From the March 2010 issue of Entrepreneur

From a Lean Year, a Rich Vintage

For generations, Napa Valley has cultivated its image as carefully as its grapes:

It is America's premiere wine region, known for its boutique operations turning out small quantities of some of the most sought-after wines in the world.

But the utilitarian winery in Healdsburg where James Stewart produces his Slingshot Cabernet and Sauvignon Blanc throws a bucket of cold water on that romantic idea. It's a prefab warehouse in one of the valley's industrial parks, indistinguishable from countless other rent-a-fermenter facilities dotting California's wine belt. Amid rows of massive steel tanks and the woozy aroma of fermenting grape juice, Stewart is talking about turning the place into a gold mine.

"We're trying to take advantage of what's happening," he says.

Others might say Stewart is a new breed of entrepreneurial winemaker--capitalizing on sudden surpluses of top-quality wines and grapes, producing better wine at lower prices and potentially remaking the California wine industry along the way.

Here's "what's happening": Napa Valley is facing the worst wine downturn since the early 1980s. Premium wines priced between $50 and $125 were "a dead zone" in 2009, according to Silicon Valley Bank's annual wine market report, while domestic sales of bottles that cost more than $10 were estimated to have fallen 2 percent to 8 percent. At Constellation, the world's largest producer of wine--which notably sold off many of its lowest-priced labels a few years back--third-quarter profits fell 47 percent compared with the same quarter in 2008.

"No one knows what is going to happen," says Vic Motto, a business advisor to high-end Napa wineries. Although Motto is confident American consumers will return to "aspirational" spending on wine, he notes 2009 sales plummeted 40 percent at some Napa wineries.

James Stewart of Stewart CellarsDespite the grim numbers, the volume and quality of California wine haven't changed at all. The wineries are still standing; the vineyards planted and productive. Fearing permanent price drops, vintners got so desperate last year they tried an unprecedented "marketing program" for restaurants and retailers: Buy one bottle, get one bottle free. Inventory still piled up in warehouses. Now nervous wineries have begun dumping some of their best wine in the bulk market and walking away from prized contracts with grape growers. Many winemakers say the 2009 harvest will mark a turning point for the industry.

By most measures, Stewart should have been one of those panicky winemakers. But the general manager of Stewart Cellars was positioned for opportunity--in addition to the family's prestige Stewart Cellars label, he had begun making the lower-priced Slingshot wines a couple of years before, as a lower-cost sideline.

Need it be said that the tail is now wagging the dog at Stewart Cellars? In the coming year, the volume of the family's high-end wines will stay flat, while Slingshot and its younger cousin Hollis are expected to grow. As Stewart sees it, everything he needs to build his wine business is going on sale: High-quality bulk wine is about to flood the market, vineyards have been discounting premium grapes by the truck full, and distressed wineries are going on the market.

"The wine market is not even close to being done falling," he says. "We won't see the bottom for another year."

And for Stewart, that's good news.

Shaking up Wine Country

California's wine industry goes through boom-bust cycles about every five years, when supply exceeds demand. Of course, that isn't what's happening now. Banks are turning up the pressure on over-leveraged wineries. Havens Wine Cellars, a critically acclaimed producer, defaulted on its loans last summer and was liquidated. More defaults and a flurry of bankruptcies are expected by this spring's bud break.

"The world has changed," says Nat DiBuduo, president and CEO of Allied Grape Growers , which represents vineyards throughout the state, including large tracts in Napa and Sonoma, where the pain is most acute. "We've got to start doing really well, really quickly if we are going to turn this thing around."

Greg Livengood, president of Ciatti Co. , a leading broker in bulk wine and wine grapes, chooses his words carefully. "It doesn't feel like high-end sales are recovering, nor does anyone expect them to quickly," he says. "There is a pervasive fear that there has been a major shift in the wine market."

For every 100 wine drinkers willing to throw down $100 for a celebrated bottle of Napa Valley Cabernet Sauvignon last year, half as many will buy that wine today, and those that do expect to pay half as much. Across the price spectrum, the "half the buyers paying half the price" calculation has gained traction. Winemakers desperate to slash production simply walked away from grape contracts they had fought to get during the 2009 harvest, and that fruit, like the excess wine, wound up on the bulk market.

It has always been possible to buy bulk wine and snag orphaned fruit. But it was usually the lowest-quality wine and grapes that were left behind. That's changing, perhaps permanently--and so is the price. Stewart and other savvy winemakers are scrambling to capitalize on the chaos.

"The crush of '09 was a watershed," says Matthew Bonanno, who creates his BonAnno Cabernet Sauvignon by buying Napa Valley grapes and working in rented winery space. Grapes he would have paid $5,000 a ton for in 2008 cost him only $1,000 a ton in 2009. While bigger wineries were panicking, he expanded.

