Fizzy business: lessons in disruption from Champagne

There is a widespread assumption that, in any business sector, disruption to the established ways of doing things comes from those firms that are newcomers to the industry in question. Freek Vermeulen, Professor of Strategy and Entrepreneurship at London Business School, and his former PhD student, Amandine Ody-Brasier, now a professor at Yale, put this to the test with extensive research into one particular business: Champagne.

Their findings around industry pricing structures turn the conventional wisdom on its head and find that it is established firms that are permitted to deviate from industry rules, formal and informal, while new entrants who try to do so can face various forms of punishment.

In this interview, Professor Vermeulen outlines this intriguing paradox.

 

1. You note that “traditional industry insiders would be permitted by the industry as a whole, not least the grape growers, to deviate from the industry’s established practices, but relative outsiders were not”. Does this mean all change is driven by established firms? How long does an outsider have to be in business before it is considered an insider?

No, it does not mean all change is always driven by established firms; it just means that, for the reasons we uncovered, such as the tendency of grape growers to raise their prices and decrease grape quality to “punish” newcomers, changing things is more difficult for outsiders than for insiders. This is a surprising finding, because we usually assume that it is the newcomers that disrupt things. We show that this is actually more difficult for them than is assumed by common wisdom.

But insiders may potentially suffer from other sources of inertia, making it difficult for them to see the necessity of change, because they have been in the industry for a long time. Habits and established internal practices can make them rigid. Outsiders suffer from inertia for external reasons: they are rigid perhaps not because they do not see the potential of or necessity for change, but because other companies – for instance their suppliers or customers – don’t allow them to act. They think outsiders coming in should just stick to the rules.

How long it takes to become seen as an insider will likely depend on the particular industry. In the Champagne industry it took a very, very long time: people still spoke about certain Champagne houses as “newcomers”, although they could be half a century old!

 

2. You note that “growers punished Champagne houses that violated the unwritten rules in the industry by raising the price of raw materials”. Has any action been taken by the competition authorities with regard to this?

No, many things are prescribed – also by law – in this industry (for instance how to grow and harvest the grapes), but grape prices are not. In fact, prices are very opaque; it is custom in this industry to be very secretive about prices, and growers also use a complex system of various contractual clauses and mark-ups. It was quite a challenge, even for Amandine (who is a native French speaker), to figure them out.

 

3. You mention the Californian wine scene with regard to Champagne houses setting up of subsidiaries to make non-Champagne sparkling wine. Do similar constraints operate in California, or anywhere else in terms of discouraging new entrants from disruptive behaviour? Are these constraints unique within France to Champagne, or do they operate in the Bordeaux, Burgundy and other sectors?

We mention the constraints that operating in other wine regions, such as California, imposes on Champagne houses in the sense that their suppliers – grape growers – really do not take kindly to it: they think it is a very serious norm violation to start producing sparkling wine anywhere outside of Champagne! It really makes them quite angry. And this anger leads them seriously to increase the price of their grapes for any Champagne house that ventures outside of the region. They really make them pay through their noses. They told us also stories of giving them deliberately bad service and even the occasional bout of violence.

The Champagne industry was particularly well suited to letting us examine and uncover this type of behaviour and these price-setting practices. We did not examine it in other areas, let alone industries. However, there is certainly evidence of similar processes happening in other places and I think it is also quite intuitive: if your partner firm (e.g. supplier or customer) does things you really do not like and that go against your sense of norms and interests, you may feel inclined to retaliate. We show in this research that firms may do this to try and reaffirm the norm, but frankly also out of sheer spite: it makes them feel better to punish the norm violator!

 

4. How widely applicable are your findings, given that Champagne is a fairly specialised industry that may have evolved its own practices in a unique way?

Champagne certainly is a unique industry with unique practices – which enabled us to really zoom in on this phenomenon. The quite human – and I think recognisable – inclinations, however – of indignation, anger, retaliation, and so on – I believe are quite universal, and will undoubtedly influence business practices, markets and prices in a lot of places and industries. It is just that we had not taken into account these human behaviours in our theorising about markets before.

 

5. Did any of the people you spoke to rationalise the indulgence towards established disruptive players and the intolerance of such behaviour by new entrants?

