However, it is easy to show that the Napa cabernet grape prices are way out of line even given Napa's reputation for high-quality cabernet wines.
The data I will use to show this come from the AAWE Facebook page: Average price of cabernet sauvignon grapes in California 2016. This shows the prices from last year's Grape Crush Report for each of 17 Grape Pricing Districts and Counties in California. The idea here is to use these data to derive an "expected" price for the Napa district based on the prices in the other 16 districts, so that we can compare this to the actual Napa price.
As for my previous modeling of prices (eg. The relationship of wine quality to price), the best-fitting economic model is an Exponential model, in this case relating the grape prices to the rank order of those prices. This is shown in the first graph. The graph is plotted with the logarithm of the prices, which means that the Exponential model can be represented by a straight line. Only the top five ranked districts are labeled.
As shown, the exponential model accounts for 98% of the variation in the rank order of the 16 grape districts, which means that this economic model fits the data extremely well. For example, if the Sonoma & Marin district really does produce better cabernet grapes than the Mendocino district, then the model indicates that their grapes are priced appropriately.
Clearly the Napa district does not fit this economic model at all. The model (based on the other 16 districts) predicts that the average price of cabernet grapes in 2016 should have been $3,409 per ton for the top ranked district. The Napa grapes, on the other hand, actually cost an average of $6,846, which is almost precisely double the expected price. This is what we mean when we say that something is "completely out of line"!
In conclusion, 16/17 districts have what appear to be fair average prices for their cabernet sauvignon grapes, given the current rank ordering of their apparent quality. Only one district is massively over-pricing itself. Even given the claim that Napa produces the highest quality cabernet wines in California, the prices of the grapes are much higher than we expect them to be. If we bought exactly these same grapes from any other grape-growing region then we would pay half as much money — the "Napa" name alone doubles the price. Something really has gotten out of hand — we are paying as much for the name as for the grapes.
Part of the issue here is the identification of prime vineyard land, for whose grapes higher prices are charged (see As the Grand Crus are identified, prices will go even higher). The obvious example in Napa is the To Kalon vineyard (see The true story of To-Kalon vineyard). Here, the Beckstoffer "pricing formula calls for the price of a ton of To Kalon Cabernet grapes to equal 100 times the current retail price of a bottle" of wine made from those grapes (The most powerful grower in Napa). This is a long-standing rule of thumb, and it explains why your average Napa cabernet tends to cost at least $70 per bottle instead of $35.
Anyway, those people who are recommending that we should look to Sonoma for value-for-money cabernet wines seem to be offering good advice.
Vineyard area
While we are on the topic of California cabernets, we can also briefly look at the vineyard area of the grapes. I have noted before that concern has been expressed about the potential domination of Napa by this grape variety (see Napa versus Bordeaux red-wine prices), but here we are looking at California as a whole.
A couple of other AAWE Facebook pages provide us with the area data for the most commonly planted red (Top 25 red grape varieties in California 2015) and white (White wine grapes in California 2015) grape varieties in 2015. I have plotted these data in the next two graphs. Note that the graphs are plotted with the logarithm of both axes. Only the top four ranked varieties are labeled.
On the two graphs I have also shown a Power Law model, as explained in previous posts (eg. Do sales by US wine companies fit the proverbial "power law"?). This Power model is represented by a straight line on the log-log graphs. As shown, in both cases the model fits the data extremely well (97% and 98% of the data are fitted), but only if we exclude the three most widespread grape varieties. Note, incidentally, that there is slightly more chardonnay state-wide than there is cabernet sauvignon.
The model thus implies that there is a practical limit to how much area can be devoted readily to any one grape variety — we cannot simply keep increasing the area indefinitely, as implied by the expectation from the simple Power model. The data shown suggest that this limit appears to be c. 40,000 acres, at least for red grape varieties (ie. increase in vineyard area slows once this limit is reached).
Both chardonnay and cabernet sauvignon have twice this "limit"area, which emphasizes their importance in the California grape-growing economy. However, the Power-law model indicates that we cannot yet claim that the domination by these grapes is anything unexpected.
Note:
Olena Sambucci and Julian M. Alston (2017. Estimating the value of California wine grapes. Journal of Wine Economics 12: 149-160) have subsequently pointed that the price estimates are likely to be underestimates, as they apply only to grapes sold (not to grapes crushed by the grower). This would probably increase the average prices of the grapes in the more expensive areas, because the retained grapes are more likely to be of better quality than the sold grapes..
