How will restaurants respond to the economic downturn?

Here's an interesting article from Slate arguing that restaurants need to retool their current business plans in the face of an economic downturn. Here's the current situation:

The emphasis on wine has a simple explanation: Wine sales are the lifeblood of many restaurants. Ronn Wiegand, a Napa, Calif.-based restaurant consultant who holds the rare Master of Wine degree, says that wine accounts for 10 percent to 15 percent of total sales for casual restaurants and as much as 60 percent at fancier establishments. Restaurants generally have low profit margins and thus need to slap markups on pretty much everything they put on the table. But a $250 Bordeaux is obviously going to make a far greater contribution to the bottom line than a turnip. . . . For decades now, markups of 2.5 to three times the wholesale price have been the industry norm. According to Wiegand, such multiples are an economic necessity for most restaurants; anything less and they may have trouble sustaining themselves. But not every wine on the list has to be marked up at the same rate. So long as the average cost per bottle is in the 2.5-to-three-times-wholesale range, list prices for individual wines need not follow any formula. And, in fact, most restaurants that take wine seriously use a system of progressive markups: They generally slap the biggest markups on inexpensive wines and the lowest ones on pricy bottles (the idea being that the closer an expensive wine is to its retail price, the more apt the customer will be to bite).

But with consumers pulling back on their spending, some retooling is needed:

The easy profits are over, and restaurants hoping to weather the recession ought to think about dialing back their wine prices. Kevin Zraly, a New York-area wine educator who helped pioneer the use of progressive markups when he oversaw wine service at Manhattan's Windows on the World, says that at this point, restaurants just need to fill seats and should scale back their wine markups as a way of attracting diners. "Wine is a tool to get people into restaurants, and in this economy, wine prices need to be dropped to do that," he says. "We had adjustable-rate mortgages, now we need adjustable-rate wines." He also says that restaurants that allow customers to bring their own wines but charge relatively high corkage fees should think about reducing the amount they charge for BYOB. Zraly believes $20 per bottle is a reasonable tariff.

Restaurants that charge $35+ for corkage and sell their wine for 3x-retail will get eviscerated. There is no bigger turn-off to going to a restaurant, seeing a bottle of wine that is already overpriced at $50 retail, offered for $100+ on the wine list. And when the natural impulse is to save more, consumers will become even more reluctant to purchase such insanely priced bottles. In short, the restaurant sector is another part of the wine sector that is due for some shaking up in the current climate. The bubble's over....

Wine and the downturn.

The Wine Economist has two interesting posts on the impact of the economic downturn on the wine market here and here.

On how the current credit freeze will impact wineries' ability to obtain the funding they need throughout the year:

Even if the Treasury rescue plan is a success, I still believe that credit will be much tighter for the next three years (some of my colleagues think it will take even longer to work though the credit cycle). This will have serious effects because so much of the real economy has become dependent upon ready credit to finance business operations and to fund customer purchases. Winegrowers are obvious potential victims of this trend. Winegrowing is a risky business with special credit needs and an overall credit freeze could have serious effects that may extend all the way from the price and availability of the grapes themselves to the value of vineyard properties. Retailers and distributors may also need to scale back their operations to match their reduced access to credit.

Second, there are already signs of the "hollow middle" being, er, hollowed out:

There is a lot of turbulence in the middle of the Wine Wall ($4-$10), which is the heart of the market in some respects. Microdata harvested from grocery store loyalty card programs suggests that buyers really are trading down from $7.99 to $5.99, for example. Since the cost of making the distributing a $5.99 wine is not $2 less than a $7.99 wine, trading down has a big effect on producer and retailer profits. Wine may be recession proof if you look only at overall volumes, which have held up pretty well for the industry as a whole, but don’t expect revenues and profits to tell the same sanguine story.

Finally, spending patterns may be seeing a shift:

So while some people will trade down to lower price, others will trade over — to a different idea of wine that allows them to spend less without feeling like they are giving up their lifestyle. I’m still serious about wine, their choices say, but I don’t take my self so seriously all the time. I like to have fun with wine and so I’m buying wine that reflects this fact now.

Here at House H., wine spending has dropped tremendously over the past few months. There are a number of first tier wines that I am passing on now (e.g., Penfolds Grange, the 2005 Leoville-Barton) as that same budget could be spent on more wine and for less. Value has become the watch-word, with wine that I find well-made but over-priced being pushed to the side (e.g., Grgich Hills Cabernet and Chardonnay). Focus has shifted toward a combination of short-term consumption with a smaller portion dedicated for long-term aging. In all, it makes for an interesting phase during which to maintain a collection!

Is the wine market due for a price correction?

