Caroline Hermann MW: Wine Profitability versus Financial Sustainability
Photo by Towfiqu barbhuiya on Unsplash
Is profitability the same as financial sustainability? If not, how can we define, assess, and measure financial sustainability? Why does it matter?
Caroline Hermann MW is an alcohol and beverage lawyer in Washington D.C. Previously, she has worked as an attorney for both the U.S. Environmental Protection Agency and the Environmental Law Institute.
She is also a certified WSET instructor for both wine and sake, who teaches at the Capital Wine School in Washington DC. She has consulted for wineries, trained restaurant wine and beverage staff, and judged wine competitions. She spoke with ARENI about managing social and environmental risks, and on the differences between profitability and financial sustainability.
This conversation was first published on September 22nd, 2022
ARENI
A winery, like any business, can’t go very far without money. But is financial sustainability the same as profitability? And how much money do you actually need to be financially sustainable?
Caroline Hermann MW
Profitability is just financial gain really. It’s a very simple definition of the difference between the amount earned and the amount spent on operations. Financial sustainability can be defined as delivering financial returns in both the short and the long term, while generating a positive value for society while operating within environmental constraints. So we’re really talking about a more holistic approach to profitability.
You need to be financially sustainable first in order to be profitable. And the reason I say that is because if you’re not taking into account some of these environmental and social pressures, costs and externalities, you may be profitable in the short term, but it’s going to be much harder to be financially sustainable over the long haul.
Profitability is just financial gain. It’s a very simple definition of the difference between the amount earned and the amount spent on operations. Financial sustainability can be defined as delivering financial returns in both the short and the long term, while generating a positive value for society while operating within environmental constraints. We’re really talking about a more holistic approach to profitability.
Caroline Hermann MW
ARENI
When we think about wineries, or even distributors, that’s really a big change of mindset, right? It’s not just making sure we’ve got enough money in the bank throughout the year. It’s really, are we putting the money in the right place to make sure that we are still here in 20 years?
Caroline Hermann MW
It’s also taking into account things that aren’t happening now but may happen in the future. And how do you know what’s going to happen in the future? Well, you can look around and you can see where other countries are maybe struggling with floods or droughts or upcoming regulations that they would need to budget for. There are costs and inputs that you can take into account now, in order to promote financial sustainability in your business.
ARENI
How can we measure the true cost of wine? Another way of saying this is, how can we internalize the externalities of producing wine?
Caroline Hermann MW
I think we start with the definition of what is an ‘externality’. One way of defining it is “things that can cause harm”. Because of my environmental background, I would say that climate change is the main negative externality. For example, every time I drive a car that’s not an electric car, it’s emitting exhaust from the tailpipe and that causes harm. Every time I turn the car lights on at night-time, I’m creating light pollution. For some of the big companies that I looked at as an environmental lawyer, a lot of things we were looking at were their air emissions, the waste water they were discharging into rivers and streams.
That has historically been the way that we have dealt with waste because the environment is not charging us any money to do that. It’s just a free place to dump our waste. We’re now finally seeing the repercussions of that. We are now at a point where we have to reckon with our past practices of freely admitting emitting pollution into the air, soil and waterways. It’s catching up with us now. We are at a point where we now need to consider these externalities. And one way of doing that is to consider them in the cost of the products.
ARENI
How do you put a cost on this?
Caroline Hermann MW
There are calculators online. Carbon calculators, waste water calculators. More practically speaking, do you necessarily need to quantify the amount of waste or can you just start capturing some of these elements? For example, some of the biggest air emissions that wineries face is carbon dioxide as a by-product of fermentation. There may be a way to go down to your local hardware store and get some PVC piping for $20 and reroute that carbon dioxide to a closed container and be able to capture those emissions instead of just allowing them to pollute your air. Similarly, with waste water, there are loads of opportunities to use water in a winery, and once you’re done scrubbing out your barrels or tanks, can you then capture all of that instead of it going down the drain? And so the cost would maybe be a little bit of extra equipment.
