 38.3tier competitors as was noted in Figure we have noted is the Millennial is percent of total wine consumption.16, showing the Dow Jones Luxury willing to spend the most per bottle That’s second only to the BoomersIndex matched against the S&P 500. on average. However, a scratch of that today. The data lead us to wonder, who data revealed the numbers of expensive is marketing to Gen X as that seems toWith fine wine sales, we have noted bottles purchased were few compared be the missing opportunity now versusthe same trends reflected in luxury to older demographics who bought the Millennials?retailing. The absolute cult brands thatsell on an allocated basis — those with Figure 17: Demographic Sketch of Wine Drinkerslong waiting lists of customers just to beoffered a bottle — sold out their wine Unemployment Rate % of Population % of Winewith no price adjustments in 2009 and Race/Ethnicity2010. But just below that level, 2009 White 8.5 68.9 78.5was a difficult time, particularly forwineries selling wine above $50 if they Hispanic 13 13.4 8.9were doing so in any significant volume. African Americans 15.8 10.8 7.3By 2010, a still small but growing Agepercentage of expensive luxury wine 21-24 15.3 7.4 4producers was beginning to participate 25-34 10.1 18.7 13.6in the recovery, too. That said, a non- 35-44 7.8 19.6 16.3allocated wine selling for more than 45-54 7.5 20.6 22$50 a bottle is still a difficult sale, but 55+ 6.9 33.7 44.1the situation is getting better and will Educationcontinue to improve in 2011. High school diploma 15.3 19.2 10.2 No College 10.6 28.4 20.2Who are the people buying fine wines College Grad 4.9 24.3 39.9today? If you read popular press youmight think the Millennial is the Source: Nielsen Beverage Division 2011-2012 State of the Wine Industry 13

Figure 18: Credit Availability Since Market CrashCredit Availability 40%Random Traveler: Excuse me sir. 35%We’d like you to have this flower? 30% 25%This was a scene where Robert Stack 20%was coming into the airport to save the 15%day and accosted by everyone he met. 10%Back in the olden days, free speech 5%meant running a gauntlet of people 0%in the airport who were proselytizing Much easier Somewhat Unchanged Somewhat Much more Almostand fundraising for their preferred easier more difficult impossiblecharity. Before the market meltdown, difficultthat scene was a little like bankers at a Source: Silicon Valley Bankwine conference: everyone was chasingdown a winery owner, delivering theirpitch and hyping their organization. deals they booked would have lending relationship when they performed well in the growing are doing well and even perhapsWhat’s happening today? When we economy. But regulators get very improving. The variable in this caseasked wineries to compare commercial direct when a portfolio of loans is the specific financial institution’scredit availability, terms and price has more than about 12.5 percent understanding of the wine businesspre- and post-crash, the answers were of the loan balances characterized and/or their regulatory health.far more negative than we expected as having a “material weakness,”with 78 percent noting credit has especially when there is no positive Wine 2.0, CRM, Surveyingbecome more restrictive (Figure 18). change and even more so with the and Social MediaPerhaps our experience is unlike scrutiny given banks since the crash.other banks. SVB’s wine division hascertainly seen a significant up-tick in With 7 percent of the industry Steve McCroskey: Gunderson, checknew borrower requests this past year, describing themselves as “very the Radar Range. Anything yet?and we grew substantially as a result. weak” today and really little change Gunderson: (gets up and opens theAccording to survey data, however, in the overall way wineries describe door of the Radar Range microwave,credit conditions have actually their financial condition year-over- which is roasting a turkey) About twotightened slightly in 2011 over 2010. year, it’s not hard to imagine a more minutes, chief.We see a fair number of competitors lender taking on more than average Steve McCroskey: Two moreourselves, but definitely not as many risk in the years leading up to the minutes? They could be miles offas before the crash. Perhaps the crash, expecting to see a recovery course!change year-over-year is explained bailing them out of a poor credit Rex Kramer: That’s impossible.by more activity from those lenders decision and now being required They’re on instruments!who are more inexperienced in the to make changes to their lendingbusiness. practices. Those changes would apply to healthy and weak borrowers There is a lot of confusion aboutA bank jumping into the wine alike. It’s unfortunate from a electronic and digital support. Mostbusiness after the last recession borrower perspective. Those winery remember when social media consistedwould have experienced favorable owners would clearly be confused of a flyer from the Elks Lodgeconditions through Q3 2007. Most or frustrated over changes in their and CRM was an abbreviation for14 APRIL 2011