A few months ago, I wrote about the potential, negative impact the state of the economy could have on the wine market here and here. Wine Spectator's James Laube recently posed this observation:

I expect that the wine market will be challenged in the coming year or two. The main reason, of course, is a slumping economy and most people will be holding on to, and playing more carefully with, their money.
...
Some producers, though, effectively shoot themselves in the foot by setting unrealistically high prices, and often raising them, even when the quality didn't justify the price to begin with. Day after day I come across new wines from new wineries with no track records, and they're asking $50 or more for a Pinot Noir, or $60 for a Chardonnay, or $75 to $175 for a Cabernet. Their justification? I guess the fact that they only made 100 or 300 cases, or that they have a rock-star winemaker, validates the high price in their minds.

But surely in these times, some of these high-priced wines will sell slowly, or maybe they won’t sell at all. Or they’ll sell once the market determines a fair price. And for some of these producers of overpriced wine, by the time the market determines a fair price, it will be too late.

Mr. Laube clearly focuses on new, unproven wineries seeking the premium label from the start. I think he, quite correctly, highlights how exposed these wineries are to an economic downturn. However, he ignores that even established wineries are very exposed.

Applying the theory of the hollow middle, "commodity" wines should not face a serious problem in this market. Cheap wines, after all, can still be bought and enjoyed. Thus, just as people still buy at Wall-Mart during a downturn, people will still buy the cheaper offerings from Robert Mondavi, BV, etc., etc. Similarly, any consumer who could afford Screaming Eagle, Chateau Petrus, Chateau Latour, Harlan, etc., etc., two years ago most likely can afford to buy those wins today (unless, for example, that consumer also happens to be a highly-paid trader at Bear Stearns).

So, who faces real exposure in a downturn?

"Premium" wines that often go from $50 to $300 a bottle, but lack the true investment potential of a collectible. While these may be top quality wines in similar numbers to top French chateaus, they do not have the same reputation that those chateaus have (a rough analogy would be Volvo to BMW).

So, what do I expect to happen during lean times to producers of these wines? If I had to guess, there will be either: (1) drift from these producers to "commodity" wines; or (2) a scale back in production of their top wines to a point where they become collectors items (and, hence, an increase in price due to a more limited supply). But can one expect a 9,000 case run of wines costing over $200 a bottle?

What's missing from this story?

Take a look.

HINT: the 2005s will be released in 2008....

California vs. Bordeaux.

California vs. Bordeaux. Which one appears to give the better value (at least, at the "cheap" end of the scale).

What is wrong with this picture?

I will leave it to the reader to determine what is wrong with the following statement from this Bloomberg story:

``We can feel that there's an increasing market for this [$400 beer], as some of our customers order extremely expensive wines without blinking an eye,'' Lau Richter, restaurant chief at the Noma restaurant, said today by phone. ``Ten years ago, it was a rare event selling a 1,000 kroner bottle of wine at a Danish restaurant, now we do it every day.''

A not surprising result

From Bloomberg, a not surprising result:

Prices for Bordeaux first-growths including Chateau Lafite and Margaux held stable at Sotheby's first wine sale this year in London, with right-bank producers Petrus and Cheval Blanc accounting for seven of the top 10 lots.

. . . .

``I think it's indicative of the market at the moment,'' said Stephen Mould, senior director of Sotheby's international wine department. ``Prices have probably flattened out a bit.''

Wine is a luxury good and as people become more concerned with their own financial health, discretionary spending on luxuries is cut back. In short, this could lead to "interesting times" for California producers who will be subjected to high fuel costs, increased labor costs, and a weakening economy. Even more, could this lead to a drop in the prices for the soon-to-be-released 2005 Bordeaux. In effect, did the Bordelais decide to cash in too late?

Wine and big four accounting?

Yes, someone made the connection. (HT: The Professor.)

Does more expensive wine taste better?

Here is a report about an interesting study from CalTech. I could swear I wrote about this topic before, but I cannot find the post. In any event, here is a quote from the article:

Researchers from the California Institute of Technology and Stanford's business school have directly seen that the sensation of pleasantness that people experience when tasting wine is linked directly to its price. And that's true even when, unbeknownst to the test subjects, it's exactly the same Cabernet Sauvignon with a dramatically different price tag.

I am not going to go off on a rant about this study like some wine writers have, and I liked that the researchers apparently took a $90 bottle of wine and claimed that it was a $10 bottle of wine in doing this study. Nor am I going to get bent out of shape that some, foreign wine critics have taken this study as a sign that Americans are concerned only about price, not value.

