Wine sales thrive as old barriers start to fall

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The business of wine is breaking free of one of the world's most archaic and tangled retail systems. The result: a rise in sales, and an explosion of new ways to buy wine.

One of wine's new winners is Gary Vaynerchuk, a 30-year-old Belarus immigrant who recently dipped his nose into a glass, inhaled deeply, and stared into a videocamera. "Bell pepper, green pepper, red pepper," he declared. "This smells like a salad."

That observation helped ring up sales of 194 cases of 2003 Noblaie Chinon Rouge, an obscure French red, at $14 a bottle, by the Wine Library in Springfield, N.J. It used to be a small store in a New York City suburb. Today, with a busy Web site, it's one of the highest-grossing independently owned wine and liquor retailers in the nation, with about $45 million in annual revenue. Web sales -- launched in 1997 and buoyed by Mr. Vaynerchuk's folksy online reviews -- grew by about $10 million in the past two years alone.

The market is in upheaval because its many barriers are starting to crumble. Recently, a Seattle federal court struck down state rules forcing retailers to buy through wholesalers at pre-established prices. Several states are lifting rules that prevent consumers from buying wine directly from out-of-state producers and retailers.

At the same time, giant players like Costco Wholesale Corp. -- today the biggest wine seller in the country -- are pressing for reforms that would largely eliminate the industry's powerful middlemen.

The changing landscape is helping wine move into new mainstream markets. At 7-Eleven Stores Inc., shoppers can buy Chardonnays and Pinot Noirs. Roughly 500 Target Corp. stores carry wine, compared to 280 last year. Growth in U.S. dollar sales of wine is outpacing that of beer and liquor, according to research firm ACNielsen. Americans spent $7 billion on table wine at food, drug and liquor stores over the past year, 9 percent more than they spent the previous year.

For decades, wine and liquor marketers have been restrained by the 21st Amendment, which ended Prohibition in 1933 and granted the states broad power to control sales of alcoholic beverages. Fearful that a single player might dominate alcohol sales as gangsters had in the 1920s, the states set up a three-tier marketing system.

By law, producers could sell alcohol only to state-licensed wholesalers. Wholesalers then sold products to state-licensed stores, who ultimately made sales to consumers. Until recently, the three-tier system -- with its patchwork of state regulations -- made online sales nearly impossible. Some states, such as Missouri, even had laws in place setting a minimum wholesale price for wine and liquor sold in the state. Elsewhere, wholesalers often had to adhere to mandated minimum markups of 10 percent or more, or were required to sell each wine to all retailers in a state at the same price.

Retailers grew dependent on wholesalers -- some larger than the companies whose products they sell. Miami-based Southern Wine & Spirits of America Inc. is the market leader, with roughly $7 billion in annual revenue, according to the research firm Impact. The world's biggest wine company, Constellation Brands Inc., by comparison, has roughly $3.2 billion in annual wine sales.

Wholesalers only carry certain brands in a particular market, so stores must often go to dozens of them just to get the products they want. Since no one wholesaler does business in every state, national chains might have to deal with more than 450 different wholesale suppliers.

The snarl of rules explains why no retailer has emerged to carve out a nationwide franchise in wine, as Starbucks did with coffee, Victoria's Secret with lingerie or Home Depot with hardware.

Over the past several years, a spate of mergers in the wine business sparked similar consolidation among wholesalers, anxious to maintain their bargaining power. Giant companies like Southern, whose operations straddle several states, fought state-mandated controls on wholesale prices and some other restrictions.

The first major challenge to the old system came in the late 1990s, from small wineries in Virginia, Northern California and elsewhere. Eager to ship wine to customers in other states, the wineries began mounting legal campaigns against laws barring interstate wine sales in Indiana, Texas, Michigan, New York and North Carolina.

Their efforts culminated in a major victory last year, when the Supreme Court ruled that states must allow wine shipments to consumers from wineries both in and out of state -- or ban such sales altogether. While the court sanctioned interstate sales, it left it up to each state to permit them or not. The ruling didn't address beer and liquor producers, which are fewer in number than wineries and whose products are more broadly distributed in retail stores across the U.S.

Today, 34 states let consumers order direct from out-of-state wineries. In 1997, only 17 states allowed such shipments, thanks to lobbying in the 1980s and 1990s in those states by wineries in California and elsewhere.

Big retailers such as Costco, Target and Wal-Mart Stores Inc. are now pushing for change too, eyeing a lucrative new way to expand their sales. Wal-Mart found that at its new, upscale store in Plano, Texas -- where the median household income is nearly twice the national average -- its 144-square-foot wine section generates more sales per square foot than dairy products.