cream on your shopping list. But the evolution of social media. If you had and share it with friends/followers,world evolves and access to markets built a model on clicks back in the day, and they have ability to discoverhas become increasingly complex. you would have wasted a lot of time something new and share it. We areCompetition comes from every side and money. But if you never even got more fortunate than other industriesnow; legal turbulence remains; digital a Web page, you are probably already because we are an experientialtools continue to evolve, but are not yet irrelevant. So in the evolving digital industry and people enjoy sharingsufficiently integrated; and traditional world, where should you invest scarce those experiences on social media. 20distribution is increasingly ambivalent resources? Where do you dive into the small producer. The digital world and where do you observe from the In reality, the evolving use ofand the Internet are now critical for sidelines? social media may be to connectsuccess. While only a small part of with your customers and hear whatthe digital world, online wine sales are Social Media they think, more than specificallynow estimated at approximately $500 Facebook recently outpaced Google as selling to them. Either way, we hopemillion dollars, 20 percent of which is the most trafficked site on the Internet. you have adopted the use of socialbeing driven by the emergence of flash What is more amazing today is the media in some form, if not just tosites.16 That said, electronic support transformation in how we consume audit the growth and scope of theseems to have its own lifecycle of information and how we are able to share phenomenon. If you haven’t, thatintroduction, adoption, misuse, correct information. We have lived in a Google flight is boarding and ready to closeuse and finally acceptance of some economy for over a decade. Search the doors. While we hope you aredefined use by the masses. Jump in too engines have given us unprecedented getting on, our survey of West Coastfast and you waste time and money. power to find information. No longer wineries revealed only a minority useDon’t jump in and you risk being left is the consumer only armed with search social media today in a meaningfulin the dust, needing to burn the after engines to explore the world, now they way, with fewer still dedicating anjets to catch up. are empowered with exponentially employee to run the digital side of increasing networks of friends through marketing.Think back not too long ago and most social networks.of us still remember when the e-mail era Surveying and CRMbegan. Some early adopters used it as a In this market, the wineries thatcost-effective way to send mass e-mails “Social Media is the fiber for will do best will be those that discovery.”to lure people into purchase decisions devote time and resources towith discount offers.17 That was cool, developing customer-level preferenceuntil the term “e-mail blast” became There is nothing in the world we can’t information and embed curiositysynonymous with spam18 and lost its find if put in a search engine. However, into their culture. Questions suchusefulness. Then the Web became real the challenge with search engines is we as: Why did members leave the club?and wineries all got Web pages. That can’t find what we AREN’T looking How old are my customers? Dowas pretty cool too, because it meant for. Outside of surveying a known younger buyers purchase differentcomputers were connected with each demographic, there is no easy and SKU’s? How do my customers preferother. But nothing happened with sales trustworthy mechanism for discovery to communicate? Do they like tountil the advent of electronic shopping until now.19 Companies are increasingly come to consumer events, or do theycarts, faster modems, fulfillment and storing personal information about really prefer to entertain at homethe addition of POS tools. About that consumers and developing profiles with my wines? How often do theytime we started driving eyeballs to that one day will allow the individual buy? Are older buyers purchasingour sites and became obsessed with to see only things he cares about more than younger buyers? Are thoseclicks, thinking a sale was all about the purchasing. For today, there is the who buy my wine using social media?number of at bats, versus the quality personal recommendation and blog What is the most a given age groupof the plate appearance. More recently that’s cutting into traditional wine paid for a bottle of wine in the lastwe have seen the dynamic growth and reviews. Consumers enjoy something six months? 2011-2012 State of the Wine Industry 15

