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The Economic Potential of Georgian Wine

Winemaking is one of the oldest Georgian traditions that have survived to this day. Archaeologists have proved that the history of Georgian wine production reaches back into the past at least 8000 years. Arguably, this makes Georgia the earliest place on earth where wine was produced. And the tradition is alive – today there are not just big wine firms, but it is common among ordinary Georgians to grow grapes and produce their own, home-made wine.

The great history of Georgian winemaking has been acknowledged internationally. Since July 2012, Georgia has the exclusive right to sell wine in the European Union with the slogan “Georgia – The Cradle of Wine”.


A HIGH-END PRODUCT

Not many things produced in Georgia are so exclusive and special that they can compete in the luxury segment of the market. Wine is one of these products, and that is for good reasons, as both domestic and foreign experts agree that Georgian viticulture is unique in the world.

Firstly, Georgia offers an amazing variety of endogenous grapes. More than 500 endogenous kinds of grapes are cultivated in Georgia, which is 20% of all grape varieties which exist in the world!

Secondly, Georgia is home to the famous wine making technology kvevri – instead of fermentation in wooden barrels, metal or concrete containers, as it is done elsewhere in the world, the kvevri winemaker uses earthenware vessels buried in the ground. They vary in shapes and sizes, which range from a few to several thousand liters. In 2013, UNESCO included kvevri on the list of Intangible Cultural Heritage of Humanity.

From the 19th Century onwards, Georgians have begun to make wine according to European fermentation practices. The first European style cellar was built by Ivane Mukhranbatoni, a descendant of the old Georgian dynasty Mukhrani and major-general in the imperial Russian army. In his residency, Chateau Mukhrani, a beautiful estate in 19th century French style not far away from Tbilisi, wine is produced still today. Mukhranbatoni pioneered what soon became a business model for the whole Georgian wine industry: producing wine in European style and exporting it not to Europe but to … Russia! By using creative marketing, his wines soon became the preferred choice of the Russian upper classes, and due to their objective qualities, they gained international recognition. In 1898, one of Mukhranbatoni’s wines won the highest prize at the Paris wine exhibition.

In Soviet times, Georgian aspirations to produce world class wines came to an end. Georgia and Moldova were the main suppliers of wine for the Soviet Union, yet as with most consumer products of the Soviet Union, quality deteriorated and reached an all-time low in the 1980s. Soviet winemakers heavily relied on adding sugar to increase sweetness and alcohol content, yet Soviet citizens had no alternatives to which they could compare Georgian wine. One of the most famous Georgians, Josef Stalin, preferred throughout his life semi-sweet Khvanchkara from Racha and the well-known Saperavi to Russian vodka. The special role of Georgian wine in the Soviet Union explains why Georgian wine was still in high demand in Russia after 1990, and the Russian embargo on Georgian wine imposed in 2006 was a blow for the Georgian wine industry. Up to 2006, more than 80% of wine exports went to Russia, and in 2006 the total value of Georgian wine exports decreased by almost 50% and continued to decrease in the subsequent years. However, the Russian ban forced Georgian winemakers to further increase quality and adjust to international standards, and Georgian wine received unprecedented recognition. Just in 2014, in the prestigious International Wine and Spirit Competition and in the International Wine Challenge 39 and 32 Georgian wines received awards, respectively.

Experts are full of praise for Georgian wine. The webpage of a UK wine importer (Gaumarjos) states that the 2005 Kondoli Rkatsiteli has “complex, honeyed, ripe apple aromas, and is crisp and steely on the palate with just a hint of buttered toffee.” About a 2007 kvevri wine, we can read that it has a “rich golden colour, with complex aromas of baked apple, dried pear and quince, overlaid with creamy vanilla hints. In the mouth, it is serious and weighty with intense fruit and a surprising structure for a white wine, which will enable it to age elegantly. An intriguing snapshot of tradition, but don’t serve it too cold – just lightly chilled.


