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Wine brands must blend demand, margin to move upscale, says O'Neill Vintners & Distillers CEO

Wine Industry Conference

Read more interviews with Wine Industry Conference 2018 speakers (nbbj.news/wine18qna):

Keynote: Brian Vos, CEO of The Wine Group Panel: Drive to Premiumization

Jeff O'Neill, founder of O'neill Vintners & Distillers, Larkspur

Judd Wallenbrock, president and CEO of C. Mondavi & Family (Charles Krug Winery), Napa

Kevin Phillips, vice president of operations for Michael David Winery, Lodi

Bob Torkelson, president and CEO of Trinchero Family Estates, St. Helena

Panel: Wine Growth Cycle: Are we at the peak?

Dan Leese, president, CEO and co-founder of V2 Wine Group in Sonoma

Gary Schlossberg, Wells Capital Management

Jon Moramarco, Managing Partner, BW 166

Tony Correia, The Correia Group, North Coast vineyard appraiser

JoAnn Wall, Above & Beyond Real Estate Services, Central Coast vineyard appraiser

Carl Stillman, Stillman & Associates, Oregon vineyard appraiser

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Details on the conference: nbbj.news/wine18

O'Neill Vintners & Distillers started 14 years ago as a producer of wine and spirits brands and in bulk for retailers and other beverage-alcohol companies. But in the past few years the Marin County-based company has been creating and acquiring its own national brands in a move upscale.

In 2016, the company purchased the 80,000-case-a-year Robert Hall Winery of Paso Robles, propelling O'Neill into the fast-growing California Central Coast premium-wine category. Two years before that was a deal with North Coast vintner Roy Cecchetti to bring his upscale labels Line 39, RedTree, Austerity, Backhouse and Exitus into the portfolio and oversee national brands.

And just prior to Cecchetti, O'Neill acquired the Camelot and Pepi brands from Jackson Family Wines. Also picked up was the Martin & Weyrich Allegro moscato brand.

In 2011, O'Neill and partners launched the Ram's Gate Winery project to produce luxury-tier wines from Sonoma County's Los Carneros appellation.

Today, O'Neill ranks No. 26 among U.S. wine companies, producing 760,000 cases a year, and proprietary brands and control labels bump that figure to 1.125 million cases, according to Wine Business Monthly.

“Premiumization” and “trading up” have been buzzwords in the wine business in the past several years, reflecting a trend in U.S. wine sales toward faster growth a higher price levels, particularly more than $10 a bottle. Jeff O'Neill, founder and CEO of Larkspur-based O'Neill Vintners & Distillers, is set to be on a panel discussing that trend at the Journal's Wine Industry Conference in Santa Rosa on April 26 (nbbj.news/wine18).

O'Neill got into the wine business in 1980 and five years later teamed with private-equity firms to found Golden State Vintners, a Marin-based producer that eventually went public. O'Neill was CEO until The Wine Group acquired it in 2004.

He talked to the Business Journal about his company's move into $10–$20 wines, efforts to leverage large-scale production capacity to produce high-quality wines at those prices, and whether it's more profitable to create new brands or revive existing ones to balance costs and bottle prices.

Where are we in the premiumization trend?

JEFF O'NEILL:

Consumers in general are aspirational, so if they have the money, they are always going to try to upgrade to a better-quality wine. Overall, we've seen the consumer is fearless (buying wine retailing) above $10 (a bottle). Maybe not a lot above. We can provide pretty outstanding wines in the $10 to $20.

I think the train has left the station on premiumization and has a pretty good head of steam. The real question for all of us is we're hearing quite a bit of softness around the U.S. from wholesalers. You have to dig deep to determine what that is. That includes everything from regional wineries to direct-to-consumer platforms like Winc, Drinks.com and Amazon.

Everyone is picking at channels right now. If anyone is terrified in this business, it's about what the distribution channels will look like in 10 years. They are all changing.

There's no question that all the growth, generally, is above $10. Below $10 with the exception of BotaBox, Black Box and Barefoot, everything else is down. That tells you that either people are drinking less wine or they are trading up.

Generally, shipments for every single category are up slightly, call it 1 percent.

Is the growth reaching a pinnacle point of, say, $20?

