A catalog arrived at our house at the beginning of the holiday shopping season, one I had never seen before. It was entitled "Wine & All That Jazz," and its warm-hued cover pictured a champagne bottle, a set of glasses atop a wood-inlaid table, with a rococo bronze framed painting filling the background. Inside, the glass champagne "flutes" were for sale--$22 for a set of four. So was the "Millennium 24 carat champagne stopper" atop the bottle. But not the champagne bottle itself, not a drop of it. Indeed, as you thumb through the its pages, you discover to your surprise that Wine & All That Jazz (www.winejazz.com-still under construction at this writing) carries no wine whatsoever.

What's going on? As it turns out, selling wine by catalog, or by the Internet-especially within the U.S.-is so difficult that few companies are ready to take on the task. "It's a lot of leg work," says Tod Buckley, president of the Wine & All That Jazz. "The law is so complex that it would take a full time legal staff just to deal with the ramifications." Without knitting together a network of retailers and wholesalers, Tod's catalog can legally ship wine only within its home state of New York. Exporting out of the country is no easier, requiring a tough-to-get license. Ironically, though, a licensed exporter in the U.S. would have an easier time serving Japan than it would the 50 U.S. states.

The story behind this conundrum involves two famous California valleys and one powerful East Coast lobby. The Silicon Valley, known for its technology, is where the biggest online wine merchants are based. The Napa Valley, at the heart of California's wine growing region, is best known for its vineyards and tasting rooms. Interests in both valleys would like to do for the wine industry what Amazon.com has done for books-create virtual wine shops where customers can peruse and buy from vast virtual wine cellars, sending the bottles to themselves and their friends and family around the world.

The lobby is the Wine and Spirits Wholesalers of America (WSWA), a Washington D.C.-based organization that has battled effectively on the part of its members. As the early pioneers in this business have discovered, the wine business isn't the book business, especially as it operates in the United States. And so, this thin slice of the e-commerce pie is embroiled in a war of words and a thicket of legislation that is pitting wine makers and e-commerce sites against the WSWA, state interests, and politicians. So far, the wholesalers are winning.

The Napa Valley is about an hour's drive from San Francisco. With its acres of vineyards, its cute, European-style tasting rooms, its hot summers with hillsides of dried grass and oaks, and its chilled, rainy winters, the place looks to many visitors like a piece of France slipped into the Northern California countryside. (This is especially true on weekdays in the quieter times of the year when Napa Valley towns aren't clogged with cars and tourist buses.) Napa Valley also becomes synonymous with the premium wine making region of the state, which also includes neighboring Sonoma Valley, and Anderson Valley further north. Within this broader region are hundreds of small "boutique" wineries, some owned by celebrities like director Francis Ford Coppola, others by dedicated families in pursuit as much of the romance of the wine industry as the profits.

For these small vineyards especially, the electronic wine business is a potential godsend, just as the broader Web is a potential blessing for small book publishers and garage bands. The biggest difficulties for boutique vineyards is in getting shelf space at stores. Online wine sites could potentially eliminate that problem by eliminating the middleman, buying directly from wineries and selling directly to customers. In doing so, direct selling could put the fruits of even the smallest wine maker in front of a global audience of wine lovers. The problem with this scheme is that the middleman is both upset and politically powerful. The wine wholesalers who control almost all distribution of alcoholic drinks within the United States view direct sales as a direct threat on their livelihood, and they are not going away without a fight. And whereas direct sales are not new, the Internet threatens to accelerate the pace.

Wineries individually may oppose the wholesalers, but they also depend on them for their business. Perhaps for that reason, these companies are reluctant to speak out directly in favor of direct sales. Their lobbying organization-called Free the Grapes!- has its own Web site (www.freethegrapes.org), but no contact numbers. The group, which targets its appeal directly to wine lovers, includes the American Vintners Association, the Family Wine Makers of California, the Napa Valley Vintner Association, and the Wine Institute. All represent wine makers, primarily, although not entirely, in Northern California. Free the Grapes! says it doesn't want to so much as to overturn the three-tier system as to augment it at a time when the entire face of retail sales is changing faster than any time in history.

The consortium will have its hands full. For one thing, the wholesalers, by the group's own account, have consolidated and organized politically. Whereas in the 1960s there were some 10,000 different wholesalers, that number has now shrunk to around 300-with a few controlling a sizeable piece of the business. That has in particular irked some of the smaller wineries, who complain they get ignored by larger distributors. A survey by the Wine Institute, a consortium of wineries, said that 37 percent of its 176 members felt they couldn't enter some states because they couldn't entice a wholesaler to ship their products.

