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Inflation, Ukraine: Is it time to rethink wine strategies?

Vine Notes

Jason Ruiz is a senior relationship manager in Rabo AgriFinance’s Santa Rosa office.

The content, views and opinions in this article are based, in part, on research produced by RaboResearch Food & Agribusiness, a unit of Rabobank Group. The information contained herein is intended for general educational purposes only and is not to be construed as legal, tax, or financial advice. Please consult with your own legal, tax or financial adviser for guidance with your own particular circumstances.

Read previous Vine Notes columns.

We’re all now familiar with the consequences of supply chain issues that have been exacerbated by the COVID-19 pandemic.

Virtually every industry in the global market has been affected, and wine is no exception. While the industry is normally fairly well-positioned to adapt to volatility, the current landscape of pandemic consequences and the crisis in Ukraine is creating a perfect storm of factors that deserve some thoughtful consideration.

Five factors affecting the supply chain

The main challenges facing the wine industry at this time can be broken down into five key factors — freight, fuel, labor, geopolitics and agricultural production.

Freight

Container shipping rates experienced an exponential spike in 2021, attributed to disruptions to shipping routes, industry consolidation, and rapid demand growth. The spike led to a significant increase in the cost of importing wine in some markets. Many U.S. retailers have reported difficulty in keeping all of their brands in stock.

Fuel

Fuel costs have presented another critical challenge for wine companies across virtually all markets, particularly in regard to the fuel-intensive process of producing glass bottles. The cost of glass bottles in the U.S. has risen by as much as 20%, according to some brands, and transportation costs have surged.

The cost of glass bottles in the U.S. has risen by as much as 20%, according to some brands, and transportation costs have surged.

Labor

Rising labor costs have affected many wine-producing regions. In California, minimum wage rates have risen by more than 40% over the past five years. The impact of rising labor costs are felt all along the supply chain: in the vineyard, wine production, transportation, etc.

Geopolitics

The global wine industry has also felt the direct impact of numerous geopolitical developments in recent years, whether from rising tariffs (e.g., Australian wines in China) or from other events (i.e., lost sales to Russia and Ukraine due to the war). Looking forward, access to more attractive terms of trade between markets appears increasingly uncertain.

Production

Finally, these disruptions are coming at a time when inventories are relatively tight. In California, wildfires and drought have certainly contributed to this and are keeping upward pressure on prices.

Structural vs. cyclical disruptions

As wineries grapple with these disruptions, it’s worth noting that all will not be felt evenly in different regions or even by different producers in the same region.

For example, producers along the North Coast benefit from structural growth in demand due to premiumization, but they may feel more pressure from supply chain disruptions, as smaller wineries will not have the same negotiating leverage with their suppliers (glass manufacturers, transportation companies, etc.) as large wineries.

On the other hand, smaller, more premium wineries that focus more on direct-to-consumer (DTC) sales may have more room to take price increases than larger wineries selling through wholesalers.

It’s also important to consider whether these disruptions are structural or cyclical in nature. This difference informs how long the disruption might be in place and how companies should respond, though the difference is not always clear. Swings in agricultural production as the result of the drought may be cyclical, but the policy response to increased drought is a structural change that could lead to water use restrictions even within a year of adequate rainfall.

Positively, we can expect to see some relief from some of these supply chain issues over the coming year, but the industry will need to be prepared for a scenario in which input costs may remain stubbornly high beyond the next 12 months.

What’s ahead for 2022? Creative solutions

The outlook for wineries is certainly not all doom and gloom. Producers are increasingly finding innovative solutions to cope with the supply chain’s unpredictability. The rules of the game have simply changed. Cheap freight, cheap energy, and declining trade barriers are no longer sure things.

One obvious response to rising costs is to raise prices. This is a complex issue. The wine industry is highly fragmented, and consumers are already grappling with the rising cost of basic goods and services. While pricing actions will be necessary, wineries may also need to consider additional measures to help maintain margins and mitigate risks.

On option to control cost is packaging. The traditional 750-ml glass wine bottle is an iconic format that will not disappear any time soon, but rising glass costs provide incentives to evaluate other options.

Lower-priced brands might find a shift to bag-in-box a compelling option to reduce not just packaging but also transportation costs.

Most high-end wineries will resist moving their brands to an alternative format such as bag-in-box (Tablas Creek’s recent success with a $95 bag-in-box rosé is a notable exception) but might consider using lighter-weight glass as a near-term solution.

Reusable bottles is a longer-term solution. But it would require changes in bottling practices and investments in infrastructure.

Startups like Conscious Container are working to build those systems, starting in the North Bay. Not only could these solutions reduce greenhouse gas (GHG) emissions, but according to Conscious Container, the reusable bottle systems could also result in lower bottle costs for the winery.

This latter point highlights an important consideration. When energy prices are low, GHG reduction goals are often in conflict with goals for financial cost controls. However, in a context of higher energy prices, the two goals become more aligned. When seeking opportunities to control costs, looking at the biggest sources of GHG may be a good place to start.

While issues in the supply chain have disrupted the world as we know it (and some of them are likely here to stay), the wine industry has an opportunity to explore a number of strategic and ongoing changes that will have multiple benefits now and for the future.

Vine Notes

Jason Ruiz is a senior relationship manager in Rabo AgriFinance’s Santa Rosa office.

The content, views and opinions in this article are based, in part, on research produced by RaboResearch Food & Agribusiness, a unit of Rabobank Group. The information contained herein is intended for general educational purposes only and is not to be construed as legal, tax, or financial advice. Please consult with your own legal, tax or financial adviser for guidance with your own particular circumstances.

Read previous Vine Notes columns.

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