Editor’s note: This article originally appeared in the April 18, 1983 issue of Fortune.
The California wine boom has ended. From Mendocino to Bakersfield, the glowing expectations of a dozen years are evaporating, leaving a residue of gloom. The 1970s were a decade of new grape plantings, new technologies, and new wineries that conferred world-class status on California wines. The 1980s are shaping up as the decade of the low-cost producer and the no-nonsense marketer.
Last year California table-wine shipments flattened at 273 million gallons after a decade of 10% average annual growth, compounded. About half the state’s 70 leading wine producers shipped fewer cases than in 1981. Most California vintners are afflicted by overcapacity, from behemoth E&J Gallo, which shipped 57.8 million cases last year, to spare-no-expense arrivistes in quest of the perfect Chardonnay producing 25,000 cases.
Between the 1981 and 1982 harvests, wine inventories soared 16% to 685 million gallons, largely less marketable reds such as Barbera and Zinfandel. In wine-growing valleys, storage tanks and warehouses brim with unwanted wine.
During the 1970s optimistic farmers pushed 163,000 acres into wine grapes, bringing the state’s total acreage to 343,000-not including some 360,000 acres of grapes like Thompson seedless that can be used either as table grapes or for wine. Now many of these maturing vines are just reaching full capacity. Last year’s 3.l-millionton grape crush, up 29% from 1981, broke all records, and prices plummeted.
Gallo dropped the price it offers for prime Cabernet Sauvignon grapes from $1,000 to about $650 a ton. A Sonoma grower, expecting $700 a ton for his Gewiirztraminer, took $300 instead, barely meeting his production costs. For the first time since the repeal of Prohibition, fruit remained on the vine to wither into raisins: an estimated 280,000 tons of grapes simply were not picked. A bountiful harvest is expected this year, barring unexpectedly harsh weather during the growing season; premium grape prices will probably fall another 20%, according to leading Napa and Sonoma growers.
To make room for the 1983 crush this autumn, some surplus new wine will be sold cut-rate to brandy makers, including Gallo’s flourishing five-year-old E&j concern. Aging inferior wine owned by some growers may end up at the alcohol distillery, the wine industry’s glue factory, fetching pennies on the dollar. Since growers drew loans based on much higher estimated crop values, the losses could force some undercapitalized farmers into sellouts and mergers.
Some of the troubles, to be sure, are transient; the recession has squashed the growth of all alcoholic beverages. Long-run consumption trends still seem as golden as a glass of sweet Riesling. Per capita adult consumption in the U.S. today averages a modest 3.1 gallons, and relatively few people do the drinking. An estimated 7% of the population consumes nearly two-thirds of all table wine sold, and nearly half these people live in five states: California, New York, Florida, Illinois, and Texas.
Table wine continues to captivate younger adults; as William P. Jaeger jr., managing partner of Rutherford Hill Winery, puts it, “Every time an old bourbon drinker dies, two wine drinkers come of age.” By 1990, says Marvin R. Shanken, publisher of the wine and spirits industry journal Impact, per capita consumption will reach 5.4 gallons a year; that would translate into a sales increase of about 80% over the decade.
But California’s main problem mirrors that of Detroit or Pittsburgh. While domestic sales flattened last year, wine imports grew 6.5%, continuing their steady climb of the past decade. Their market share reached almost 24%, compared with 13% in 1975.
Increasingly drinkable low-priced wines are pouring in from countries as diverse as Yugoslavia and Spain, Algeria and Argentina. The biggest source is the so-called European wine lake, the result of declining consumption in France and Italy, that now laps at American shores. Italy’s exports of table wine to the U.S. grew from 3.8 million to 63 million gallons between 1970 and 1982, and French exports from 6.7 million to 18.1 million gallons. The French and Italians are benefiting both from the strong dollar and from improved wine-making technologies, some developed in California. Italy has captured 60% of the import market, primarily on the strength of Riunite and other fruity Lambruscos (see “The Toyota of the Wine Trade,” FORTUNE, November 30, 1981). Crisp, dry loaves like Folonari can satisfy even sophisticated drinkers looking for a l.5-liter bottle of white priced at $3. And lesser but still drinkable Italian wines are coming in priced as low as $7 a case wholesale.
