An Example of Different Types of Grape Price Escalators
Long-term grape contracts require a mechanism to dictate price throughout the term of the contract. These mechanisms can make an enormous difference in the profitability of the contract for both sides. The chart below is an illustrative case study. It assumes a three-year contract was signed for District 11 (Lodi) Zinfandel that was priced at $900 in 2015.
Six types of escalators/indexes are examined:
Inflation: Some contracts index to inflation, which I typically define as the Consumer Price Index as reported by the Bureau of Labor Statistics. This would be the second best of the possibilities for the grower, in this case.
Percentile: $900/t corresponds to the 80th percentile price for the district and variety, per Table 8 of the Crush Report. The conventional wisdom is that the higher the percentile price, the more stable the pricing. For this contract, that was not the case and this would have been one of the worst ways to index the contract for the grower.
Multiple of Average: $900/t is also roughly equal to the average district price, plus 25%. If one used this as an escalator, it would have been, arguably, the worst possible outcome for the grower.
Nominal Premium: $900/t is also roughly equal to the district average, plus $180. Though better than the last two escalators, it's still a poor outcome for the grower.
Compounded Annual Growth Rate: The compounded annual growth rate for the 80th percentile from 1991-2015 was 3.3%. A grower who secured a contract that set prices going forward at that CAGR would have been the best choice for a grower.
No Change: Prices generally rise over time, which means that setting forward prices at the current level is typically a bad deal for growers. Not in this case. It would beat 3 of th 5 other indexes.
District 11 (Lodi) Zinfandel, 80th Percentile
Note the wide range of outcomes. The 2018 price for the "Multiple of Average" contract was $776.54, while the "CAGR" price was $992.07. The CAGR price is 28% higher! That could easily be the difference between losing money and making money.
What's my point? Pay attention to the escalators; do your research; and consider contacting me before you sign your next contract. Hiring the wine industry's best grape price forecaster is almost certain to yield a positive return on investment for you.