How To Lose $100M
A rundown on why venture capitalists don't care about your new beverage alcohol startup.
Welcome back. HUGE correction needs to be made before we get started here. In the last issue of Unfiltered, I suggested that Pix Wine had shut down along with Haus and Vinebase. I need to clarify — Haus and Vinebase have both announced they will be shutting down. Pix, on the other hand, has downsized and is currently regrouping.
Put simply, Pix wine has not shut down and they’re not going anywhere.
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- 🍺 Investors Don't Like the Alcohol Space — There's a reason that most early-stage investors have an aversion to the BevAlc category. The industry is opaque, highly regulated, and exhibits few success stories.
- 1️⃣ Problem 1: The Incumbents — Wine's competitive landscape is dominated by a few massive players that have been illegally stifling competition for decades while regulators turn a blind eye.
- 2️⃣ Problem 2: The Regulation — Tied-House laws restrict producers while driving down the total ad spend across the industry. Suppliers must rely on their distributors to properly advertise their brand.
- 3️⃣ Problem 3: The Product Complexity — There were over 111K new SKUs submitted to the TTB last year alone. Product complexity is the killer of consumer adoption and, by extent, investor interest.
- 👩🏾🤝👨🏼 The Regrouping — Pix isn't going anywhere: “We are regrouping to determine how Pix can realize the vision that we were trying to achieve.”
IT'S NOT YOU, IT'S ME
This week, I wanted to dive into one of the topics covered by the Drinks Business interview with Paul Mabray. It’s one that continues to come up in any conversation regarding new wine companies — Investors. And, in this case, venture capital investors.
Now, in a previous life, I actually worked as an Analyst at a few different venture capital (VC) firms. As a result, I know the kinds of conversations that are happening behind closed doors. So, I thought this would be a great opportunity to give a little more context around the relationship between venture investors and the wine industry.
Investors Don't Like the Alcohol Space
Venture investors have always had an adversarial relationship with the wine industry. I often suspect it’s because the two are so similar — Largely relationship-based, mysterious to the outside world, and dominated by a few large competitors that drive profits for the entire industry.
But the reason for this aversion to BevAlc, at least on paper, is because the wine industry is opaque (true), highly regulated (very true), and exhibits very few success stories (kind of true).
The dirty little secret that venture investors never want to admit (especially early-stage investors) is that most of what they do is an educated bluff. When a business is 1-3 years old, you have little to no information off of which you can base an investment decision. So, to compensate, you look at all the data surrounding that information gap.
What’s the potential market size for the entire industry? Who else is building a similar product? How experienced is the founding team? Are there any other success stories that can support the viability of the idea? Hell… Any prior successes that can validate the industry itself?
Venture investors need to know, first and foremost, that the industry is adequately large (or small with room to grow) and winnable for a new entrant with a great team and product.
Unfortunately, the alcohol industry as a whole faces several major problems that prevent venture investors from entering the space.
Problem 1: The Incumbents
The wine industry is massive. Somewhere around $340B globally and projected to reach $400B by sometime before 2030. But, it’s highly regulated and wildly inefficient.
For the investors that really do their diligence, they find a competitive landscape dominated by a few massive players that have been illegally stifling competition for decades while regulators turn a blind eye.
It’s not necessarily that incumbents (major distributors and retailers) are always acting deliberately to extinguish existing competition. Rather, it’s that the existing competitive landscape and three-tier system doesn’t allow upstarts a chance to compete in the first place.
You could pick any single one from a number of attributes that define the competitive landscape within the three-tier system and it would be enough to disqualify the entire industry for even the most risk-tolerant investors.
- Horizontal integration of distributors and suppliers that stifles competition throughout the entire industry.
- Horizontal Boycotting further consolidates the largest distributors and extinguishes remaining competition that wasn’t already pushed out or acquired.
- Opaque ownership of subsidiaries and shell companies by the largest players to circumvent laws against vertical integration of suppliers and distributors.
