When are High Wine Prices Justified?

DESCRIPTION

In the wake of some of the latest chatter about The Wine Trials 2010 (this one from Joe Briand, wine buyer for New Orleans’s excellent Link Restaurant Group, e.g. Cochon, Herbsaint, with a response from Wine Spectator executive editor Thomas Matthews), I thought it was time for a quick clarification of first principles here.

People have sometimes (often, maybe) misinterpreted The Wine Trials (and The Wine Trials 2010) as making the claim that no expensive wines are worth the money, or that cheap wine is generally “better” than expensive wine. In fact, I make neither one of those claims in the book.

Rather, my basic points are these:

  1. Evidence has shown that most everyday wine drinkers (not wine professionals) don’t prefer more expensive wines to cheaper wines in blind tastings. This is separate from the question of whether the properties of expensive wines are aesthetically superior in the minds of experts.
  2. Many (but certainly not all) expensive wines, such as the luxury brands from LVMH-which are advertised much like the group’s TAG Heuer watches, De Beers diamonds, Guerlain perfume, or Louis Vuitton handbags-are overpriced because such a large portion of their cost base is spent on marketing. This doesn’t just go for superpremium wines like LVMH’s Château d’Yquem, Krug, and Dom Pérignon; it also goes for brands like Cloudy Bay, a straightforward New Zealand Sauvignon Blanc whose price-without any apparent change in the production method-rose from about $15 per bottle to about $30 per bottle after LVMH acquired the brand in 2003 and began marketing Cloudy Bay as a luxury product. To me, when the consumer dollar is going more toward advertising than toward materials or production, it’s a paradigm case of overpricing. It bothers me that the mainstream wine media doesn’t take brands to task for this.
  3. There are also wines that are overpriced for reasons other than marketing-reasons like an irrational premium Bordeaux bubble that’s being inflated by indiscriminate demand from rich, unsophisticated consumers in emerging markets like China and Russia. Even if Pétrus spends no money on marketing, $5,000 is an irrational price for a bottle, and this is a demand-side phenomenon.
  4. Then there are the producers who model themselves after Pétrus in an effort to capitalize on that same demand-side phenomenon. These producers make “high-end” wine (with the characteristics typically associated with the 95-and-higher-point wines in wine magazines, e.g. aging in new French oak, high alcohol, extreme concentration), and price it as such. Here, there aren’t necessarily the extreme marketing expenditures of LVMH; rather, there’s simply a price-signalling play: the hope that positioning the product at the top end of the market will speak for itself, and that consumers in search of a luxury good will buy into that notion. In this case, the consumer dollar isn’t paying for lots of advertising and marketing-it’s just sustaining unconscionably high profit margins for the producer.

What situations two, three and four have in common is that the cost of production of each of these premium wines is virtually unrelated to the street price.

One might divide wine pricing theory into two rough schools of thought. There is the camp that believes wine should be priced from a supply-side/cost-plus perspective-you take the cost of production of the wine, you add reasonable costs and a modest profit for the producer, you factor in markups for distribution and retail, and you arrive at more or less what the wine should cost. The other camp believes that wine should be priced from a demand-side perspective-that a wine is worth whatever the market is willing to pay for it.

The reason I’m in the first camp, and not the second, is that I don’t subscribe to the neoclassical model of consumer rationality upon which the demand-side pricing theory is built, a counterfactual universe of stingily hypersensitive, quality-sniffing consumers. My sense is that, especially when it comes to hazy markets like wine, real human beings — within certain constraints — generally anchor themselves to market prices that are imposed upon them, and generally pay for things what they’re told those things are worth.

One attempt to justify superpremium wines with modest costs of production is an opportunity-cost-of-land argument — that wine in the Champagne appellation is so expensive that the opportunity cost of that land can justify higher prices. I’m unsympathetic to that argument, because real estate prices track market wine prices, so the price of land is not an independent factor.

So when are premium prices justified in my camp?

When the cost of production is high. The fact that Matthews and Briand mention 1er Cru Burgundy and German whites as examples of expensive wines worth the money suggests that they might be in my camp too, because these are particular examples of wine regions in which grapes are often harvested from small plots with very low yields. In the case of German TBA, for instance, the harvesting is often done on steeply terraced slopes that are extremely difficult to work. Ice wines and botrytized wines — the priciest of German whites — are indisputably more difficult and expensive to produce than almost any other type of wine.

In short, while spending $50 or $75 or even $100 on a good Sauternes, TBA, or top red Burgundy might not always make economic sense for the buyer — particularly if it’s a buyer without much experience in wine — it’s at least justifiable from a supply-side pricing perspective. The $150 you’ll pay for a bottle of Opus One or Krug, meanwhile — never mind the $5,000 you’ll pay for a bottle of 2005 Pétrus — has little to do with the cost of production.

TAGS:

Leave A Comment

Comments are moderated and generally will be posted if they are on-topic and not abusive.

 

COMMENTS: 106

View All Comments »
  1. Garrett Pendergast says:

    There are differences in wines. Mostly I drink Two Buck Chuck (Charles Shaw) because it tastes good.

