Monday, July 22, 2019

Should the FTC allow the Gallo/Constellation deal?

These and 25 other wine brands were sold in April from Constellation to Gallo, pending FTC approval
Gallo is already the largest wine producer in the world. In April, it agreed to buy 30 wine brands from Constellation for $1.7 billion. But the Federal Trade Commission is holding up the sale, presumably to see if it would make the wine industry less competitive.

I wrote a news story last week about how the FTC's investigation is making some grape farmers nervous. That led me to thinking more about the deal.

Before I go further, I will speculate that the FTC will allow the sale, if only because the business of the Trump Administration is big business. That's not the question I want to answer here.

Is the Gallo/Constellation deal bad for consumers? Is it bad for farmers?

Let's look at consumers first. The 30 brands being sold account for about 23 million cases of wine, and include big names like Ravenswood, Black Box, Clos du Bois and Hogue Cellars.

(The full list: Arbor Mist, Black Box, Blackstone, Blufeld, Capri, Clos du Bois, Cook's, Cribari Tables & Desserts, DiseƱo, Estancia, Franciscan, Hidden Crush, Hogue Cellars, J Roget, Le Terre, Manischewitz, Mark West, Milestone, Paul Masson Grande Amber Brandies, Paul Masson Wines, Primal Roots, Ravenswood, Rex Goliath, Richards Wild Irish Rose, Simply Naked, Taylor Tables and Desserts, Toasted Head, V. No, Vendange, Wild Horse)

Using Wine Business Monthly's figures from its February issue, moving 23 million cases from Constellation to Gallo gives you this new leaderboard of largest wineries (based on 2018 sales):

  • 1. E&J Gallo Winery 93 million cases
  • 2. The Wine Group 53 million
  • 3. Constellation Brands 27 million
  • 4. Trinchero Family Estates 20 million
  • 5. Treasury Wine Estates 15 million
  • 6. Delicato Family Vineyards 11 million
  • 7. Bronco Wine Company 10 million
  • 8. Ste. Michelle Wine Estates 9 million
  • 9. Jackson Family Wines 6 million
  • 10. Deutsch Family Wine & Spirits 3.5 million

Gallo is enormous, but it doesn't stand alone in the cheap-wine category. It would be nearly twice as big as The Wine Group, and that would give it market leverage. Based on Gallo's history, it would use that leverage.

Gallo could demand that large retail chains give its wines prominence. Gallo could also use its market size to create economies of scale, buying everything in bulk to make its wines cheaper. Being bigger should allow Gallo to put lower prices on wines comparable to those of other producers.

But who does that hurt? Other producers of cheap wines, sure. But would it hurt consumers?

The reason that most monopolies with predatory pricing schemes need to be broken up is simple. Once they drive competitors out of the market, they can jack up the prices to whatever they want to charge. Look no further than the prescription drug market for extreme examples.

This can't happen with wine. Let's say Gallo drives The Wine Group into bankruptcy (good luck with that, but we're just talking theoretically.) Gallo would then dominate the entry-level wine segment in a way nobody has since ... Gallo in the 1960s.

But what would it do with that domination? Maybe Gallo's economies of scale first allow it to sell $7-quality wines for $6. It takes over that price category and jacks the prices up to $9.

However, if Gallo decides to sell Ravenswood California AVA (not single-vineyard) Zinfandel for $15 instead of the current $9 or $10, it will run into a lot of competition, and not just from domestic wine. It's difficult for imported wines to compete in the US under about $8 because of shipping costs. Take the retail price up to $15, though, and the whole world of wine wants in.

Sales of wines under $9 have been dropping for years. The hot spot for competition is $15. A few of the brands Constellation are selling are strong in that price point and they will help Gallo in the supermarket battle. But for $15 wines, Gallo would not dwarf its combined competition. It would be about the same size as the No. 3 through 8 wineries combined (skipping No. 2). Gallo would be the big dog, bigger than it is now, but it wouldn't end competition.