Others, too, are positioning themselves to sop up the glut and hoping for the best. Five years ago, Bonanno says, "I could count on two hands the people who were doing what I was doing." While the predicted surfeit of cheap, better-than-usual wine has yet to materialize, Livengood is seeing new customers at his wine broker's office eager to be first in line when the deluge begins.

"The people with new bulk wine concepts are starting to come in," he says. Producers were hoping to sell their backlog of wine during the holidays, says Jon Fredrikson, a leading wine industry consultant. But it didn't happen. "This spring will bring opportunities for people able to buy these inventories. It's ugly out there."

Whether these buyers--called negociants--will have better luck selling wine, even heavily discounted wine, is the question.

The Rise of Slingshot

Stewart started working outside of the traditional Napa business model in 2005, using unsold grapes from the 900-acre vineyard his father bought in Napa's Pope Valley 10 years ago. The first vintage of his wine, called Slingshot, was 10,000 cases of $20 Cabernet Sauvignon and 2,000 cases of $14 Sauvignon Blanc. He sold out in nine months. The same year Stewart created Hollis, a $35 wine from juice that didn't make the cut for his dad's high-end Cabernet.

James Stewart of Stewart CellarsThe elder Stewart, James' father Michael, founded the company in 1999 after selling his Houston-based computer company. Like so many other upstart vintners, he wanted to craft a Napa Cabernet Sauvignon on par with the critically acclaimed "cult Cabs." He hired a famous consulting winemaker, Paul Hobbs, to produce his first $50-a-bottle wine. Then he began working on a super-premium wine--the kind that costs $150 a bottle and aims for top scores from influential critics such as Robert Parker Jr.

Five years ago, James Stewart moved to Napa to work for his father. Just 25 at the time, he needed a break from the grind of working on reality television shows in Los Angeles. He started keeping the books for Stewart Cellars, then handling marketing and distribution. He absorbed how to make and market wine from his father's more established wine friends. He spent long weeks on the road selling wine; his cell phone and laptop became his office.

Everywhere Stewart went, he asked retailers and distributors: What's the hole in the market? What would be the easiest wine to sell?

The consistent response: A $20 Napa Valley Cabernet Sauvignon. Everyone, including Stewart Cellars, was racing to produce the next pricey, blockbuster Cab. Napa vintners were ignoring everyday drinkers. Slingshot was about filling that niche. Today, the Stewart Cellars line has barely budged past its initial 1,800 cases a year. And that super-premium reserve wine? It's called Nomad, and the first vintage was just released at $115 a bottle, a steep drop from the $150 projected list price.

"Slingshot and Hollis are our growth engines," Stewart says. He is producing 15,500 cases of Slingshot's 2009 vintage and will release 1,000 cases of Hollis this year.

The Sweet Spot

In a nondescript white-walled room at Stewart's winery, he and Slingshot's winemaker, Stephen Test, tasted through the 2009 wines. It was only mid-December, and the wines were raw, fresh from the fermentation tanks. Yet the Russian River Pinot Noir, made with an opportunistic purchase of orphan grapes with great provenance, showed particular promise. It would be Slingshot's first Pinot Noir, one of many additions he wants to make to the line.

"There were no buyers for these grapes. This is way above the wine quality I thought we'd get. It's a keeper," he says, making a note to renew the contract for next year. Stewart next pours a Cabernet Franc and Petit Verdot from label-less sample bottles, swirling, sipping and spitting the astringent juice into plastic cups. For these, he used grapes from his Pope Valley vineyard. With the grape market saturated, it makes much more sense to use the fruit to fuel Slingshot's expansion. "Grape prices are ratcheting back to reflect reality," he says with absolute certainty.

Other forward steps are not yet as clear. He has rented space in St. Helena for an office and tasting room, where he can host trade clients. But he's hesitant to bring on staff; he wants Slingshot to stay nimble and competitive.

Retailers and distributors tell him that the downward pressure on prices is so intense now that even $20 wines, like Slingshot's, are considered expensive. Stewart would like to jump into the $12-and-under wine market, where sales are booming. There is no limit to the grapes available to fill his unused tanks. He could easily make a decent $10 to $12 quaffing wine--the kind his friends drink at parties.

But he also knows that could be entering a race to the bottom. The giants of the wine world--Gallo, Constellation, Kendall-Jackson, Diageo and Bronco (maker of the infamous Two-Buck Chuck)--dominate the under-$12 category. Going mano a mano against such marketing juggernauts would be brutal. The smarter strategy, he decides, is for Stewart to expand the size of the $20 Slingshot and $35 Hollis bottlings.