Proffered bibliography:
ReplyDelete"Are Napa, Sonoma Vineyards Getting Too Pricey?"
Link: http://www.northbaybusinessjournal.com/opinion/7132224-181/are-napa-sonoma-vineyards-getting?artslide=0
Excerpt: top Napa Valley vineyards setting new records, with some selling for as much as $300,000 an acre.
"Napa Cabernet Prices Raise Concern"
Link: https://www.winesandvines.com/template.cfm?section=news&content=185502
Excerpt: "Any land that's in Napa Valley . . . that can be planted to Cabernet and produce a good crop of Cabernet is being planted today, and they can make a call and sell the fruit for $5,000, $6,000 $7,000."
“Full Bouquet on Wine Costs;
From grapes to glass, prices vary by region and quantity”
Link to this Sacramento Bee "Business” Section
(February 14, 2008, Page D1ff) article is not available.
Excerpt from accompanying sidebar exhibit titled “Breaking Down a Bottle”:
The value of wine grapes depends on where they’re grown. While grapes are the primary ingredient in wine, they make up only a splash of a bottle’s retail price. Here’s a breakdown of the estimated costs in a typical $80 bottle of wine:
Grapes . . . . . . . . . . . . . . . $ 5.75 Cab Sauvignon [e.g., Napa]
Winemaking operations . . . $ 6.25 small lots
Oaking . . . . . . . . . . . . . . . . $ 2.00 French oak barrel
Bottle glass . . . . . . . . . . . . $ 2.00 Heavy European glass
Label . . . . . . . . . . . . . . . . . $ 0.65 Small order, fancy label
Closure (cork) . . . . . . . . . . $ 1.00 Highest-quality cork
Capsule . . . . . . . . . . . . . . $ 0.18 Tin
Bottling . . . . . . . . . . . . . . . $ 0.50
Subtotal: $18.33
Winery mark-up (%): +150% [e.g., small, renowned winery]
Winery mark-up ($): +$27.50
Subtotal: $45.83
Wholesaler mark-up (%): +35% [e.g., low volume = high mark-up]
Wholesaler mark-up ($): +$16.04
Subtotal: $61.86
Retailer mark-up (%): +30% Wine shop
Retailer mark-up ($): +$18.13
Total: $79.99
Sources: Sacramento Bee; Robert Yeltman, UC Davis; National Agricultural Statistics Service
"Dark Days for Cult Cabs" [Circa 2010]
Link: http://articles.latimes.com/print/2010/feb/04/food/la-fo-cultcab4-2010feb04
Excerpts:
Even wine critic and Cult Cab kingmaker Robert M. Parker has issued warnings: "Wines priced over $300 have encountered considerable resistance, with their mailing list customers dropping off, or taking much smaller allocations," he wrote in the December [2009] issue of his widely read newsletter, the Wine Advocate.
"Sadly, far too many proprietors of high-end Napa wines are in denial, and have failed to recognize the dramatically changing parameters in the wine world of the consumer."
Not all of Napa's Cult Cabs are dead, of course. Wines still in the good graces of critics like Robert Parker and James Laube of the Wine Spectator are weathering the storm well, including Shrader, Screaming Eagle and Harlan, as well as the more recently anointed, such as Scarecrow, Maybach and Kapcsandy. But many more may be out of luck. "FOR A WINERY WITH NO TRACK RECORD, THIS IS A NIGHTMARE,” [former Screaming Eagle winemaker Heidi] Barrett says. "If they came into the market thinking they could start in at a $200 price point, they have no chance."
On the subject of wine pricing, consider these economic phenomena:
Veblen goods – http://en.wikipedia.org/wiki/Veblen_good
Excerpt: “Some types of luxury goods, such as high-end wines, designer handbags, and luxury cars, are Veblen goods, in that decreasing their prices decreases people's preference for buying them because they are no longer perceived as exclusive or high-status products.”
Giffen goods – http://en.wikipedia.org/wiki/Giffen_good
Excerpt: “Some types of premium goods (such as expensive French wines, or celebrity-endorsed perfumes) are sometimes claimed to be Giffen goods. It is claimed that lowering the price of these high status goods can decrease demand because they are no longer perceived as exclusive or high status products.”
Really great analysis and comment. Thanks for the work!