Maintaining the status quo

In the U.S., the sales of alcoholic beverages is regulated much more tightly than other merchandise. The reasons go back to this country's history. With the easy availability of beer and wine in much of the U.S., it is hard to imagine that back in 1920, alcoholic beverages of all kinds were prohibited across the country. But as it turned out, "prohibition" was easier to enact through a constitutional amendment than it was to enforce. Instead of giving up drinking, many Americans procured liquor illegally, with supply provided by "bootleggers." The best known bootlegger, Al Capone, earned an estimated $60 million annually for his efforts while gaining almost complete control of alcohol distribution.

Thirteen years later, the U.S. Congress repealed prohibition by passing the 21st Amendment, which gave control of alcohol beverages to the states. Over the years, that control has largely meant the ability of states to tax alcoholic purchases, and that, in turn, has meant millions of dollars in revenue. That's where the wholesalers say they come in. Under the current three-tier system, winemakers, beer brewers and liquor distillers make the goods, which are picked up by distributors and sold be retail stores, as well as bars and restaurants. The distributors' powerful lobby, the Wine and Spirits Wholesalers of America, obviously has much invested in this system and sees any attempt at circumvention a threat to its members' livelihoods.

In some cases, wholesalers have fought hard to maintain their central position in the distribution chain. Consider the lobbying effort waged by Southern Wine & Spirits of America Inc., a large Miami, Florida distributor, which joined with smaller wholesalers to successfully push for stronger punishments for illegal direct shipping. As a result, where such direct shipments were once a misdemeanor, incurring only a minor penalty, they can now result in a tough, third-degree felony. And Florida is not alone-direct shipment is a felony in several other states. Interests that would like to sell directly accuse the wholesale lobby of discouraging free enterprise through bullying tactics. The message to winemakers, they say, is "ship the wine, do some time." As the Wall Street Journal noted, "Shipping a case of Merlot from a winery in California to a home in Fort Lauderdale [Florida] could carry roughly the same penalty-up to five years in prison-as burglary of a home."

Indeed, the Journal-America's most influential financial newspaper-has editorialized on behalf of the direct shipping faction. One editorial put it this way: "You live in Indianapolis and order a flannel shirt from L.L. Bean in Maine. No one would think of saying that you can't do that, or you have to buy it through a licensed Indiana flannel-shirt distributor. But when it comes to California Chardonnay or New York Cabernet Sauvignon, that's the argument." The newspaper cites a 1949 Supreme Court ruling that says that the constitution guarantees that "every farmer and every craftsman" will "have free access to every market in the Nation." And that "likewise, every consumer may look to the free competition from every producing area in the Nation." In the Journal's estimation, the very definition of a free market requires the free flow of goods.

The WSWA counters that it is simply looking out for the interests of the states. They say that distributors play an integral role in enforcing the 21st amendment and its guarantee of state control. U.S. manufacturers and importers already must file a report on where their goods have been shipped, thereby giving states a basis for taxation. But distributors file their own report, providing a double-check to verify the numbers. The WSWA cites a Forbes magazine estimate that direct shipments of wine alone approach $1 billion a year and argues, without citing any studies, that states lost revenue on taxes. "Unlike the checks and balances in the current excise tax collection system, any effort to tax a shipment that takes place outside the licensed three-tier system results in a 'trust me' situation," said Juanita Duggan, the WSWA's chief executive officer and executive vice president, in a U.S. Senate hearing. "The shipper, if caught, tells the state what taxes he owes, leaving the state with no independent way to verify that amount or enforce payment."

That contention is disputed by John W. Gay, president of Rosemount Estate, a winery in California's Sonoma Valley. "We as suppliers are certainly capable of collecting these taxes directly. We'd simply program our computers accordingly, collect the tax from the customer, and repay on a regular basis. The wholesaler doesn't have a thing to do with it."

The WSWA also argues that direct sales are more likely to lead to underage drinking because anyone with a computer can order alcohol. The vision of 12 year olds importing kegs of beer or a rare vintage of Merlot into their homes, unbeknownst by their parents, may not strike some as realistic. But the organization argues that enforcement will drop if direct sales take over. "Illegal direct shipping replaces the face-to-face transactions that occur in a highly regulated, licensed liquor store with a harried delivery truck driver dropping anonymous packages at doorsteps," said Duggan in her testimony. "The driver's job is to deliver as many packages as possible. The 'adult signature required' sticker doesn't come close to slowing these delivery services down. Moreover, it is not a common carrier truck driver's responsibility to enforce a state's alcohol law."