to the fundamentals of knowing your “What’s not expressly permitted is customer. Fortunately, tools are finally prohibited.” That was certainly a way “Instinct can be deceiving when there are changeable atmospherics emerging that help us understand to quell the entrepreneurial spirit of surrounding the business.” and properly scale client experiences those who were trying to find modern- so you can deliver seemingly day solutions to selling wine. It’s quite individualized experiences in groups of a pickle. On the one hand, the oldJust what is your digital media communications. laws don’t address the Internet. On thestrategy? Are you targeting mature other, you have an advisory that seemsaffluents or are you targeting the to say that because the Internet isn’tMillennials with your social media “How can a winery deliver an expressly addressed, it’s prohibited. Inefforts? You might be getting friends appropriate client experience other industries, a big company wouldand followers, but what is social media if it doesn’t fully understand the lawyer up and push through a solution.creating for your brand image? Is that client?” But in the wine business largely madepositive or negative? Who uses social of family wineries and boot-strappedmedia anyway? The list of questions companies in e-commerce, nobodyis endless and each drives at actions Our industry is well behind in wants to risk being the test case for athat can be taken to improve sales and adopting what should be rudimentary new law.marketing. tools in sales. After our recent survey, we’ve discovered CRM is Mired in this debate are third-partyThere are many ways to collect data, barely touching our industry with marketing agents, businesses thatincluding asking the sales force to less than 3.5 percent, adopting it in promote, market or sell alcoholiccollect information from their drive- any meaningful way, no matter the beverages but generally don’t take title.arounds, having tasting room staff to do case size. How can a winery deliver Examples include flash sites like Ru-La-verbal interviews, using highly-evolved an appropriate client experience if it La, Wine Woot, Lot18 and others suchCRM tools, and taking advantage of doesn’t fully understand the client? as Groupon, Snooth and phone agentinexpensive or free online survey tools There is no better investment in the models. The good news is the TTBthat wineries can employ to get at some success of your brand than putting is working on an industry circular toof these answers.21 resources into understanding first, clarify some of this issue. THEN servicing your customers. 22There is a saying carpenters oftencite: “Measure twice. Cut once.” Even The FAA “Our position is the discounters willweekend carpenters hate to make a Legal and issues surrounding social either change their business modelmistake measuring and be forced to media and Web 2.0 are evolving areas or will fail.”make another trip to the lumberyard. of interest coming into legislative andWhen it comes to pricing decisions and legal focus as the Internet moves tomarketing, family business owners too satisfy the marketing and information That said, from our perspective, thereoften skip the measuring step. They needs of consumers, colliding with laws are really two questions that needestimate once, make a decision, and made decades before the Internet was answering. One is, of course, the legalthen adjust with thousands of dollars even envisioned. The legal questions one, but the second is the businessin lost opportunity in play. Instinct are overwhelming and could apply even model itself of some of the third-partycan be deceiving when there are to blog posts and Tweets according to marketing agents. We’ve heard manychangeable atmospherics surrounding John Hinman.23 discuss discount models and theirthe business. survivability in wine. In our opinion, Much of this fear started with a narrow those that replicate the wholesaler’sIt’s somewhat ironic that as we push trade advisory from the California theoretical job and focus and owndeeper into a digital existence, it Department of Alcoholic Beverage the wine buyer’s experience should beonly emphasizes the need to return Control in 2009. Essentially, it said, successful because they have pricing16 APRIL 2011

