This annual industry report, presented by Rob McMillan, founder of SVB's Wine Division,is based on SVB's in-depth survey of wine industry experts and insiders, third-party research, and ourunique perspective as a long-time observer of the wine industry.

1. 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 By
Rob McMillan
Founder, Wine Division
707.967.1367
rmcmillan@svb.com
APRIL 2011 1

2. º Slightly too much wine at the producer
The movie Airplane was about a The industry has soared from being
level
flight 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 level
carrying our reluctant hero Ted Striker. consumption alone is projected to º Most growers supplying fine wine
A former combat pilot who had lost his increase by 9 percent to $23.8 billion producers would get less for their grapes
mojo to fly, Ted along with his lost love by 2014.1 on expiring contracts
interest Elaine Dickinson, together find
a way to land the plane and save the day, Flight Log With the exception of our overly
thus triumphing over their own fears Looking back at the State of the Wine bullish guess on the timing of any
and personal tragedy. Too bad about Industry flight log from last year (2010), improvement in discounting, we believe
the pilots, but that’s not important right we forecasted improving conditions in our predictions were largely quite
now. What is important is Airplane is the fine wine business2: accurate. In fact, we saw fine wine
our canvas for painting a picture of the º Improving consumer climate sales come in right in the middle of our
wine business this year with all of the forecast range of 8-12 percent.
º The end of the trading down trend
ups and downs, misunderstandings and
drama. 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-year
for those needing more entertainment,
º Revenue growth in fine wine to outpace Rumack: Can you fly this plane, and
in the electronic version of the report
growth in lower price wine segments land it?
you will find links to clips from the
movie. To co-opt a line from an airline, º Improving affluent spending, corporate Ted Striker: Surely you can’t be
we 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’t
Valley Bank! call me Shirley.
into Q3
º Improving distributor purchases for the
year as depleted wine is reordered
Executive Summary Could you be cautiously optimistic if
º Positive momentum in the adoption of you were Dr Rumack? I hate that term
The 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 with
refuge in a rural lifestyle, with an … but we noted several drags on a cautiously optimistic outlook from
additional twist of elegance and producer performance: an expert? It’s like a pilot announcing
occasionally, for some lucky souls, the º Persistent financial and economic over the cabin speaker, “Ladies and
promise of semi-retirement. Today, hurdles nationally gentlemen, we’ve started our final
the U.S. wine industry has taken full descent. I’m not sure exactly when
º Fine wine sales would not return to the
flight, respected for the quality of its we are landing. Hopefully our angle
high point of the past decade anytime
product, domestic consumption and its won’t be too steep and it won’t be our
soon
impressive international market share. final-final descent. But I’m cautiously
But 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 wide
cyclical and economic shocks to its distribution Following several years when we felt
bucolic roots along with longer-term more like a coroner than a cheerleader,
º Wineries selling sizeable production
structural changes driven by distribution this year we are happy to declare
above $50 would find it a difficult time
consolidation and the digital revolution. we are off the bottom of the wine
No longer is the wine business a game º Producer profitability in family wineries industry down cycle and we are solid
for amateur pilots flying a Piper Cub. would be negatively impacted optimists for the industry looking out
2 APRIL 2011

3. º Low adoption rates in the use of digital
several years. Based on our outlook most importantly, individual skill in
marketing tools
for the economy and our knowledge executing their sales strategy. A wide
of the wine business, we believe we º High fixed costs to produce wines with disparity between winery business
are at the beginning of another long- lowered and reset price points models continues to exist, making the
term steady growth pattern in fine º Slowly improving economy, but several “average winery” even more difficult
wine sales. We are off the tarmac and issues that hold back the recovery: to find today. What might be a
are predicting growth rates for the defined risk for one winery could be
º Euro zone challenges
fine 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 and
marginally improving profitability. 3 funding/budget problems differentiate a given winery and brand,
but also raises the risk for owners,
º Geopolitical risk in oil-producing
We are predicting: investors and lenders alike who might
countries
º 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 consumption
º 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 your
º 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, wineries
º 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 all
º 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 no
º 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 something
Spoiling 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 them
headwinds: for the past two years, it’s unlikely we red wine, but they only like white
º 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 approximate
º 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 have
º 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