THE ECONOMIC ANGLE

To some it may come as a surprise that economists have to say something about wine. Yet wine economics has become a vibrant field of research in the last years. There is the American Association of Wine Economists, there are various websites like www.wineeconomist.com (run by Mike Veseth, the author of the book Wine Wars, which “tells the compelling story of the war between the market trends that are redrawing the world wine map”), and there are specialized scientific journals like Wine Economics and Policy (Elsevier) and the Journal of Wine Economics (Cambridge University Press). Various books and uncountable academic articles echo the importance of the subject for the economics profession.

So, what can we say about the economic aspects of the Georgian wine industry? First of all, there is the good news that Georgian wine exports have constantly increased in recent years and in 2013 amounted to almost 130 million dollar. Yet 2014 seems to be an even better year! Only in first eight months Georgia grossed 118.5 million dollar from selling wine abroad, 83% more than in the same period of the previous year. After the reopening of the Russian market for Georgian wine in 2012, Russia got back its place on the top of the list of countries importing Georgian wine. Also, the export price of Georgian wine per liter has been increasing from the middle of the 1990's from below 1 dollar to 3.2 dollar in 2011. Today, the export price of Georgian wine is above the world’s average, underpinning its status as a luxury good. In future, it is likely that the increase of supply will put pressure on the export prices for Georgian wine, as it was the case in Australia in the 2000's, yet this may be more than offset by increased recognition of Georgian wine especially in Europe and the USA.

If production volume and prices of Georgian wine go up, who will benefit? It turns out that wine has the potential for creating “inclusive growth”, i.e. growth which not just raises the incomes of entrepreneurs and people who are already well-off (as it is often the case with economic activities in developing countries). This contention is based on the fact that grape growing is a main activity and an important source of income for many households in rural areas, especially in Kakheti. While many wineries cultivate grapes themselves, it is also common to partly or entirely buy grapes from local families. It is estimated that approximately 2-3 times more wine is produced as “family wine” than by commercial companies. This means that if demand and price of Georgian wine go up, Georgian grapes may become scarce, and companies will start to compete for grapes grown by households, driving up prices. In this way, the renewed prominence of Georgian wine in international markets may directly translate into higher incomes for Georgian smallholder farmers!

In addition, companies producing wine in Georgia will be taxed, and higher volume and prices will generate additional profits and tax revenues.

Yet how much more Georgian wine can be produced? In recent years, between 30,000 and 40,000 tons of grapes were processed annually by winemaking companies. Of the grapes grown by families, most is used for producing home-made wine, but if wine companies would offer higher prices for those “family grapes”, private wine growers would sell their harvest instead of consuming it. If that would happen, commercial wine production could be more than doubled.

Currently, about 60 thousand hectares of Georgia’s land are covered with vineyards. This is just a half of the amount of land used in the early 1980's (a great share of the vineyards were destroyed in the wake of Gorbachev’s anti-alcohol campaign), but still the share of arable land used for wine production is the fourth highest in the world (after Portugal, Chile and Italy) and amounts to 8% of all arable land. Therefore, exports could be further boosted by planting grapes on those areas that were already used for Soviet vineyards.


PROMOTING GEORGIAN WINE

While in Russia, Georgian wine is well-known (but not everyone knows that the quality has improved so much), recent history tells us that Russia is not a reliable market. So, Georgia should diversify the group of countries to which it sells wine. Georgian wine can be sold to other CIS countries, to Europe, the US, and Asia (wine consumption is picking up in China, which is an extremely important development for every wine-producing nation in the world). Yet in most markets outside the CIS countries, Georgian wines are hardly recognizable and mostly known to experts.

According to Kym Andersen (“Is Georgia the next 'new' wine-exporting country?”, Working Paper 162523, Robert Mondavi Institute Center for Wine Economics), experiences of wine exporting countries outside of Europe show that it is more effective when the country of origin is promoted rather than a particular brand. Likewise, Sophie Ghvanidze (Ph.D., Hochschule Heilbronn) shows in her Ph.D. thesis (Bedeutung des Country-of-Origin-Effekts für die Wahrnehmung deutscher Weinkonsumenten: eine Untersuchung am Beispiel des georgischen Weines) that in Germany (the world’s largest wine importer) the country of origin has a strong influence on the purchasing behavior of wine consumers.