power and the most important asset: the Figure 19: Wineries with an Employee Dedicated to Digital Marketingbuyer. But those who have established a We have at least one dedicated employee (their sole job) to help us focus on digital branding and sales, socialfollowing by taking overstocked wines media, and emerging practices employing electronic toolsoff producers’ or retailers’ hands on 5.00%slim margins, then sold on price will 4.50%have a supply problem in an inventory- 4.00% 3.50%balanced fine wine space. Producers 3.00%won’t sell their wines to those sites 2.50%when they can get better margins 2.00%through other channels unless the 1.50% 1.00%dollar gains strength and they can 0.50%move to offshore products. 0.00% 1 - 2,500 2,501 - 5,001 - 10,001 - 25,001 - 50,001 - 100,001 - >250,000Make no mistake, there is the 5,000 25,000 100,000 250,000opportunity for marketing agents to Source: Silicon Valley Bankevolve into being highly relevant inthe business and bring professional pocket. It already is the number one tool In the SVB Wine Conditions Survey,retailing skills as an outsourced for accessing search and soon will be we asked about resourcing of digitalfunction, if they are legitimate and the primary tool for accessing social strategies and discovered that no matteravoid the mistake of selling luxury networks. I’m sure you have been the size of the winery. Fewer than 5goods on price alone. on a wine aisle and seen someone percent of the respondents staffed this researching a wine on their phone. most important of functions with aE-commerce With the evolution of mobile devices dedicated employee (Figure 19). TheE-commerce still is the fastest growing and phone applications, getting take-away is we have a long way to go toDTC channel in our industry despite it relative position in cyberspace so your understand the digital world, make it abeing the most underfunded.24 We have brand is represented is becoming one part of our business and planning, staffunprecedented access in our industry more digital discussion you need to and resource it and follow up for successwith more states than ever being open have. metrics. At some point, that too couldto DTC shipping. The ability to reach evolve to an outsourced function, butthe customer (even if it is not a direct But outside of research, people are it’s so early in the game, wineries don’tsale) is more important than ever. But even more interconnected via the yet see the need for allocating dollarse-commerce is only a concept unless we mobile phone and able to praise or to the budget. So, expecting a supportstaff it with qualified people, marketing criticize a business in their personal business to emerge for this need mightdollars and good infrastructure. It also network wherever they are physically. still be a little way out, unless it’s ais not an instant success. You can’t just What if someone compliments or business that enters the wine space withturn on the e-commerce switch and pans your wine at your tasting room an existing list of clients in other areassuddenly expect a wave of sales. It takes while on a phone, or does the same at who can support overhead.a real strategy as well as infrastructure a fine restaurant? How are you goingand people with goals and experience. to engage that customer and convert Forecast the experience to a positive one?Mobile What is your strategy? How will you (repeated line, to Ted and Elaine)The mobile phone just outpaced the enable your digital presence for that Dr. Rumack: I just want to tell youcomputer for accessing the Web. More ever-growing user base of consumers? both good luck. We’re all counting onthan half the households in America They are looking for you on their you.don’t have land lines. Smartphones are phone. They are talking about younow smarter and the Internet is quickly on the Internet through their phone. At SVB, we do one thing in our winebecoming accessible in everyone’s Are you connected? division: provide banking services to 2011-2012 State of the Wine Industry 17

wineries and vineyards on the West Figure 20: 2011 OutlookCoast of the U.S. We don’t do anything 40%else. If you fail, we fail. So we are grateful 35%for the success of our clients and hope 30%the expertise and the tools we offer have 25%helped you to achieve some level of 20%success and assisted in navigating the last 15%couple years. So, from all of our families 10%for the next 12 months we’d like to say: 5%Good luck. We’re all counting on you. 0% rs ar er g ar r er ve in ea Ye at Ye ev nt rE W rY oi d g ar ea in oo ng pWe always start the forecast part by tte Ye ap tY ng di G Be s st lle ea ul A Di Be ic ha ur Trasking what winery owners expect the i ff fO tC tD O os os ne mnext year to look like. It’s hardly a perfect M O Agauge of what is likely to happen because Source: Silicon Valley Bankinformation is imprecise and ownersgenerally seem to lag on this question In 2011, we expect sales of fine prized fruit. They will see their lot in lifesomewhat and predict a continuation of wine to