4. We hope you will find the following and go. Even into late Q3 there was still thus sealing the extension of the Bush
helpful in sorting through some of your discussion of a double dip mirroring era tax cuts. Maybe consumers were
top-level thoughts, and that exercise will the business cycle from the Great just tired of earning less than the cost
assist in your decision making and drive Depression. Some even put the odds of inflation for their savings and were
greater success for your business in 2011- as high as 50/50.5 Clearly, wineries had ready to take on more risk. Whatever
2012 and beyond. no upward pricing opportunity against happened, by Q4 2010 business was
that backdrop. good — not great. But it was at
2011-2012 State of the Wine least good again, and that was great
Industry 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 LEI
Contrails 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 showed
Steve McCroskey: Looks like first time since the market meltdown. the strongest price point growth in
I picked the wrong week to quit Maybe it was the addition of QE2, the $20+ category last year. And with
drinking. 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 Index
shouldn’t talk about “The Crash.”
Steve McCroskey did what a lot of 140
people did in late 2008: quit drinking. 135
Well they didn’t quit really, they
130
traded down to cheaper wines and
glue. (Trust me, you’d have to see the 125
movie clip.) Anyway, in 2008 with the 120
economic hardships surrounding us, 115
the foul mood of the U.S. taxpayer, 110
and resultant inventory bulge ensuing
105
from slack retail sales, many thought
100
the 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-10
Gone were the vestiges of conspicuous
consumption and public celebrations.
Source: Economic Cycle Research Institute
Consumers were trading down to lower
price 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 Segment
Moving into 2010, the fine wine Lat 52 Lat 26 Lat 52 Lat 26
business 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 Beverage
4 APRIL 2011

5. Ascent Figure 3: Price Changes in 2011
Roger 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 which
direction. It’s a little confusing to find 0.00%
Reduce the shelf Reduce the shelf Hold my shelf Selective price Shelf price increases on
the right vector, Victor, especially when price significantly price a little price increases most or all wines.
it comes to pricing decisions. So, in
SVB’s Wine Conditions Survey, we Source: Silicon Valley Bank
asked wineries what they intended to do
with their pricing in 2011. The responses Since the press has been full of stories have evolved and the affluent consumer
are reflected in Figure 3. Roughly 25 in the past year of cult wineries cutting is back spending, while the middle class
percent of the 598 respondents said price, finding this result seems a little makes some inroads as supported with
they thought they would have selective like expecting a lead airplane to fly — lower unemployment rates and higher
price increases in 2011. In fact, by although technically lead planes could levels of job creation. In addition, it’s
a small margin, the responses again fly with the right wind speed and lift. the job of every producer to balance
indicate we are past the bottom of Obviously, the luxury end of the fine inventory and many times that means
the recession and trending up. But wine business has gotten lighter; the blending down to lower tires. So the
in our current view of the industry, news isn’t as bad as we think; or the chart really is reflective of the drying up
we see only very limited upward economic atmospherics have changed. inventory bulge and a very positive sign
pricing prospects considering inventory foretelling the end of this down cycle.
balance, distributor challenges and From our desk, we would vote for
the enduring, soft economy. The fact the latter. Although the economy as The economic recovery has not been
there is any upward pricing pressure, a whole still works to avoid financial equal across all income groups. Until
however, is noteworthy. wind shear, the consumer atmospherics 2011 the growth in sales came largely
Just where is the pricing opportunity? Figure 4: Price Changes by Price Point
Surprising to many perhaps, it’s
not with $20 wines. It’s with more 35%
expensive wines. 30%
25%
Figure 4 compares by average price
point, 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 see
wines 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 Prices
between $15 and $40.
Source: Silicon Valley Bank
2011-2012 State of the Wine Industry 5

6. from the affluent because the impact Figure 5: Dow Jones Luxury Index vs. S&P 500
of accommodative policy and low rates
1600
has floated the stock market again
1500
where they had investments. On the
1400
other hand, for the middle class who
have little stock investment and more 1300
of their wealth tied to their homes, life 1200
has not been close to being what it was 1100
pre-crash. As of this writing, about 23 1000
percent of all homes in the U.S. have 900
equity that is less than the mortgage 800
amount. 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 500
percentage of the population who are
in a bad spot and unlikely to spend Source: Bloomberg and SVB Financial Group
much on luxuries. But the start of
2011 has started with real job growth middle class more forcefully join the teachings stick with us. One that many
accompanied by the first decline in the recovery, specifically with respect to of us might hold to is a long-held belief
jobless 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 for
to see the start of a healing middle class home market prices in 2011 with new better wine and then play hell raising
that will have a positive impact on fine housing inventory still higher than price back later. Reading the press
wine 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 to
But the reality is the affluent have a prospects for the continuing pace of believe that they can find better wines
dominant role to play in retail sales in job creation to continue are clouded at at lower prices. Is that true? Our belief is
the 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 on
is moving the luxury end of the wine Flight School its face.
market forward. This can be seen in
part by the divergence of the Dow Jones Captain Oveur: You ever been in a “When wine inventory goes back
Luxury Index from the S&P in Figure cockpit before? to a balanced state, price can and
5. 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 weighted
to the affluent and, as such, a reduction Consumers of fine wine in an
in the unemployment rate won’t have the We all have long memories of our information age are far more aware of
same impact as improvement in major foundations in the wine business, what they like and don’t like. While
stock indices. But it’s another good sign our first sip of wine, first taste of a there are wide substitutions available
the 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 when
will support some level of increased who gave us guidance and asked us the the business is in balance or in short
purchases. 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 down
For there to be upward pricing maybe the occasional misperception demand curve.8 That means recovering
opportunity in all luxury price points, such as Kareem never playing defense in price is quite realistic under the right
though, we are going to need to see the the regular season. Some of those early circumstances. Those circumstances are
6 APRIL 2011

