The Deep Discount Effect

Time was, a winery would set the price for a bottle of wine, the wholesaler used that price as a close guideline, and the retailer paid a price that was real-world reflection of what each wine was likely to sell for in that particular market. And retail prices rarely varied by more than a dollar or two either way.

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0307dsc1This Costco, in Santa Rosa, CA, is just one of some 390 outlets in the chain that is now the largest wine retailer in the U.S., having sold an estimated $583 million in wine in 2002 (a small percentage of its annual $40 billion in sales).

But that was at a time before the wholesale market shrank into a few large megacompanies, each with a portfolio that offered a number of major wine houses, each competing for a share of the same retail shelf space that today has become so much more precious, the two-and-a-half inches of real estate worth possessing.

Over time, discounting became a way of life in American wine, and then other market forces took hold and created a patchwork quilt of pricing that was partly based on regional considerations (what was happening in each individual marketplace, or general population base); the general tone of the economy (was it booming or busting?); the supply of wine and demand for it, and the willingness of retailers to help with promotions.

Programming dollars were a factor here — how much wineries and wholesalers were willing to spend on promotion and the degree to which discounting would be encouraged, or discouraged.

The marketplace worked in an orderly way for a long while. Some adventuresome retailers, rather than discount specific items, took smaller margins across the board. And a few (including some supermarket chains) offered multiple-bottle buyers an even deeper deal. “Buy six bottles and take another 10% off!”

Coupon discounts, both mail-in and at-the-register, became popular, and coupon promotions (“Get $2 off when you buy this chardonnay and a pound of fresh seafood”) all grew in importance. Bottle-neckers that contained recipes also were created to move wine.

Then along came Costco.

Along Came Costco

Founded in 1978 in San Diego as Price Club by a man named Sol Price, the operation began carrying wine almost immediately, and priced most of it at about 12% over cost. The effect was initially not staggering in the San Diego market, mainly since Price Club had but one store, and it wasn’t until 1981 that a second was built. Moreover, the annual $25 fee to become a member seemed (at the time) to be a huge stumbling block to the success of the chain.

But the real change in the marketplace came when Costco Wholesale, based in Kirkland, WA, and structured similarly to Price Club, created the first major competition in the budding “discount warehouse” marketing concept to Price Club. And although initially it was not wildly successful in wine sales, it and a later entrant, Wal-Mart’s Sam’s Club, soon established a new concept for wine sales: a smaller inventory and low prices based on thin margins.

Since Costco acquired Price Club exactly 10 years ago, the chain has grown to 390 stores with annual sales of about $40 billion.

Post-merger, wine became more important to the chain’s overall sales. In 2002, it was estimated that Costco sold some $583 million in wine. (Still, that represented only 1.5% of the company’s gross sales.)

One would think that Costco has made it by selling downscale wine, but increasingly over the years the chain has prospered by taking advantage of high-image wines that are made in larger quantities than the marketplace will absorb at their full suggested retail prices.

Attesting to the upscale nature of Costco’s product line is its current ranking as the world’s largest seller of Dom Perignon. Costco’s price of $79.99 compares with a national suggested retail of $120. (You might think that DP, as it’s called, is an allocated wine, but even though the company won’t disclose how much Dom Perignon is made, estimates are that it is in the multi-hundred-thousand case range.)

It is true that Costco is not a “full-service” wine store since in any one store at a given time there are rarely more than 100 different wines, occasionally a few more. But what Costco has done with its buying power and its strategy of taking such a low margin (averaging around 6% to 10%) is to radically disrupt the pricing structure for wine in many metropolitan markets.

And it all starts these days with the head wine buyer for Costco, David Andrews, who is not only a true wine lover, but a man blessed with a sophisticated palate. I have judged with him at major wine competitions and can vouch for his market savvy and acute tasting ability.

Andrews, 40, rarely gives interviews about his strategy, but he appears to appreciate the importance of “impact” brands, and typically carries wines from Opus One, BV Private Reserve, Francis Ford Coppola, Far Niente, Joseph Phelps, Heitz, Caymus and even an array of classified growth Bordeaux. What you rarely see here are high-end Burgundies, esoteric Italian wine or German wines.

If there is a criticism of Costco, it is simply that customers can almost never find a Costco salesperson who knows something about wine. But Andrews, who has been with Costco for 15 years, seems bent on changing that as well. He is training key managers around the chain, even sending some overseas to learn about European wines on site.

Pursuing a Dual Strategy

The high-end wines seem more important to Costco at the present. When Beaulieu had problems late last year with its 1998 BV Private Reserve Cabernet Sauvignon (a slight moldy problem in the aroma), the wine was seen at Costco not for its suggested retail price of $100, but at $38.99. (Clearly, this was done with the cooperation of the winery.) The discounts on Mondavi’s Reserve Cabernet haven’t been as deep, but the wine is often seen at 30% less than suggested retail, and is usually offered for the lowest price in the country.