grow in the range of 11-15 change when the producer is better ablewhat they presently see. Be that as it may, percent. Our forecast is supported by to raise prices.this year they are more divided than last improving luxury consumer trends,year and we’ve seen more responses move bottoming of the de-stocking phase Taxiingto the ends of the chart with fewer in of the business cycle, recovering stockthe middle. It’s hard to draw too many market wealth, improving retail sales, Rumack: Now we know what we’reconclusions from that change, but it is lower unemployment, improvement in up againstconsistent with both the bifurcation in restaurant sales and the national economy Elaine Dickinson: How serious is itbusiness we noted in slide (See Business remaining somewhat more stable. doctor?Models Figure 10 on page 9), and the Rumack: Extremely serious. It startsbelief that the recovery isn’t floating We believe the financial performance will with a slight fever and dryness of theall business models. Some are slipping be negatively impacted by some continued, throat. When the virus penetrates themore, while others are recovering. but declining, levels of discounting as red blood cells, the victim becomes inventories balance out this year. Factors dizzy, begins to experience an itchyThe outlook for small, family-owned influencing this trend are demand, rash, then the poison goes to work on the central nervous system, severewine business in 2011-2012 is best emerging legal and legislative changes, muscle spasms followed by thedescribed as improving, with success distribution and channel shifting issues, inevitable grueling.defined more by the business model, and more echoes of the market crash that Rumack: At this point, the entirecapitalization, professionalism of will be addressed in national and global digestive system collapses accompaniedmanagement and, more than anything, politics, then played out in world debt and by uncontrollable flatulence (Oveurthe sales strategy (Figure 20). There equity markets. begins to fart uncontrollably)will be more winners this year and Rumack: Until finally, the poorfewer losers as well as some startups and Overall profitability in the family-run bastard is reduced to a quiveringsupport businesses taking advantage of wine business will begin to rebound this wasted piece of jelly.opportunities created by change. We year with most of the expensive grapesalso expect to see a few more wineries from pre-crash vintages now passing So now you know what you’re up against.changing hands as the rising tide isn’t through the income statement. Growers It’s good news and bad news. To sum it allfloating all boats. Some have too much will continue to find difficult conditions up, we are cautiously optimistic. So makeballast. (Sorry for the off-theme nautical renegotiating for the prices paid in prior your plans and plot your vector, Victor.reference.) agreements, however, except for the most Good luck. We’re all counting on you.18 APRIL 2011

GOVERNMENT WARNING: (1) ACCORDING TO THE SURGEON GENERALSTRESSING ABOUT THINGS YOU CAN’T CONTROL WILL LEAD TO DEFECTS INLIFESTYLE.(2) COMPLETELY IGNORING THESE DEPRESSING EVENTS THOUGH WILLLEAD TO THE EARLY TERMINATION OF YOUR CHOSEN PROFESSION.(3) LISTENINGTO THE FAR LEFT OR RIGHT REGARDING ROOT CAUSES OF THE ECONOMICMELTDOWN WILL CAUSE INCREASED CONSUMPTION OF ALCOHOLIC BEVERAGESWHICH IS A GOOD THING IN MODERATION BUT IMPAIRS YOUR ABILITY TO DRIVE ACAR OR OPERATE MACHINERY, AND MAY CAUSE HEALTH PROBLEMS IF SAIDMACHINERY IS BIGGER THAN YOU. (4) THE GOVERNMENT IS HERE TO HELP ANDHAS THE SITUATION UNDER CONTROL. 2011-2012 State of the Wine Industry 19

Silicon Valley Bank’s Proprietary Peer Group MetricsSilicon Valley Bank’s Peer Group Analysis program is a benchmarking tool the company developed to track and compare avariety of financial measures among premium wineries. Due to the company’s niche focus and significant market share ofpremium wineries, it is able to develop meaningful benchmarking information and it makes the data available to its clients.The data, based on financial information from over 100 premium wineries over several years, also allows Silicon Valley Bank’sPremium Wine Group to monitor industry trends.About SVB Financial GroupFor nearly three decades, SVB Financial Group and its subsidiaries, including Silicon Valley Bank, have been dedicated tohelping entrepreneurs succeed. SVB Financial Group is a financial holding company that serves companies in the technology,life science, venture capital, private equity and premium wine industries. Offering diversified financial services through SiliconValley Bank, SVB Analytics, SVB Capital, SVB Global and SVB Private Client Services, SVB Financial Group provides clientswith