ARENI
We’ve always talked about fines that are given to companies that pollute the air or water, but is there a reward system for people that are doing good?
Caroline Hermann MW
You are right that in the States we do have a regulatory system whereby you have to, if you’re a business, comply with water and air regulations that limit what you can dump and what you can emit. But it is a different approach to try to offer incentives. It would be up to the particular lawmaker or state legislature to shift the focus from enforcement and compliance to reward, and everything comes back to money.
ARENI
We’ve been talking about environmental externalities, but over the last three or four years, social sustainability has been such a big part of the conversation too. How do we measure the impact that winemaking or wine production has on society at large?
Caroline Hermann MW
Let’s clarify what you mean by social. That can include the health and safety of your employees. That can include diversity, equity, inclusion, or it can the health effects of consuming alcohol.
If you don’t have a labour force the size that your property requires, you’re going to have a hard time getting your product made. In the States, and other countries too, we have laws on people working in agriculture using pesticides, taking breaks, things like that. What we saw during the California wildfires over the last few years is that oftentimes the wildfires would wipe out the homes of the vineyard workers. Of course the wildfires always seem to hit around harvest. So how are you supposed to get your grapes harvested and, and wine made when your employee is now newly homeless?
ARENI
Is there a framework for social sustainability? In the U.S., is there something like legislation that companies can go to and say, OK this is a checklist of externalities?
Caroline Hermann MW
There are health and safety regulations that, reside at the Federal and state and local levels. A winery would need to make sure they are in compliance with those standards. When we talk about things like diversity, equity and inclusion, that’s much harder to legislate for. We are starting to see some guidelines, but there are not really any hard and fast rule that says, “if you aren’t diverse as defined by thus, then you’re breaking the law and you have to pay so much in penalties”.
ARENI
The third aspect of social sustainability could be the impact of alcohol consumption on health.
Caroline Hermann MW
Just sticking with the regulatory agencies, the U.S. has the Food and Drug Administration, and they regulate the health of products, of food and drugs. They work very closely with WHO standards. Other countries have their own set of standards. So there are baseline considerations for the safety of beverages, and there are tolerance levels that are set and enforced. Taking into account the alleged harmful benefits of alcohol, I believe that the response would be that no one’s forcing us to have a glass of wine. It’s our decision to have a glass of wine and thus it would be our decision to drink with moderation.
ARENI
There is so much change in regulations at the moment, some helping sustainability, some not really helping. Can you tell us a bit more about what’s happening?
Caroline Hermann MW
Just to follow up on the point about cost, trying to define the cost of externalities is sometime done through taxation, so it’s not always up to the individual wine producer or company, though the goal for all of us would be to be operating a business with a full understanding of the impact of our actions.
The goal for all of us would be to be operating a business with a full understanding of the impact of our actions.
Caroline Hermann MW
The Securities and Exchange Commission does a lot in terms of ensuring that investors have the correct information to make investment decisions. One thing that happened earlier this year in March is that the S.E.C. proposed a climate disclosure rule that says that listed companies would need to provide an accounting of their greenhouse gas emissions, environmental risks that they may be facing and measures that they’re taking in response to those risks. This is quite interesting because it’s requiring companies to do what you were talking about earlier—to operate with more awareness and actually quantify these externalities. There are lots of consultants very eager to enter into the space of accounting for greenhouse gas emissions.
The way that rules work is that a proposed rule is put out by a federal agency. And then it invites comments, and comments can come in from anyone all over the world. If you read the rule, it’s gotten over 5,000 comments. It’s probably going to be delayed. There may be lawsuits lodged against the proposal of this rule. Why is it bad to have to account for your greenhouse gas emissions? It’s going to cost the companies money and it’s not going to provide a direct return on investment.
We’ve always just been able to emit our greenhouse gases into the environment. And now all of a sudden, you’re asking us to account for that. It means that information about that facility’s operations is going to be public, because they have to be publicly disclosed in their financial reports to the S.E.C. That can go to a potential damage of reputation and potential reduction of share price. And so, you can now see the trickledown effect. This could have quite an adverse effect on profitability.
