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March 2017 WINES&VINES 37 VIEWPOINT a price higher than the cost to produce the asset." Volatility It should be no surprise that selling bulk wine is riskier than selling grapes, as bulk wine prices seem to fluctuate much more than grape prices. Between 2011 and 2015, for example, the year-over-year change in average price for So- noma County Chardonnay bulk wine advertised on winebusiness. com was more than five times that for Sonoma County Chardonnay grapes. Other measures of volatil- ity yield similar results, as I re- cently demonstrated in a blog post on my website. Volatility can sometimes be a good thing. For one, you could sometimes benefit from price spikes, though one's ability to anticipate this is severely limited, even with intense analysis. More importantly, some growers believe that bulk wine prices can serve as a hedge against falling grape prices. In many instances, this is speculative and can lead to catastrophe. However, some well-run wine- growing businesses will crush wine for this hedging aspect with no attempt at speculation. One grower I spoke with stated that he simply crushes 30% of his crop every year. On the other hand, I have heard from both grape buy- ers and sellers that when a grower decides to crush his grapes to avoid selling them at low prices, he is often simply doing the work for the buyer, who then purchases that same bulk wine at a similarly low price. I used data from winebusiness. com to shed light on these differ- ent narratives. The chart at right shows the average advertised price, weighted by tonnage, of District 3 (Sonoma/Marin) Char- donnay grapes and bulk wine per gallon. As one can clearly see, the two prices move in opposite direc- tions. In fact, they have a correla- tion of -.8135, indicating that they would make excellent hedges against one another. This is encouraging news, but with some very important cave- ats. The actual price movement for the grapes is minimal; the period studied is only five years long, and this is only a single va- riety for a single region. Still, this indicates that the potential for hedging grape prices with bulk wine does exist. Recommendations Growers turn to winemaking ei- ther to capture a greater share of the profits that the supply- chain provides, to hedge against drops in wine grape prices, or both. In reality, wine production can increase or decrease profits. Similarly, it may be an effective hedge against prices, but it also has the potential to make reve- nues more erratic. One risk factor wine produc- tion invariably intensifies is the constraint on cash flow. Revenues occur on a significantly longer timeline and, in most cases, ex- penses continue to accrue. Ad- ditionally, there is some small level of additional risk that vini- fication will proceed poorly and reduce revenues. Before you decide whether bulk wine is right for you, I recom- mend that you do three things. First, make sure that bulk wine sales will achieve your goals in terms of hedging and profitability. Review historical data for the ap- pellation and variety you will be selling and confirm costs with custom-crush facilities available to you. Call brokerages to confirm that the numbers you are assum- ing make sense, and get feedback about which custom-crush opera- tions work well with clients and brokers. Check with your accoun- tant to determine how much bulk wine production you can sustain with your expected cash flow. Second, develop a strategy that you can stick to. Modify this strategy, as needed, after careful analysis, but never devi- ate from the strategy you have committed to. To compare this to financial investments, if your goal is diversification, then you should be managing your asset allocation, not picking stocks. If your goal is speculation, make sure you have a very solid meth- odology to ensure profitability. Avoid a situation in which you are reacting emotionally to out- side forces. Understand that once you crush your grapes, their price will be determined solely by the will- ingness to pay of the market's participants. Your costs become sunk costs. Anchoring to these costs could cloud your ability to make a level-headed decision about what offers to accept. Finally, keep in mind that the high volatility of bulk wine prices implies that you should generally be selling a large ma- jority of your grapes as grapes and not as bulk wine. The high volatility of bulk wine prices, relative to grape prices, allows you to effectively hedge your grape prices with a small amount of bulk wine production (roughly one-fifth of your total production in the case of Sonoma County Chardonnay). It also means that, in a situation where your bulk wine program performs poorly, you will want a large buffer of grape sales to sustain you. Gabriel Froymovich is proprietor of Vine- yard Financial Associates in Healdsburg, Calif. VFA provides financial and business consulting services to wineries, vineyards and investors in the wine industry. He blogs at vineyardfinancialassociates.com. GRAPE SALES SCENARIO— 1 ACRE OF CHARDONNAY IN SONOMA COUNTY Price per Ton $2,100 Yield per Acre (Tons) 6.75 Revenue per Acre $14,175 Viticultural Expenses per Acre $5,500 Gross Profits per Acre $8,675 Based on data from winebusiness.com, the USDA and UC Davis Extension. Based on data from winebusiness.com, the USDA and UC Davis Extension. BULK WINE SALES SCENARIO— 1 ACRE OF CHARDONNAY IN SONOMA COUNTY Price per Gallon $20 Gallons per Acre 950 Revenue per Acre $19,000 Viticultural Expenses per Acre $5,500 Vinification per Acre at $525 per ton $3,375 Gross Profits per Acre $10,125 The prices of grapes and bulk wine move in opposite directions in this example and could make excellent hedges against one another. AVERAGE DISTRICT 3 CHARDONNAY PRICES, GRAPES VS. BULK WINE, WINEBUSINESS.COM 2010 2011 2012 2013 2014 $2,205 $2,000 $1,950 $1,900 $1,850 $1,800 $1,750 $35 $30 $25 $20 $15 $10 $50 $0 Correlation = -.8135 — Weighted Bulk Wine — Weighted Grapes