commercial, investment, international and private banking services. The company also offers funds management, broker-dealer transactions and asset management, as well as the added value of its knowledge and networks worldwide. Headquarteredin Santa Clara, Calif., SVB Financial Group (Nasdaq: SIVB) operates through 26 offices in the U.S. and international operationsin China, India, Israel and the United Kingdom. More information on the company can be found at www.svb.com.About Silicon Valley Bank’s Wine DivisionSilicon Valley Bank is the premier commercial bank for emerging, growth and mature companies in the technology, life science,venture capital, private equity and premium wine industries. Its Wine Division specializes in commercial banking for premiumwineries and vineyards and the industries that support them. SVB has the largest team of commercial bankers dedicated to thewine industry of any bank nationwide. Founded in 1994, SVB’s Wine Division has offices in Napa and Sonoma counties andserves clients in the fine wine producing regions of California, Oregon and Washington. By virtue of its dedication to the wineindustry, Silicon Valley Bank is able to support its clients consistently through economic and growth cycles, and offer guidance onmany aspects of their business, beyond traditional banking services. Silicon Valley Bank is a member of global financial servicesfirm SVB Financial Group (Nasdaq: SIVB), with SVB Analytics, SVB Capital, SVB Global and SVB Private Client Services.More information on the company can be found at www.svb.com.Contact Us:For more information about this report or Silicon Valley Bank’s Wine Division, please contact us:Rob McMillan Bill StevensFounder Division ManagerPhone 707.967.1367 Phone 707.967.1373rmcmillan@svb.com bstevens@svb.com20 APRIL 2011

1 International Wine & Spirit Record (IWSR) and Xavier de Eizaguirre, Chairman Vinexpo.2 We define fine wine as that selling over $20 a bottle, for no other reason than there are more data available using that as a demarcation line. It is not, however, a universally accepted term.3 We establish our forecast on the expectation that no major additional economic surprises come into view which drive fear and set the financial markets back in a material way, and that federal support in the form of stimulus and QE2 are not suddenly pared back. Another regulatory wildcard is the CARE ACT (H.R. 1161) which is the attempt by the wholesaler lobby to roll back the Granholm v. Heald decision of the U.S. Supreme Court. The Act could change the playing field in many ways, but it’s really about safeguarding our kids and communities if you look at the linked web site. So I guess we should all get behind it.4 SVB 2011 Wine Conditions Survey.5 James A. Bianco, President Bianco Research, L.L.C.6 Visual Flight Rules, for the non-aviators in the crowd, are used when you can see well enough to fly without instruments.7 The SVB Annual Wine Conditions Survey is sent out early each year as part of the preparation for this report. This year, the survey was completed on January 15 by nearly 600 West Coast respondents. The complete set of responses, charts and summary analysis is sent exclusively to the participants along with exclusive access to a webinar that provides and analysis of the results. All wineries are welcome to participate. To participate in the 2012 survey, please e-mail the author at rmcmilla@svb.com.8 A pure luxury good in economic terms is one for which an increase in price has no negative impact on volume. Conversely, a pure commodity is one for which any price increase has a material negative impact on volume sold. The closer a wine is positioned as a true luxury good, the easier time you would have with raising price — in theory. Substitutes are goods that will move opposite a change in price of another good. So for instance, if luxury wine increased price as a whole, some might in theory start drinking more craft beer if that were truly a substitute good. It is not and survey data we’ve seen over the years places wine closer to a need versus a want in a recession.9 Distributors need to know they can get the wine. In a short market, they horde as a measure of safety. In a long market, they don’t worry about it and go to as close to just in time ordering as they can get. But it doesn’t matter if the situation was a demand shock caused by recession or a supply shock caused by over-planting. The reaction is very much the same in the distributor’s world.10 There is liberal usage of the term “discounting” in the wine business. If the retail price of a wine has reset and remains at that price, that’s not a discounted price. That’s the price of the wine.11 The Current Situation Index measures current trends in four industry indicators (same-store