O'NEILL:

It looks like it is going to keep ratcheting up. Volume growth at $20 to $25 is relatively strong as well. It's probably up 10 to 12 percent, but the base volume is not that huge.

I doubt consumption is going to increase significantly, but we're going to continue to see people move up the quality-wine chain.

When you're looking at your strategic direction, are you going to continue to diversify into a wide spectrum of price points and categories? Are you looking to target specific price points or products such as rosés, red blends, cabs or pinots?

O'NEILL:

We try to back into that decision. The question is, where is the growth, and what is the consumer doing? If you get out there and look at the consumer and deliver the best value, that means you are going to play in the rosé market, you're going to play in the oaky, butter chardonnay market. It means you're going to play in the Paso Robles red wine market. And all those can be done in the $10 to $18 range, and the quality can be outstanding.

Rather than look and see what we have, we look at what the consumer will want over the next several years. If the consumer doesn't want it, that means the retailer doesn't want it, the wholesaler doesn't want it, and we got a problem.

Wine Industry Conference

Read more interviews with Wine Industry Conference 2018 speakers (nbbj.news/wine18qna):

Keynote: Brian Vos, CEO of The Wine Group Panel: Drive to Premiumization

Jeff O'Neill, founder of O'neill Vintners & Distillers, Larkspur

Judd Wallenbrock, president and CEO of C. Mondavi & Family (Charles Krug Winery), Napa

Kevin Phillips, vice president of operations for Michael David Winery, Lodi

Bob Torkelson, president and CEO of Trinchero Family Estates, St. Helena

Panel: Wine Growth Cycle: Are we at the peak?

Dan Leese, president, CEO and co-founder of V2 Wine Group in Sonoma

Gary Schlossberg, Wells Capital Management

Jon Moramarco, Managing Partner, BW 166

Tony Correia, The Correia Group, North Coast vineyard appraiser

JoAnn Wall, Above & Beyond Real Estate Services, Central Coast vineyard appraiser

Carl Stillman, Stillman & Associates, Oregon vineyard appraiser

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Details on the conference: nbbj.news/wine18

In the old days, when you had excess capacity, you made extra wine, and you could sell it here and there. We are trying to be much more focused on what the consumer wants and make sure there is margin in it every step of the way. At the end of the day, the consumer may want it, but if there is not margin for the retailer, wholesaler and producer, obviously, that's not a sustainable model.

One of the things we also think about is we have to have efficient production facilities as we go down the road. We have built our facilities to accommodate taking in high-end grapes from around the state and aggregating them in small lots around a large facility. One of our objectives is to have excellent operating costs in a world where many of these grapes are grown the facilities are not quite as efficient.

Efficient in terms of being able to hyperspecialize the winemaking practices that go into each brand to make them more cost-effective to the brand you're producing?

O'NEILL:

For example, we're bringing coastal, small-scale winemaking techniques to the Central Valley. What we do is if we're going to do a barrel-fermented chardonnay or an aged Paso Robles cabernet, we can do that on a big scale. We're doing that in 5,000-, 10,000- and 15,000-barrel increments.

If someone on the coast was trying to do the same thing and doing it with 300 barrels, we have an advantage because we're doing it on a larger scale.

Our tank presses hold 60 tons of grapes, but if you go down the road to XYZ big bulk winery, they are either putting it through a continuous press or they are putting in presses that hold 10 (truck) loads.

We've tried to build facilities that are scalable but provide wines in that $10 to $20 range.

You focus on what the consumer is wanting and target production and brand creation to that demand, so does that mean brands in this modern world are short-lived?

O'NEILL:

If brands are going to be long-lived, you are going to have to continue to make significant investments, not only in the quality of the grapes and winemaking but also in the actual brand, whether that's advertising or social media. The days of putting a brand out there and expecting it to survive are long gone.

There is an evolution of brands as well. If the investment isn't there, the consumer gets bored with them and probably the retailer does too. But think about great brands that existed 30 years ago. Thirty years ago, it was the biggest brand in America, and the second-biggest was probably Paul Masson. Now, they're nearly nonexistent. You have to reinvest in them to keep them relevant to the consumer or create something else that takes their place.

Is your margin more in newer brands than existing brands? Is it difficult to take up prices for existing brands?