At the lower price points, Costco often carries wines that are not exactly household names, but which have a staggering impact. Take, for example, the year-ago offering of Cavit Pinot Grigio. At a time when Santa Margherita Pinot Grigio sales (in the $18 to $20 per bottle range) were escalating, the Cavit was selling for $8.99 per magnum. It isn’t clear how much of the wine Costco sold nationally, but import figures show that Cavit grew from a virtually nonexistent brand in the U.S. in 2000 to 1.9 million cases in 2002, according to the Adams Handbook Advance 2003.

Such a dual strategy, high-end wines at deep discounts as well as lower-end wines that are part of “hot” niches, works like a charm, even though it is employed with a limited number of wines. I have seen some consumers with three or four bottles of Second-Growth Bordeaux as well as a case of Ravenswood Vintners Blend Zinfandel ($6.99) in the same shopping basket.

This strategy has done a lot to change retailers’ buying patterns nationally. For one thing, it has forced wine shop owners to alter their buying strategies when they know that a particular item is going to be carried by Costco. Such an item is a risky buy at a nearby wine shop because the shop owner knows that those potential case buyers who are also “shoppers” will be aware of pricing differences and are unlikely to buy a case at the shop. Not when Costco has the same item for $4 a bottle less, which works out to a $48 savings by the case.

Moreover, some retailers actually buy their Dom Perignon from Costco and then re-sell it for a slightly higher price, just to make sure they don’t lose sales to Costco. The rationale is simple: Costco’s price is lower than the wholesale price when bought in smaller quantities. (In many states, such a strategy is actually illegal, but some retailers say they have to employ it to remain competitive.)

Responding With Staff and Selection

In response to Costco’s lower pricing, the more sophisticated wine shops around the country have found Costco’s main weakness — lack of a knowledgeable staff — and have focused on it. Costco has almost no one on the floor of its stores who can answer a simple question about one of its wines.

By contrast, says Dan Manning at Haskell’s in Minnesota, “What we’ve tried to do is build on service and our broad selection.” He said his staff is extremely knowledgeable about almost every wine in stock, and is eager to help consumers who have queries. DSCN0118

Costco’s successful dual strategy incorporates high-end wines at deep discounts with various other wines at bargain prices.

He added, “We’re aware of the Costco’s and the Sam’s Clubs and the other deep discounters, but we don’t react to what they’re doing because we have our own agenda and we’re sticking to it.”

He said Haskell’s reinforces the service aspect of its business without compromising its margins.

The Dom Perignon example is compelling. Manning pointed out that by offering the wine at $99.99, he knows the wine is, at Haskell’s, $20 a bottle more than Costco. But the typical DP buyer wants only one bottle for a special occasion, and may want a few bottles of a well-priced Cru Bourgeois Bordeaux, a dessert wine, and perhaps a Chianti — wines not available at Costco.

He said Costco may not carry any of those items, and even if they did, would have no one to explain the wine to a customer seeking advice. (Moreover, who wants to wait at Costco’s seemingly interminable check-out lines?)

So, the Dom Perignon may cost a bit more at Haskell’s, but Manning suggests that the slightly higher price is more than made up in the guarantee of better wines and values acquired from a knowledgeable staff.

Creating a Large Selection

Chip Cassidy of Crown Wine and Spirits in Florida says that because Costco only carries at most some 200 brands, his huge selection is his big draw. He said Costco and other discount warehouse operations typically “go after whatever is getting a lot of attention in the marketplace.”

It’s true, he said, that occasionally Costco impacts Crown more directly than at other times. “For example, around Christmas they sell Dom Perignon for 8% above their cost, and [all retail shops] pay the same price for it, and that kind of hurts. They sell it below all of us.

“So we simply make it up with service.”

With 24 stores, Cassidy said, Crown’s buying power “enables us to buy on a grand scale, as good as they buy, and we have a niche.”

Three major aspects of Crown capture your eye on first glance: the fact that patrons can get a glass of a featured wine to try while shopping, that gourmet foods are a key component of the wine-food experience, and that Cassidy is a great wine educator — he teaches at a local college. Thus, he infuses knowledge into his staff, a key feature of the chain’s value to consumers.

“Most people perceive us as individual stores, not part of a chain,” he said.

I asked him if Costco’s low prices aren’t a constant diversion. His reply: “If you worry about what the other guy is selling it for, you’re gonna drive yourself nuts.”

In fact, it was deep discounting that put Crown into financial straits, and led to the hiring of Cassidy in 1985 to bail the company out. Rather than discount, he focused on information, high-quality wines at fair prices, and service.

“Before I arrived, we were discounting everything, and paying the staff on commissions. The dollar was more important than our friendship with our customers,” Cassidy said.

“The [Robert] Parker geeks, let ’em chase it. We want to get wines that are affordable to everybody, and give good, sound advice. There was a lot of hype for the 2000 Bordeaux. Well, we didn’t buy much, because they were generally too overpriced.”

Instead, he said, he found dozens of better values and used Crown’s status as the sixth largest privately owned chain in the country to buy low and pass the discounts along to consumers. “Most of these are wines that no one has heard of before,” and, more importantly, wines he said Costco wouldn’t likely buy because of their obscurity.