7. a healthy, affluent consumer and wine of paying the same money for lesser Then once you get it, sometimes you
supply that is not long. Consistent with quality wine in the bottle, or have to be need a translator because it can sound
the winery owners’ views that there are willing to price up slightly to find the like straight out jive talking. Even if
selective 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 every
anticipate that we will begin to see feasting on values over the past two day in our jobs. So, trying to sort out
upward movement in price in future years, we predict the trend will end this inventory in last year’s SVB Wine
years 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 that
depending on varietal, price point and when wineries will stop blending down 35 percent of respondents said they
appellation. their good juice into less expensive still had too much wine on hand
wines. Knowing that answer gives a in the cellar. That number seemed
In practical terms, it’s important to good indication of where we are in the high because we had seen clients and
remember 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 positioning
Distributors, when confronted by a When wine inventory goes back to a for the future. After discussions with
change in demand or supply, stop balanced state, price can and will rise. brokers, we decided to predict a
ordering while they work down their balance in wine supplies around
stocks.9 Once they reach their optimal Fuel Q3 2010 and a gradual ending to
inventory level, they start ordering discounting.10 We were wrong and,
again to match depletions. The same is in fact, discounting continues to this
true 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 mistake
In 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 harvest
offerings, and sell off bulk supplies. The Inventory and Appellations we think inventories are now, or very
higher-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 wineries
than the cost to produce, and put into
less expensive SKUs. The end result is Figure 6: Current Inventory Positions
the value-conscience consumer can find
better value at lower prices. But that
trend is not sustainable because it’s not 3% 4%
14%
economically viable. 25%
25%
We have way too much wine
The production of fine wine is an We have too much wine
expensive, lot-by-lot and barrel-by-barrel
We are roughly in balance
undertaking. Wineries won’t produce
Are short on wine
uneconomically for much more than
Are very short on wine
one to two years as they balance their
supplies. Once inventories are corrected
54%
in the cellar, wine consumers who
discovered great values in a disjointed
market are presented with the choice Source: Silicon Valley Bank
2011-2012 State of the Wine Industry 7

8. reporting long positions have fallen to Figure 7: Ranked Inventory Imbalance
29 percent (Figure 6). That still seems
intuitively high, so we took a look at
inventory sorted by case production to 47.37%
see if we could spot an anomaly. But
the 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
y
respondents are less optimistic than we ar
en
re
as
n
ke
o
rb te Ce
sp
M
W
La
Ba on
bi
O
a M
are for 2011 and expect lower growth t
is
an
Lu
S
n
-23.08%
Sa
rates.
Source: Silicon Valley Bank
Looking purely at a net long/short for
the fine wine industry doesn’t give all is Lodi. While that may be an accurate since 2006 to understand the impact on
the information we would like either, assessment, it should be noted that it is evolving and changing tonnage from
as fine wine is appellation-based (if a a small sample set and, as such, more the vineyard and bulk markets. As we
winery needed Russian River Pinot prone to sampling error. have said in the past, the best thing
Noir, it doesn’t really matter that the about the just completed recession (it
Santa Rita Hills have an excess). To The clear message to us is that while is over in theory) is that we are largely
better understand the appellation prices have reset lower, we will continue not in a position of over-supply and
positions, we netted out the responses to see less true discounting in 2011. this downturn hasn’t had the trailing
of those wineries that reported excess There will still be some good value impact of non-bearing acreage, making
positions 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, because
were in balance. Figure 7 shows that those kinds of uneconomic buys will This year, with the slightly small
Mendocino has the largest imbalance soon come to an end. harvest, there are only two varietals we
and 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. Even
are the closest to being in balance. The We have monitored the level of bulk with the recession, we are closer to being
region 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 Research
8 APRIL 2011

