I hoped that Part 3 of the Three Horsemen of the Grapepocalypse would be shorter than the wannabe magnum opus I stumbled into last week. But, if you’re a glutton for glumness, you’ll be happy to know that it is nearly as long as Part 2! Hopefully, it will be as well-received.
Let me jump right into the thesis of this post: this industry has seen labor costs rise over the past several years and, as revenue falls due to cyclical and/or macroeconomic effects, that will pinch profits. It may, in fact, push many businesses into the red.
Tracking Inflation for the Wine Industry – A Primer
I’m about to get a bit teacher-y here for a bit. This section will set the foundation for the analysis in later sections, explain how I forecast changes in expenses and give you some tips on forecasting changes in expenses yourself.
Inflation, according to Wikipedia, “is a sustained increase in the price level of goods and services in an economy over a period of time.” In general, when economists talk about inflation, they are talking about the broad rise in prices, driven by increases in the money supply.
Business owners should keep an eye on inflation. The four most common measures of inflation are:
The Consumer Price Index (CPI) measures the price changes in a representative basket of good and services purchased by consumers. This is the number one metric you should track, as it has the broadest implications.
The CoreCommodity Index (CCI) tracks commodities prices. This is useful for tracking or anticipating price changes for vineyard and winery materials.
The Producer Price Index (PPI) measures prices received by domestic producers for their outputs. Though some accountants and financial analysts use this index for many purposes, including in the wine industry, I don’t find much use for it for the wine industry, for reasons I will discuss shortly.
The Employment Cost Index (ECI) tracks the cost of labor. It is, unsurprisingly, useful for tracking and anticipating the costs of your labor force.
I mostly look at the CPI. I have found it to be more strongly correlated to broad wine industry costs than the PPI. It also has the best publicly-available forecasts. Because the PPI has weaker correlation and is less-specific than the CCI and ECI, I don’t use it much. The CCI and ECI have their usefulness, but keep in mind that our sector uses specific materials and labor that are often best-tracked through other public data and/or my own proprietary data (or your internal data.)
The Philadelphia Federal Reserve publishes forecasts of CPI, as part of its Livingston Survey. Their forecasts have gotten to be pretty good, though they general underestimate the scale and rapidity of shifts in inflation, as you can see in the chart below, from an article by Dean Croushore in The Business Review:
One useful practice is to download this file from the Philadelphia Fed and take a look at the individual forecasts for inflation. You can often anticipate a shift, when you see a few brave souls moving their forecasts away from the cluster of more conservative forecasts.
So, what do you do with this number? Do you just plug it into your financial models as the general increase in cost? You can. But I do more with it. First off, you can create probabilistic distributions of expense increases, based off of the different individual responses. That’s useful for computerized simulations, scenario analysis and other weird stuff that gets me all hot and bothered (and helps my clients with financial planning and strategy development.)
More broadly, you need to adjust that number to fit your region. The change in costs of planting a Napa vineyard may not be the same as in Monterey. And the CPI, of course, is based off of a basket of goods and services more appropriate to anticipating the cost of buying a Christmas ham than planting a vineyard. Your adjustment should be based off of internal and industry indications.
For instance, according to the most recent Davis cost study for Sonoma County vineyards, the materials cost for a single herbicidal strip-spray for a Sonoma County vineyard was $38.50 per acre. In the 1999 cost study, this cost was $19 per acre. Without adjusting for possible differences between the hypothetical scenarios depicted in each cost study, this equates to a 103% increase in cost, yielding an annualized rate of 4.3%.
The CPI base in 2018 was only 144% that of 1999, for an annualized rate of 2.2%. You can do this type of analysis using such publicly-available information or your own operation’s data. You may want to talk to your PCA and, depending what he says, you would assume that herbicide costs will increase at a rate of (CPI + 2.1%). You can do it for any item, whether a minor one like herbicide cost for a single spray, or, to save time, on an aggregate level, like your total IPM materials cost or all-in management cost.
For instance, my cost inflation estimates for general vineyard expenses in Napa are as much as 2.5%-3.0% higher than CPI. For the Sierra Foothills region, they’re pretty darn close to CPI.
OK, with all of that out of the way, let’s move on to the meat of this post…
Labor has become a challenging issue for both wineries and vineyards. Though securing adequate and qualified vineyard labor is the most pressing challenge for the industry, many wineries are also finding it difficult to hire qualified staff, whether for tasting rooms, wine clubs or crush pads. I want to take a look at the way wineries and vineyards are getting pinched separately, since some of the reasons for the labor shortage vary. Let’s start with vineyards…
The Vineyard Labor Crunch: A Song of ICE and Fire
It has become very difficult for vineyard owners to keep their crews at full capacity. The pipeline for new migrant labor was clenched shut, while other industries are increasingly hiring away our crews.