A country brand for Georgia may umbrella not only wine, but also (wine-)tourism, mineral water, other foodstuff, and whatever else Georgia wants to sell to the world. Such a brand cannot be established by private companies, even if they cooperate, due to the notorious free rider problem: it is impossible to force companies to be involved in the establishment of the country brand, but every Georgian company would benefit from the marketing efforts, even if they did not contribute. Therefore, companies would do best by not participating and free-ride on the efforts of others.

Only the government could create a country brand, and this is something that should be seriously considered.

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Guest - Eric Livny on Tuesday, 07 October 2014 15:25

A nice read.

"Only the government could create a country brand, and this is something that should be seriously considered." This is being considered. Also see Jacques Fleury's pieces http://www.iset.ge/blog/?p=1789 and http://www.iset.ge/blog/?p=1841 from about a year ago (or even more)

A nice read. "Only the government could create a country brand, and this is something that should be seriously considered." This is being considered. Also see Jacques Fleury's pieces http://www.iset.ge/blog/?p=1789 and http://www.iset.ge/blog/?p=1841 from about a year ago (or even more)
Guest - Simon Appleby on Tuesday, 07 October 2014 18:18

In the southern hemisphere, State national wine promotion in many cases was superseded or supplemented by industry-based promotion. Until the 1980's, "New World Wines" were almost unknown in Europe and Asia, and not well known in the USA. Australia and New Zealand in the 80's, and Argentina/Chile/South Africa in the 1990's, laid the groundwork for huge increases in the $/hectalitre exported through carefully planned and executed national branding campaigns in tandem with individual company promotional activities. Different countries accomplished this with a different mix of state and private funding.

New Zealand has a very private-sector approach, with levies on both grape production and wine production contributing to market development abroad, with not a great deal of state support http://www.nzwine.com/about-nz-winegrowers/

Australia, with largely state-run promotion until the 1980's, has a hybrid model with promotion funded by wine levies on wineries and Federal government subvention http://www.mondaq.com/australia/x/333654/Industry+Updates+Analysis/New+Australian+Grape+and+Wine+Authority

Given that much of the Georgian grape harvest is vinified at home or traded informally in the barter economy in the village, grape levies would be impossible to manage here.

A possible model for a country like Georgia, with modest government resources, is for Samtrest to provide funds for national branding activities abroad on a matching-funds basis, 10:1 State: Industry initially. Wineries would be compelled to remit levies on each hectalitre exported to support industry's matching contribution, and a planned 20-year transition to 100% industry-based fund raising and market development could be mapped out. Other export focussed agro-industrial segments like hazelnut, stonefruit and herbs could imitate the same model.

In the southern hemisphere, State national wine promotion in many cases was superseded or supplemented by industry-based promotion. Until the 1980's, "New World Wines" were almost unknown in Europe and Asia, and not well known in the USA. Australia and New Zealand in the 80's, and Argentina/Chile/South Africa in the 1990's, laid the groundwork for huge increases in the $/hectalitre exported through carefully planned and executed national branding campaigns in tandem with individual company promotional activities. Different countries accomplished this with a different mix of state and private funding. New Zealand has a very private-sector approach, with levies on both grape production and wine production contributing to market development abroad, with not a great deal of state support http://www.nzwine.com/about-nz-winegrowers/ Australia, with largely state-run promotion until the 1980's, has a hybrid model with promotion funded by wine levies on wineries and Federal government subvention http://www.mondaq.com/australia/x/333654/Industry+Updates+Analysis/New+Australian+Grape+and+Wine+Authority Given that much of the Georgian grape harvest is vinified at home or traded informally in the barter economy in the village, grape levies would be impossible to manage here. A possible model for a country like Georgia, with modest government resources, is for Samtrest to provide funds for national branding activities abroad on a matching-funds basis, 10:1 State: Industry initially. Wineries would be compelled to remit levies on each hectalitre exported to support industry's matching contribution, and a planned 20-year transition to 100% industry-based fund raising and market development could be mapped out. Other export focussed agro-industrial segments like hazelnut, stonefruit and herbs could imitate the same model.
Guest - Eric Livny on Wednesday, 08 October 2014 08:54