    Thumb up 1 Thumb down 0
  2. azmyth says:

    You can take that position because you don’t make wine. Any wine maker will quickly switch to pricing at the highest price that they can still sell at because that’s what makes the most money. Eventually capacity will increase until the price gets driven down, but it takes time.

    Thumb up 1 Thumb down 0
  3. John, Boston says:

    You are an idiot my friend. Wine should be priced exactly as it is.

    It’s like this, if the wine is overpriced as compared to its competitors and there is good knowledge transfer to the purchasing public, then the price will eventually be forced down through demand side price pressure. What the price “Should” be is irrelevant in every case. In the case of Bordeaux, I say the price is exactly the price the market demands. Outside a notable increase in the supply (unlikely, but intelligent if they do it), the price will remain high due to demand.

    Marginal cost is equal to marginal revenue in the long-run for pure and monopolistic competition. However, in the shorter run these margins can have gaps. If someone can act monopolistically (al la the Bordeaux manufacturers) they can constrain the supply and artificially increase the price. This is why we have the sherman anti-trust act in the US, so that manufacturers like those from bordeaux cannot collude to price fix by constraining supply. Supply side price fixing is what you have with those manufacturers.

    Incidentally, it is also why oil is so overpriced. OPEC exists solely as a price fixing authority worldwide. They use supply side targeting to fix higher prices, caterus paribus.

    Silly ruminations like your book merely confuse the issue.

    Thumb up 0 Thumb down 2
  4. Tristan says:

    I don’t know if I buy the cost of production pricing model, it all comes down to the “reasonable profit” line. I’d agree that some of these wines are making way more profit than others, but maybe some of the cheap wines should be making more profit, but people aren’t willing to pay more for them?

    I would look at the cost of substitutes; if you want a white wine, and you can’t tell the difference between a $30 and a $15 bottle then you should be buying the cheaper one, or the more expensive one should cut it’s price, or the cheaper one raise it.

    I suspect that what most people who buy a $100 or $1000 bottle of wine want is for other people to know that they bought an expensive bottle of wine, and there’s really no substitute for that.

    Thumb up 1 Thumb down 0
  5. William G says:

    Just because you “don’t subscribe to the neoclassical model of consumer rationality upon which the demand-side pricing theory is built” doesn’t mean it’s not valid.

    If people are buying $5,000 bottles of wine that cost $10 to produce, then I believe what you believe is quite false.

    Thumb up 0 Thumb down 0
  6. Erik says:

    I’m not sure where neoclassical views don’t allow for imperfect information. Advertising can absolutely affect a demand curve, pushing it out. One needn’t be perfectly rational to fit within a demand-driven scheme; one just needs to have preferences.

    As with most things in life, the solution here isn’t wineing(ha) about the way things are, but either taking advantage of the imperfect information (open a winery) or educating the aspiring oenophiles to be more discerning, thereby diminishing its effects. Either way, you get the benefit of more money (from your new ultra-luxury winery) to afford these outrageously priced wines, or prices drop, and you can afford the no-longer outrageously overpriced wines.

    I haven’t read your book yet, but I’m guessing you have already started down the latter path. If so, then kudos for not just complaining.

    Thumb up 0 Thumb down 0
  7. Pete says:

    I was able to answer your question by only reading the title of the post.

    “When are high wine prices justified?”

    Whenever people are willing to pay them. That’s it. Wine is not even remotely a staple good, and if people want to avoid rational choices and pay more, there is no reason to expect winemakers not to charge those prices.

    Buying wine is a completely voluntary transaction, and to suggest that we should restrict or alter how one side is able to participate that transaction is absurd.

    Thumb up 0 Thumb down 0
  8. David L says:

    I’m surprised at the distinct lack of economic thought here, in a Freakonomics blog post no less. I haven’t read Wine Trials, however, we all know that the price of any good is related to two and only two factors: supply and demand. While luxury brands’ marketing expenditures may or may not have the effect of driving demand, the notion that they somehow factor into a “cost base,” of which a “large portion” is comprised of marketing, utterly ignores economic principles. The cost of bringing a product to market (including marketing costs) has no DIRECT bearing upon the market price of that product. In only plays a role insofar as a) companies that do not control their costs effectively will go out of business, leaving fewer competitors who can therefore charge more for the product due to decreased SUPPLY; and b) companies will SUPPLY less of a product at a given price as it becomes more expensive to produce.

    Markets for wine are informationally and transactionally efficient, comparatively: there is plenty of information regarding wines and wine prices, and the transaction costs are minimal. Therefore, there is no such thing as “overpriced” wine–only wine that you or I wouldn’t pay for.

    Another way of looking at it is through the lens of signalling theory. Just like other luxury goods you and I might colloquially deride as “overpriced,” expensive wines can serve as a signal to others of the buyer’s wealth or social status–therefore, only people who place high value on broadcasting such a signal would be willing to pay for ridiculously expensive wines.

    Thumb up 0 Thumb down 0