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.


Garrett Pendergast

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

azmyth

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.

John, Boston

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.

Read more...

Tristan

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.

William G

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.

Erik

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.

Pete

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.

David L

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.

Read more...

David L

To clarify my post above:

"becomes more expensive to produce" = "becomes more expensive to bring to market"--inclusive of marketing costs.

David L

Also, what the hell are you proposing--legislation to put a ceiling on the market price of certain wines?! I assume not. Short of something astonishing like that, wine sellers and buyers will continue to sell and buy wine just as they always have, so why are you complaining? If you don't want to buy expensive wines, then don't. If others do want to, then they are obviously happier with their $100 bottle of wine and without their $100 that they would have been vice versa, so who are you to tell them they should contrain their utility?

Todd S

Don't some of these assertions assume that *quality* is dependent on *cost of production*?

For example: say a baker makes one cake by training white tigers to mix together the ingredients, and another cake by using modern kitchen equipment. The first cake is full of tiger hair and poorly put together, while the second tastes objectively better. The cost of production of the first cake is higher, but that doesn't mean I will be willing to pay more for it.

I agree with most of the points in the article, but disagree with the main point that cost should be the only indicator of price. Because wine-making is more of an art than, say, papermaking...taste and quality need to be accounted for independent of production cost.

That being said, I tend to drink delicious cheap wine too...

Brenner

So, if you worked at a wine company, are you really saying that your company should price their wine far lower than consumers are willing to pay? That's not very good economics, is it?

Perception is reality for consumers. We wouldn't buy an expensive wine if we didn't think it was worth it. In cases of highly expensive wines, you also have to account for the psychological benefit that the buyer receives.

We are not robots and our purchases are not made in a vacuum - we respond to products that tell a good story, that make us feel good, and that we want, not just need. The utilitarian value counting that you seem to be engaged in does not begin to describe why people buy the things that they do.

Respond on Twitter @BrennerHeintz if you please.

PT

But you're taking away the impact of present recognition of value on future values (as in critical acclaim), as well as the often decoupled real estate price factors on production, often based on trends unrelated to agriculture.

Demand-based pricing works just fine in my opinion. It provides the seller/producer the potential for a significant upside with good wine, which is motivation for improvement. It also allows semi-trained wine drinkers like myself the ability to play the market fluctuations. I have no problem avoiding the trendiest brands in my quest for value -- it enables me to broaden my palette by trying new wines more frequently. And on the flip side, there are cases where a great vintage suddenly jumps in value, which protects some true connoisseurs from the average un-appreciating market from picking up sale bottles at the grocery store and causing a dwindling supply.

R2D2

So Robin, you are saying that the current pricing of wine is somewhat "artificially" way too high. Since there are not many wine makers, and entry to the wine-making industry is restricted, this is extremely profitable for the wine-makers. If you were a wine-maker, you would be extremely happy. We, as smart consumers are sad (not so smart consumers just take for granted that that's the cost). We can do something about it though. Since relatively no other firms can enter the market to bring the price down, we can behave as consumers that live in "camp 1." If we purchase wine based on what they cost to produce (buying the cheap wine, which actually reflects cost), wine-makers might be forced to lower their price on overpriced wine.

Thank you Robin, for enlightening us; therefore shifting the artificially high demand curve leftward little by little. To attempt to inform each and every single consumer, until price reaches where it is supposed to be.

PS: Advertisement has been doing a great job at "brainwashing" us the idea of "This wine is SO good! You must have it! Show it off!"

Read more...

htb

to John, Boston (@3):

That's just the point: There *isn't* "good knowledge transfer to the purchasing public". Furthermore, there can't *be* good knowledge transfer, because whether this wine or that wine is better is a highly subjective, personal, context-dependent question.

For example: I encountered red wine that I find essentially undrinkable. It is dramatically improved when paired with a bit of chocolate.

How much is that wine worth? My answer ranges from "you'd have to pay me $5 a glass to drink it by itself" to "I'd pay a total of $10 for a half-bottle and a large candy bar."

My husband, on the other hand, is quite happy to part with $20 to get a half-bottle.

What's "the" answer? The retailer can't very well set a different price for each customer, and knowing what I think of it doesn't really help you figure out what you are willing to pay for it.

Kevin

Market factors will ultimately determine the price of wine, but the difference is the starting price point. Many winemakers price their wine to be compared to other wines (bargain, mid-priced, luxury, boutique, cult, etc.) If enough consumers accept their price model, the winemaker will be successful. If not, they will be forced to discount their price or accept lackluster sales (meaning future vintages will be harder to sell).

Another factor in pricing is the cost of production can vary greatly from year to year (higher/lower yields and quality due to weather and other factors). Winemakers try to balance these in their pricing.

Ultimately, my take is that it is easier to find a good $30 bottle of wine (or higher), but their are equally as good bottles to be found for far less.

Matt

Who will stop these robber barons from conning wine snobs? Won't someone think of the snobs?!

Christophe

The value of a thing is what a fool will pay for it. End of story.

Todd

Your two schools of thought are actually the same, if you don't assume "the market" as one entity, but millions of individuals. Some are gullible and will pay more for the same wine, and some aren't - either way, the price of the wine is what that part of the market is willing to pay.

From a non-expert perspective, I have always suspected that the additional quality per dollar added to a bottle of wine declines rapidly after about $8/bottle (by the case)

If more people thought this way, all the additional marketing money they spend wouldn't be worth it, and they would stop charging crazy prices.

Tristan

From the intro I'm guessing that Robin usually get's people all in a tizy by suggesting that they can't judge the quality or value of a wine very well - that they're being duped and paying too much. At least here he gets the chance to get people all worked up a different reason, saying that we shouldn't let people who can't judge the quality of wine (either from lack of infomation or lack of taste) pay too much.

Plus, two of the funniest comments of the day. Who will think of the snobs? and white tigers baking cakes.