In Georgia's specific circumstances, there is another problem with both private and public funding to promote Georgia as a brand. The incentives to do so are extremely weak in the presence of insatiable demand from Russia/Eurasia. Why bother if Georgia can sell almost any quantity of almost any of its traditional products to Russia with a very little marketing effort. Of course, this is a dangerous trap given the geopolitical situation we are in. Am not sure how it can be avoided given how incentives are structured... The speculation (see recent statements by Zurab Abashidze) that the railway connection to Russia (via Abkhazia) might be restored, will makes Georgian exports to Russia even more competitive.

I would presume that the "Russian option" did not exist in the case of new wine countries such as Chile, New Zealand or Australia :)

In Georgia's specific circumstances, there is another problem with both private and public funding to promote Georgia as a brand. The incentives to do so are extremely weak in the presence of insatiable demand from Russia/Eurasia. Why bother if Georgia can sell almost any quantity of almost any of its traditional products to Russia with a very little marketing effort. Of course, this is a dangerous trap given the geopolitical situation we are in. Am not sure how it can be avoided given how incentives are structured... The speculation (see recent statements by Zurab Abashidze) that the railway connection to Russia (via Abkhazia) might be restored, will makes Georgian exports to Russia even more competitive. I would presume that the "Russian option" did not exist in the case of new wine countries such as Chile, New Zealand or Australia :)
Guest - Randy on Wednesday, 08 October 2014 16:27

Ignoring the geopolitical issue (which of course is essential - no matter how one feels about Russia it is never good to be dependent on one market), Nino still makes an excellent case. Profit margins are always higher as one moves up the quality scale. Just because Scotland COULD sell all the rotgut it could make in Russia doesn't mean that it is logical for the distilleries to stop making single malts to do so. I just paid a high price to purchase a bottle of Jack Daniel's in Tbilisi. I am sure the distillery could sell its full output within 50 miles of Lynchburg Tennessee if it cut both prices and quality, but why should it do that? The real question is the price/quality elasticity of demand in Russia versus more sophisticated wine markets and Georgia's ability to create a brand name. In Russia I suspect there are two market segments - the high end oligarchs who will buy Bordeaux simply because those are the best known names (just like the Chinese) and the mass market with is competitive and therefore can only yield zero profits for the producer. In Europe and the US I agree with Nino that there is a possibility of creating a brand name and, therefore, market power and positive profits.

By the way, Simon is right, there are models of both government and strictly voluntary wine marketing efforts so Nino overstates things when she says "Only" government could create a country brand. If I am not mistaken "Wines of Chile" (the national promotion association) is member supported and very successful.

Nice piece. If you want to try and develop something more formal for the Journal of Wine Economics, let me know. The editor has been after me to do something on Georgia for years.

Ignoring the geopolitical issue (which of course is essential - no matter how one feels about Russia it is never good to be dependent on one market), Nino still makes an excellent case. Profit margins are always higher as one moves up the quality scale. Just because Scotland COULD sell all the rotgut it could make in Russia doesn't mean that it is logical for the distilleries to stop making single malts to do so. I just paid a high price to purchase a bottle of Jack Daniel's in Tbilisi. I am sure the distillery could sell its full output within 50 miles of Lynchburg Tennessee if it cut both prices and quality, but why should it do that? The real question is the price/quality elasticity of demand in Russia versus more sophisticated wine markets and Georgia's ability to create a brand name. In Russia I suspect there are two market segments - the high end oligarchs who will buy Bordeaux simply because those are the best known names (just like the Chinese) and the mass market with is competitive and therefore can only yield zero profits for the producer. In Europe and the US I agree with Nino that there is a possibility of creating a brand name and, therefore, market power and positive profits. By the way, Simon is right, there are models of both government and strictly voluntary wine marketing efforts so Nino overstates things when she says "Only" government could create a country brand. If I am not mistaken "Wines of Chile" (the national promotion association) is member supported and very successful. Nice piece. If you want to try and develop something more formal for the Journal of Wine Economics, let me know. The editor has been after me to do something on Georgia for years.
Guest - Simon Appleby on Thursday, 09 October 2014 12:26

