Wine and competition in New Zealand

In the following story on Stuff, we are told that a New Zealand wine maker has sold a whole bunch of wine for $3.50 a litre – an incredibly low price for the premium brand.

The reason for these “firesales” of wine we are told is:

these big sales come on the back of a bumper harvest this season, resulting in surplus stock

So winemakers have had a bumper season – and as a result they are having to sell some of their wine excessively cheaply. Doesn’t this seem weird.

Well it makes complete sense when we think either:

  1. There is competition in the wine industry or,
  2. The wine company is able to price discriminate between markets

Discuss 🙂

  • Steve

    I think it does seem wierd. yes there is competition in wine and yes the wine company can price discriminate… but this doesn’t mean they should sell it cheaply.

    Wine has what I would call “snob” value. Value from it being expensive. I have seen studies where the increase in duties on wine resulted in more wine being sold. This goes particularly well with findings that show people (even wine coniesieurs) don’t know the difference between expensive and inexpensive wines. see http://freakonomics.blogs.nytimes.com/2008/07/24/keep-the-cheap-wine-flowing/

    Wine is a unique product because over a certain price, quantity demanded actually increases in price. This is because the utility the conumer gains from the wine is from the value of the wine, rather than necessarily the taste.

    Furthermore if we sell new zealand wine cheaply, won’t this taint the new zealand brand? therefore reducing price of all new zealand wines (or at least reducing the desirability because of the percieved lower quality due to some new zealand wine being sold cheaply).

  • “but this doesn’t mean they should sell it cheaply”

    It may not maximise profits in the industry, but if we had perfect competition then a bumper crop of grapes may lead to individual firms flooding the market and reducing each others product.

    Price discrimination allows the wine company to split up the market – that way they can maintain prices for their standard product but still flog off the extra grapes they’ve made.

    Remember, we aren’t trying to say whether the sale of the grapes is increasing industry profit or not – we are just trying to understand why they are having a “firesale” for types of wine during a bumper crop year.

    “Furthermore if we sell new zealand wine cheaply, won’t this taint the new zealand brand”

    That is an important point methinks – the fear is that individual firms, selling off cheap wine, will have a negative externality on firms by “reducing the perceived value of NZ wine generally”.

  • Michael Kluge

    Oh no! Please don’t flood the market with cheap wine!

    I think the key thing here is they are dumping it on the Australian market, not NZ, for 2 reasons:
    -the added tax bonus with relation to Aus. alcohol tax (greater ability for ‘firesale’ approach)
    -they won’t compromise the value of their wine in NZ

    When they have a bumper year they end up with a lot more grapes and a lot more wine than an ordinairy year – a position most wineries are probably in. So there will be a greater supply of NZ wine this year than normal. Demand normally wouldn’t grow to match the good year unless they lowered price. They probably don’t want to do this in their local market because it will be perceived as a devaluation of their product. Dumping it on the Aussie market is probably a better option because I would guess they have a smaller slice of the market pie there.

    So I guess I’m supporting point “2. The wine company is able to price discriminate between markets”

  • Andrewj

    me thinks that the large drop in wine consumption in the UK is putting the heat on. Also a large crop of average to poor quality, we need to price on quality we all have bad years.(except in nz according to wineries) Too much planting too dependent on 1 variety which is basically picked green, and too much planting without planning on marketing. Looks like we may all be able to afford a good Savi pity about the tax although we may start finding some good savi out of Chile cheaper and above average quality .

  • Hi Mike,

    I think you’ve pretty much hit the nail on the head with your description – I feel like those are the main factors as well.

    Hi Andrewj

    That is very interesting about the drop in wine consumption in the UK, I realised that demand had softened here so it is interesting to hear of more examples.

    I think the fall off in wine demand both domestically and internationally has played its part in exacerbating the issues associated with having a bumper crop this year.

    The quality issue is also an interesting one – as that would help increase the level of price discrimination in the market, as wine made from good grapes not a perfect substitute for wine from bad grapes and so they can be sold as separate products.

    In this situation I was under the impression that the “firesale” wine was actually of the same quality as the good wine though.