ReplyDeleteIn the case of wine, you have under priced your brand if it sells out before the next vintage & you have over priced it if you still have inventory. In the case of high end Napa Cabernet Sauvignon, most of it sells out before the next vintage. So in the classic sense, it's still under priced not outrageously over priced.
ReplyDeleteRetail bottle prices drive the per ton price & the per ton price drives land value.
No one is forcing consumers to buy Napa Valley Cabernet so until we see consumer demand plateau, we will see grape prices increase.
David,
ReplyDeleteAnother great post. I couldn't find you on Twitter, so I hope you don't mind me posting a link to a blog post of mine, giving a contrarian point of view: https://www.vineyardfinancialassociates.com/single-post/2017/07/10/Maybe-Napa-Cabernet-Sauvignon-Prices-Arent-That-High
(Preface: with David's indulgence, this is going to be a l-o-n-g three-part follow-up comment.)
ReplyDeleteGabriel Froymovich of Vineyard Financial Associates writes in his blog titled “Maybe Napa Cabernet Sauvignon Prices Aren't That High!”:
“. . . Pay scales rise in some predictable relationship to skill. But not for the very top. Having one of the very best quarterbacks greatly increases a team’s likelihood of winning a championship. This causes salaries for those QBs to seriously deviate from the typical pay curve. Similarly, even if the best CEO is only slightly better than the #2 CEO, he is, according to typical pay dynamics, worth a great deal more.”
Not so fast.
Let’s first put U.S. CEO executive pay into perspective with this Wall Street Journal 2015 blog:
“Top CEOs Make 373 Times the Average U.S. Worker”
Link: https://blogs.wsj.com/economics/2015/05/13/top-ceos-now-make-373-times-the-average-rank-and-file-worker/
See the accompanying exhibit titled “Top CEOs vs. Average Workers”
More recently (2017):
“CEO-Worker Pay Ratio Generates Outrage -- And Some Insight”
Link: https://www.wsj.com/articles/ceo-worker-pay-ratio-generates-outrageand-some-insight-1499332341
See the accompanying exhibit titled “Four Play: Ratio of realized CEO pay to average pay for the top 350 U.S. firms by sales”
Excerpt: “The ratio has ballooned since the 1970s: The bosses of America’s 350 largest companies made on average 276 times the money of their rank-and-file subordinates in 2015, up from 30 times in 1978, according to the left-leaning Economic Policy Institute.”
(Part Two of Three)
ReplyDeleteQuoting NBC News’s report titled “Who Decides How Much a CEO Makes?”:
Link: http://www.nbcnews.com/id/11414878/ns/business-answer_desk/t/who-decides-how-much-ceo-makes/#.WWR-NoTysdU
“So how do these packages get approved? Corporate boards usually include a subset of the board called the compensation committee. The problem is that many corporate directors (so-called 'inside' directors) report to the CEO. So their judgment is not exactly impartial. . . .
“When it comes to ‘outside’ directors (people who work for other companies), some CEO pack their boards with friends and cronies. . . .”
As the Washington Post reported in “Cozy Relationships and ‘Peer Benchmarking’ Send CEOs’ Pay Soaring”:
Link: https://www.washingtonpost.com/business/economy/cozy-relationships-and-peer-benchmarking-send-ceos-pay-soaring/2011/09/22/gIQAgq8NJL_story.html?utm_term=.654cde43387f
“. . . at the vast majority of large U.S. companies, boards aim to pay their executives at levels equal to or above the median for executives at similar companies.
“The idea behind setting executive pay this way, known as 'peer benchmarking,' is to keep talented bosses from leaving.
“But the practice has long been controversial because, as critics have pointed out, if every company tries to keep up with or exceed the median pay for executives, executive compensation will spiral upward, regardless of performance. Few if any corporate boards consider their executive teams to be below average, so the result has become known as the ‘Lake Wobegon’ effect.*
[* ". . . former Federal Reserve chairman Paul Volcker called it the ‘Lake Wobegon syndrome’ in congressional testimony in 2008, referring to Garrison Keillor’s fictional town where ‘all the children are above average.’"]
“Since then [2006], researchers have found that about 90 percent of major U.S. companies expressly set their executive pay targets at or above the median of their peer group. This creates just the kinds of circumstances that drive pay upward.
“Moreover, the jump in pay because of peer benchmarking is significant. A chief executive’s pay is more influenced by what his or her ‘peers’ earn than by the company’s recent performance for shareholders, according to two independent research efforts based on the new disclosures. One was by Michael Faulkender at the University of Maryland and Jun Yang of Indiana University, and another was led by John Bizjak at Texas Christian University.