The Migrant Labor Pool is Getting Shallower
According to Philip Martin of UC, Davis, over 90% of California crop workers are Mexican-born and at least 60% are not authorized to work in the United States. According to the Labor Department’s Inspector General, only 2% of farm job vacancies are filled by US workers. Clearly, we in the wine industry rely upon foreign and often unauthorized labor to tend our vines. That pool of labor is shrinking.
Stronger-than-ever border enforcement, the Great Recession and record deportations reduced this labor pool steadily during the Obama administration. If you’re attached enough to reality to know your name, you would likely and rightly assume that this trend has only escalated since Trump’s election.
The chart below, from the Department of Homeland Security website, provides estimates of the unauthorized Mexican immigrant population in the United States:
As you can see, this population has been slowly shrinking through 2014. There is no reason to think that it has started to grow since 2014. That would imply a drastic reduction in new arrivals. The chart below confirms that hunch:
This chart shows a reduction in border apprehensions, which are a logical proxy for measuring successful border crossings. Judging by the continual increases in enforcement efforts, we can reasonably assume that the number of successful crossings as a ratio to apprehensions has decreased. Assuming that is the case, a hypothetical chart that could show successful crossings would likely indicate an even stronger trend downward.
Of course, not ALL of our labor is unauthorized and some small percentage of our agricultural labor force is Central American. Using numbers from the Migration Policy Institute, I created a chart showing the estimated, total population of Mexican and Central American immigrants, regardless of eligibility for legal employment:
Note that the Y-axis starts at 14 million. As you can see, this population’s level has, well, leveled off. Considering that this population likely has a birth rate significantly higher than its death rate, this would imply a drastic fall in new immigrant arrival. And new immigrants, I believe, have historically made up a large segment of our labor force, while those who arrive at a young age are less likely to find their way into our vineyard crews.
According to the Department of Homeland Security, “Of the 12.1 million unauthorized immigrants in 2014, more than 75 percent had been in the United States for longer than 10 years, whereas only five percent had entered within the last five years (2009–2013)... In the peak period in 2007, less than half of the population had been in the United States for longer than 10 years and more than 20 percent had entered within the most recent five-year period (2002–2006). This pattern suggests a declining rate of new unauthorized immigration, or that an increasing share of new unauthorized immigrants are being deported or otherwise returning home.”
The trend toward a lack of new Mexican and/or unauthorized immigrants has, as we’ve seen, only accelerated since then.
Long story short: our pipeline of new workers from south of the border has, after many years of slowing, finally come to a statistical stop. In fact, it looks like we may actually be seeing attrition, with people departing the United States.
There is no reason to expect this situation to improve. Once upon a time, there were plans for “common-sense” immigration reform and we could hold out hope. Now, the talk is of not just reducing unauthorized immigration, but also of cutting into our H-2A visa programs that provide our only legal method of bringing in foreign agricultural workers. My assumption is that, for the next two years, immigration reform efforts are about as likely to pass Congress as I am to pass the Army Ranger Physical Fitness Test. In fact, our wait may be much longer than two years. The chart below shows the Philadelphia Federal Reserve’s Partisan Conflict Index:
Since 2009, political polarization has skyrocketed. Nowadays, partisan conflict undergoes frightening spikes during election season. Worse yet, we are seeing a gradual upward trend from a dramatic, upward level shift that occurred in the first Obama administration. Note that this chart ends in October, 2018. I would think that this hyper-partisanship would impede efforts to reform our system of immigration.
Before we move on from immigration issues, now might be a good time for a drink.
Increased Competition for Workers from the Construction Sector
Historically, vineyard workers have had the option of leaving the vineyards to join construction crews. When the housing market imploded a decade ago, our labor pool increased and wages stagnated or fell. The chart below, from the Sonoma County Economic Development Bureau (EDB), shows that, during this time, new household formation far outpaced new home construction, creating a backlog of unmet housing demand. By the time new home construction caught up to the pace of new household formation, the PG&E wildfires reduced housing stock by 5,0000 units in Sonoma County alone. I think it is safe to assume similar dynamics for much of the rest of the North Coast and, to a lesser extent, statewide.
Not only do thousands of homes need to be built, but builders have the money to hire away workers to get them built, as one can assume from the rising home prices depicted in this Sonoma County EDB chart:
I have looked only at the residential market, due to the ease of finding data. However, there is plenty of commercial real estate construction occurring, too, magnifying the demand for labor.