9. that is an average and there will be some Figure 9: Grape Purchases vs. Price in 2011
vineyards this next season that may
still 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 owners
pay 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 Price
In reality, the vineyard owners are the
last ones to feel the pain in the supply Source: Silicon Valley Bank
chain, in part because they are under
longer-term contracts that producers Atmospherics really have the position and negotiating
are faced to honor or renegotiate even power with the sales channel, leaving
when grape prices drop. So wine-grape Morphing Models the craft manufacturers to find their
growers 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 wine
To get a handle on what wineries were practice in the early 1990s, it was
Johnny: (jumps to an overweight
expecting to do with their purchases of controller) And Leon is getting common to see successful business
grapes in 2011, we asked them simply laaaaarrrrrger. models in nearly all volume segments
how much they expected to buy and at and price points. Small brands making
what relative price. The answer is about a few thousand cases of super premium
what we would anticipate in that 56 The wine business has evolved almost wine seemed to thrive right alongside
percent 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 cases
but 64 percent said they also expect to in the end, it’s the larger wineries that of popular premium wine, larger-scale
pay less (Figure 9).
Figure 10: Business Models
It’s a time where perceptions may
not 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 Model
negotiating to lock in price at 2011 60%
levels because per ton prices will start 50% Stuck In The
Middle
to reverse once bottle prices start to 40% Distributor/Negociant
Eff Model
icie
inch back up. If sales of premium wine nt
Fro
30% ntie Large Scale
grow as we expect this year, and the r
High Volume
Low Cost
harvest isn’t large, perceptions of what 20%
1,000 10,000 100,000 1,000,000 10,000,000
is available and at what price should
Case Sizes
change to the positive from the grower
perspective this next year. Source: Silicon Valley Bank
2011-2012 State of the Wine Industry 9

10. wineries making 100,000 cases and Figure 11: Restaurant Segment Growth Rates
more. Each had a very similar selling
8.0%
strategy: they moved wine through a
nationwide distribution system and sold
4.0%
a little in their tasting room. A very
small winery might not make a lot of 0.0%
money, but it could at least break even
and 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 Q3
until recently when we now witness 2006 2077 2008 2009 2010
Qsr - Specialty Full Service Specialty QSR Casual Dining Family Dining
the almost complete consolidation
of both the distribution system and Source: Demeter Group
the large retailer accounts for chains
and restaurants. Now, the relationship shift to more at-home entertaining. is sold (Figure 11). Examining the
between distribution and the family When negative press about the big NRA Current Situation Index,11 we
winery can kindly be described as in bonuses for CEOs and Wall Street note that as of this writing the index
transition. 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 improving
SVB has been underscoring the trend spending on corporate retreats, same-store sales, growing customer
illustrated 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 growth
clients and prospects to consider their out. According to The National that is now at the highest level in
place 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 impacted
We realize that when the business is part of the restaurant trade had been According to Malcolm Knapp, president
working, it’s hard to change, although the higher-end, full-service white of the New York-based consulting firm
once it’s not working, it could be too tablecloth restaurants — precisely the bearing his name, sales at full-service
late to take corrective action. target accounts in which fine wine eateries, will rise 0.7 percent in 2011
Restaurants Figure 12: NRA Current Situation Index
Most wineries selling fine wine
104
move between 20-30 percent of their
product through restaurants. So, the 103
changes that have taken place in 102
restaurants subsequent to 2009 have
101
been of particular interest to the
fine wine business. That said, the 100
changes really started in early 2007 99
when the restaurant industry began
98
a contraction phase according to
the 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 11
T&E budgets and a recession-based Source: National Restaurant Association
10 APRIL 2011

11. after adjusting for inflation — the Figure 13: Wine Industry Financial Performance
first 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 Bank
We have good news and bad news as we gross margins, sales growth and pretax or positive growth with most reporting
look at the financial position of wineries profit (Figure 13). It should be noted growth in the 5-15 percent range and
this 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 unaudited
pass through the balance sheet, which financial information. Year-end tax Examining gross margin and pretax
lowered profits. The good news is there planning will likely reduce gross and profit, in the prior full year ended
was still a sale on fine wine ... Wait, is pretax profit somewhat. Nonetheless, 2009, the fine wine segment had cycled
that good news? Maybe if you were a it’s a great sign of emerging health for back to the lowest levels of profitability
consumer, but there is good news for the industry. since 2002 — the bottom of the tech
wineries when you look at the growth in recession. Some might want to look
fine wine sales this past year. Sure, there Confirming the positive year-end back and try to predict that this time
was still a wine sale and discounting, but results, in the conditions survey we we’ll have the same type of recovery off
the industry is gaining altitude again asked wineries to estimate their full year the bottom of the recession, but there is
with 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 still
unaudited 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 from
Nielsen 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 Growth
last year. What is nice to see in this data
is a firm bottom noted in the improving Source: Silicon Valley Bank
2011-2012 State of the Wine Industry 11