“Since the 1970s, median pay for executives at the nation’s largest companies has more than quadrupled, even after adjusting for inflation, according to researchers. Over the same period, pay for a typical non-supervisory worker has dropped more than 10 percent, according to Bureau of Labor statistics.
“Critical to executive pay levels is peer benchmarking.
“The practice has persisted because corporate board members, many of whom have personal or business relationships with the chief executive, have been unwilling to abandon the practice.”
(Part Three of Three)
ReplyDeleteAs for the notion that CEOs have an outsized impact on a company’s results, see this Wall Street Journal article titled "Why Turning the Page on a CEO Isn’t Always a Panacea”
Link: http://online.wsj.com/article/SB10001424052748703735004574575880529756434.html
Excerpts:
“If you took the CEOs with the best track records and brought them in to run the businesses with the worst performance, how often would those companies become more profitable? According to economist Antoinette Schoar of Massachusetts Institute of Technology's Sloan School of Management, who has studied the effects of hundreds of management changes, the answer is roughly 60%. That isn't much better than the flip of a coin.
“ ‘Some people,’ Prof. Schoar says, ‘may have this almost blind belief that the manager at the top changes everything. Our results show that managers do matter, but they don't change everything.’
“Since the 1970s, several other studies have measured what happens when companies bring in new bosses. Most of the findings have been consistent: Changes in leadership account for roughly 10% of the variance in corporate profitability on average.
“But something else is going on here, says Princeton University psychologist Daniel Kahneman, who won the Nobel prize in economics in 2002. ‘We believe that people with certain characteristics will produce certain consequences,’ he says. ‘But we're wrong, because THERE IS WAY, WAY MORE LUCK INVOLVED IN DETERMINING SUCCESS than we're prone to think.’
[CAPITALIZATION used for emphasis. ~~ Bob]
“The real force in corporate performance isn't the boss, but REGRESSION TO THE MEAN: Periods of good returns are highly likely to be followed by poor results, and vice versa. High returns attract fierce new competition, driving down future profits; low returns leave the survivors with fewer rivals, leading to better results down the road.
“Most researchers agree that a company's results are determined less by its CEO than by its industry and the economy -- which, in turn, are shaped by a host of factors that most CEOs can't control, like the price of raw materials, the value of the dollar, interest rates and inflation, bursts of technological innovation and so on.
“In short, good management can't solve all problems, while some problems can get solved even without good management.”
Thanks, Bob. Point taken and I very much agree with much of this. Perhaps the example is fallacious (maybe I should have kept with the star athlete example), but I think the logic stays the same. In fact, it may still be an apt comparison, since in the end, we are talking about the perception of quality, not necessarily quality itself, in the case of both CEOs and Napa wine.
ReplyDeleteLet me cite one more article.
ReplyDeleteExcerpts from Forbes Magazine Online
(June 16, 2014):
"The Highest-Paid CEOs Are The Worst Performers, New Study Says"
Link: https://www.forbes.com/sites/susanadams/2014/06/16/the-highest-paid-ceos-are-the-worst-performers-new-study-says/#7a633bb57e32
By Susan Adams
Forbes Staff
Across the board, the more CEOs get paid, the worse their companies do over the next three years, according to extensive new research. This is true whether they’re CEOs at the highest end of the pay spectrum or the lowest. “The more CEOs are paid, the worse the firm does over the next three years, as far as stock performance and even accounting performance,” says one of the authors of the study, Michael Cooper of the University of Utah’s David Eccles School of Business.
The conventional wisdom among executive pay consultants, boards of directors and investors is that CEOs make the best decisions for their companies when they have the most skin in the game. That’s why big chunks of the compensation packages for the highest-paid CEOs come in the form of stock and stock options.
. . .
. . . Cooper and two professors, one at Purdue and the other at the University of Cambridge, have studied a large data set of the 1,500 companies with the biggest market caps, supplied by a firm called Execucomp. They also looked at pay and company performance in three-year periods over a relatively long time span, from 1994-2013, and compared what are known as firms’ “abnormal” performance, meaning a company’s revenues and profits as compared with like companies in their fields. They were startled to find that the more CEOs got paid, the worse their companies did.
