We’re all familiar with the story by now: wine sales below about $10 a bottle have been falling while premium wine sales have been expanding, with progressively greater percentage increases at higher price points. In other words, consumers have been trading up to higher priced (and presumably higher quality) wines. The premiumization trend has continued unabated for a decade now, a welcome development for the industry as it has mitigated the impact of slowing volume growth on winery revenues.
The crucial question is whether the premiumization dynamic will continue going forward. It is tempting to simply extrapolate past trends into the future. But extrapolation is a naïve forecasting technique that often leads to poor business decisions. Fundamental analysis, which involves examining the underlying forces and conditions that drive demand, typically produces superior results. From this perspective, I see several factors that suggest the conditions that drove premium wine demand over the past ten years are likely to be less supportive over the next ten. I’ll highlight these briefly.
Slower growth in disposable income
Inflation adjusted disposable income has expanded at a robust pace since the Great Recession ended. Growth was driven by the longest economic expansion in U.S. history, which caused unemployment to drop to its lowest level in more than sixty years. Low inflation and tax cuts also bolstered growth. Covid-19 did tip the economy into recession in 2020 – but at just two months it was the briefest in history – and income growth accelerated due to unprecedented government stimulus.
The favorable economic backdrop and rising incomes provided ample resources for consumers to trade up to higher priced wines. But economic conditions are not likely to be as supportive over the next ten years and the odds of another recession free decade are relatively low.
Unemployment stands at just 4.2% and labor force growth will slow as the U.S. population ages. Thus, employment growth will be more subdued even if the current economic expansion continues unabated. And given ballooning government debt and a rising ratio of retirees to workers, the prospects for additional tax cuts look dubious. Moreover, inflation is running at its highest level in three decades and outpacing wage gains. The current bout of inflation may prove to be transitory, but there are arguments that suggest it is due at least in part to longer-term structural forces.
Slower growth in disposable income doesn’t necessarily imply that consumers will begin to trade down – but it will impact their ability to trade up.
A diminishing wealth effect
The U.S. wine consumer has also been buoyed by an epic expansion in asset values over the past ten years. Home prices doubled and the S&P 500 returned a stunning 350%. Premium wine consumers tend to be mature and affluent – demographic groups that also tend to be asset rich. The wealth effect associated with rising home prices and swelling investment portfolios has doubtless fueled spending on non-essential and luxury goods, including premium and luxury wine.
The prospects for a repeat of this performance over the coming ten years also look doubtful.
Asset price appreciation was supported by the strong economic backdrop. But it has also been stimulated by ultra-low interest rates. Given their low starting point today – there is seemingly less room for improvement – and the Federal Reserve has already signalled its intention to raise rates in 2022. Moreover, following a decade of robust gains, the home price to income ratio is now as high as it was at the peak of the housing bubble, and based on the cyclically adjusted PE ratio, equity valuations have only been higher at the height of the dot.com bubble.
Thus, much slower appreciation in inflation-adjusted asset prices is nearly assured, so consumers may become less willing to splurge on wine. A severe decline could precipitate a reversal in the wealth effect and stimulate trading down.
The boomers have been the key drivers of the premium wine boom as they moved through the peak wine spending years, and they still account for an outsize share of premium wine spending. But they are shrinking in numbers and moving into the stage of life associated with more restrained spending.
The number of boomers is expected to shrink by 11 million over the next ten years, so many will exit the wine market entirely. The oldest turned 75 in 2021 and the youngest will reach the traditional retirement age of 66 in 2030. Given their advancing age, the remaining boomers are likely to become more frugal, which suggests they are apt to trade down rather than up, a trend that could be accelerated by an asset price decline.
The diminishing presence of the boomers in the wine market wouldn’t be an impediment to premiumization if there was an equally large and wine loving generation following in their footsteps. Unfortunately, this is not the case. The boomers will be replaced by Gen X in the prime spending years, which is both smaller and less enamored with wine.
This demographic transition represents another potential headwind for premium wine demand in the decade ahead, though it will progress gradually.
Does this spell the end of premiumization?
Probably not. The premiumization trend should endure over the long run so long as the standard of living continues to improve, as there is a natural tendency to trade up to higher quality products as societies become richer. And there appears to be considerable momentum in the near term given the current trajectory of the economy and asset prices, as well as the substantial excess savings consumers have built up since the pandemic began.
But as the forces discussed above illustrate, there are reasons to suspect that the premiumization trend is nearing its peak. The economic and demographic conditions that have supported it are apt to be less favorable over the next ten decade. Premiumization is likely to decelerate as these tailwinds subside. Moreover, a severe recession or collapse in asset prices could cause setbacks in the years ahead.
Premiumization is obviously more nuanced and there are many additional factors to consider. A more comprehensive and rigorous market analysis is required to complete the picture. The point is that the wine industry should not assume premiumization will continue unabated without questioning its fundamental underpinnings. And some of its key drivers are likely to weaken going forward.
I’ll close by noting that the picture will be muddied by impending price increases as wineries begin to pass escalating costs on to consumers. This will cause the average bottle price to rise – even if consumers continue to buy the same brands as before. More refined sales metrics will be needed to sort this out.