  • I would go for pricing to market. The own price elasticity of demand in Aust may be higher than say in NZ, hence the lower price. It has been argued that Marlborough Sauvignon Blanc is the most profitable wine in the world, see here. If this is due to low costs of production then it could still be profitable to sell the wine at a low cost in Aust. Also if it is not being sold under the producers own label then there are no reputation effects.

    I would argue against the “perfect competition” argument for wine. Product differentiation is clearly standard practice for the wine industry.

  • Andrewj

    it was a very difficult year in the south island. Over cropping and rain at the wrong time. Quality will be lower. Also the growth is huge and creating problems. Greed is alive in the wine industry and growers with contracts for 150 tonnes produced 250 off the same area. I heard of grapes been tipped out in a field. Costs are rising and growers feel the cost rises are going to choke them. Its only savi blanc making money, Id keep out of grapes in NZ till the over supply is worked through. Its a very expensive country to grow grapes and wine is expensive here. Chile is shaping up to be a major competitor they can grow on cuttings and have substantial advantages in climate and wages.Kiwis are all over Chile. Europe wine consumption makes bad reading. June Wine sales in UK fell %5 in middle of summer- one month!

  • John

    When I buy wine I work on the principle that the wine makers know that only a minority really know the quality of their particular product (information asymmetry) so I head for the cheap wine at the bottom of the rack. I try not to know too much about wine as that could lead to an expensive habit. Usually I choose Merlot.

  • sorry to burst the bottle but the reality is somewhat simpler. You have an amount of storage. You have new wine coming in. You can either pay ridiculous prices for short term storage or bottling or you can sell it cheap and get it off your hands. Of the 3 options that obviously made most sense at the time. There are no long term trends evidenced here, just that someone did not arrange bottling or sale from the vats early enough.

  • Andrewj

    Matt
    interested in you views on wine.
    Im looking at agriculture from inside. Im interested in some of the comings and goings. Sheep are a nightmare no body is making money from sheep farming. Beef is better but drought has ravaged farms, dairy is at an all time high but milk powder is now being stock piled in USA as production ramps up and recession bites sales. Wine production costs are unsustainable except in Sth Island by over cropping and risking quality.
    In this environment Wrightson Pgg have managed to double profits from their finance arm. this interests me. Wrightson sold the finance arm off years ago to Rabo. Rabo got a bargain and wrightson were barred from entering the finance industry for I think 7 years. Wrightson then entered the industry and built up quite a large portfolio and have taken over W&K and PGG finance. However they must have taken on more risk as when they entered, farms were expensive and they had to break into new ground with strong competition from the trading banks and Rabo. How have they doubled income in a drought year with low sheep and beef returns when many farms have run at a loss and had to borrow to pay interest including dairy farms? Wrightson Finance at the end of the day are another Finance company but a profitable one.
    Their foray into Uruguay is interesting but only Wrightsons are making money and values appear to be set by the last farm purchased.
    Interesting Company but now we are heading into unchartered territory. Falling farm Values, Credit crunch, Recession and over production due to high commodity prices that are now falling. Fed farmers estimate on farm inflation this year at %26.Highest priced farms around especially compared to Australia could be that the rural sector is in for some interesting times farm debt in 1999 was 9 billion now over 40 billion yet farm profits up only 17% 380% increase in debt. This was not based on income but from a rush by banks to lend to anyone with equity. We have our own rural subprime. If land in NZ drops to Aust value,s the banks in NZ have a problem. Its not about income anymore its about equity ie the value of land. I think banks are avoiding forced sales but they must be getting close. They hope to exit people like from a jumbo jet in an orderly fashion however if that jet crashes,and every one runs for the exit at the same time screaming their heads of in Panic ? Lets hope the dollar Collapses and inflation takes care of debt its the only safety slide we have.

  • Hi Paul,

    “I would argue against the “perfect competition” argument for wine. Product differentiation is clearly standard practice for the wine industry.”

    Completely agree – that is how I feel about the dealing as well.

    Hi John,

    “so I head for the cheap wine at the bottom of the rack”

    This is a fundamental issue for the industry isn’t it – if people believe that cheap wine is as good as top quality wine they become closer substitutes, which damages the firms ability to differentiate different products.