American producers have reacted, offering the deepest discounts in memory. A price war is under way among high-volume vintners whose chief products are so-called generic wines-blends sold under such names as Mountain Red and Chablis. Prices of magnum-size jugs have plunged by half since late 1981; in major food stores, for instance, jug prices have dropped from $5.50 or $6 to less than $3.
Data are scarce about the effect of all this on profits; most California wineries are either privately held or are such small parts of publicly held corporations that their performance is not disclosed. But what evidence there is suggests a glum picture. Almaden’s parent, National Distillers & Chemical Corp., reports that the winery’s operating profits fell over the past two years by 50%, to $10.5 million on revenues of $180.6 million in 1982. Robert M. Furek, president of Heublein’s wine division, says profits were never easy to come by, even in the boom years, “but the lure of growth obscured the constant cash drain.” Now, says Furek, “profits have become the biggest issue in the business.”
The squeeze will be most severe for small wineries producing wines that sell for $6 to $17 a bottle, which have less room to cut prices. Some 300 wineries have been opened in California over the past dozen years, some by starry-eyed newcomers long on graceful living and short on managerial skills, and others by serious vintners who have joined established wine makers like Louis M. Martini and Concannon to make excellent estate-bottled wines. They have brought imagination to the business and provided enophiles with an overabundance of excitement.
But as Rutherford Hill’s jaeger says, “Six dozen vineyards are trying to copy six successes; the field is hopelessly overcrowded.” And more of those wines than not are overpriced. Many $12 price tags reflect inflated start-up costs and debt service, not necessarily an ultimate Cabernet Sauvignon. “There is $5 in mortgages and interest rates in most of those bottles,” asserts Darrell F. Corti, a Sacramento retailer admired by wine makers for his encyclopedic knowledge of their business.
If the future does belong to the low-cost producer, nobody seems better positioned than E&J Gallo. Gallo sells more than a million cases each week-about 36% of all wine made in California. Its sales are almost three times those of Heublein, a shrinking and troubled No. 2, and four times those of CocaCola Co.’s Wine Spectrum, its most formidable competitor. Beside it, 12-million-case Almaden and Joseph E. Seagram’s eightmillion-case Paul Masson forfeit Goliath status.
Gallo defies measurement. Analysts admit that their estimates of the dollar volume of its sales, $650 million to $700 million a year, are largely guesswork. But the company’s size and dexterity unquestionably give it a commanding, even pivotal, place among California wine makers. Its technical prowess is legendary: a 75-member technical staff, which many in the wine business think the equal in quality of the University of California’s famed enology department at Davis, can develop and blend consistent, good wines in 25O,OOQ-gallon lots, equivalent to the annual production of many not-so-small Napa and Sonoma wineries.
Gallo enjoys operating economies at every stage of making wine. Long-term contracts with hundreds of growers ensure a steady stream of grapes, produced to meticulous 2 standards. Gallo makes its own bottles and caps, and runs its own delivery fleet. And its precision-drill sales force can march Hearty Burgundy or Chablis Blanc into discount houses and general stores with equal ease, gaining central displays at eye level.
At the heart of this private empire stand the brothers Ernest and Julio Gallo. The proud and stem Ernest, 74, orchestrates sales and marketing from his central winemaking complex in Modesto, bounded by barbed wire and the Tuolumne River. Brother Julio, 73, oversees the vineyards and wine making.
Though the brothers are secretive to the point of being reclusive, they’ve never lacked understanding of the U.S. wine market. The Gallos started out making cheap ports and muscatels when the market worked on the “pennies per proof’ principle-the most alcohol for the lowest price. They segmented that market in the 19508 and early 19608, establishing brands such as Thunderbird and Ripple as premium products. In the late 1960s, they introduced highly successful generics, including Hearty Burgundy and Chablis Blanc. In the 19708 the Gallos boldly broke into the fancier trade, offering estimable varietal wines designed to undersell those of established producers.