To push this point, the WSWA has funded another organization, Americans for Responsible Alcohol Access, which claims it has direct evidence of teenagers ordering liquor over the Web. Direct shipping proponents dismiss these claims as industry-sponsored sting operations, saying that in the real world, no evidence exists that kids are using the Web as a wine tasting room. Free the Grapes! says that wineries too have a vested interest in keeping its products out of the mouths of children. The organization argues that shipping services are perfectly capable of obtaining an adult signature, and that, in any case, children need access to a credit card number to order online. As for taxes, the group's voluntary, nine-point Code for Direct Shipping calls for the shippers themselves to remit all taxes directly to each state.

The WSWA is smart enough to know that taking on the Internet directly is futile. Instead, the group has endorsed a Web site, Wineshopper.com, that provides wine over the Internet while still embracing the three-tier system. The site (which at this writing was scheduled to go up in December) must traverse a thicket of state regulations, while, by design, keeping wholesalers in the picture. (The site has announced no plans to ship internationally, but says it is looking at the market.)

Wineshopper.com's structure vividly demonstrates how cumbersome this business can be. For wine ordinarily sold in a buyer's state, the site provides a locator service based on a database of information provided by state wholesalers. For other brands, the site provides the services of a related company, Wine Shopper Direct, using an "established network of wholesalers and retailers." Delivery is ordinarily to the home. But if your state doesn't permit that, you may be directed to pick up the order at a local wine store. While this practice defeats some of the convenience of electronic purchases, it complies with state laws.

A somewhat different approach is being taken by Wine.com, the leading site in the field. Wine.com began life as a direct shipper, but now also works with wholesalers and retailers within the United States. The company doesn't appear to have quite the cozy relationship with wholesalers that Wineshopper.com enjoys, and has spoken out against efforts to limit direct shipment.

Both of these merchants, and their competitors, promise wine lovers the best sort of elixir: greater variety. Variety and the ability to procure scarce vintages is a big deal to serious wine lovers, the kinds of people who might buy a hardwood and stainless steel wine cellar, with vacuum-sealed doors and temperature and humidity cooling systems, from Wine & All That Jazz. As one wine aficionado has noted, it is easier in America to buy an assault weapon at a gun show than a coveted bottle of Chardonnay.

An online wine merchant could also charge less-if it could get around the three-tier system. Direct shipment advocates say that wholesalers typically charge between 18 and 25 percent of the price of a bottle of wine. That's a lot more than, say, Federal Express might charge for picking up a case of Pinot Noir at a Napa Valley winery and shipping it to Cleveland. One consulting firm, Booze Allen & Hamilton, Inc., says that the overhead in distributing alcoholic beverages is higher than any other packaged goods.

Wine may cost more than it should, but plenty of people-especially in the U.S.'s boom economy-seem willing to pay the price. And where there's a market, there's a Web merchant ready to provide the goods, and a few merchants that have worked hard to legally work around the thicket of state laws. Indeed, these laws are serving to raise the barriers to entry and keep competitors out. Some observers are asking who will become the "Amazon.com of wine"-that is, the Web site whose share of mind in this category equals that of Amazon.com for books and, increasingly, for other merchandise. Ironically, a company not yet even in the running is Amazon.com itself.

An interview with Bill Newlands, president and CEO, Wine.com

Bill Newlands heads what is arguably the leader in the electronic wine industry with the best URL: Wine.com. He was previously president and CEO of LVMH (Louis Vuitton Moet Hennessey), the French company that owns Moet and Hennessey and Dom Perignon, among others. He came to Virtual Vineyards, a smaller Wine.com competitor, in June as CEO and president. Virtual Vineyards then purchased Wine.com and retained the name, and he now heads the merged organization. Newlands works out of the company's Napa Valley office-the company also maintains offices in Palo Alto near Stanford University.

Are you shipping to Japan now?

We are shipping to Japan in a limited way. But more importantly, we plan to go into Asia next year in a much more broad-based fashion. We're are currently in the planning stages.

In looking at the industry's problems in the U.S., is it easier to ship overseas at this point?

As a general rule, there are fewer stipulations in many countries than there are here. In the U.S., every state is almost a different country as far as wine shipments are concerned.