Competition from Other Farmers
Outside of the North Coast, other agricultural operations are significant competitors for agricultural laborers. This dynamic is likely at its strongest in the Central Coast region. Monterey raspberries sell for roughly $7,000 per ton and Salinas Valley lettuce land averages roughly $15,000 per acre in salad greens production. Monterey County farmland also averages about $15,000 per acre in celery production. Meanwhile, each acre of Monterey County vineyard land produces roughly $5,500 in wine grapes. (Source: Monterey County Crop Report.)
My proprietary data, which is, admittedly only anecdotal evidence, indicates that berry producers are able to pay nearly 10% more per hour than vineyard owners. Even then, tens of millions of dollars of berries go unpicked every year, due to a lack of labor, according to the berry industry’s lobbyists. This leaves vineyard owners relying upon those older workers who would rather avoid the back-bending labor involved in berry harvesting.
It would involve too many charts to show here, but berry production of all types is continuing to increase statewide. (Source: California Department of Food and Agriculture reports.) So, too, then is the pressure that berry production puts on our shared labor pool.
Legalization of Recreational Cannabis
Now that marijuana has been legalized for recreational use, we can expect cannabis growers to compete for our laborers. By the way, this seems a good a time as any to put out there that I have begun accepting my first cannabis clients. If you know anyone in the cannabis industry that could use help with financial planning & analysis, forecasting, business planning, financial planning or business and financial consulting, please put us in touch.
Since well before recreational legalization, I have had many colleagues who worked in, owned and/or managed cannabis production operations. Prior to having children, I also picked up my fair share of “trimmigrants” along the highways and byways of the North Coast. It seemed clear to me that wine and cannabis crews had negligible overlap. In general, trimmers wouldn’t be useful on a vineyard and vineyard workers wouldn’t be a good “lifestyle” fit for trimming crews.
With recreational legalization, however, cannabis operations will change and vineyard workers will likely be more comfortable with the idea of working with “mota.” To what extent this will reduce our labor supply, I don’t know, I couldn’t guess and I can’t find useful data for. But it will.
Cost of Living
The conventional wisdom is that wine country’s high cost of living creates an issue for maintaining a strong local labor pool, but this issue isn’t as critical as many think. For Napa and Sonoma Counties it is an issue, but not for most of our wine-producing regions. Even in Napa and Sonoma Counties, costs of living are in line with the statewide average. I’ll let the following charts from www.BestPlaces.net do the talking for me:
So, this is an issue for these two counties and, perhaps, some other pockets of important wine production. But for most of California’s wine-producing regions, the cost of living is actually below the state average.
Another issue is the regulatory regime, which is ever-changing and not in favor of agricultural employers. The proliferation of labor regulations has and will continue to drive up costs in many ways. In some regions, the increased minimum wage may have some impact on pay for lower-skilled laborers. The elimination of the agricultural work week will impact output per dollar of salary either directly or by introducing inefficiencies in order to work within the newly-mandated work schedule. From heat illness prevention regulations to restrictions on piecework pay, vineyard operators have and will continue to see regulations drive up the costs of employing people in their vineyards.
Summing It All Up
So, we know there is clearly an unrelenting shortage of vineyard labor. This, along with various other factors, has driven up wages. But, by how much?
Answering this question is difficult. Public data isn’t great and I’m not going to release proprietary data. Furthermore, it is harder to measure than one thinks. In the end, it’s not about an hourly wage, but about output per dollar. And that output per dollar is affected by non-labor issues, such as weather.
This chart from the Los Angeles Times, however, illustrates the point pretty well:
Since 2015, pay has continued to rise. Keep in mind that this nearly 50% increase is in inflation-adjusted terms. On top of salary hikes, many employers are also increasing the benefits package they are offering employees. Though my estimates vary significantly by region, I think it would be correct to say that, statewide, we are currently experiencing roughly 2% annual increases in the inflation-adjusted cost of labor per unit of output.
The market for winery labor is more closely integrated into the broader job market than vineyard labor. The broad market for labor has, of course, been tightening. In fact, we are at a nearly 50-year low, according to data from the St. Louis Federal Reserve:
As with vineyard workers, the high cost of living is problematic in some areas, but is not, by any means, the primary driver of rising winery labor costs. So, how much have wages been rising? Here’s a great summary chart of winery jobs' salary growth from Wine Business Monthly’s annual salary survey:
As you can see, wage increases have been steady and reasonable. They are possibly just now growing in response to a tightening market. One thing I want to point out, is that, even in the depths of the recession, when wineries were seeing revenue streams dry up, they continued to increase salaries at a rate that outpaced CPI growth.