Nothing symbolizes Ernest and Julio’s plans for the future better than a subterranean aging facility for varietal wines completed in 1977. The length of two football fields, it contains 650 4,OOQ-gallon casks of Yugoslavianand French oak for aging varietal wines. Bringing such economies to the upper end of wine making, they can produce an excellent Cabernet Sauvignon that sells for about $5 and-according to New York Times wine critic Terry Robards and other experts-compares with some Napa and Sonoma labels selling at three times the price.
Among competitors, Gallo’s efficiency and unerring marketing judgment inspire awe, fear-and sour grapes. A high executive of one rival firm insists the company doesn’t make money. “Ernest has everything he could want and just loves selling more wine,” he says. “He earns a zero rate of return on sales. American wine profitability is sitting on the edge of an explosion and the only thing holding it back is Ernest’s wealth.”
That assertion ignores not only imports but also tangible evidence of Gallo’s profitability: mammoth tank farms, new trucks, acres of oak barrels, and advertising expenditures of over $25 million in 1981. Few in the wine business take seriously the idea that the Gallos don’t make money-lots of it. Depending on whom you ask in the trade, the ~ family fortune is thought to be anywhere from $700 million to $1.2 billion.
Doubts about the Gallo future center on who can replace Ernest and Julio. Ernest’s passion for total control has made it difficult to develop a stable of informed executives, says San Francisco wine consultant Terrence Clancy, who started out as a Gallo sales representative. The result is a highly vertical organization that rests on a handful of able, intensely loyal senior managers. Julio’s son Robert is one of several family members working for the firm, but none of the younger Gallos has yet shown evidence of the fathers’ genius.
Gallo’s chief challenge at the moment comes from Coca-Cola’s Wine Spectrum, whose marketing goals are global. Since entering the business in the mid-1970s, Coke has chalked up spectacular successes. Coke claims its Taylor California Cellars brand is California’s fastest-growing mass premium line: last year sales rose 30% to about 8.5 million cases. “Coke has had more impact on the industry than anything since Prohibition,” observes Louis R. Gomberg, a consultant to the industry for decades.
Atlanta-based Wine Spectrum is aptly named; its five brands, launched in 1977 and 1978, embrace all the major table-wine market segments. Under the planning of Coca-Cola Vice Presidents Albert E. Killeen, 70, now a consultant, and Harry E. Teasley Jr., 46, Spectrum bought Napa Valley’s elegant Sterling Vineyards to secure a place at the top end of the business (Sterling’s wine prices range from $10 for a 1981 Sauvignon Blanc to $27.50 for its 1978 Sterling Reserve Cabernet Sauvignon). It purchased distressed Monterey Vineyards, in the heart of the north central coast amid new grape-growing terrain, gaining a strategic berth in the middle range with wines selling from $4 to $6.
But in its crucial stroke the Wine Spectrum acquired for about $100 million the 103- year-old Taylor winery in Hammondsport, New York,gaining what may be the nation’s best-known label and widest wine distributing system after Gallo. Marrying eastern label and western fruit, Killeen and Teasley started up Taylor California Cellars in 1978. While analysts thinkCoke’s Taylor holdings in New Yorkare losing sales, Taylor California has proved a fair and muscular scion
Saving money at the start, the two planners chose not to buy vineyards or crush grapes from scratch. They contracted for underutilized facilities to ferment and store young wine; then, at their own $34-million state-of-the-art plant at Gonzales in the Salinas Valley,they blended this bulk into Taylor California’s own generics. “We had to move fast,” says marketing wizard Killeen. “We wanted to establish immediate leadership.” Only last year, when blending and bottling operations were secure, did Taylor California bring its winery into full operation.
Today the Gonzales plant bottles up to 25,000 cases daily.Some of the blended wine is shipped cross-country in tank cars to the old Taylor factory in Hammondsport, to be bottled as Taylor California for eastern distribution. For a total investment of less than $150 million, Coke has built up a business worth roughly $4()()million today, according to Marvin Shanken.
From the beginning, worried California vintners wished disaster on Coke. Noting that Pillsbury Co. had written off $4 million in its iii-fated Souverain wine venture, they hoped that this other outsider would suffer similar humiliation. But fear turned to loathing the moment Taylor California aired its first television commercials in 1978.