ARENI
Can you talk a bit more about what’s happening in Texas?
Caroline Hermann MW
Coming back to the S.E.C, they proposed disclosure requirements for investment companies and investment advisors that have funds with an ESG [environmental, social and governance) focus. If you’ve got good investment advisers, they’re going to look at the profitability of these ESG-focused companies. It’s just disclosing to that potential investor why the ESG fund exists, what they think the impact of their fund will have, and how they think the fund will achieve these impacts.
What we’re seeing is that relatively conservative states are pushing back on this and they’re doing it in their own way. (The S.E.C. is a federal agency and the rules that become final are implemented at the Federal level; however, states have their own laws and their own legislatures and their own priorities).
Texas penalises companies for having ESG factors or other social policies. The states will have pension funds for their teachers, their nurses, their firefighters, and those pension funds are basically investment funds. What Texas has said is that they will keep a list of companies that are seen to consider environment or social issues. So for example, if a company boycotts energy stocks or oil and gas stocks, they are required to explain why they have that position. And if it doesn’t meet the standard of the state agency, the agency will divest from that company.
The reason that it made the news recently is because Texas listed BlackRock as a company that is too green to be doing business in Texas. And BlackRock is the largest asset manager in the world. West Virginia recently banned JP Morgan and Wells Fargo because West Virginia alleges that they boycott fossil fuel companies in their investments.
Texas penalises companies for having ESG factors or other social policies. […] If a company boycotts energy stocks or oil and gas stocks, they are required to explain why they have that position. And if it doesn’t meet the standard of the state agency, the agency will divest from that company.
Caroline Hermann MW
ARENI
If I look at it from a winery perspective, what it means is that I live in a very polarized world.
Caroline Hermann MW
What we’ve all got to do, whether we’re a winery or an individual or a multinational listed company, is we have to start acting with more awareness of our impact. Whether that’s quantified or gets legislated, it just helps you in your winery operations from day to day.
You may be a very small winery, but one day you may get a big contract with a large distributor that maybe is a publicly traded organization that does have to abide by some of these disclosures, or maybe you want to sell your product in a grocery store that has to abide by some of these requirements. They may choose the brand or product that is already going in that direction.
ARENI
We don’t think about them enough, but I think one of the people that will choose for us are insurance companies. Are we going to be able to insure our business tomorrow? I know that in Napa that people are getting dropped by the insurers because they’re not worth it for them.
Caroline Hermann MW
That’s exactly right. There are fewer policies available. This is a real problem for any business that needs property insurance. For example, if a winery needed to borrow money from a bank, they would have to show property insurance. And if they can’t, either they can’t get the loan or the insurance company will provide insurance for them at very unfavorable rates. We’re starting to see a bit of work on this side. California has introduced a law, the California Catastrophic Wildfire Insurance Act. The essence of that is to provide a fund to companies to cover their losses because of these wildfires. It’s meant to be financed by taxes and various bonds and other instruments.
The problem is that when you talk about the damage from a wildfire, it’s just massive amounts of money that no one insurance company would be able to afford.
ARENI
It’s time for fine wine to think about this and to really look at tomorrow.
Caroline Hermann MW
The irony is that if we were to talk in terms of fine wine, oftentimes fine wines are backed by companies with a lot of money and a lot of internal expertise on compliance and ESG. Sometimes those companies are the best positioned to be able to invest, in terms of having a product with a lower carbon footprint.
We’re all human beings and it generally takes an external force to make us do anything. I think that the external force comes either from government legislation, or from your consumer, from your client, whoever’s paying your bills ultimately.
We’re all human beings and it generally takes an external force to make us do anything. I think that the external force comes either from government legislation, or from your consumer, from your client, whoever’s paying your bills ultimately.
Caroline Hermann MW
This conversation is part of ARENI’s publication 12 Conversations: Different Ways of Looking at Sustainability, published in September 2022, available to all.