    However, as Steve said at the beginning, wine is a special good as the price can influence the value – in a sense you can sell the same wine at two different values and people will split themselves up, allowing price discrimination. Not many products have that attribute, so it is useful 🙂

    “Usually I choose Merlot”

    I prefer a Sav, I’m not much for the reds 🙂

  • Hi Phil

    “sorry to burst the bottle but the reality is somewhat simpler. You have an amount of storage. You have new wine coming in. You can either pay ridiculous prices for short term storage or bottling or you can sell it cheap and get it off your hands”

    Or you can pay to dump it.

    Trust me, if selling off the wine cheaply destroyed their market – the wine sellers wouldn’t do it. As a result, we are discussing reasons why selling off a bunch of cheap wine may not impact on their brand or the sale of the rest of their wine. Your explanation only answers part of the question – hence why it is simpler.

  • Hi Andrewj

    I think the important thing to remember is commodity prices have not collapsed yet – infact some commodities are still rising.

    Milk prices tripled – they have now come off the peaks, but should remain at about double their 2005 level.

    Beef and lamb prices have risen substantially recently (up 40% and 30% on a year earlier respectively). Furthermore, global supply of lamb especially is incredibly low – following the cutting of farm subsidies over the United Kingdom and Ireland. Lamb may have some way to rise yet.

    Furthermore, NZ has a comparative advantage in agricultural production that is only getting bigger as the price of feed rises – as we grass feed. Rising fertilizer costs are a pain, but everyone is facing them, so they should translate into higher prices to compensate.

    Also remember that farm values are not falling – they are the one property area that is still lifting markedly in value. How long this can be maintained with the rest of the property market falling apart, I don’t know. However, as long as we don’t have a collapse in commodity prices we are fine – thats the kicker.

  • Andrewj

    Matt sorry you are wrong
    Lamb in the UK is back to 70 pounds for a 20 kg animal. Lamb forecast for coming season is $3.84 a kg, way below production costs.Lamb consumption in Europe is falling .
    We have no advantage in cost of production, we used to have. Fontera has issues they have debt and sell most product as a commodity. Milk production in France up 25% this year. The reality is that farmers are not making money except for dairy farms with low debt. We have a boom in world milk production caused by high prices. The UK is becoming a large dairy farm. More sheep and beef farmers are converting to dairy due to appalling returns. if you can over produce wine why can we not over produce milk.
    As a disclaimer I have a Vineyard and a sheep farm.

  • Andrewj

    Matt farm Values are falling. It is not documented but banks have toughened lending criteria. Sheep farms run at a loss but with valuations of $8m could be hard to sell now. Costs are swamping farming my sheep farm has run at a loss for 2 years. It can sustain no borrowing, I look at farms in Aust and wonder why they can buy a dairy farm for 6k an acre while we pay 25k an acre they have a bigger portion of milk going fresh and therefor a more stable price structure.
    In my area very few farms have sold and the ones that have, are ones where the banks have financed farmers %100 into neighboring farms. demographics alone show a problem with the average age of farmers approaching 60.

  • “Lamb in the UK is back to 70 pounds for a 20 kg animal. Lamb forecast for coming season is $3.84 a kg, way below production costs.Lamb consumption in Europe is falling”

    I agree that lamb consumption in Europe is falling – but production levels have also collapsed. Even at $3.84 a kg for lamb prices would be up 60c on where they were a year ago. Add to this the fact that Aussie has been forced to destock over the last couple of years and the world price of lamb looks set for an upwards correction.

    It is interesting that you say that this is well below production costs – surely meat farmers around the rest of the world must be feeling the same pressure, which would imply that there is further upside risk for meat prices.

    “We have no advantage in cost of production, we used to have”

    Our costs have risen heaps, but the cost of farming overseas has risen even more – this implies that our cost advantage is now greater.

    “The UK is becoming a large dairy farm. More sheep and beef farmers are converting to dairy due to appalling returns”

    Indeed, which is why I’m saying that Milk prices are going to ease – and why meat prices will get boosted (as these conversions have been happening for several years now).

