Coordination of the California Wine-Grape Supply Chain

1. Coordination of the California Wine-Grape Supply Chain Jason Franken (jr-franken@wiu.edu) School of Agriculture Western Illinois University

2. Motivation • Quality is a key competitive factor in wine industry. • Several ways to organize/manage wine-grape supply chain • Oral agreements, formal written contracts, & common ownership & management of neighboring stages in chain. • Organizational economics (Grossman & Hart, 1986; Williamson, 1975; 1979) • Uncertainty & investments influence vertical coordination! • Applied to explain: • CA grower marketing (Goodhue, Heien, Lee, & Sumner, 2003) • Spanish wineries procurement decisions (Fernández-Olmos, Rosell-Martínez, & Espitia-Escuer, 2009)

3. Objective • Investigate vertical coordination of 98 CA grape handlers • Handler procurement • Informal & formal contracts & in-house production • Contract complexity & number & type of contract terms • Handler marketing • Factor analytic measures (Hair, et al., 1995) • Limit measurement error • Conserve degrees of freedom in regression analysis • Contributes a broader, more comprehensive perspective • Marketing, procurement, & contract terms

4. Literature – Wine-Grapes • Goodhue, et al(2003) find for CA growers • Written contract significantly more likely for producers of • High quality (priced) grapes, • Experience (years in business & years dealing with buyers) • Size (acreage) • High (low) grape quality associated with contract provisions about production process (incentives for attributes, like sugar content) • Fernández-Olmos, et al(2009) find for Spanish wineries • Choices to predominately grow grapes positively related to • Quality (differentiation of reserva & crianza vs. guarantee of origin wines) • Growers’ investment in dedicated & specialized assets • Level of behavioral and environmental uncertainty involved • Vertical integration is negatively related to size (average capacity) • Call for more comprehensive research across modes of exchange

5. Literature & Hypotheses • Businesses use own grading standard & quality premium to source inputs with quality attributes that support differentiation strategy (Jang & Sykuta, 2008; Jang & Olson, 2010), & external suppliers may require these terms in writing. H1: Buyer quality measurement is positively associated with sophistication of procurement mechanism. H2: Quality premiums is positively associated with use of formal contracts.

6. Literature & Hypotheses • If quality is imperfectly measurable or costly to measure, then contract provisions can stipulate best practices known to yield quality, presuming their use is easily verified, i.e., task is highly programmable (Mahoney 1992) H3: Measurement difficulty is positively associated with usage of formal contracts. • Gergaud & Ginsburgh (2007) show technological choices (i.e., grape varieties, picking & fermenting technologies) affect quality much more than natural endowments (i.e., land characteristics & exposures of vineyards) H4: Buyer specification or provision of inputs for growing & harvesting grapes is positively associated with sophistication of exchange mechanism.

7. Literature & Hypotheses • Reuer & Arino (2007) show contract complexity (number of provisions) is significantly greater in presence of such investments & significantly lower when prior ties exist among contracting parties. Such investments increase use of enforcement provisions designed to safeguard quasi-rents, while prior ties decrease need for basic coordination provisions but not enforcement. Prior ties engender trust & knowledge of each other’s needs, etc. H5: Buyer specification or provision of inputs for growing and harvesting grapes is positively associated contract complexity & enforcement provisions in particular. H6: Duration of trade relationship is negatively associated with contract complexity & coordination provisions in particular

8. Research Design • Sample: 98 wine grape handlers. • Data are from a 1999 survey of 385 commodity handlers in California (Hueth, Ligon, and Dimitri 2007). • Data publically available at http://www.aae.wisc.edu/hueth/calag.zip. • Responses to an open-ended question about the firms’ activities reveal that at least 70% are involved with grape production and 43% make wine. • Average years in business is 25 compared to 21 for California firms involved in grape production and/or marketing in Goodhue, Heien, Lee, & Sumner (2003).

9. Reliability of Factor Analysis – Cronbach’s (1951) α • Enforcement Provisions 0.67 • Coordination Provisions 0.39 • Growth Inputs 0.57 • Harvest Inputs 0.70 Contract Complexity  More terms checked

10. What are the most important quality attributes for grapes? Table 1. Respondents’ Rankings of Top Four Quality Attributes Measured. N = 98. Financial incentives may adequately ensure performance on objectively measurable or quantifiable attributes, like sugar (i.e., degree brix) or acidity, but other quality attributes, such as appearance or color and taste or flavor may be more subjective.  Measurement difficulty issues!

11. Empirical Methods • Hurdle Model (Cragg 1971): • xi , zi = independent variables, βα , γ = coefficients, σ = variance, and αi = proportion contracted. • Tobit Model: • Also comprised of Probit & OLS, but … • β is same for adoption & proportion decisions. Probit Truncated OLS

12. Results Overview • Grape Procurement • Quality considerations relevant (H1, H2, & H3) • Task Programmability in form of Growth Inputs (H4) • Procurement Contract Terms • Complex Contracts protect Growth Input investment (H5) • Relationship duration limits Contract Complexity (H6) • Marketing – More contracting with buyers if • Sell to retailers (e.g., supermarkets) or wholesalers (e.g., brokers, processors, shippers) • Contract with growers & higher probability if quality premium

13. Grape Procurement Methods H4 H1 H3 H2

14. Procurement Contract Provisions H5 H6

15. Marketing Methods

16. Summary • Grape Procurement • Handlers that measure quality themselves are 54% more likely to also own vineyard & rely 84% more on their own production • If offer quality premiums, source 13% more on formal contract • Measurement difficulty decreases probability of using informal contracts by 28% & increases proportional use of formal contracts 13% • Growth Inputs increase probability of contracts 7% & of vineyards 18% • Procurement Contract Terms • Use of protective contract provisions rise with investments • Growth inputs increase probability of dispute & renewal provisions 13% • 1 year increase in relationship duration decreases contract complexity & decreases probability of renewal provisions 0.3% • Marketing • If selling to retailers or wholesalers, formal contract use rises >40% • If quality premium to growers, probability of formal contract rises 20%

17. Conclusions • Prior findings regarding wine-grape procurement mechanisms used in California are corroborated (i.e., Goodhue, Heien, Lee, & Sumner, 2003). • This study extends prior analyses, providing insights regarding various categories of procurement contract terms and also a first glimpse at marketing methods. • Future research • Examine if these relationships hold in other grape and wine production regions. • Investigate alternative/complementary explanations of supply channel formation.

18. Any Questions?

19. Hypotheses H1: Buyer quality measurement is positively associated with sophistication of procurement mechanism. H2: Quality premiums is positively associated with use of formal contracts. H3: Measurement difficulty is positively associated with usage of formal contracts. H4: Buyer specification or provision of inputs for growing and harvesting grapes is positively associated with sophistication of exchange mechanism. H5: Buyer specification or provision of inputs for growing and harvesting grapes is positively associated contract complexity and enforcement provisions in particular. H6: Duration of trade relationship in years is negatively associated with contract complexity and coordination provisions in particular.

20. Empirical Methods • Hurdle Model (Cragg 1971): • xi , zi = independent variables, βα , γ = coefficients, σ = variance, and αi = proportion contracted. Probit Truncated OLS