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Monday, September 30, 2013

The Wine Spectator Serves Up An Excellent Example of The Value Added by Corporate Law

I haven't posted anything in 3 weeks, mainly because the weather has been too good to sit at a computer for any length of time.  However, I happened to come across an article in the October 15, 2013 edition of The Wine Spectator that provided a pithy example of the value of corporate law; In contrast to the populist cliche that corporate law is just about making rich people richer at others' expense, this little story shows how corporate law can solve a problem that had paralyzed a business from making good decisions and thereby enable the business to grow to make a whole community better off.

I'll set the stage (all the quotes in this post are from the article I have linked to:  "Campo de Borja" is a "quiet corner of northern Spain, a dusty red blur of rocky hills and sleepy towns located on the western border of the region of Aragon."  On the slopes of Moncayo, a mountain about 7,000 feet high near the town of Borja, garnacha (grenache in French) has been grown and made into wine for centuries.  "On a small plateau perched at 3,000 feet, a modest parcel of vines is blooming, thrusting green canes toward the sun. This is el Tablon, a vineyard where the average vine is 104 years old. Their trunks are as thick as a man's torso, undulating masses of wood that have grown slowly in this difficult environment for decades."

"Aragon was devastated by economic isolation during Francisco Franco's decades-long reign. In the 1950s, cooperatives became a way for farmers to pool their resources. Borja's cooperativa, Agricola de Borja, was founded in 1958."  Jose Sanmartin, the hero of our story, became general manager of the cooperative early in the 1980's.  "Borja was doing well selling gallons of cheap wine in bulk, but Sanmartin knew those days wouldn't last. And yet, growers were doubling down on high-volume wines, ripping out Borja's best asset by the roots.... Sanmartin believed Borja's future lay in good wine.  In 1990, the Borja cooperative began bottling its better wines, naming this new brand Borsao, the ancient Celtiberian name for Borja."  With the 1992 vintage, Sanmartin began selling Borsao to a U.S. wine importer, who was soon buying 40,000 cases a year.

Now we come to the business problem.

"One day in 1997, the U.S. importer "called Sanmartin with a problem: When he had opened wines from the latest shipment, a viscous, oily mess had oozed out of the bottles. The co-op had not dosed the wine with enough sulfur before bottling, and now the importer had 10 shipping containers—about 9,000 cases worth of wine—that were undrinkable".

Sanmartin understood exactly why the problem had arisen. "Cooperatives are not, by nature, innovative. Every grower in the organization gets a vote in company decisions. ... Men who had kept their farms afloat for decades thanks to their arrangement with the co-op were not prepared to give in without a fight. 'It was not easy to convince hundreds of winegrowers to change their minds,'says Sanmartin. 'They had to adjust to the idea that they would be more paid based on quality rather than on quantity of grapes produced.' But in the end, a majority recognized that adjustments were necessary."

And here is where corporate law provides the tool to solve the problem.

"To create a more nimble operation, Sanmartin proposed creating a separate corporation: Bodegas Borsao. This new entity would source its grapes from the co-op and produce all the wines itself. Co-op members would be shareholders in the enterprise, but the business would be run by a professional management team. And most crucially, growers would be paid based on the quality of the fruit they harvested. ...In order to compete in the new global wine world. Bodegas Borsao S.A. was incorporated in 2001."

And thereupon three things happened:  First, "Sanmartin made quality and control the main focus in the cellars."  The corporation hired a technical director in 2001. "Quality has been the first priority since he came," Sanmartin says. "He makes sure nothing goes wrong."

Second, the new corporation "authorized a cellar expansion", installing new tanks better suited to quality control.  With greater confidence in the quality of Borsao's operations, the U.S. wine importer "asked for a new product ,,, for the U.S. market" that would be of higher quality and carry a higher price point (known as "Tres Picos")..

Last, the U.S. importer introduced an Australian vintner to the region and the two of them formed a joint venture with the new corporation -- not the cooperative --which produces an even higher rated and higher priced wine (known as "Alto Moncayo").

The author of the article closes his article with a paragraph that recognizes the economic significance to the Borja community of the decision to abandon the cooperative structure for the corporate structure:

"If it weren't for the ingenuity of Bodegas Borsao, it's unclear what life would be like in this small town. Perhaps all the old vineyards would have been ripped up  ... and small growers would have abandoned their farms for the city. But today, the old vines remain rooted to the slopes of Moncayo, as timeless as the mountain on which they grow."

We live in a world in which the words "corporation" and "corporate" are stereotyped epithets, usually paired with words and phrases like "greed" or "soul-crushing".  A movie set in a corporate setting can be counted on to reinforce the populist cliches and portray the corporation as some sort of extrusion of hell on to the surface of the earth.  In contrast, other ways of organizing people, such as cooperatives or governments, are portrayed as noble expressions of democracy, regardless of the reality of their many flaws (cumbersome decisionmaking, political entrenchment, self-dealing, etc.)  More intellectual analysis from winners of the Nobel Prize for economics like Ronald Coase or Douglas North have shown that the corporation is merely a form of economic technology that improves decision-making and resource allocation over other forms of organizing people and their resources, such as contracts or, in the case of the Borja wine-growers, a cooperative.  So I set this example out as a reality based counterweight to the populist and romanticized stereotypes and I hope it serves that purpose.