O'NEILL:

Some will disagree with this, but we find it very, very difficult to raise pricing. Ultimately, you have to create brands with higher margins to absorb increases in costs. Inflation is cruising along; it's not costing us less. Labor and transportation are big issues in California, and those go up every year 2 to 4 percent, regardless what we do.

You do end up with margin compression on brands, for example, that sell at $9.99. You go to the retailer and say, “I'm going to raise the price 10 percent.” They say, “Terrific. I'm going to take it off the planner, and it will be stuck on the shelf. And if it doesn't sell on the shelf, it will be off the shelf.” There is huge resistance to raising prices.

It's possible that there are five or six brands out there that are the Almadens of the future. They are not relevant anymore, so those producers have to shift production to products under the same brand halo or create new brands, which is sometimes much easier.

It is a dilemma, because you have all this brand equity. But if you have a brand that was $10 historically and you now have a retailer selling it for $5, your margins are compressed. Where do you go? You can't go back to the grower and say, “I need lower prices.” They will say, “I can't get labor to pick it, and to pick it I have to pay more.”

We get shown (brand-acquisition) deal after deal, where the margin is too low, and that would make it difficult to compete.

Slowly, everyone is repositioning their portfolios to better margins, so as you hold these prices in the marketplace they do stick. If you look at great brands out there, pricing hasn't moved a lot. There are a handful I can think of that can take price increases.

What commonality is there with brands that are able to move pricing up?

O'NEILL:

A handful have almost a cult status. They're able to raise pricing almost every year. Rombauer is one of them, on chardonnay. But they'll tell you that they can't raise the price on red but they can on chardonnay. Big-name Champagne producers have been able to move pricing up.

I don't know what the magic is. I wish we could find it.

Is it getting too expensive to make wines under $10 in California with rising costs? Or maybe even under $20?

O'NEILL:

We've bucked the trend a bit. Part of it is because we've made an investment in the future with technology in winemaking facilities and being very regional in our grape-buying to make sure we can match the grape with the price point and the consumer taste profile.

Will there be margin compression in the future? Yes. Will we be at a disadvantage against imports? I think we already are to a certain extent. Our labor situation probably is much worse than it is in Chile, Argentina, Australia or South Africa.

There are competitors in this market that have an advantage through better labor costs or potentially government participation in advertising campaigns. Maybe there is a limit to how efficient we can be in California.

Are you looking to source from Oregon and Washington to help with the price-quality proposition?

O'NEILL:

There are opportunities in both those places. We're not participating yet in Oregon or Washington, but we're looking closely at just about every region that overdelivers at the consumer level.

You still start with what does the consumer want. And the consumer today is looking at pinot grigio. They are looking at pinot noirs from Oregon. They're looking at pinots from California. Sauvignon blanc seems to have some traction, in particular, from Lake and Mendocino counties.

Then you look at the location, and it may not be in our back yard in California.

When considering consumer wants and how long it takes to get into production, is there a danger consumer tastes will shift for something else? Sauvignon blanc growers over the years have said you're either killing it or taking it in the shorts, based on wildly fluctuating demand.

O'NEILL:

It's actually happening right now. Part of it is the sauvignon blanc base is relatively small, and swings likely will moderate as the base grows larger.

It's also a grape you can't grow everywhere. You can grow chardonnay in almost every region in the state and the world and come up with a decent wine. Sauvignon blanc is extremely more problematic when it comes to location.

But we're finally seeing a sauvignon blanc base that is getting larger, and as it gets larger it will be a little bit easier to manage it with inventories.

Is there a challenge with less-expensive sauvignon blanc imports, such as from New Zealand?

O'NEILL:

Part of the reason the sauvnignon blanc segment is so popular is because of New Zealand. That phenomenon started about 20 years ago with a couple of the brands that were startling with how good they were. It has forced everyone who wants to do sauvignon blanc in California or wherever to up their game. It's created a category that has a following.

We produce quite a bit, from a number of regions. Our Line 39 brand makes about 90,000 cases of it. We make sauvignon blanc for other folks as well. We end up blending from around the state, with zero coming from the Central Valley of any quality.

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Jeff Quackenbush (jquackenbush@busjrnl.com, 707-521-4256) covers the wine business, commercial construction and real estate.

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