Another counter-intuitive conclusion: The negative effect was most pronounced in the 150 firms with the highest-paid CEOs. The finding is especially surprising given the widespread notion that it’s worth it to pay a premium to superstar CEOs . . . Though Cooper concedes that there could be exceptions at specific companies (the study didn’t measure individual firms), the study shows that as a group, the companies run by the CEOS who were paid at the top 10% of the scale, had the worst performance. How much worse? The firms returned 10% less to their shareholders than did their industry peers. The study also clearly shows that at the high end, the more CEOs were paid, the worse their companies did; it looked at the very top, the 5% of CEOs who were the highest paid, and found that their companies did 15% worse, on average, than their peers.
Conclusion of article.
ReplyDeleteExcerpts from Forbes Magazine Online
(June 16, 2014):
"The Highest-Paid CEOs Are The Worst Performers, New Study Says"
Link: https://www.forbes.com/sites/susanadams/2014/06/16/the-highest-paid-ceos-are-the-worst-performers-new-study-says/#7a633bb57e32
By Susan Adams
Forbes Staff
How could this be? In a word, overconfidence. CEOs who get paid huge amounts tend to think less critically about their decisions. “They ignore dis-confirming information and just think that they’re right,” says Cooper. That tends to result in over-investing -- investing too much and investing in bad projects that don’t yield positive returns for investors.” The researchers found that 13% of the 150 CEOs at the bottom of the list had done mergers over the past year and the average return from the mergers was negative .51%. Among the top-paid CEOs, 19% did mergers and those deals resulted in a negative performance of 1.38% over the following three years. “The returns are almost three times lower for the high-paying firms than the low-paying firms,” says Cooper. “This wasteful spending destroys shareholder value.”
The paper also found that the longer CEOs were at the helm, the more pronounced was their firms’ poor performance. Cooper says this is because those CEOs are able to appoint more allies to their boards, and those board members are likely to go along with the bosses’ bad decisions. “For the high-pay CEOs, with high overconfidence and high tenure, the effects are just crazy,” he says. They return 22% worse in shareholder value over three years as compared to their peers.
. . .
What can be done about all those negative numbers? The paper doesn’t venture to say but Cooper notes that some finance experts have suggested so-called claw-back provisions. In a CEO pay contract, there would be an item that says, if the firm does poorly compared to its peers, the CEO loses a share of his compensation. “That proposal hasn’t gone over real well,” says Cooper. “There is another school of thought, that CEOs are just too highly paid, period,” he adds. “The U.S. is pretty egregious as far as the ratio between median pay and what the CEO makes.”
Excerpts from The Wall Street Journal "Opinion" Section
ReplyDelete(August 1, 2017, Page A13):
"Excess At the Top"
Link: https://www.wsj.com/articles/a-better-way-to-reward-ceos-1501542185
Book review by Philip Delves Broughton
[author of, among other books, “The Art of the Sale: Learning From the Masters About the Business of Life.”]
"The CEO Pay Machine"
By Steven Clifford
(Blue Rider, 277 pages, $23)
In 1978 the average chief executive at a large company was paid 26 times more than the average worker. By 2014, depending on your method of calculation, he was paid 300 to 700 times more. It has become standard for a CEO to make more than $10 million a year, and a few make more than $100 million. These aren’t founders or major shareholders but hired guns, managers playing with house money.
It is not like this everywhere. In the U.K., the fifth largest economy in the world, the pay ratio of CEO to average worker is 84 to 1. In Japan, the third largest, it’s 16 to 1.
. . .
The CEO “pay machine” works like this: When a chief executive is hired, a company will also hire one of a handful of compensation consultants to establish a benchmark for his pay. The consultant will look at a bunch of companies in different industries and then propose that the CEO be paid at the 75th percentile. (No company wants to think it is paying its CEO at the 25th percentile.) The consultant is out to please the future CEO, since the real money will come if he is hired to design the company’s pension or health-care plans. ...
But salary is just the beginning. Next come the short- and long-term incentive plans. Short-term plans contain bonuses for meeting annual targets or for simply accomplishing the tasks one expects of a senior manager. ...
The marvelous thing about bonuses at this level, Mr. Clifford notes, is that they aren’t binary. If you fail to meet your targets, you don’t lose your bonus; you just get less of it.
...
... Board members—and no doubt well-heeled CEOs—suffer from several delusions, in Mr. Clifford’s view. Among them, that the CEO is as important to the performance of a company as a quarterback is to a football team. Not true, he says. Many are no more significant than the water boy. ...