Beware the Siren Song of DTC Gross Margins
Premium and luxury U.S. wineries need to look at wholesale and DTC sales in an ecosystem and focus on contribution margin.
Harvest in the U.S. typically means two things: the shot of peace to your soul as the fruits of your labor start to come in from the vineyard and the winery fills with the aromas of fermentation, and the shot of cash to your bank account as your team processes your Fall Wine Club just in time for those harvest bills to be paid. In fact, it is often this time of year around wine country when I hear winery owners and executives singing songs of praise to the cash rush and gross margin that DTC sales provide and then quickly, and mistakenly, start thinking of their business as a dichotomy between high-margin DTC sales and mid-margin wholesale sales. After all, that average premium winery margin we see in multiple publications doesn’t move much outside the high 50s percentile range, which is usually made up of a heavier weight of DTC sales at 60-70 percent gross margin, and wholesale sales at 25-35 percent gross margin. That’s when the siren song of DTC starts hitting a crescendo. I hear statements at local coffee shops or in online forums like, “It’s all about DTC!,” or “Why do we even sell through wholesale?!,” or “Next year, we’re going to grow production and shrink our wholesale sales!”
The wine industry is so often stuck in a repetitive loop of myopic thinking even as the beauty of an ecosystem is demonstrating itself in nature all around us.
Several years ago, I started referring to the interplay of premium winery sales channels as an ecosystem. I found that agricultural professionals and winemakers intuitively understood this framing and it opened a great discussion about maximizing brand value. The discussion leads ultimately to moving past the lure of gross margin and really digging into contribution margin with an aim of maximizing a product’s blended contribution by scaling in DTC and wholesale.
My colleague and friend Amanda W. Higgins and I recently taught a course called “Take Control of Your Wholesale Future” and one of my favorite sessions was breaking down DTC vs. Wholesale contribution for hypothetical $35 retail and $75 retail products. We started with this chart from the famous SVB State of the Wine Industry Report:
As always, the SVB charts are rich with value and helpful in seeing new angles from multiple perspectives. Let’s look at this graph from the perspective of the journey of an entrepreneurial startup winery or wine brand:
Peter starts his premium wine brand by producing a product that a specific cohort of wine consumers demands, with a clear brand promise and strong emotional tie to the end consumer.
He starts by selling to his family and friends, and as he cultivates strong consumer relationships, word-of-mouth (both literal and through social media) becomes a catalyst for Peter’s brand to move quickly to the 2,000 9L case level. Peter now has a robust wine club and great AOV with his core customers and has even started selling the wine wholesale to some local restaurants.
At this point, Peter is in that ~80/20 DTC to wholesale world shown on the SVB chart. His gross margins are great, but the cost of producing his product while maintaining quality is going up and so are the selling and marketing expenses of maintaining high LTV direct customers and acquiring new ones. Peter’s ambition, though, is to scale this brand and he’s got the momentum to do it. A few years in, Peter has exceeded 10K cases of production with good inventory turn, his production cost ratios are stabilizing as he scales, and he’s started to open multiple states with wholesalers as demand for his amazing product continues to accelerate.
Soon, his sales mix matches the SVB chart and he’s at about 60% DTC and 40% wholesale sales. To achieve this growth, he’s leased a tasting room in his home town and hired a team, upped his point-of-sale game with Hermès-like packaging, travels to customer’s homes to do luxury catered wine dinners and recruit new DTC fans, moved from packing and shipping everything with his wife to outsourcing both, travels to new wholesale markets to launch distributors, conducts retail product demos and restaurant wine dinners, and has even been able to hire his first wholesale sales manager. Some exciting national distribution opportunities arise, and Peter hires a CEO to lead the next phase of scaling. Now on the road to 50K cases with a near-even mix of DTC and wholesale sales, momentum is amazing, but Peter is still struggling to hit his EBITDA targets. The bank is on him, so Peter takes off his sales cap and puts on his economics cap and digs in with his new executive. His new CEO looks at the financials and immediately says, “Why are we even selling through wholesale? Maybe we need return to scaling DTC in our next phase; the margins are so much better!”
What the data in the SVB chart says, though, is that the next phase of Peter’s wine business journey, that critical scaling from 50K to 100K or more cases means that the business will inevitably flip to 80/20 wholesale dominant, the mirror image of his startup years. We understand this intuitively and through experience because very few premium and luxury wine brands are built entirely through DTC. Sure, there are statistical outliers, but these unicorns are just that. Since the average premium DTC customer will purchase about one 9L case per year, a 100K case wine brand (or line of brands) would need 100K active DTC customers per year; even a doubling or tripling of average order volume would be an impossible DTC customer base for almost all but the largest and most scaled wine businesses. We don’t need to look at this at such scale either; this reality shows why the sales mix starts to flip dramatically even at the 10K case level.
While scaling the DTC business is critical, a true understanding of contribution margin by channel is rarely achieved by wine business managers. After all, gross margin pays the fixed bills in theory; contribution margin pays them in reality.
The siren song of DTC is that 60-70% gross margin. Often the winery or wine business, though, is not properly assigning the variable expenses for those sales to that channel. Software and transaction fees, compliance, special packaging, digital marketing, tasting room expenses, events (both at the winery and in the market) and many other variable selling expenses related to scaling DTC stack up fast and must be properly accounted for in that channel. It’s easy to look at a wholesale sales manager’s hotel and airfare and freak out about expenses, but strangely we don't do the same with maybe less obvious but growing DTC expenses. If both channels are properly managed, the spread between their contribution margins is much less dramatic than the spread between their gross margins. In the end, a growing premium wine business begins to see that both are essential to scaling profitability and building lasting brand value. Digging even further, we can start to focus on improving efficiencies in both channels rather than throwing in the towel on one or the other.
Moreover, adopting a mentality of sales channel ecosystem is critical and so rarely achieved. Wholesale sales are still the best billboard money can buy, especially as the on-prem has become more competitive. Sales that create usage occasions such as your wine being featured by-the-glass in a hot restaurant or in a luxury hotel banquet program not only create case sales volume, they create exposure for your brand which can drive DTC sales if managed properly and cross-promoted. Yes, you can cross-promote your DTC business with your on-premise customers and even turn it into a value-ad for those accounts. You just need to know how. Similarly, a “backstage” guest experience in DTC can create lasting brand loyalty that translates to sales at restaurants, hotels, country clubs, and retailers potentially throughout the globe.
Succeeding in premium wine sales is never black and white, just as making a great wine isn’t. Ask any gifted vigneron what makes a great wine, and few would ever distill it down to one element. The vigneron manages the vineyard and the cellar in an ecosystem, seeking harmony and balance for success. In sales we should do the same and manage our wholesale Billboard and our DTC Backstage Pass to create the ultimate customer journey and the most successful premium brand.
Happy Harvest Everyone!
--Peter
**I wrote this article myself and it is entirely original. I used both Chat 5.0 and Gemini as editing tools, asking them only to point out grammar errors, not to create a "better" version of my original. I find this to be the most honest and effective way to use these great assistants: like an editor, not a ghostwriter. In my opinion, AI-generated writing is becoming increasingly formulaic and obvious. For what it's worth, I have found Gemini to be the better editor of the two.