12. 2000s. That was an isolated, shallow Figure 15: Current Financial Health
and fast recession. We were led out of it
by 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 recovery
a 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 own
financial health? That’s a question that
Source: Silicon Valley Bank
we posed in the conditions survey and
again surprisingly there was little year- Sometimes the simplest answer is the Understanding who is buying your wine
over-year change between the results right one and sometimes it’s not. Take and knowing why they buy is far more
from the 2010 survey and the 2011 off the sunglasses and you still get the important than trying to categorize age
survey. The good news is that about 70 same look. The case being made for groups and looking for generalizations
percent describe themselves in the range Millennials this second is overblown so you can sell a luxury good. Why? It’s
from “good” financially, to “rock solid.” if you believe they are the group to not age that matters. It’s discretionary
Another 7 percent describe themselves chase and you sell a $30 bottle. They income that matters, no matter if you
in 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 an
likely the un-bankable segment and the map. That’s obvious when you experience: what the wine does for your
again about the same percentage as last consider most are not of legal drinking consumer. Affluents more than any class
year (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, and
What we have observed is small wineries discretionary income, and have the those wineries that focus on the brand
have been amazingly resilient in this smallest amount of wealth of all the and experience will have more success
downturn. Time and again, they find demographic tiers. than those who don’t.
ways to cut costs to survive and hold
on. That said, the majority of those will Figure 16: Dow Jones Luxury Index vs. S&P 500
need to be recapitalized or sell soon. It’s
unlikely a winery in that situation — 1600
losing money and unable to get more 1500
debt — will find a way out of the high 1400
fog without changing pilots or refueling. 1300
1200
Demographics, Affluent Consumers 1100
and Luxury Brands 1000
900
Rex Kramer: Alright Steve let’s face a 800
few 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
/2
glasses)
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 Group
12 APRIL 2011

13. Affluents represent a much smaller salvation of the business. That will the expensive wines and a lot of less
percentage of the consumer by number, be true someday, but not this year. expensive wine as well, driving down
but 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 responsible
Marketing points out the top 20 percent for 44.1 percent of purchases — more Work from Unity Marketing supports a
of U.S. households14 represent: than double that of the Millennials. concept that resonates with us. It points
º 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 window
º 40 percent of all consumer spending
than their parents at similar times for retailers selling luxury goods is the
º 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 disposable
º 80 percent of all premium wine sales15
a very high unemployment rate and, income and a willingness to take on
Not unlike the full service restaurant as we demonstrated last year in the debt because of increased expectations
sector, luxury retailers took a pretty State of the Wine Industry report, of higher personal cash flow in future
steep nosedive when the markets a miniscule percentage of consumer years. That window is between the
collapsed, but results began to change net worth. No job and no wealth ages of 35-54. Today, that spans the
in 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 from
brands started to pull away from lower retail information sorted by age, what Nielsen represents a combined 38.3
tier 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 Boomers
Index 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 to
With fine wine sales, we have noted bottles purchased were few compared be the missing opportunity now versus
the same trends reflected in luxury to older demographics who bought the Millennials?
retailing. The absolute cult brands that
sell on an allocated basis — those with Figure 17: Demographic Sketch of Wine Drinkers
long waiting lists of customers just to be
offered a bottle — sold out their wine
Unemployment Rate % of Population % of Wine
with no price adjustments in 2009 and
Race/Ethnicity
2010. But just below that level, 2009
White 8.5 68.9 78.5
was a difficult time, particularly for
wineries selling wine above $50 if they Hispanic 13 13.4 8.9
were doing so in any significant volume. African Americans 15.8 10.8 7.3
By 2010, a still small but growing Age
percentage of expensive luxury wine 21-24 15.3 7.4 4
producers was beginning to participate 25-34 10.1 18.7 13.6
in the recovery, too. That said, a non- 35-44 7.8 19.6 16.3
allocated 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 44.1
the situation is getting better and will Education
continue to improve in 2011. High school diploma 15.3 19.2 10.2
No College 10.6 28.4 20.2
Who are the people buying fine wines College Grad 4.9 24.3 39.9
today? If you read popular press you
might think the Millennial is the Source: Nielsen Beverage Division
2011-2012 State of the Wine Industry 13