May 7, 2012

The Future Of Wine In China (Part 1)

Though wine consumption is growing rapidly in China, the industry has a long way to go

Despite some headline-catching news, China’s wine market remains at an early stage of development. While this gives market participants an unprecedented opportunity to shape it to their advantage, it also increases the level of uncertainty under which key decisions must be made.

In this column, I highlight some of the key factors shaping China’s wine market, as well as its domestic wine industry. Some of these are global in nature; i.e., they have been influencing the industry in other markets and are likely to be felt in China, although potentially in a different way and at a different pace. Others are more local, rooted in China’s particular stage of market evolution and relationship with wine.

Quick Facts: All the Grapes in China

China’s recent rise in the world of wine has been rapid:

• With wine consumption growing approximately 35 percent in 2010 in terms of volume, China is now the fifth largest wine market in the world, ahead of the UK. Demand for super premium red wines in particular has surged, leading to higher average import prices.
• For fine wines, the center of the auction world has decidedly shifted to Hong Kong, with record prices being achieved
• But China is also planting more vines and expanding domestic wine production at an equally impressive rate. Production has more than doubled over the last five years, making China the world’s sixth largest producer and allowing it to meet around 85 percent of local demand.

Emma Gao (高源), chief winemaker at Silver Heights (Image: Silver Heights)

However, in spite of sustained double-digit growth, wine’s share of total alcohol consumption (3 percent in China vs. 18 percent globally) and per capita consumption (0.7L/yr vs. 3.5L/yr globally) remain low, and much of the wine consumed each year in China is during a limited number of occasions. At the same time, and despite the strong growth outlook, competition is set to intensify, as the 450 or so domestic Chinese winemakers look to take on their counterparts from elsewhere in the world. Many of these competitors are either already in China, or are thinking about entering in the hopes of capturing demand that is not met locally — especially in the higher-end segments.

Opportunities & Uncertainties: What will Shape China’s Wine Industry?

Based on our observation of global wine markets as well as China’s particular market context, we have identified five factors that are critical in shaping the future of China’s wine industry:

1.) Luxury Item or Everyday Drink: How Will Chinese Consumers Adopt Wine?

In many developed and more mature markets, wine’s adoption as a relatively mass-market product has typically been driven by a number of factors. These include the underlying wine-making and -drinking culture, which has traditionally been rooted most strongly in countries of southern Europe, as well as general increases in disposable income and lifestyle changes. However, wine adoption has not been limited to countries with a strong wine culture. A prime example is the UK, which has become one of the most sophisticated wine markets in the world, with local grocery chains Tesco and Sainsbury’s emerging as some of the world’s largest wine sellers and Decanter magazine one of the most influential voices in the world of wine.

In China, many cities now have an emerging wine culture, with local restaurants offering a range of wines and local wine clubs forming, not to mention a proliferation of small independent wine shops or chains, in addition to the expansion of wine shelves in hyper- and supermarkets. More and more consumers are also learning how to distinguish between different types of wines.

However, China’s wine market remains small compared to other alcoholic beverages, and wine remains an exception rather than the norm, competing with traditional Chinese spirits like baijiu as well as Western spirits such as whiskey and cognac, or mixed drinks and cocktails.

A key factor shaping the future of the wine market in China is whether it can grow deep enough roots to become part of consumers’ everyday lives. In part, this will depend on the direction and speed of China’s overall disposable income growth and distribution, i.e., the continuation of the “China urban middle class story.” In part — and this is an opportunity for Chinese wine companies in particular — given their understanding of Chinese consumers, it will depend on the industry’s ability to foster a stronger wine culture and relationship with wine.

2.) “Craft & Terroir” or “Branded Consumer Good”: How Will Wine Be Marketed in China?