Instead, nothing about this study surprised me because so often expectations can influence one's enjoyment of wine. Imagine you bought a $350 bottle of wine. You open it up with your significant other over a great meal (maybe some candles are lit). Maybe even, with the first glass, you get engaged. But, suppose the wine is average. Would you not want that wine to taste better than it tastes? And since perception is such a key part about enjoying wine, and your own desires can influence your own perceptions, is it not realistic to expect that one would view the wine as exceptional?

Now, here is the funny thing. I can give an example where I have known the prices of two wines (because I paid for both of them), I enjoyed those wines in the same night with a great group of people, and my views on the wine did not match the results of the study. Here is one of the wines. Here is the other. And the second one was significantly better than the first, and significantly cheaper.

So what does this all mean? Simply, that one's expectations can influence one's perceptions. But, often the best way to appreciate or enjoy wine (or anything) is to let those expectations go and enjoy what is right in front of you. Abandon the view that a wine that costs $350 must be great. Abandon the expectation that a $5 wine must be terrible. Simply recognize the wine for what it is, and enjoy. If I have learned any lesson from my exploration of wine, it would be to recognize the value of the thing that is right in front of you.

So I've been lax in my duties....

Yeah, I know, I haven't posted in a while. What can I say? Work's been busy.

On the other hand, I've had all sorts of fun going to the candy store lately. Which, as a note, being a wine lover and going through bonus season is really, really dangerous to one's checking account. Curse the French, and the relatively weak dollar.

The "hollow middle" and wine.

One of my favorite blogs has an article that mentions another of my favorite topics, the "Hollow Middle." I'll let Mr. MacEwen sum up the "Hollow Middle" model:

"An increasingly prevalent industry structure sees firms migrating both to the high end, high-value, premium quality level, and to the no-frills, low-end, commodity level, with little comfortable territory remaining in between."

As an example, Mr. MacEwen points to jug wines and Screaming Eagle -- wines at the extreme ends of the price spectrum. Oddly enough, I've been thinking about the same thing lately due to an ongoing debate on Wine Spectator's various blogs (see here, here and here) about the skyrocketing prices of new releases or the lack of value from some regions.

So, why have I been thinking about this issue with regard to the price of new releases of wine? I think we may be seeing the creation of the Hollow Middle in the wine world. First Growths and Cult Cabs are pushing the prices for new releases into the upper $100s -- if some producers haven't reached the four digit price range yet, they are approaching it. So, what does this mean for the rest of the market?

First, for the "premium" wines, it raises the ceiling on the asking price on release. For example, Penfolds Grange currently releases at $250 a bottle. A Clarendon Hills Astralis releases at $350. If the top bottles from other countries release at at least $500, where does that enable producers to move the price on these bottles to? If the market for First Growths and Cult Cabs is sustainable, those producers have a few $100s they can add to the price of a bottle.

Second, for the "commodity" wines, they can continue to exploit a market for everyday consumption. A $20 or $10 (or cheaper) bottle of wine is a bargain by comparison to a $500 wine.

So, what happens to the mid-range producers who cannot compete at a few hundred dollars a bottle? Consider someone who produces wine that costs $75 a bottle -- They can't compete (in terms of perceived quality or investment potential) with a "premium" wine. If that producer happens to be located in a region with high production costs (e.g., Napa Valley) -- costs which will continue to increase (e.g., illegal immigration crackdowns) -- he or she cannot reduce the price for each bottle of wine to match those producers whose wines retail at $10 to $25 a bottle. In effect, the mid-tier producer gets squeezed. Thus, thanks to increased globalization and the Hollow Middle model, we may be on the verge of some major changes in the wine market. Will the mid-tier producers be around ten years from now? Maybe not....

Economics and wine.

I have been thinking a lot about the economics of wine -- everything ranging from pricing strategies for premium wines, to changes in immigrant policies on the price of wine, to the effects of the current market uncertainty on wine auctions. I'm going to focus on the last issue for this post.

Wine auctions are one of the few places one can buy older vintages of first growths and other "exceptional wines." Lots frequently sell for thousands of dollars and, should one of those lots include a case of older Romanee-Conti, the prices can get astronomically high. Needless to say, these auctions are at the height wine consumerism.

But, if the market is getting tighter, or there is a slow down, shouldn't that be reflected at wine auctions? Numbers from the first-half of 2007 appear strong -- but that would be expected, as those auctions were held before the subprime market crunch. So, as a potential sign of the economy's health and a sign on the current the wine market itself, I'm curious to see how the following questions play out:

(1) By percentages, how many lots are sold in Fall '07 compared to Spring '07?
(2) How many lots have their reserve option exercised, preventing the sale?
(3) For comparable wines, what are the prices sold in Fall '07 compared to Spring '07?
(4) By percentages, how many lots are sold to foreign investors in Fall '07 compared to Spring '07?

A downturn in 1-3 and an uptake in 4 could be a harbinger of things to come....