Collectively all of us are beginning to experience the impact of the first round of wine tariffs which were the Trump Administration’s reaction to the WTO’s Large Commercial Aircraft decision in mid-October. Last month I posted about this initial tariff in some detail, and with the announcement of two more upcoming tariff waves my phone is ringing off the hook – For this reason today seemed like a good time to break the current situation down for you.
This is not a political post, and without taking any political stance I’ll say this: Over the last 80 years it has become crystal clear to anyone with a basic understanding of economics and/or history that in almost all instances tariffs decrease long-term economic prosperity for all parties involved. They restrict our natural human instincts to cooperate, limiting our personal freedoms while in the process inviting opportunities for distortion and fraud. Tariffs are as un-American as martian space dust – This is a universal truth that people on all sides of the political spectrum will agree with.
Tariff Round One
As we all know the October tariffs (aka Large Commercial Aircraft Tariff Resolution Round One) only impacted a select group of wines – Still wines at 14% or below ABV from France, Spain, Germany, or the United Kingdom. Because the US Government only gave the our industry 11 days of notice, all major importers inevitably had millions of dollars of goods on the water during the time of announcement and this spelled cash flow devastation for many…Why the cash flow devastation you ask? These tariffs are due (and in most cases auto-deducted from bank accounts) upon the physical arrival of product in destination port. Were you an importer with four containers of wine on the water on October 17th? Let’s assume each container contained $100,000 worth of wine? Congratulations you now instantly and unexpectedly owe the United States Government $100,000 (a 25% tariff on the value of each container means $25,000 times 4 which means $100,000). This “four container’ scenario is pretty mild. Most mid-sized importers/distributors in our industry had much higher volume than this on the water at the time of announcement. I did not get into the aforementioned cash flow angle when originally covering this topic, but at this point I’d say it is the most disastrous implication of the whole mess.
Cash, credit, and insurance…not the most exciting of topics, but essential in this discussion. Most European wineries rely on one of two credit insurance companies to cover their receivable risk, and these companies proactively dictate the amount of receivable debt a winery can hold for a given US importer/distributor. What happens if/when these credit insurance companies refuse to cover receivables for US importer/distributors? We’d end up in a situation where all business is prepaid, with the extra strain of a tariff bill due upon port destination. This is untenable and would mean a stop to most EU-US wine commerce. All is still “green light mode” with the major credit insurance companies, but my colleagues in London tell me they know of uninsured wineries who are now starting to refuse the release of new orders to US importer/distributors fearing that October’s tariff surprise will end up bankrupting their US importer/distributor customers due to the implications of the cash flow strain of the initial 11 day “surprise” cited above. An ominous sign.
From a pricing standpoint, almost all impacted European wineries graciously offered at 5-10% discount to help absorb the 25% tariff bill. From there one of two things happened. Firms who operated on an “Efficient” business model (i.e. one with minimal channel waste, most often this meaning a direct import route to market) accepted offers from wineries on this 5-10% discount on new invoices, squeezed their own margins to share in the pain, and made small upward adjustments to prices, resulting in retail pricing on average a few dollars higher than it would have been pre-tariff. For the efficient firms things are more or less going by math laid out in the example I used this October where a 3,40 Euro cost directly imported, $12 retail French Chardonnay ends up at $15 retail post-tariff. For this “Efficient” set life is lean but still manageable. How about firms who operate on a “Less Efficient” business model (ie one mostly dependent on three separate 30% margin tiers)? The majority of imported wine in the US comes to the consumer this way. Most of these firms panicked. Anyone in that camp knew that their $15 pre-tariff Chardonnay was already $3 too expensive and that seeing it go to $18 post tariff would mean a screeching halt on the sales front. A 10% reduction in ex-cellar cost from the winery does little to help when you have a 25% tariff with three margins stacked on top of one another, so what we have seen with the “Less Efficient” crew is either denial (i.e. no price changes and no new containers on the water), salespeople agreeing to lower commission rates, or end-of-year layoffs, and in some cases a depressing combination of all three.