In China, former NBA star Yao Ming could be a marketing godsend for California's wine industry

Closely linked to wine’s consumer adoption story  has been the shift towards more “consumer friendly” offerings. The complexity of the wine category – rooted in complicated old world “appellation” systems – has been as source of consumer intimidation and a significant barrier to purchase. However, over the past two decades, many producers, in particular those from the New World, have made wine more accessible by introducing modern marketing techniques such as consumer goods-style branding, transparent product language and appealing labels

New World wine has also forgone the notions of “terroir” and sought to create more consistent, easy-to-drink products, tailored to suit mainstream consumer preferences, achieved by blending different grapes and wines with the help of modern, salable and repeatable production techniques – a practice much criticized by wine enthusiasts.

Currently, wine in China remains positioned around the notion of exclusivity and newness, in particular at the high end of the market, where rare and expensive French Reds dominate. In the mass market, key elements of the marketing mix copy their high-end counterparts. However, the fact that wine is still a relative unknown for many Chinese consumers remains an adoption barrier.

A key question, closely linked to the consumer adoption story, therefore, is how branding can be used effectively to guide more consumers to drinking wine more often — e.g., by creating brands that are closely linked to specific consumer segments or consumption occasions. Related to this, and closely linked to a second question (arguably even more critical to the future of wine in China), is whether brands can help unlock the mid-market segment, between the headline-grabbing-but-too-expensive-French-Reds and the mass market offerings.

3.) From On-Trade & Specialty Shops to Mass Grocery Retailers: How Will Wine be Sold in China?

Another force that has played an instrumental role in creating and shaping a “new world of wine” is mass retailing. Not only have mass retailers become the primary channel for wine in many countries, but they are also increasingly acting as producers via own-label offerings – affordable, mass-produced, globally sourced wines, often sold in Tetra Pak or PET containers.

In China, the wine channel universe is different for imported and domestic wines. The latter are still largely sold through on-trade and, more and more, small specialty stores and select mass market retailers. Imported wines are distributed by a handful of successful players such as ASC, Summergate or Torres (and many unsuccessful ones that exit the business after they have failed to break into the market with their first set of imported containers).

As expected, domestic wines are much more deeply distributed, both in mass market retailers as well as the (local) on-trade, leveraging the distribution reach of their parent companies.

A key question is how these mass market retailers will act in the years to come: Will they use their global wine-buying muscle and bring in a much broader range of mass- and mid-market wines, either as branded or own-label products? While even the larger foreign retailers with experience in wine, such as Carrefour or Tesco, are still relatively small in China in terms of store footprint, this could nevertheless have an impact on domestic brands.

4.) Large Global Leaders or Local SMEs: How Will China’s Wine Industry Structure Evolve?

Richard Shen and the "face" of Chateau Laulan Ducos, Zhang Ziyi

Despite a steady flow of wine M&A activity over the last decade, the global wine industry continues to be highly fragmented, especially in Europe (although less so in the US and Australia). A growing number of distressed smaller companies, the promise of scale economies, and the need for better geographic diversification could foster more M&A activities going forward. The highly saturated traditional wine markets of Western Europe and Australia seem to be the best candidates for consolidation, while major wine companies may pursue M&A in emerging markets, as many still derive 80 percent or more of volume from their top three markets.

In China, the industry has been characterized by imports, especially from France, dominating the high-end, and the three major domestic players — COFCO, Changyu and Dynasty — taking the lion’s share of the mass volume wine market. Meanwhile, around 400 other local players are trying to carve out their own niches, either regionally or through specialty distribution. The divisions are blurring, though, as the influx of imports is increasingly weighted to mid-end choices from the US, Australia and Chile, while Chinese brands are moving into the premium segment via a small local supply of quality Crus and overseas Chateau acquisitions and partnerships.

A key question is how this structure will change in the future, as some of the global players — such as EJ Gallo or Pernod Ricard — undoubtedly have deeper ambitions in China, and once import restrictions ease, they may be able to make a bigger push. At the same time, leading Chinese players may also take advantage of the global availability of smaller wine companies to acquire them outright. This might mean that M&A can go both ways, as the aforementioned global brands tap China for growth, while local players look outside for brands, technology and supply from established premium terroirs.