I also looked at new hires in relation to total wine sales in the US, at the Wines & Vines website. Between October 2015 and October 2018, the 12-month Wines & Vines Job Index increased by 26%, while total US wine sales, in dollar terms, increased by 27%. This is a balanced ratio, of course. One question which I will come back to, however, is whether this ratio can be maintained, if total wine sales fall or stagnate.
An important note: Wines & Vines reports total wine sales, whereas I am more interested in domestic wine sales. I triangulated with Wine Institute data and don’t see any reason to think that domestic wine sales don’t parallel this same trend. So, that’s good news.
The Outlook for Labor Issues
For vineyard managers, it is hard to see the potential for improvement in the labor market. As I laid out earlier, the potential for political action to provide relief is pretty low. Without political relief, we as an industry are tasked with increasing labor supply or reducing demand. Here is what we are doing or can do:
We can modify farming practices to reduce labor-intensive processes, but this is generally associated with lower quality or quantity.
We can increase reliance upon mechanization, but this typically requires burdensome capital expenditures on both machinery and re-planting and may also be associated with reduction in quality.
We can increase use of mechanical aids, such as automatic pruners, but the upside here is minor, while requiring capital expenditures and training.
We can, in theory, increase wages. This not only reduces profitability, it may have little actual benefit in such an inelastic and limited labor pool. After all, by my estimate, average hourly pay for a Napa fieldworker is $30/hr and rising.
We can use training to bring in unskilled workers, or improve the output of slightly-seasoned workers, but this costs money and time, without a guaranteed positive return on investment.
We can increase utilization of the unwieldy and onerous H-2A visa program.
Our industry seems to be focusing primarily on 1, 4 and 6. Over time, these will help, but I am unsure that our efforts are keeping pace with the factors that are working against us. My worry is that even in the face of a drop in grape prices, we will not be able to profitably manage labor costs. As we have seen, we have severely limited capacity to reduce our need for labor and major structural obstacles to slowing wage growth.
I do have two small hopes to share. While a recession would most certainly be a bad thing for vineyard owners, it may be accompanied by a freeze in rising labor costs, especially if it halts new home construction. On the other hand, the demand for new home construction, with a backlog of unmet demand exacerbated by fires, may not be lessened much by a recession. Furthermore, as I discussed in Part 1 of this series, we have our own industry-specific issues to deal with, in addition to a recession.
Additionally, we in the wine industry are not the only ones looking for solutions. The other crop growers who compete with us for labor will also be taking the steps outlined above to reduce their demand for labor. So, there’s a sop for the optimists, for what it’s worth.
For wineries, my main worry is the general stickiness of salary costs. We may have hired up in direct correlation to revenue growth, but we will not be able to ratchet down when revenues stagnate or fall. For most humans, the least comfortable ways to reduce costs are to fire people who rely on that job to make a living; cut pay to people who have come to rely on that level of pay to get by; or reduce benefits to people who have come to rely on those benefits. And in fact, as I pointed out, wage increases outpaced cost of living increases even during the Great Recession.
Most employers in this industry really care for their family of employees and, for that reason, salary costs are very sticky. I anticipate that this will cause difficulties for some companies in the event of a recession or even just a dip in wine sales.
A Few Final Thoughts
This is going to be a quick section. Originally, I thought I would find rising costs of all sorts to worry about, but that is not the case. Plant materials, heavy equipment and critical commodities have seen prices rise at very manageable rates. A recession or industry-specific dip will likely bring those prices down even more. So, let me briefly mention two other worries.
First off, the US is flirting with a global trade war. We have seen tariffs put in place that will hurt our exports. Our exports, however, are a minor part of overall California wine sales. It’s just not that important. My understanding is that the administration has actually extracted a reduction in trade barriers to exports to Canada, which should at least partially offset other harms from recent trade tensions.
Finally, as mentioned in the previous posting in this series, the next recession could see inflationary risks materialize. We are already employing an unprecedented level of deficit spending. If we ramp this up in a recession and accompany it with super-loose monetary policy, we might inflate the currency. Of course, I’m not a macroeconomist and could be far off the mark. It could be that we’re facing deflationary pressure a few years from now, instead. If we do see the currency weaken during a recession, we could see costs increase while revenues stagnate, which would create a very challenging business environment.
Alright, that’s the Third Horseman of the Grapepocalypse. My next post will focus on what we should be doing to prepare. Until then...