The retail side has been slightly less interesting thus far but things will devolve quickly in 2020. At most chains distributor price increases are passed onto monthly shelf tags regardless of whether or not stock was purchased prior to the tariff/price increase. On this front we saw a relative slowdown in depletions of our impacted wines (yes we have fast container turnover and ended up with a long list of Nov 1 price changes) – Consumers in general snubbed their now-more-expensive “first choice” for a similar style replacement from a non-tariffed region. At bottle shops we saw smart buyers avoid early tariff items, preferring to purchase as much pre-tariff stock as they could find while it is still around. For the country’s largest independent retailers, who represent a huge amount of 3PL business for us, we saw a crippling effect – Pricing on this level needs to be competitive with global Wine-Searcher averages, a large volume of these sales are invoiced to end-consumers pre-arrival, and uncertain tariffs meant a complete freeze on futures orders for European wines. Many Bordeaux negociants are penciling in “0’ for their 2020 USA sales projections. Inventory turnover from winery to shelf with this retail sector is fast, and this sort of low margin 3PL business almost always necessitates immediate tariff payment on behalf of 3PL import partners – Something not in the business model or capability of most of the United States’ high-volume independent retailers. Dominoes will fall, even with just the initial 25% tariff.
As if this wasn’t enough chaos we were welcomed with two new tariff surprises in early December, which we will call Tariff Round Two: “The French Digital Services Tax Tariff” and the Tariff Round Three: “The Second Installment of the Large Commercial Aircraft Spat.”
Tariff Round Two
Round two brings us the Trump Administration’s reaction to the new 3% Digital Services Tax France retroactively placed on large American technology companies this summer with a 1/1/19 effective date. What is this tax you ask? In short it is France’s attempt to regain tax revenue that has “gone away” as fulfillment of goods and services continues to shift from French-owned brick-and-mortar firms to multinational digital firms. How does this go down exactly? Let’s say Amazon.fr invoices a baseball bat to a consumer in Dijon. Local French governments theoretically lose out on much the tax revenue that would have been created by a brick-and-mortar firm. Most studies quote this revenue loss at 13% in total (on average digital service “sales” generate 9% in combined French local/national tax revenues, whereas brick-and-mortar “sales” generate 22% in combined tax revenues). The European Union has been working on a unified taxation plan to address this revenue shortfall, but limited progress has been made and the French went rogue in taking a unilateral decision to blaze ahead with their own taxation plan. Why? France has a huge budget deficit and must pay for, among other things, the agreed pension and social safety net demands of the “yellow coat” movement (remember that last winter?). Ironically most experts on either side of the aisle consider France’s Digital Services Tax a tariff in and of itself and the odds are high that if this tax makes it to a WTO trial, France will lose in the same way the European Community lost the Large Commercial Aircraft case this October. Harvard Business Review breaks down this digital tax controversy thoroughly, have a look by clicking here.
Regardless of a person’s position on France’s approach to the taxation of digital services, a tentative “deal” was reached between the US and France this Fall where taxation of such services would be addressed and resolved by 2021 with any overpayments from France’s existing 2019-2020 rates refunded to Amazon, Google, etc. at time of a final multilateral agreement. Everything seemed fine, but earlier this month the Trump Administration decided open up a Section 301 investigation into the “discriminatory nature of the French tax,” playing offense by threatening tariffs during what most pundits assumed would be a balanced 24 month negotiation period. The gory details? The Trump Administration promises a tariff of up to 100% on all French sparkling wines along with many other French luxury goods including most cheeses, spirits, porcelain cookware, and designer handbags. To read the full list of items tentatively slated for this 100% tariff you can click here.
The Trump Administration by matter of policy accepts open comments which are due until 1/6, and we expect a final decision on 1/14. From there we project that this round of tariffs will go into effect 1/17/20 based on the short 11 day notice given the last time around. The consensus amongst government contacts in both the US and in Europe along with our colleagues in the freight industry is that this round of tariffs will proceed in full as threatened. Because it hits some very powerful interests (Louis Vuitton Moet Hennessy for example), things could get explosive and that is of course Trump’s whole point in targeting the categories listed.
As a frightening side note, other countries including Italy and Turkey are attempting to enact similar digital services taxes independently of a more coordinated EU approach. Not good.