    “Matt farm Values are falling”

    I agree that we will see them fall – but I can’t say they are falling without any evidence. You seem to have evidence of it happening in your area, and I’m glad that you have shared that with me 🙂

    The dairy farmers I have talked to do not seem to be as pessimistic about the outlook, specifically given the fact that any fall in commodity prices would also see our dollar slump – which would help to buffer any reduction.

    I also completely agree with you that there is a risk that some new farmers are relying too much on capital gains rather than productive farming activities in order to get returns. What regions do you think are most heavily concentrated in this sort of speculative activity – I would pick the East and South of the South Island myself.

    Thanks for the information by the way 🙂

  • Andrewj

    My concern regarding Lamb is the retail price. In Europe and the USA lamb is up to the top as far as pricing goes. Affco’s decision to stop processing Ram Lambs will help as this has made our lamb very gamey and put consumers off. I will have to change my breed to stop my weather lambs getting too fat. I work with a consultant and i can absolutely confirm that there exist distressed farmers. These farmers cover the range but mostly in the sheep industry. Anyone owning a hill country sheep farm has issues with profitability.Dairy farmers have issues with debt and costs, beef farmers also have falling margins and now many more will try and change to beef from sheep. On many hill country farms fertiliser has not been applied for 2 years and now its price has risen dramatically.
    A lower $ will help in the short term but we still will have some long term fundamentals to face up to sometime in the future as do many businesses in New Zealand

  • “A lower $ will help in the short term but we still will have some long term fundamentals to face up to sometime in the future as do many businesses in New Zealand”

    I suppose that the there must be a lot of concern surrounding the ETS as well – fears of a “tipping point” in the industry

  • Steve

    “Paul,

    “I would argue against the “perfect competition” argument for wine. Product differentiation is clearly standard practice for the wine industry.”

    Completely agree – that is how I feel about the dealing as well.”

    I disagree. Certainly in the retail market there is high differentiation, but we are talking about a wholesale market with a firesale here. In the wholesale market I am willing to bet it is almost perfect competition. See my above comments that people can’t tell the difference between low cost and high cost wines. Meaning that the increase in cost is all in the branding at the retail level. Additionally any winery that has particularly expensive/fancy wine is unlikely to participate in the wholesale market.

  • Hi Steve, thanks for the comments.

    If it was perfect competition, then why isn’t all the wine selling at a lower price? That is the kicker for me – if they can sell the initial wine for different prices there must be some type of market power going on.

    If you have an explanation for why this might be, and why it may still be perfect competition, then I would be interested in hearing it (I think I might have an idea – but I’m feeling a little to clogged up with the flu to realise if my idea makes any sense 🙂 )

  • John

    What I meant about heading for the cheapest wine at the supermarket is that since there are so many brands (and most consumers aren’t well informed) I figure that some brands are discounted as they are unknown. I also assume that given modern viticulture methods most wine is of a reasonable average quality.

  • Interesting to read Economists take on wine sales. From reading press releases about the success of New Zealand wine, one would believe that everything is golden.

    What is missing from this discussion is the understanding that consumers perceptions of New Zealand, New Zealand wine and how it relates to their wine experience determines the activity in the market.

    My observation is the perception of New Zealand is very singular and pidgeonholed at one tiny space in the giant sea wine. This has the potential for the fashion police to say “been there done that” or ” I’m over that style”. While this is begining to happen in the USA within the trade, consumers are still happy. Beware of the fashion police.

    I believe the challenge is to make every effort to connect directly with consumers and buyers and “put a name to the face” or “tell a story”. This has the potential to lift a wine brand to a different place and the purchase is no longer made exclusively on price.

    Because this is missing many consumers stay stuck in one place and just buy on price. Interesting article in your National Business Review back in December about the importance of New Zealand businesses learning to tell their story. Right now too many are content on letting someone else do it for them or just expect it to happen. Not a good thing to outsource.

  • John

    John Hawkesby does that on Nine to Noon “it’s got the little bit of lavender and taste of oak, the river stones and game -keepers boot”. I read once about the limits of language and how it relates to psychotherapy and (eg) wine.