Costco mounted a federal court challenge to the three-tier system in Washington state's U.S. district court. In April, it emerged victorious when Judge Marsha Pechman issued a sweeping ruling, calling state wine and liquor regulations "plainly anticompetitive" and in violation of antitrust laws.

Judge Pechman not only struck down state pricing controls but also, earlier in the case, she prompted lawmakers to address the direct-sales issue. The state enacted new legislation allowing out-of-state wineries and brewers to ship their products directly to Washington retailers.

If the court's rulings ultimately are upheld on appeal and applied broadly, they could drive wine prices down and streamline the sales process. Warehouse clubs and other wine discounters could benefit the most because they compete ferociously on price. Costco already has a following from consumers looking for deals on fine wines, especially from France.

Washington's alcohol control board and wholesalers have filed separate appeals. Wholesalers say they play an important role in checking the power of big retailers and helping smaller stores compete.

Costco is "trying to change the system so they can apply direct pressure on suppliers without wholesalers being involved," says Craig Wolf, general counsel for Wine and Spirits Wholesalers of America. "The regulations challenged by Costco -- such as uniform pricing and no volume discounts to stores -- were intended to prevent big retailers from having advantages over the mom and pops, who lack the resources to keep up."

John Sullivan, associate general counsel for Costco, says its suit is about "bringing competition to the distribution of beer and wine, so that the distribution is subject to the same competition as every other facet of business." He says Costco is not trying to do away with wholesalers, but argues "there's no reason that wholesalers should have a special protection from competition just because of the things that happened 70 years ago."

In the months since the ruling, Costco has begun trying to get out-of-state wine and beer suppliers to sell to it directly, without much success. "We are doing our best," Mr. Sullivan says. "The current system has some inertia and there's great resistance" from wholesalers.

"Everybody wants to see how this plays out," says Mike Martin, a spokesman for Constellation Brands, which has refused to sell wine to Costco directly.

Last year's Supreme Court decision regarding interstate trade applied to wineries, not retailers. But store-owners argue they also should be covered. Some wine stores, wanting to directly ship bottles to consumers nationwide, have begun mounting their own legal challenges to state restrictions.

Earlier this year, for instance, California-based Wine Country Gift Baskets.com, K&L Wine Merchants and Beverages & More joined with a few Florida stores in an alliance to change the rules. The group hired Northern California wineries' legal counsel -- including a former U.S. Solicitor General, Kenneth W. Starr of Kirkland & Ellis -- to help them challenge bans on out-of-state retail orders in states such as Texas. In May, Texas alcohol regulators agreed to suspend enforcement of its ban.

Amid the gradual erosion of rigid rules, other marketers are rushing into the business of selling wine. Often they use nontraditional sales tactics, from flashy floor displays to unusual packaging -- to lure consumers. The players include startups such WineStyles Inc., a fast-growing national franchise of 64 stores which popped up in 17 states in the past two years. It focuses largely in states with less-restrictive wine retailing laws, such as Florida, Texas, Illinois, California and Minnesota.

As retailers gain clout, more sellers are similarly threatening the role of wholesalers by selling their own private-label brands. Generally priced at $20 and under, these store brands are at least twice as profitable to retailers as other wine. Most retailers don't disclose that a particular wine is their private label; shoppers generally can't tell the difference, and don't seem to care.

At Cost Plus Inc.'s World Market, a home-textiles chain that is also one the largest wine sellers in the country, markets its own brands -- such as Atacama Chilean merlot, and Timbuktu Big Block Red, a South Australian blend -- just as if they were any other wine.

Wine shoppers are romping through a new world of choices. Ruthann Stambaugh of Deltona, Fla., says she recently started experimenting with Cabernets from around the world, some of which she purchased from Wal-Mart's Sam's Club, where prices on some brands are $2 a bottle cheaper than at her local wine merchants.

Mr. Vaynerchuk, the director of operations at the Wine Library, started the store's Web site nearly a decade ago, but originally he used it only as a tool to take orders for pick-up. Some states allowed shipping from his store but he didn't bother untangling the forbidding rules.

Over the years, he started keeping track of states that allowed direct delivery. He pounces with each new opportunity. In May, when he learned that Texas had begun allowing shipments from out-of-state retailers, Mr. Vaynerchuk quickly removed the state from his site's "restricted list." Within days, he had sent out email notices to the hundreds of Texans who had previously sent his store email inquiries.

His video tastings appear online almost every day, and they sell wine. Even a $60 old-growth Tuscan red he described as redolent of "stinky socks" saw its sales rise by 5 percent.


Kris Hudson in Dallas contributed to this article.


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