5.) Domestic Producers or Global Exporters: The Role of Chinese Vineyards in the World

While trends in wine production have shown significant variation by region, overall the industry continues to wrestle with a supply glut. Despite a steady decrease in output, the largest wine-producing countries (France, Italy and Spain) still produce around 30 percent more wine than they sell. After a period of rapid growth, Australia is now also suffering from overproduction. At the same time, production in less traditional but increasingly recognized wine countries like the US, Chile, and China has continued to grow due to more robust local or export demand.

In the longer term, climate change is threatening to render many of today’s established wine growing areas too hot for cultivation, while giving other regions the chance to compete. Australian vineyards in particular are already being affected by severe water shortages. On the other hand, Eastern European regions such as Moldova, Croatia and Poland could play a bigger role, as could Canada and even the UK.

With China now the world’s sixth largest producer of wine, and the country making acquisitions of wine assets around the world, a key question is what role Chinese wine producers will play globally in the future. Will their focus remain squarely on the domestic market, or will they start creating wines for the world, from a combination of locally and globally grown grapes?

Torsten Stocker is a partner and co-head of the Asian Consumer Goods Practice at Monitor Group, the US strategy consulting firm. He is based in China.

Business & Finance / Features / Food, Wine, & Spirits / Investment / Lifestyle / Market Trends / Marketing & Branding
Tag: acquisitions, changyu, chile, EJ gallo... , More
  • Pingback: The Five Main Factors Now Shaping China’s Wine Industry – Jing Daily - My Wine Broker

  • http://twitter.com/RoyalAmWines Royal American Wines

     Amazing article.  Cannot wait for Part II.  We have been importing Washington, Oregon, and California wine for the past year mainly throughout Southern China and have been getting some very positive feedback.  Are you on twitter?

    • chinaluxculturebiz

      Great. Our Twitter handle is @JingDaily:twitter 

  • China Wine Tours

    Excellent article!  

  • Pingback: Though wine consumption is growing rapidly in China, the industry has a long … – Jing Daily - My Wine Broker

  • Thomas Jullien

    Good one! One quick reaction : so far the complex ‘appellation’ system has not deterred Chinese consumers from buying, I would even argue that it has boosted Bordeaux to a formidable growth, and I am not refering to the high-end here as 80% of Bordeaux exported to China is entry-level or mid-market. Here the appellation blends into a brand that appeals to consumers. The notion of appellation vs brand is wine-industry centric and not necessarily reflected in consumers understanding.
    On another level, there’s a huge portion of the wine distribution in China which is not mentioned here : the informal channels (as opposed to traditional ones described in your article), very specific to the China market and a sure driver of the recent growth. But maybe this is for next part!

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  • AussiewinemaninChina

    The most inciteful article on the China wine market that I have read. Well done!

  • Steve

    Torsten, very nice.  Should a western restaurant in Shanghai offer Chinese wine?  My impression that a local who spends RMB300 on steak and salad would avoid Chinese wine.  Is there a stigma?

    • AussiewinemaninChina

       Hi Steve. This is actually no different to the “growing up” of wine in other countries. I would say emphatically “Yes” – Chinese made wine is improving in leaps and bounds. Avoid the commercial brands though….

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  • http://www.travconsult.com.au/ Trevor Lee

    Torsten, I agree completely with Aussiewinemaninchina; the most informative article I have read on this subject. Most wine regions in Oz are  now paying attention to the potential of the Chinese market. But some, I fear, will chase the market blindly, rather than doing their  homework first and learning about China, its consumers and the wine industry there. I am looking forward to part 2; thank you again for a great article.

  • Chris Devonshire-Ellis
  • http://profiles.google.com/erin28r Erin O’Donnell

    Thanks for the insights. You said wine consumption is on the rise. How about wine collecting? Is this seen as a luxury hobby in China? It seems that wealthy Chinese would begin collecting wine and cellaring it. 

    • chinaluxculturebiz

      Erin,

      Yes, wealthy Chinese are becoming one of the most important buyer classes in wine auction markets like Hong Kong: http://www.jingdaily.com/asian-buyers-snub-bordeaux-but-auction-houses-insist-theyll-be-back/13805/

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