- The entire industry is still largely relationship-driven at every point in the value chain, from grower to retailer.
Problem 2: The Regulation
This dead horse has been beaten to the point of being entirely unrecognizable, but I’ll keep swinging — The alcohol industry is pretty regulated.
In his interview, Mabray points out that tied-house laws create substantial problems for the wine industry; the biggest of which is the fact that advertising spend is lagging compared to most other industries. This is primarily because tied-house laws prevent wineries from being able to advertise on their own behalf.
As a result, that role falls to a winery’s distributor. And, unless there’s a prior agreement in place that outlines how much is to be spent on advertising (which is sometimes the case), distributors can kind of just do whatever they want, while allocating spend to whomever they want.
Plus, tied-house laws are intentionally opaque, which allows prosecutors to exact major penalties for minor infractions. It’s so bad that, in many states, social media platforms are considered to be advertising channels. In fact, every once in a while, regulators will pick a single case to pursue aggressively as a way of making an example for everyone else.
As a result of all of this, the wine industry as a whole spends far less on advertising than most other industries (especially food/bev). This is further exacerbated by a serious lack of meaningful, measurable outlets for sales.
VCs are in the business of backing the companies that will be able to take an initial investment and grow to become really, really big. Highly-regulated industries pose challenges that are often outside of the control of the company/team, no matter how good the product. For most investors, that’s a dealbreaker.
Problem 3: The Product Complexity
There’s an atrocious level of product complexity in the wine category — Countries, regions, varietals, quality designations, vintages. As Paul shared in the interview, there were over 111K new products submitted to the TTB in 2021.
This level of product complexity is wildly confusing to consumers and makes the greater market even more difficult to accurately forecast for venture investors.
However if, say, there were a boutique search tool that could allow your average consumer to find and purchase any wine from anywhere in the world… that would likely help reduce information asymmetry and provide greater clarity regarding demand across the entire industry 👀
So Where Does That Leave Us?
So, what would you do if you were tasked with managing a $100M fund on behalf of school endowments and state pension fund across the country? Would you put grandma’s retirement into an industry with these kind of obstacles?
I sure as f*ck wouldn’t.
After all, VCs and fund managers aren’t idiots. They may not understand the alcohol market as well as your average importer, but they understand that BevAlc doesn’t behave like other normal categories. They can conduct enough diligence to conclude that there are too many threats that can’t be controlled for by the founding team.
In order to prove these investors wrong, the wine industry is still waiting for its first real, big software success. The solution to this, Mabray believes, is using tech to bridge the gap between wine and the consumer (emphasis on improving the consumer experience, not the trade experience… yet). All it takes is one big win in the software category to attract new money into the space.
And, to be honest, I think we have to be the ones to make that first big win happen.
“We are regrouping to determine how Pix can realize the vision that we were trying to achieve.”
A couple weeks ago, Pix CEO Paul Mabray gave an interview to Christian Smith over at The Drinks Business. In it, he describes the current state of the wine industry and the relationship between institutional investors and new wine companies.
In the interview, Paul mentions that Pix is currently regrouping to find a way to best serve their current customers as they adjust the company’s strategy. So far, he doesn’t seem to have shared much else publicly.
For now, I’ll keep an eye out for any new developments. But, I'm stoked that Pix is still going strong.
Cuttings are cancelled today because Y'ALL have not filled out your surveys yet. Robbie needs 38 more responses from wineries (wineries only***) in Paso, Washington, and Lodi.
Don't let our boy down, otherwise there's going to be no annual report for anyone.
562 responses thus far to the Annual #SVB#Wine Conditions Survey. We need another 38 to hit our goal, every region is important but we need more responses from Paso, Washington and Lodi. Please encourage your colleagues to complete the industry survey!
— Rob McMillan (@SVBWine)
Oct 18, 2022
DM me pictures of your survey entries and I'll give you a shoutout on the next newsletter.
(It takes you to the signup page, but that's basically the same thing)