Is the value-add for people in Japan the variety of California wines? Why wouldn't they go to a Japanese source online?

A number of factors. One is our selection. Roughly half our wines are from domestic U.S. producers. The rest are from international producers. The consumer in Japan sees a full array of wine and opportunity presented to them from the places where they know make great wine, be it Australia, New Zealand, California or France, for example.Furthermore, I don't believe that the wine Internet space is as developed elsewhere as it is here in the United States. But as a general rule, that relates to the Internet business as a whole.

Do you expect that Japanese customers will become a significant part of your busness?

Yes. Wine is a tremendously growing business in Japan; red wine in particular is growing substantially. The growth market is not only at the high end, which represents the traditional wine pattern in Japan, but as an everyday beverage, which is just taking off

.

Here in the U.S., how are you grappling with the thicket of regulation?

Our model is regulatory compliance. We have worked on a state-by-state basis to put a model in place-and we are legal in every of the 44 states in which we ship. That said, there's no question that the laws in some states are not conducive to an adult consumer making a purchase in the fashion that they wish.

What happens if you live in a state where direct delivery of wine is not permitted?

There are six states that we do not ship to because there are laws that do not permit that. If you go to our site and say you want to send wine to Utah, it tells you we cannot do it.In some instances, we do go through either a wholesaler or a retailer, or both in a particular state. So in a sense this is a hybrid model in that where we are allowed to go direct to the consumer, we do. However, the consumer experience is always the same. That's a critical part of maintaining a brand equity, and that is different from some of our competitors.

What do you mean by consumer experience?

The presentation, the customer service, the follow-up. If you have a model that requires something to be handled on a local basis, like some of our competitors, then the process is not in our control. When the product leaves here, even if it passes through the three-tier system on the way to the consumer, it leaves here ready for the consumer. That guarantees that the packaging, the styling, the information we provide with the product, the tasting notes, everything that goes inside that package is uniformly consistent for every consumer, regardless of where they live. That's a critical part of making sure you get the same value for what you are doing, no matter where you are.

Are you opposed to the three-tier system and the control exerted by the wholesalers?

We are focused on the end consumer. We are unfocused on the distributor. We are focused on doing in any market what we need to legally be able to ship. Our focus is on providing a great consumer experience. At certain times that requires going through the distributor network, at least in part. But our focus is not on that, it's on the consumer and the supplier.

Would it be fair to say that you are trying to become an Amazon.com of the wine industry?

It's probably a fair comment. Whether you are a novice or an expert, our aim is that you can come here no matter what your interest in wine.

Why would someone buy online rather than going to their local wine shop? Is it the variety?

Variety is part. But a lot of it is information driven. This is a high information need category. People, as a general rule, don't understand a great deal about wine and the subject can be intimidating at times. The Net is the perfect place to overcome that. Every wine on our site is written up with rich content, so you know what you are getting. You get a sense of whether this wine is dry or sweet, or how it relates to any other wines that you might not like. That's a rich experience for the consumer and we try to do it in an unintimidating way. We have Peter's Tasting Chart, which talks about individual wines in a way that people can relate to.

Are you planning a chat room?

Absolutely. This past week we announced a $50 million new round of [venture capital] financing. We will be using part of that, in addition to the international focus, in adding a great deal more content and community. We've made significant purchases of old and rare wines, which will be on the site. We've added an accessories business. We'll have products that collectors will be interested in. If you want to learn more about Australian wines, we can help you with that. Over the long term, you'll be able to fine the full range of the life style of wine on our site.

There's been some speculation in the press that this would be a hard category to fund because of the patchwork of local regulations. Do you consider this funding something of a breakthrough?

Not a breakthrough. Certainly our investors felt very strongly that we are far and away the leader in the category, and that our model is one that is going to have tremendous returns for them not only domestically, but worldwide.

But they must have thought there was some promise in the category even with, for example, the legal clampdown that Congress seems to be showing.

My personal opinion is that the legislation in place is not going to have much effect on us. The legislation creates federal relief in any state where somebody is doing something illegally. Well, we don't ship illegally anywhere. So since we already have that, in many respects it becomes a barrier to entry for anybody else because it takes a long time to set up the kind of network that we have.

Putting together a compliant network is very expensive and it takes a long time. We've already spent many years doing that, and the problem is now behind us. Our focus now is on great branding and providing great wines, as opposed to putting together a network that solves the needs of individual states.