Economics and Wine Prices

Robin Goldstein (author of The Wine Trials 2010) in the New York Times Opinion section, responds to some criticism regarding his position that high wine prices are often unjustified.

While certainly price and quality are not necessarily related, Mr. Goldstein shows a common ignorance of Economics in his argument for pricing wines based on the cost of production.

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.

That there is a ‘first camp’ at all is an indicator to me that too many people don’t get enough (any?) exposure to fundamental Microeconomics. You don’t need to take an advanced price theory course (although that was the most fun I had in a college course, with everything taught in terms of beer and pizza) to understand how prices are set.

The price of a good is the amount of money a seller is willing to accept and a buyer will pay for the next unit. Marginal cost and marginal utility are the primary considerations, and it’s important to recognize that these two things are not the same for each unit sold, nor are they the same for every seller or buyer. I may be willing to spend $120 on a bottle of Silver Oak and you may consider it overpriced backwash; but I put a value on the memory of our trip to Napa that included a stop at Silver Oak, I put a value on how nice they were, how much fun it was, and that I like that style of wine. You might have a similar reaction to a winery you visited on a trip to Bordeaux when you were in college with that really cute little read head. The utility of a good (in this case, wine) isn’t just what’s in the bottle. The market is built upon all of those individual choices and transactions, and prices are set to clear the market; to find the spot where the supply and demand curves cross.

Goldstein goes on to suggest pricing should be based on the cost of production, marketing, and distribution, with a little profit on top.

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.

There’s the fundamental hole in the argument: this approach sets prices that are incorrect, and that will create either shortages or surpluses (primarily shortages). The other hole in the argument is that it directly contradicts his issue with the high cost of marketing some premium brands. Marketing is a cost of production, isn’t it? While he may think it doesn’t make sense to spend money marketing premium brands, the brand itself is also part of marginal utility. Don’t you think impressing clients at a business dinner by pulling out the corporate AMEX and dropping $300 on a bottle of wine has a value to some people? Trust me, it does.

I agree that many wine prices seem unreasonably high and not related at all to the quality of what’s in the bottle. So I don’t buy wines I think are overpriced. In fact, I’m ordering Goldstein’s book today; I’m quite excited to try some inexpensive highly rated wines! As more consumers become more educated* and come to the same conclusion, those lofty prices are sure to come down. If they don’t, that just means there’s someone, somewhere, willing to pay that price, and at that price, the producer sells enough wine.

*I am not suggesting I am some elitist wine snob, but that even just a little exposure to good and bad wine at a variety of price points will teach anyone that price and quality are not necessarily related.

Crossposted at The Grand Crew