Tariff Round Three
Now is the time to talk about Tariff Round Three, which is the result of a 12/2/19 WTO rejection of the EU’s appeal to October’s Large Commercial Aircraft case – The one that put the initial round of 25% tariffs into effect. Why was the EU’s appeal rejected? The WTO determined that the EU is continuing to subsidize Airbus illegally, which resulted in more Trump Administration activity and this new tariff threat. What are the details here? We are looking at a second round of tariffs on a broad assortment of European goods, all of which are threatened to go up as high as 100%, and this time they include all categories of wine and also all EU member countries. To read the whole list, grab a glass of scotch while you still can and click here. The Trump Administration is accepting comments on these proposed tariffs until 1/13, with a likely decision to be announced on 1/17. All final tariffs from this wave are expected to go into effect on product landing in port after 1/28/20, again, based on an assumed 11 day notice period. Kleenex are not on the list which is good because we will need them should this pass.
Some importers are hot-shotting wine into the USA in “buzzer beater” fashion – This theoretically works for East Coast ports assuming wine is loaded in the next week or so. Strikes in France are making this difficult however. Others are shipping wine via air freight, which is an approach we’ve taken on some higher-end wines (it makes little economic sense for anything over 15 Euros in cost when you take into account that air freight plus airport customs clearance will run you upwards of $3.50 per bottle on a good day). Both are only band-aid solutions, and gambles at that.
This is all part of a perfect storm when you factor in the other two major global export markets for premium French wine: Hong Kong and London. The riots in Hong Kong brought fine dining/tourism/consumption/trade in that market to a screeching halt, and these riots were ironically triggered in no small part by the US versus China tariffs (attempts to absorb tariff costs on the production side squashed wages in China and Hong Kong fueling the tinder box of discontent necessary for these riots). London as we know is in the middle of Brexit, and amid the uncertainty that engulfs that situation merchants are afraid to make any moves. A Brexit-related exchange rate slump means 10-20% higher post-exchange cost for UK Merchants, and some professionals are predicting UK tariffs of 30%+ on EU wines post-Brexit once the dust settles. At some point inventories will pile up in Europe and we will see a downward price spiral, which will further strain the already modest livelihood of Europe’s farmers. Inventory could pile up for American wineries as well. Why is this? Retaliatory tariffs have already squashed American wine exports to China and retaliatory tariffs from the EU are on the way. When the madness all ends it will be a feeding frenzy of epic proportions for merchants who still have money on hand.
You might at this point ask about the status of the “other” WTO Airbus vs. Boeing subsidy case? You know, the one that is essentially the opposite of the October commercial aircraft case? The United States was found guilty for subsidizing Boeing in exactly the same way the EU subsidized Airbus, and “reparations” (i.e. acceptable tariffs against the US) will theoretically be determined by the WTO sometime in 2020. Why do I say theoretically? Two of the three WTO Judges who made the the October and December decisions are now finished with their WTO tenure. There are no successors to these positions because the Trump Administration is blocking any action on new appointees. You need a minimum of three WTO judges to try a case. This effectively means no WTO (for now anyway), and no WTO means no decision on tariff rights awarded to the EU, and more alarmingly a world with no limit on new tariffs.
As for us at here at Grape we pledge to carry on, fearlessly examining all possible routes to bring you the balanced, handmade wines all of us want to drink with our dinner each night. It will be a crazy year in 2020, but rest assured we will carve out creative/compressed routes to market for your vinous enjoyment. I put together a grid and YouTube video showing market route/margin combinations for some common European wine categories based off of current rates for major wine categories in question – Have a look by clicking here. When time allows I’ll place a editable spreadsheet link in the video notes.
Does this all sound hellish to you? Now is the time to make your concerns heard! Please take five minutes today to voice your opinions to the Trump Administration on both proposals. We don’t care if you live in the US, in the EU, if you are in the wine industry, or if you are a consumer – think of this as your duty as a freedom/choice loving human. To comment on Tariff #2 click here and to comment on Tariff #3 click here. All finished with your comments? Good work. Contacting both of your State Senators is smart as well, and also quick to do… most of the time they will even write you back. We made a US Senator contact cheat sheet for you, click here and take action.
Thanks for being part of our community at Grape, and here is to a fair and timely resolution these ongoing trade disputes.