Here is an important point. Low-priced wines are commodities. Different companies' brands of $9 Pinot Noir are both made from the same sources: bulk wines and longterm contracts for cheap grapes.

Usually, commodities need more regulation than branded products, and that makes it appropriate for the FTC to look at the deal.

But all wine is not a commodity; only cheap wine.

Consumers can easily switch between cheap supermarket brands. But for higher-priced wines, Russian River Valley Chardonnay is not the same as Chablis, even if the bottles are the same grape and the same price. Consumers will have preferences that aren't strictly tied to price. No wine-producing company can corner the $20-and-up wine market because there will always be some interesting wines from outside its area.

Bronco's Charles Shaw wines are not going away
I'm having a hard time seeing how consumers will be hurt by the Gallo-Constellation deal. The prices of commodity wine might fluctuate, but only by a dollar or two. And there will be no absence of cheaper wines (Hello, Bronco!) for consumers who couldn't afford an increase.

Gallo also has always seemed a little more quality-focused than Constellation, a company whose greatest skill is branding. It's possible that the same brands of wine might be a little better under Gallo than they were before, and unlikely that they will be worse.

Here is a different question. Will farmers be hurt by the deal?

This is possible.

Gallo has more goodwill than you might think in the farming industry; more than Constellation. So farmers aren't publicly complaining about losing a large potential buyer.

But things might be different when Gallo gets these brands. It could throw its weight around when purchasing grapes. Growers might get much less per ton than they expect. Just because Gallo hasn't done this recently doesn't mean it will never happen. Even family-owned companies change over time: Gina and Joe Gallo are not as ruthless as Ernest Gallo, for example.

Is that sufficient reason for the FTC to cancel the sale?

Let's think about what happens if the sale is voided. Constellation will still try to sell those brands. I'm not sure there is another buyer, though.

The Wine Group might be interested, and if it made the deal it would become larger than Gallo, which would ease competitive concerns. But most large wine companies are moving away from the bottom shelf.

Some of the 30 brands might simply wither away: Blackstone, for example, which has shrunk as Merlot fell from fashion, and Rex Goliath, a fad brand now more than a decade old. But the overall wine market will not get smaller. People will buy different cheap wines.

Who's going to make those wines? Gallo, the Wine Group, Delicato, Bronco -- the same companies making cheap wine today. And Gallo is already the biggest of them.

These wine brands aren't physical assets. There are some winery buildings in the sale, and that obviously has value, but if there are vineyards included, that hasn't been reported. Most of these 30 brands are just empty vessels.* If they cease to exist, people will buy the same wine in other vessels.

* The funny thing is that the exceptions are not the fine wine brands like Franciscan. Dirt-cheap wine products like Richards Wild Irish Rose, Arbor Mist and Manischewitz would be missed more on the marketplace because they have unique formulas.

Whether these brands are sold to it or not, Gallo is going to get a larger share of the cheap wine business simply because Constellation is abandoning it. Losing another market to sell their grapes is going to hurt farmers, but they're going to lose that market anyway.

In sum, I don't see a reason for the FTC to disallow the sale. It gives Gallo more power in buying wine grapes, and that could make farmers uncomfortable. But I don't see the deal hurting consumers, and that's the most important thing.

If the FTC really wants to help wine consumers, it should not allow any more distributor mergers. Those mergers have a real bottom-line impact on the price and selection of wine available to consumers.

As big as Gallo is, it still can't get its wines to you without the assistance of distributors, who could decide tomorrow to handle some other company's wines instead. That should tell you where the real monopolistic power is.

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  1. "If the FTC really wants to help wine consumers, it should not allow any more distributor mergers." - This.

  2. Will have a big impact on growers in New York, who supply grapes for Constellation currently. Possibly positive.

  3. No absolutely not. Nothing good will come out of this for the growers or consumers and the rich get richer.