Yes, most definitely: and that is also what a large part of the research focused on. The “rationalisation” consists of what we call attribution – attribution theory is quite well-known. In this case, these people (grape growers), who observed the norm violations, rationalised their behaviour of punishing some houses for their actions but not others (who engaged in exactly the same actions) by attributing the reasons why these firms engaged in these actions to different motives: for old, established Champagne houses, they said: “I know I know; they really should not do these things, but there are various circumstances outside of their control that really left them no choice...”, whereas if relative outsiders did the exact same thing, they said: “These bastards; I will make them pay! I knew they could not be trusted!” (sometimes they would almost literally spit on the floor).

Put differently, they don’t really punish the actions per se; they extend punishment dependent on the motive they think causes the firm to engage in the action. To some they respond fiercely; for others they make up excuses. 

 

6. You mention that “underneath the surface, structural change has been brewing”. As mentioned earlier, this is driven by established players. Could such structural changes result in a more liberal environment for disruptive new entrants?

Yes, that is possible: norms are not fixed and they can change over time. For instance, if many of the old, established houses have been operating outside of Champagne (e.g. in California) for many years, it gradually may become more accepted, so that even relative outsiders will be permitted to make some sparkling wine outside of Champagne soil. However, we certainly see that such change can be very, very slow indeed! Norms and habits are very sticky, and you see that in lots of industries, not only in Champagne. Popular business books and even academics from institutions significantly more dubious than ours always shout that everything is changing ultra-fast and that all industries are being disrupted all the time, but the fact of the matter is that firms in many industries have been operating in the same way and according to the same patterns and habits for many years or even decades. These fundamental patterns of behaviour change only slowly because culture and norms can be deeply embedded. That’s not necessarily bad – it also leads to stability and predictability in industries – but it is easily underestimated if you’re a newcomer to an industry, thinking you have seen the light and are about to become rich by shaking things up. Our research shows it may be a bit more challenging than anticipated. 

 

7. You write: “Some even told us stories of ostracising and intimidating, including threats of violence.” Is this generally known and, if so, has it affected the brand image of Champagne?

It is certainly known in the industry, an open secret, – but I don’t want to exaggerate this: it is not that there are posses of angry grape growers roaming the streets of Reims looking to beat up Champagne makers who dared to make sparkling wine in California or, even worse, appoint a CEO who is Belgian instead of French. Most of the punishment mechanisms, fortunately, are a bit more subtle than that. For instance, we showed that growers quietly increase the prices for the Belgian guy or put some grapes of inferior quality in their supply. In fact, it is interesting that some of this punishment is extended so stealthily: if you were doing it to whip people back into behaving properly and deter others from “misbehaving”, you’d want it to be known. That they do it secretly shows that those carrying out the punishments also do it to get some individual satisfaction (without really anyone else knowing). This was interesting for us, because it is not something that is generally taken into account in theorising about markets and about the way transactions and prices are formed.

 

8. There are presumably industry/trade bodies for Champagne. Has any of them ever suggested that the present set-up is unhealthy and should be changed?

There are a lot of industry bodies or, as we say, “institutions”, in this industry, both formal ones (which extend and uphold rules and regulations) and informal ones (in the form of upholding norms). Institutions, however, including the ones in this industry, are usually geared towards reinforcing and protecting the status quo, rather than bringing about change. In fact, maintaining stability is what institutions are all about. Therefore, really innovating in an industry often implies having to change these institutions: that’s what makes it so difficult, and the power of inertia is easily underestimated. Even if formal rules change, the informal ones, the norms, can linger for years. Although a certain new practice may be formally permitted, if your suppliers or customers still frown upon it they can react and retaliate. Therefore, it sometimes has to work the other way around: first shift the norms, and the formal rules will follow. Hence, the warning – or perhaps words of caution – coming out of our research is not: “Don’t even try to innovate”, but do understand the processes that innovation may trigger, because they often will geared towards reinforcing the status quo. Do try, but count on it being a marathon rather than a sprint.

 

Freek Vermeulen is Professor of Strategy and Entrepreneurship and Director of Strategy at London Business School.