Taylor shook up the market by claiming its products tasted better than others-an approach that California vintners had hitherto considered taboo. Commercials featured prominent (and not so prominent) wine authorities declaring their preference for Taylor Californiawines-and naming what were said to be inferior brands. (“Better than Almaden, better than Inglenook. better than Sebastiani,’ said the initial ads.) Coke spent three years fighting the Federal Bureau of Alcohol, Tobacco, and Firearms as well as Almaden to win the right of comparative advertising. Meanwhile, Taylor California turned into an instant consumer hit.
Recently Coke’s comparative commercials have made Paul Masson a regular target. Two years ago Seagram hired the redoubtable Mary E. Cunningham to head its strategic planning in wine. Cunningham’s audacious plan is to crank up volume over the next decade from eight million cases a year to 60 million cases-more than Gallo now sells. Seagram expects to direct some of its enormous cash flow from spirits into Masson, streamlining and expanding production facilities. It will advertise heavily in an effort to restore Masson’s mid-century reputation as one of California’s classiest vineyards. The planned message: “Masson is better than Gallo or Taylor. but you can afford us.”
Last year the Wine Spectrum bumped Almaden from a third-place position in U.S. wine. an event that sent once complacent Almaden marketers into deep shock. National Distillers’ once powerful wine company is steadily losing ground: in 1982 its case sales dropped 5.3%. One reason. assert some industry experts. may be that Almaden’s generic whites have become inconsistent, and sometimes sulfuric, in taste
But for no wine maker has the past decade produced more disappointments than Heublein. The 1970s began with an ambitious scheme. Bright MBA planners acquired everything they needed to cover the market from top to bottom. Prestigious Beaulieu became a crown jewel. Inglenook evolved into a versatile middle. and Italian Swiss Colony served as a mass base for table wines and high-volume, high-profit pop wines. Yet almost everything went wrong with the top-topop strategy. The pop-wine boom fizzled, edged out by the Lambruscos. Meanwhile, Gallo’s Hearty Burgundy and Chablis Blanc stomped Italian Swiss Colony’s generics.
Worst of all, in 1972 the Federal Trade Commission stepped in, arguing that Heublein’s ambitions portended outside takeover of the market. Heublein was forced to stumble along through eight years of uncertainty about whether it would be able to keep its mass-market base. Though the ultimate decision was in Heublein’s favor, the company could never fully realize even the workable parts of its plan.
Gallo ironically escaped most of the FTC’s wrath by lying low. In 1976 it consented to an FTC order barring it from coercing wholesalers to give it favored status and punishing those who did not. And, according to Gomberg, it disarmed the antitrusters’ qualms about its market power by curbing its expansion. “Exercising great selfrestraint in the midst of a wine boom,” says Gomberg, Gallo allowed its market share to coast. content to develop its new varietal wines.
Since RJ. Reynolds bought Heublein last October, rumors that Colony is for sale have circulated. Heublein denies them. More likely, facing a 6.6 percentage point drop in market share since 1975, its executives are conducting a full-scale brand overhaul. “Lots of chips sit on the wine table,” says Shanken, “and I think Reynolds is willing to bet.”
Lower prices seem destined to become permanent in the California wine business, and several medium-size wineries are already pinched. Sebastiani Vineyards has scaled back plans to compete in the high-volume jug-wine market. “We were not ready to take on the world’s largest soft drink company,” says President Sam 1. Sebastiani. Norton Simon Inc. has had substantial losses on San Martin Winery, which it bought in 1977; last year it put the company up for sale. And San Francisco wine analysts assert that long-distressed Charles Krug in the Napa Valley, with sales of two million cases in 1981, is ripe for takeover. In the inevitable shakeout, the companies that survive will be the efficient and aggressive wine makers who can keep costs down and spend heavily to build their brands.
California’s triumphs of the 1970s served the American wine drinker well by producing a flood of new and better wines. Its troubles today portend further good news for the consumer. Prices are likely to stay relatively low for a long time.
