Please read the case and answer these two questions:

1. Would you enter this industry at that point in time? Add brief comments why/why not.

2. Assuming you decide to enter... how would you position your company? Please detail a profitable business model for a new entrant.

U.S. Wine Industry in 2001 Puzzle Case

Speaker 1: Wine is a way of life that has evolved over a millennia to become a 100 billion dollar global industry. Vineyards are passed down from generation to generation, from century to century. Single bottles are sold for tens of thousands of dollars. Merchants careers are made and lost in picking next year's top vintages. Consumers spend a lifetime learning the intricacies of analogy to better appreciate their next glass. Growers thoughtfully handpick each grape at their individual moment of perfect. Collectors store bottles for decades waiting for that very special occasion.

Above all else, wine is about romance. It's about prestige. It's about refined knowledge. It's about making an occasion special. It is poetry in a bottle. In this visual case study we'll explore strategic landscape of the U.S. wine industry. Its history, its competitive forces and its key players as we follow one winery's attempt to enter the American wine market. As you watch, answer the following questions. From the strategic viewpoint of convention and competitive strategy, how attractive is this industry? As an existing player in the industry, what should your strategy be? If you're not in the marketplace, should you enter? If yes, what should your strategy be?

Now let's first take a look at the history of the wine industry. Archaeologists believe that the first wine was produced consistently in late Stone Age, some 7,000 years ago in modern day Iran. From there wine making techniques developed, storage vessels were made and wine production spread across the Middle East to Egypt. By the third century BC, the Egyptian pharaohs were keeping accurate records of vintage and quality of wine. Labeling each jar, amassing enormous sellers and setting out many of the parameters of [connoisseurship 02:31] still used today. It was here where wine first took as a market of social distinction.

The Greeks brought wine into [continents 02:42] perfecting viticulture techniques and preserving wine's social distinctions. With the rise of the Roman Empire, as the Romans spread across Europe so did wine. A vast commercial network was created to provide wine from the Middle East to Scotland. Now fast forward to the 13th century and with its perfect blend of climate, soil, and know-how, France becomes the reigning wine region of Europe, exporting millions of gallons every year.

Wine making remained largely the same until we reach 18th century France wrapped in the throes of the Enlightenment. As the heart of the Enlightenment's embrace for scientific rationalism, French winemakers developed new techniques to boost their wine's complexity, flavor profile and varietal character. As wine making becomes more refined, laws are passed determining what is premium wine and what is table wine. How the label must be presented, how the wine must be aged, appellations, dominations, grape varietals. Increasingly sophisticated, the industry moves up market.

Wine makers begin to focus on the special qualities and legacy of the land from which the grapes originated. The nobility of the land and by association, the nobility of the wine maker become the central focus of wine making. If the vineyard did not have a noble lineage they invented one. Soon wineries begin adding the word Chateau to wine labels even if as often was the case there was not a Chateau on the property.

At about the same time on the other side of the world, Spanish missionaries are planting the first sacramental vines in North America. By the mid-1800s wine jumped the church wall to become a secular activity and wineries sprang up across California. For the next 150 years the U.S. wine industry continues its steady growth to become a 20 billion dollar business and by 2001 the 4th largest wine producer in the world. Now let's take a closer look at the industry's current strategic landscape.

Vic: We've seen a growth in the number of wineries in the United States. That's tremendous. In the last 10 years the number of wineries in the U.S. has increased from 2,000 to over 3,000. In the last 4 years alone in California during probably one of the worst economies we've seen in a long time in California. During that 4-year period the number of wineries has increased 44%.

Speaker 1: In the late-1990s in anticipation of soaring demand during dot-com boom, California wine growers began planting new vines with abandon. The production of Chardonnay and Cabernet Sauvignon grapes doubled and Merlot tripled within the decade making America the 4th largest wine producer in the world. While America was the 4th largest producer, it remained stuck at 34th place in the world per capita wine consumption. At the same time the U.S. government was approving over 60,000 domestic and foreign labels for the American market every year.

Consumers faced a choice of hundreds of different grape varietals and thousands of geographical appellations and tens of thousands of brands. Overall, the industry is divided into two strategic groups: Budget and premium segments. The intense competition in the budget segment has fueled industry consolidation. The top 8 companies in the U.S. produce more than 75% of the wine by volume. While the estimated 2,500 other wineries produce the remaining 25%. In dollar terms however, the wines produced by the the top 8 companies are low-priced wines selling below $7 per bottle. While low-priced wine accounts for 77% the volume of wine sold, they bring in just 48% of sales.

On the other end of this spectrum the remaining 23% of wine sold above $7 is considered premium and accounts for 52% of sales. For the previous 10 years, sales of budget wines steadily declined as sales of premium wines slowly grew. The dominance of a few key players in the low-priced volume market has given them an ability to leverage distributors to gain shelf space and put millions of dollars into marketing budgets. Small boutique wineries survive but they must stay small or risk being clobbered by the majors.

Vic: Now the distribution model is really driven by volume and scale because the distribution is a capital-intensive, labor-intensive system and as such the people who own that system want to take advance of the economies of scale.

Speaker 1: In the late-1990s as the wine market consolidated, there was a simultaneous consolidation of retailers and disturbers across the United States. The number of distributors have fallen from nearly 5,000 in the 1950s to approximately 250 by 2000. On average there are only 2 major distributors per state. At the same time there's also enormous retail consolidation with the top 10 supermarkets controlling 55% of the U.S. market in 2000.

As the bargaining power of distributors rose exponentially against the plethora of wine makers, a juggernaut emerged. While most wine producers focused on low volume high-priced wines to gain the maximum [rent 08:36] from their investment, the distribution system increasingly focused on high volume low-priced products to maximize their economies of scale.

Rebecca: I especially noticed that there's a huge amount of confusion with French wines. So many people still don't understand the place name difference. The fact that Burgundy if it's red is probably going Pinot Noir unless it's from [Beaujolais 09:04]. [inaudible 09:06]. It's really difficult for them. So I think that with so many options and so many skews on the shelf now...

Denise: The consumer does want quality or price. One of the the other. They've got to get one of them. If you're not competing in one of those arenas, you're probably not going to make it.

Rebecca: Some people just assumed that because it's expensive, it's better. I think that that's another worry. I don't know. Maybe it's like a self-fulfilling prophesy because a lot of people if they buy a really expensive bottle of wine, a $100 bottle, they're going to like it. They're damn well going to like that because if they don't they feel like they rooked.

Denise: A lot of people almost fear wine. You can see people that come into this store and there's not that many but some they're afraid to ask a question because they're afraid to ask the wrong question, so they never ask it at all. The same applies in all walks of of life. The same applies in a school. You're afraid to sound stupid in the class so you don't put your hand up and so then you never know.

Speaker 1: With the number of producers and fragmented international markets, it was nearly impossible for a company to established a dominant position. Retailer and distribution bargaining power was at an all-time high as these spaces were increasingly overcrowded. Weak poorly-run companies are increasingly swept aside. Large wineries are plowing millions of dollars and above the wine marketing to stand out. Profit margins were starting to be pressured.

Despite these challenges the nobility, glamour, growth rate and low barriers to entry invited more and more wineries into the U.S. market. Wine is now made in every state of union including Alaska. Foreign wine makers are also increasingly penetrating the U.S. market looking for new demand outside of their shrinking domestic markets. By 1999 imports accounted for 20% of all wine sales in the U.S. That brings us up to date with the U.S. wine industry. Now ask, how attractive is this industry? As an existing player in the industry, what should your strategy be? If you're not in this marketplace, should you enter? If yes, what should your strategy be?