Plural Forms of Organization in the Wine Industry: An Empirical Analysis of the Vertical
Boundary Decision of Wineries in Emerging Regions
Authors:
Fabio Chaddad, University of Missouri
Miguel Gomez, Cornell University
R. Brent Ross, Michigan State University
Abstract:
The transaction cost theory of the firm introduced by Coase (1937) has become a standard
framework for the study of alternative modes of organization or the “institutional structure of
production.” The Coasian framework helps explain not only the existence of the firm, but also
its size, scope, and internal organization (Gibbons and Roberts, 2013). Coase (1937) introduced
the notion that firms and markets are alternative institutional arrangements to govern
transactions. In particular, he posited that the firm supersedes the market when the transaction
costs of internal organization are relatively lower than in the market. In this sense, firm
boundaries not only depend on technology, but also on organizational considerations.
Since Coase’s pioneering work, the make-or-buy decision has become one of the most studied
topics in the modern theory of the firm. Building on Coase’s original insight, the transaction cost
approach emphasizes that vertical coordination can be an efficient means of protecting
relationship-specific investments or mitigating potential conflicts in the context of incomplete
contracting (Klein, Crawford and Alchian, 1978; Williamson, 1979; Grossman and Hart, 1986).
So far, empirical evidence has largely supported the transaction cost explanation of vertical
boundary decisions (Klein, 2008).
In the specific case of the wine industry, several studies have applied transaction cost economic
reasoning to the empirical analysis of the vertical boundary determinants of wineries (e.g.,
Fernández-Olmos, 2010; Franken and Bacon, 2012; Goodhue et al., 2003). The grape and wine
industry provides an interesting setting for the analysis of vertical boundaries for several reasons.
First, grape quality is a critical input to the winery’s production function and largely determines
wine quality and winery reputation. Second, grapes are perishable products that require specific
investments for production, which together raise vertical coordination issues between the
vineyard and the winery. Third, there is considerable scope for winery differentiation along with
variation in types of grapes and wines produced, size of businesses, and governance mechanisms
employed.
Despite significant progress in the literature, several theoretical and empirical puzzles remain
(Ménard, 2012). The first puzzle is that firms operating in the same sector often do not converge
on an identical governance structure to organize transactions along the supply chain. In the wine
industry, for example, wineries use spot markets, relational contracts based on handshakes,
formal contracts, cooperatives and vertical integration to source grapes used in winemaking.
Why are different forms of governance adopted for organizing the same transaction? The second
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puzzle is the increased reliance of firms on “non-standard” arrangements that combine
characteristics of arms-length market contracting with hierarchical mechanisms of coordination.
Long-term contracting, franchising, joint ventures and cooperatives are examples of such
“hybrids” that are often used in lieu of markets or hierarchies (Ménard, 2004). The third puzzle
is that a firm may choose to organize the same transaction with different forms of organization.
For example, it is not uncommon for restaurant chains to operate their own stores and to
franchise stores to independent entrepreneurs (franchisees).
In this paper, we focus on the third puzzle – why does a firm decide to use several forms of
governance to organize the same transaction within the same institutional and competitive
environment? To address this research question, we use survey and case study data collected
from wineries in three emerging wine regions in the U.S.: Michigan, Missouri and New York.
Our survey data from 116 wineries in the three states show that 19 wineries (16% of the sample)
source all their grapes from estate-owned vineyards (vertical integration) and only 1 winery
relies solely on the spot market to procure grapes. The majority of the wineries in our sample
either rely on a hybrid form (such as a long-term formal contract) or on plural forms of
organization. Indeed, 73 of the wineries – or 63% of the sample – use a plural-form strategy to
source grapes used in winemaking. These wineries combine vertical integration (i.e., wineryowned vineyards) with hybrid arrangements (formal and informal contracts with grape suppliers)
and eventually rely on spot markets to procure their grape needs. Similarly, the wineries in our
survey sample also indicate the use of multiple distribution channels for marketing wine – from
tasting rooms and other in-premise formats, to direct sales and wholesale distributors.
Our survey data allows us to show how common it is for wineries to adopt plural forms of
organization in both upstream (grape procurement) and downstream (wine distribution)
transactions. But why is this so? Ménard (2012) proposes a model to explain these plural forms
and identifies three of their determinants: ambiguity, complexity and strategic behavior. His
model predicts that firms adopt plural forms to govern a transaction when there is ambiguity
about the lowest-cost structure to govern the transaction; the transaction is highly complex; and
to capture a larger share of the quasi-rents in the transaction.
In this paper we examine these hypotheses with a set of 10 case studies of wineries located in
Missouri. The case studies were developed based on in-depth, personal interviews with winery
owners and managers. The wineries interviewed were chosen based on organizational form,
size, geography, years in business, and willingness to participate. On average, the interviews
lasted approximately 45 minutes. This multiple case study approach allows a close examination
of the vertical boundary decision for a broad range of wineries using multiple forms of
governance.
Our multiple case study analysis does not provide convincing evidence for the model proposed
by Ménard (2012). Neither determinant of plural forms from Ménard’s model – ambiguity,
complexity and strategic behavior – appears to explain the vertical boundary decision of these
ten Missouri wineries. Our case study evidence suggests the following:
• Wineries that are relatively new to the industry tend to rely more heavily on a
combination of spot market and loose, handshake agreements to procure grapes as they
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lack knowledge and financial resources to vertically integrate and have not yet developed
stable, formal relationships with grape suppliers.
As a winery matures and grows, it acquires the necessary resources to vertically integrate
and develops stable relationships with grape suppliers enforced by formal long-term
contracts.
Established wineries using plural forms of organization to procure grapes often combine
some degree of vertical integration with long-term contractual arrangements with a select
group of grape suppliers primarily to assure supply of quality grapes on a consistent
basis. In general, these wineries have plans to increase sourcing of estate-grown grapes
and to use contracts more selectively to procure specific grape varietals that do not grow
well in their region. The major reason to increase the degree of vertical integration is to
control the quality of the grapes used in winemaking as they follow a product
differentiation strategy and attempt to build reputation.
The three wineries that only adopt a hierarchical organization to procure grapes share one
common characteristic: they were all grape growers that decided to vertically integrate
downstream into winemaking. This finding suggests that the direction (i.e. upstream vs.
downstream) of vertical integration matters, an issue often overlooked in the transaction
cost economic literature.
Taken together, this preliminary evidence suggests that firm-level resources, industry experience,
dynamics and the direction of the vertical integration decision are factors that appear to explain
why Missouri wineries adopt plural forms of organization to govern the transaction with grape
growers. These considerations will inform our empirical analysis of the survey data and also the
investigation of the downstream vertical boundary decision of wineries related to wine
distribution channel choice.
References:
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