Eric is right that the Southern Hemisphere producers didn't have the Russia option. The five countries in question have comparatively small domestic markets, and had to fight tooth and nail against their European competitors in global markets. A combination of price, quality, consistency and appealing branding were all important factors in their success. Of great importance is the phenomenon explained by the vigneron's aphorism "Wine is made in the vineyard". Assuming competent winemakers operate the wineries, differences in price and quality are largely determined in the vineyard before harvest and vinification. In each Southern Hemisphere wine exporting country, vignerons adopted the best available vineyard technology from USA and Europe, developed their own very strong native R&D base in viticulture and engineering, had effective extension programmes, and hence brought the cost of grape production per tonne down in real terms while enhancing consistency and quality, with flow-on economies to the wineries. This allowed wineries to penetrate international markets with a mix of price, quality and consistency that their European rivals had difficulty matching.

Apart from a handful of corporate vineyards and a modest number of well-run family vineyards here, most vineyards in Georgia are run on a low-input/low-output model. Vineyards were granted to families by the state at no cost, weed control and pruning is done by family members, fertiliser and pesticide is rarely used, and no irrigation is in place. Harvest is done by extended family or by neighbours paid in cash or kind. This year, the driest summer in the past 45 years, many such vineyards in Georgia's east have experienced complete crop failure, or yields to 2 tonnes/Ha, due to moisture stress. While disastrous in physical terms, and undoubtedly causing hardship to smallholders in this predicament, there is little cash invested in the crop. Physical productivity of such small plots could be increased by 300-400% within a year given the right resources, but with substantial financial exposure and risk.

Commercially operated vineyards with irrigation in place have achieved yields from 6-14 tonnes/Ha this year, depending on variety, district and whether producing for the bulk wine or premium market. Unlike smallholders they must pay land tax, irrigation charges, service the mortgage on their vineyards and the capital developments thereon, pay permanent and casual labour, and pay double for chemical what their European competitors do. They also must pay income tax, which smallholders and co-ops do not, insure their workers and remit salaries tax to the revenue department on their behalf. They have a great deal more cash tied up per hectare than smallholders, and crop failure insurance is up to 15 times more expensive in Georgia than in developed markets. Interestingly, Georgian commercial plots producing for bulk wine markets still have a physical productivity 30-40% below their peers in the Southern Hemisphere, so with a modest outlay in technology and knowhow, operators could substantially improve their margins in the Russian bulk wine market.

Grape in Georgia is very expensive by world standards; this season's grape price in Kakheti averaged GEL1.66/kg in 2014, compared to GEL0.82 for all wine grape purchased in South Australia this year, for example. If we look at 2013 figures from UN Comtrade, Georgian wine exports averaged USD$356/hectolitre compared to Australian wine exports averaging USD$190/hectolitre. Australia exported 26 times as much wine as Georgia in 2013.

My own experience in Hong Kong and China promoting Georgian wine is that most distributors consider it to be too expensive at its quality level to secure a substantial following, which is a pity. If Georgian wineries wishes to gain market share at the expense of Southern Hemisphere competitors in non-Russian markets, they must aggressively drive efficiency gains in the vineyard to bring grape price down and price their wines more competitively. Alternatively, investing in vertical integration, world-class management and developing premium wines of consistent quality and distinctive character may justify the price demanded by Georgian wineries in the global market outside Russia and capture market share from established incumbents.