There are fewer consumers willing to pay even those prices. But Stewart would have less competition in a fight to capture wine drinkers working their way down from more expensive wines. He might even have the market to himself, he says. What is propitious about this moment in California, he concludes, is the top-flight fruit and wine available, and the chance to target an appreciative--if less monied--market. He will leave the bottom rungs on the ladder to the corporate giants.

"Now we have to watch who else is going to jump," he says. "I adapted early to the changes, but now everyone will come out to take advantage of the opportunities. Really great wine is everywhere."

Corie Brown is the co-founder of Zester Daily, an online food and wine publication, and a former writer with the Los Angeles Times.

Negociants: The Business Model

Most people assume that the wine in their glass came from a winemaker who tended the grapevines, crushed the grapes and then carefully aged the wine until it was ready to bottle. In truth, this is rarely the case. Many of the wines lining supermarket and liquor store shelves have been pieced together like patchwork quilts.

The people who do this are called negociants--they buy and blend wine made by others and then sell it under their own label. It is an honored profession in Europe. But in the United States, it has been an entry-level game dominated by fringe players and dabblers and is generally looked down upon by the winemaking elite.

Here's how it works. Negociants buy ready-made wine that may or may not be aged. Occasionally, they buy from wineries, but most often they go through brokers such as Ciatti Co. and Turrentine Brokerage, which sell excess product from wineries around the world. This is the market of last resort, where wine is cheapest, often less than $10 a gallon.

Negociants get samples from brokers, specifying the region, type of grape or price point, and go to work. No sophisticated laboratory equipment is required to blend a new wine. The "vintners" can sit at their kitchen table tasting samples until they find the rare one that can stand alone, or create a palatable blend. Add a catchy name and conspicuous label, and a negociant can easily sell a few thousand cases.

Marketing and distribution can be as easy as a call to grocery chain Trader Joe's, which specializes in selling negociant wines like these--labels that make a one-time appearance or have a limited run. Costco and Target also feature one-off wines.

Peter Posert, who jumped into the negociant trade two years ago, shows how fast it all happens. He was tasting bulk wine samples just a few months ago; the resulting line of $10 California red and white varietals will be on shelves this spring under the Buccio label. "This is opportunistic winemaking," he says.

The dicey part of the negociant business is the uncertainty of the bulk wine supply. Wines from the same source are never available twice at the same price, so a negociant's 2009 Cabernet rarely resembles the 2008 version.

Those who get serious and want a consistent product usually start buying grapes after a few years, often through the same brokers. But that may not be necessary in the coming years if high-quality wine begins arriving consistently on the bulk market.

Wine's Anti-Hero

Fred Franzia, maker of 'Two-Buck Chuck,' is on top of the bargain wine market. It's no wonder. He created it.

The recession has been painful for Napa Valley vintners, but it's been a boon for Fred Franzia, a pioneering wine entrepreneur and owner of the Charles Shaw label (that's "Two-Buck Chuck" to its fans). "Consumers are rejecting the claims that wine was worth the kind of money Napa vintners were charging," says Franzia, self-proclaimed champion of cheap wine. "People want a wine they can afford to drink."

Franzia, president of Bronco Wine Co. in the San Joaquin Valley, is the largest vineyard owner in the United States, with more than 40,000 acres of wine grapes in California. He crushed 350,000 tons in 2008. Last year, he crushed 500,000 tons--a company record and a volume second only to his cousins, the Gallo family. He's sold more than 400 million bottles of Charles Shaw, and demand is surging.

When he first released Charles Shaw seven years ago, a $1.99 price tag was unheard of for anything in a bottle with a cork. It ushered in a new super-value category that continues to exert a downward pull on wine prices. "If you want to survive in the wine business, you have to figure out how to compete with me at $2 a bottle, not $20," Franzia says. "Consumers are looking for bargains."

Until this year, wines selling for $20 or more constituted 10 percent of the volume of California's wine, but 35 percent of revenue--a healthy chunk of a $20-billion industry. For decades, that was the fastest-growing sector, and pricey Napa Valley wines flourished.

But today, Franzia tops the growth chart. In fact, as one of the largest buyers (and suppliers) of bulk wine, Franzia often gets the call when a Napa vintner needs cash fast. "They believed their own BS in Napa," he says, clearly delighted that he is their buyer of last resort. "They can't sell their wines, while we can't keep up with demand."

It's not the first time Franzia and Napa have been on opposite sides of the fence. In 2006, Franzia lost a bitter court battle with Napa vintners determined to stop him from selling low-rent Central Valley wine under brands with "Napa" in the label.

Neither side has ever forgiven the other.