sales, traffic, labor and capital expenditures). Any reading below 100 signifies contraction in the current situation indicators.12 SVB Peer Group Analysis is a proprietary financial data base that includes both SVB client and prospect information. Aggregated into custom peer sample sets to maintain privacy, it allows SVB relationship managers the opportunity to compare a given winery against a sample set of financial peers. The service is free to SVB clients but un-available to non-clients. With consolidated information dating back to 1991, we are also able to use the homogenous information as a tool to express top-level industry financial trends.13 After getting the results back, we were surprised some wineries reported their condition as dead. While we are sad to hear that news, we also wonder how the dead report. It’s a little reminiscent of Chicago elections.14 The upper 20 percent of wage earners make approximately $100,000 or more annually.15 Pam Danziger, Unity Marketing, Direct to Consumer Symposium, Santa Rosa, CA January, 201116 Paul Mabray, CEO Vintank.17 I remember when the e-mail era began at SVB and, believe it or not, still have my first e-mail address from 1990. It’s Rmcmilla@svbank.com if you need a good wine bank. I didn’t get to finish my name completely on the address as you might notice (it’s missing the final ‘n’). That’s because we were concerned about the processing and storage of bits and bytes in 1991. (I am starting to sound like my dad. You guys have it easy. I remember mimeographs ….)18 According to the Internet Society and other sources, the term spam is derived from the 1970 Spam sketch of the BBC television comedy series “Monty Python’s Flying Circus.” I discovered that last year, but it’s a cool fact you can throw out when you want to impress someone.19 Social Media Revolution 2. If you want to see some entertaining stats on the engagement of digital, watch this: http://www.youtube.com/watch?v=lFZ0z5Fm-Ng.20 Paul Mabray, CEO Vintank. (http://blog.stroutmeister.com/2011/03/social-media-is-better-for-experiential.html). Some examples of online survey tools include http://www.kwiksurveys.com/, http://www.surveymonkey.com/,21http://www.freeonlinesurveys.com/, http://www.freesurveytools.com/ and a host of others.22 Zappos.com provides a good example: http://about.zappos.com/zappos-story/looking-ahead-let-there-be-anything-and-everything.23 John Hinman, Founder and Partner, Hinman and Carmichael, 2011 Unified Symposium, Sacramento, CA.24 Company stats from Jason Enroth, CEO, ShipCompliantThis material, including without limitation to the statistical information herein, is provided for informational purposes only. The material is based in parton information from thirdparty sources that we believe to be reliable, but which have not been independently verified by us and for this reason we do notrepresent that the information is accurate or complete. The information should not be viewed as tax, investment, legal or other advice nor is it to be relied on inmaking an investment or other decision. You should obtain relevant and specific professional advice before making any investment decision. Nothing relatingto the material should be construed as a solicitation, offer or recommendation to acquire or dispose of any investment or to engage in any other transaction.Foreign exchange transactions can be highly risky, and losses may occur in short periods of time if there is an adverse movement of exchange rates.Exchange rates can be highly volatile and are impacted by numerous economic, political and social factors, as well as supply and demand andgovernmental intervention, control and adjustments. Investments in financial instruments carry significant risk, including the possible loss of the principalamount invested. Before entering any foreign exchange transaction, you should obtain advice from your own tax, financial, legal and other advisors, andonly make investment decisions on the basis of your own objectives, experience and resources. Opinions expressed are our opinions as of the date ofthis content only. The material is based upon information which we consider reliable, but we do not represent that it is accurate or complete, and it shouldnot be relied upon as such. 2011-2012 State of the Wine Industry 21

Silicon Valley Bank Headquarters3003 Tasman DriveSanta Clara, California 95051 U.S.A ©2011 SVB Financial Group. All rights reserved. Silicon Valley Bank is a member of FDIC and Federal408.654.7400 Reserve System. SVB>, SVB>Find a way, SVB Financial Group, and Silicon Valley Bank are registeredsvb.com trademarks. Rev. 04-27-11

SVB 2011-2012 Wine Industry Report

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SVB 2011-2012 Wine Industry Report Document Transcript