Eric is right that the Southern Hemisphere producers didn't have the Russia option. The five countries in question have comparatively small domestic markets, and had to fight tooth and nail against their European competitors in global markets. A combination of price, quality, consistency and appealing branding were all important factors in their success. Of great importance is the phenomenon explained by the vigneron's aphorism "Wine is made in the vineyard". Assuming competent winemakers operate the wineries, differences in price and quality are largely determined in the vineyard before harvest and vinification. In each Southern Hemisphere wine exporting country, vignerons adopted the best available vineyard technology from USA and Europe, developed their own very strong native R&D base in viticulture and engineering, had effective extension programmes, and hence brought the cost of grape production per tonne down in real terms while enhancing consistency and quality, with flow-on economies to the wineries. This allowed wineries to penetrate international markets with a mix of price, quality and consistency that their European rivals had difficulty matching. Apart from a handful of corporate vineyards and a modest number of well-run family vineyards here, most vineyards in Georgia are run on a low-input/low-output model. Vineyards were granted to families by the state at no cost, weed control and pruning is done by family members, fertiliser and pesticide is rarely used, and no irrigation is in place. Harvest is done by extended family or by neighbours paid in cash or kind. This year, the driest summer in the past 45 years, many such vineyards in Georgia's east have experienced complete crop failure, or yields to 2 tonnes/Ha, due to moisture stress. While disastrous in physical terms, and undoubtedly causing hardship to smallholders in this predicament, there is little cash invested in the crop. Physical productivity of such small plots could be increased by 300-400% within a year given the right resources, but with substantial financial exposure and risk. Commercially operated vineyards with irrigation in place have achieved yields from 6-14 tonnes/Ha this year, depending on variety, district and whether producing for the bulk wine or premium market. Unlike smallholders they must pay land tax, irrigation charges, service the mortgage on their vineyards and the capital developments thereon, pay permanent and casual labour, and pay double for chemical what their European competitors do. They also must pay income tax, which smallholders and co-ops do not, insure their workers and remit salaries tax to the revenue department on their behalf. They have a great deal more cash tied up per hectare than smallholders, and crop failure insurance is up to 15 times more expensive in Georgia than in developed markets. Interestingly, Georgian commercial plots producing for bulk wine markets still have a physical productivity 30-40% below their peers in the Southern Hemisphere, so with a modest outlay in technology and knowhow, operators could substantially improve their margins in the Russian bulk wine market. Grape in Georgia is very expensive by world standards; this season's grape price in Kakheti averaged GEL1.66/kg in 2014, compared to GEL0.82 for all wine grape purchased in South Australia this year, for example. If we look at 2013 figures from UN Comtrade, Georgian wine exports averaged USD$356/hectolitre compared to Australian wine exports averaging USD$190/hectolitre. Australia exported 26 times as much wine as Georgia in 2013. My own experience in Hong Kong and China promoting Georgian wine is that most distributors consider it to be too expensive at its quality level to secure a substantial following, which is a pity. If Georgian wineries wishes to gain market share at the expense of Southern Hemisphere competitors in non-Russian markets, they must aggressively drive efficiency gains in the vineyard to bring grape price down and price their wines more competitively. Alternatively, investing in vertical integration, world-class management and developing premium wines of consistent quality and distinctive character may justify the price demanded by Georgian wineries in the global market outside Russia and capture market share from established incumbents.
Guest - Simon Appleby on Thursday, 09 October 2014 13:31

For comparison, average wine price per hectolitre on exports for 2013 was USD$275 for Argentina, $214 for Chile, and $144 for South Africa. Heavily subsidised EU countries like Spain ($183) place a lot of downward pressure on the market by exporting massive volumes of bulk wine from the EU.

For comparison, average wine price per hectolitre on exports for 2013 was USD$275 for Argentina, $214 for Chile, and $144 for South Africa. Heavily subsidised EU countries like Spain ($183) place a lot of downward pressure on the market by exporting massive volumes of bulk wine from the EU.
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