How to make money in wine retail: What almost nobody understands

A student in one of my classes asked me to clarify why profitability depends on markup, investment, turnover and supply lines.

The turnover question is a very important point most retailers do not understand.  The way to make money in this business is through return on investment, not on markup alone.

Say you are selling reliably one case per week of Chateau XYZ for $150 and replacing it for $100.  You are making $50 per case and reinvesting the $100 in next week’s case.  In a year, you will have made $50 x 52 weeks = $2600 profit for a $100 investment, a 2600% return on investment.

Now the distributor offers you the chance to save 10% if you buy 10 cases at a time.  Most retailers jup at the chance to make an extra $10 per case.  Now you are paying $900 initially and making $60 each week, so your yearly profit is $3120, but your investment was $900, so your ROI is $3120/$900 or 347% instead of 2600%.  You could have spent the other $800 on other products and made a lot more, or made almost the same money for a fraction of the investment.  Not to mention the cost of storing those ten cases.

Now suppose the supplier will sell you one bottle every time you need it, for a broken case charge of $1.  Now you pay $8.33 + $1.00 = $9.33 ($112 per case) and profit $38 per case x 52 weeks,so your ROI is $1976 / $9.33 = 21171%!  You spent less than $10 that year to earn almost two grand.  And no storage costs at all.

NOW, suppose you drop your price 10% and the result is that you sell two cases per week.  Ignoring the side benefits of having people flock to your store, you have cut your revenue per case from $150 to $135 and your profit per case from $38 to $23.  So now you are making $23 x 52 weeks x 2 cases per week = $2392 instead of $1976, so your ROI increases to 25629% on your lousy ten bucks.  You make more by charging less.

This idealized example depends entirely on the re-supply lines.  I live right down the street from a restaurant with exactly this deal going.  I will deliver that next bottle any time day or night.  This is the advantage of local wineries.

Private label wines matter more and more?

Brian Rosen argues on his blog that “Private label wines matters more and more” .

I think not.

There was a time, circa 2005, when distributors and large chains figured out that they could get wine MUCH cheaper and with more consistent quality if they were willing to commit to private labeling programs. The smartest of these players developed considerable programs which included the whole supply chain, all the way back to grape contracts and well-cemented winemaker relationships, moving beyond the normal (and very expensive) What-You-See-Is-What-You-Get model.

WineSmith got in bed with a couple hundred restaurants and a dozen savvy distributors and cranked out a substantial business in the early 2000s, comprising in its heyday two thirds of our production. There were predictions that this was the wave of the future that would comprise 25% of California production.

Then it all went down the drain. Despite its impressive advantages, private labeling is greatly out of sync with the short term and risk averse distribution psyche. Dominate the supply chain, make no commitments. If the consumer is willing to eat higher prices and competition can be stifled, why should distributors and retailers invest in value? It’s a toxic situation, but it’s the way it is right now.

Admittedly, distributors in the heyday over-invested in captive brands. A highly respected Colorado independent had thirty top salespeople pushing a thousand SKUs. Suddenly, they tried maybe 25 house brands. The best salespeople ran for cover, and the enterprise tanked within a year. My point: private labels should be a profitable sideline, not a central focus.

The crash of 2007 caused all distributors to reduce inventory. Staff was diverted from promoting top-selling brands to taking out the trash. This went on for years. What emerged was a three-tier system dominated by million-case brands selling standard styles. Want variety? Buy European.

California grape supply goes in cycles of about eight years which disrupt loyalties. When grapes are over-planted, growers suffer, prices drop, and domestic market share increases. Then plantings stop keeping pace with demand (especially when the market is growing) until the growers get back on top, demanding higher prices. Wineries scramble to find grapes, prices rise, and distributors have to start being nice to any supply that will work with them, domestic or foreign.

In Europe, a longer term perspective exists as it does here for other products. Markups of 6%, like Cheerios in Safeway, are the norm for wine also. Wine is understood, standardized and cheap. No sane Frenchman plans to spend more or less than 3.5 euros on his family’s daily quaff. There is practically no private labeling. It simply doesn’t make sense. Get this: wine is not SOLD in Europe, just as, back in the U.S., the latest batch of Cheerios is not presented to Safeway for approval. We make them, we put them on the shelf. That’s the whole deal. Very efficient, very cheap.

The American three-tier system consists of wineries selling to distributors, who mark up 40 to 60%, then pushing products onto retailers, who also mark up 40-60%. The result is that a wine which costs $4 to make costs the consumer $20. For no reason. No value is added. All that cash supports warfare within the distribution system.

The three-tier system is a dinosaur. The future belongs to new models like Cost-Co’s low markup two-tier system which eliminate the middle man.

Any distributor or retailer who wants to man up to the prospect of investing in long term marriages with winemakers and growers has a place in this future. All winemakers dedicate their lives to doing exactly this.

I have yet to meet an American distributor or retailer with this kind of courage and wisdom.

No, I take that back.  The Hitching Post is at least one example of doing it right.  Man up, retail America!