Another area of skill, he says, is in specialty items like German Riesling, now hot as a $2 pistol because of the great 2001 and 2002 vintages.

“The market abandoned German wines when chardonnay became popular 20 years ago,” said Cassidy, “but I never did. Right now I have hundreds of cases of German wine on the water. And we are educating our consumers to understand them. They’re such great values.”

Wilfred Wong, head buyer for the California-based Beverages, and More! chain, said he is clearly aware of Costco’s impact on all wine businesses.

“All retailers, if involved in a pretty good-sized business, should be aware of what other retailers are doing,” he said, “and what Costco does can affect your buying.”

“We try to be very competitive on the top items, but where we really do well is with many of our own private brands.”

Wong pointed out that California now has a huge surplus of fine wine, and many high-end wine companies are willing to make “private label” blends that actually carry the name of the winery. However, such a wine would be a “one-off,” a wine that would not be carried by any other wine store.

For example, a winery called Chateau XYZ might make a Sonoma County chardonnay that sells for $20 a bottle as part of its regular lineup. But it might be willing to bottle a Carneros chardonnay that Beverages, and More!, and only that chain, could sell for $15.

Wong gave an example. He and two colleagues went to France two years ago looking for specialty products. At one large winery in Chateauneuf-du-Pape, “we tasted various blends that the house put together for us,” he said. “We asked for a little more Grenache in one of them, and they made the wine for us, and we could sell it for $13.99.”

That wine, 2000 Les Grands Serres Chateauneuf-du-Pape, sold so well that the buyer for a competing wine shop called Wong and asked who the wholesaler was so he could get the same wine.

Manning of Haskell’s prefers his staff-education approach to serving customers, and uses the Dom Perignon example as to why.

“A lot of people don’t want to go into Costco for DP,” he said. “They want to talk to somebody, they want the story. The loyalty of our customers is unbelievable. Sure, some people will only go to a Costco, but there is a certain part of all wine markets where the consumer will shop only at fine wine stores.”

Another feature of such fine wine shops is futures. Some wine buyers would rather buy such wines ahead of time at a guaranteed lower price than wait for the vagaries of the market to set prices on landed wines.

“We’ve been selling futures since 1970,” said Manning, and now with eight stores (including a franchise operation in Naples, FL), the chain is stronger than it has ever been, despite the impact of Costco.

The bottom line is simple: in cities where Costco exists, the rest of the retail market has to be that much more savvy about its stock, service and pricing. This can only enhance the overall wine knowledge of the entire wine-buying community. *


A Question of QUALITY

Consumers who buy wine at deep discounts, from discount warehouses and other deep discounters, may end up buying poorer quality wine, according to one wine marketing executive who ought to know.

He’s from E&J Gallo, one of the world’s savviest of wine companies.

Mike Novy, Gallo’s sales director for Western Europe, recently held a meeting with wine retailers and said, among other things, that the discounting of wine, which has been a way of life for many large companies, has forced many companies to reduce the quality of such wines so profit margins can stay high.

“As an industry, we are taking the easy way, relying on price promotions,” said Novy, according to reports out of London. “But it is not good value; it is sucking the oxygen out of the category.”

Novy’s remarks came as Gallo showed glimpses of how the large family-run beverage company views finer wine.

One report out of Europe said, “Gallo has been viewed with some suspicion in the past by the press and the trade, who have been skeptical of its motives within an industry that, in principle at least, values more open teamwork than Gallo was willing to enter into — a legacy of its size and lack of transparency.”

But Novy seemed ahead of the curve when he predicted that the deterioration of quality as discounts mount is a dangerous game.

One European commentator said Novy’s remarks “amounted to a genuine call to arms for the industry to stand united against pricing pressure. The words also carried weight because of Gallo’s refusal hitherto to air any of its laundry, dirty or otherwise, in the public domain.”

Novy said the passion of some companies to sell wine “on deal” has led others to use that strategy for almost every bottle in their lines.

“There is a great temptation for the consumer to buy wine at half price, but it is not good for value. . . [Wineries] have had to change their wine formulation because they can’t afford to keep selling their wine at discount prices.”

Meanwhile, in early June, Costco Wholesale Corp. said its quarterly profit climbed 18% based partly on the lure of high-end imported wine.

Net income was reported as $153.8 million, or 33 cents a share, up from $130.4 million, or 28 cents, a year earlier. Sales in the three months ended May 11 — the company’s fiscal third quarter — increased 11% to $9.34 billion, Costco said.

Costco, the largest U.S. warehouse-club store chain, charges shoppers an annual membership fee of $45 and earns most of its profits from that source.

The key to wine sales were First Growth Bordeaux wines from the good (but not great) 1998 and 1999 vintages. Costco was selling them for under $100 a bottle. Most such wines were selling for $150 and more just weeks before at non- discount retailers.

Once the wines hit Costco shelves, the wines sold out within a few hours, even though customers were limited to two or three bottles, according to a company spokesman.

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