Last week, E. & J. Gallo and Constellation Brands closed the deal for Gallo to purchase 30 of Constellation’s lower-end wine brands for $1.7 Billion. The sale came as no surprise with rumors having flurried for some time that Constellation wanted to offload their lower price-segment brands and focus on high-margin and growth segments like premium wine brands Meiomi and the Prisoner, and of course, cannabis.
Betting on high-margin and high-growth sounds like a winning strategy, and Constellation’s stock rose on the morning after the announcement. But if Constellation was so eager to get rid of these brands, and consumer trends point toward premiumization, why would Gallo want to buy them?
Two immediate reasons present themselves. First, Gallo may have gotten a good deal. When the sale of Constellation’s wine brands was first rumored, the price mentioned was $3 billion. Secondly, perhaps Gallo is just better positioned to make a profit off these brands with their high degree of vertical integration and synergies from producing multiple brands in the segment. However, the answer could also lie in the core difference in company identities between Gallo and Constellation.
Constellation is a publicly held company invested in wine, beer, spirits, and cannabis. Their outlook is constrained by quarterly earnings reports and their impact on stock prices. They have a fiduciary duty to make the most possible profit for their investors and move their investments around within their sphere to achieve that goal.
Gallo, however, is a multigenerational family-owned wine business. They are deeply invested in the wine industry, with the company’s identity and history bound up in wine as well, so it is hard to imagine them divesting from wine. As a family business, they can take a longer, generational outlook focused on passing a flourishing business to future generations.
This difference is clearly expressed in the statements each company issued announcing the deal.
Bill Newlands, Constellation Brands president and chief executive officer said, “One of the hallmarks of our success over the years has been our ability to evolve and stay on the forefront of emerging consumer trends. This decision will help enhance organizational focus on a more premium set of wine and spirits brands that better position our company to drive accelerated growth and shareholder value.”
While Gallo’s chief executive officer, Joseph E. Gallo, said, “We are committed to remaining a family-owned company focused on growing the wine industry. While we continue to invest in our premium and luxury businesses, we see a tremendous opportunity with this acquisition to bring new consumers into the wine category.”
They speak to the two macro-trends of the wine industry; premiumization, which has been ongoing for some years, and the emerging challenge of bringing new consumers into the wine category, which is causing growth outlooks to flatten, according to Silicon Valley Bank’s State of the Wine Industry Report.
The challenge for the industry is bringing in new consumers, Millennials in particular, to replenish the base as Boomers decrease consumption. The slowing growth means that brands will have to fight for share to grow, and perhaps move into the more profitable segments like Constellation did, leaving behind the slumping entry-level market.
While wine producers can stay profitable for now with a premiumization strategy, most consumers don’t start out buying $20 bottles of wine. So, if the entry-level segment isn’t replenished with new consumers at the same rate that existing ones are trading up, we will eventually reach a point when ageing premium wine consumers can no longer be replaced at a sustainable rate. And if lower-priced brands disappear because companies are chasing profit margins, there won’t be anything to attract new consumers.
That’s the challenge the wine industry is facing right now. But whose responsibility is it to invest in bringing new consumers into the category? No one in particular, or perhaps the industry associations? However, when your share of the pie is as big as Gallo’s and your outlook as long, shrinking almost certainly means a loss. So maybe this deal isn’t about Gallo needing more low-price bands, but about the industry needing entry-level brands to continue to bring consumers into the wine category. Perhaps this deal is about Gallo making a strategic move to save the wine industry for future generations of wine businesses?
By Kim Badenfort