Conclusion

The purpose of this book has been to explore wine in America from an economic perspective. The principal goal has been to explain the economic organization of the U.S. wine industry, and how individuals interact and behave in their role as wine producers and consumers. A set of fundamental economic concepts and principles have been used to organize the approach taken to the study of wine. This chapter highlights and summarizes insights from these guiding principles and the results of empirical studies presented in this book.

Economics recognizes that resources are scarce relative to wants and desires, and wine producers and consumers must therefore choose among alternative uses for their money, time, and other resources. Whenever a choice is made, a cost is incurred because a valued opportunity must be forgone. In the world of wine, as well as in every other dimension of life, trade-offs are inevitable. Nowhere is this more evident than in the trade-off between wine quality and cost. Increasing the yield per acre of vineyard land lowers grape cost, but there is a long-standing belief among winegrowers that it also compromises wine quality. Many winegrowers believe that grape quality is sacrificed when adopting cost-minimizing methods of vineyard technology such as mechanical harvesters and machine pruners. The cost of oak treatment can be significantly reduced by maturing wine in a stainless steel vessel with oak staves or chips, but many winemakers believe that more costly maturation in oak barrels yields a wine of higher quality. These and many other perceived trade-offs have a significant influence on grape-growing and winemaking decisions. Unfortunately, the exact nature of these trade-offs is often uncertain.

Economics assumes that given their limited resources, wine consumers and wine-firm owners act in their own self-interest and maximize the satisfaction of their wants by making rational decisions and choosing an alternative only if the benefit outweighs the opportunity cost. Empirical studies of the demand for wine verify that the law of demand applies to the purchase of wine products, and typical wine consumers therefore behaves as though rational when making wine-buying decisions. While many wine consumers appear to make irrational choices, much of this behavior can be explained as the outcome of rational decision-making based on expected benefits and costs under conditions of uncertainty and imperfect information. Obtaining information about wines requires the expenditure of time and money, and rational consumers will therefore acquire more only as long as the marginal benefit exceeds the marginal cost. What appears to be irrational wine-buying behavior is often a manifestation of “rational ignorance.” As the Internet continues to lower the cost of obtaining information, less of this seemingly uneconomic behavior should be observed.

Many wine producers also appear to display uneconomic behavior. Some purposely use cluster pruning to reduce grape yield, even though the cost of doing so may well exceed the revenue gain. Others use oak-barrel maturation, but could make more money by employing alternative oak treatments. Still others choose to invest in a winery and vineyard land when they could generate more profit by purchasing grapes from a commercial vineyard and contracting with a custom-crush producer or investing their financial resources in another line of business. If the objective of the wine-firm owner is to maximize profit, these choices are indeed irrational if the incremental cost exceeds the revenue. However, there is much evidence that many proprietors are willing to trade profit for other sources of utility associated with ownership of a wine firm, such as the status, prestige, and the aesthetic value of producing a high-quality wine, or the enjoyment they get from pleasurable aspects of the wine lifestyle. Proprietors with nonprofit objectives weigh both the pecuniary and nonpecuniary benefits against the cost, and what may appear to be uneconomic behavior is therefore a rational choice. What is more, not only can these non-profit-maximizing wine firms survive in an economic environment with profit-maximizers, but there is some evidence that they are able to outcompete profit-maximizers in the sale of high-quality premium and luxury wines.

To satisfy their wants, wine producers and consumers interact in an institutional setting called the wine market and exchange wine products for money. When making market exchanges, wine firms and consumers incur transaction costs, which include the cost of acquiring information and negotiating and enforcing contracts. These transaction costs, along with production costs, product-quality considerations, and owner preferences, influence wine firms’ decisions in organizing and coordinating the activities necessary to produce and sell wine. Asymmetric, imperfect information and incomplete contracts that do not specify all possible contingencies of an exchange create an economic incentive for wine firms and input suppliers to engage in opportunistic behavior. Opportunistic behavior is more likely when an exchange involves specialized assets and uncertain conditions. This increases the transaction costs of negotiating and enforcing a contract. The relative production cost of insourcing or outsourcing a task is largely determined by economies and diseconomies of scale and scope, and a wine firm’s capabilities, determined by the knowledge and skills of its owner and employees and its endowment of vineyard land and winemaking capital. A wine firm’s capabilities and the degree of control it has over grape growing or winemaking affect wine quality and the net benefits of insourcing or outsourcing. Higher transaction costs, lower internal production costs, and improved wine quality as a result of handling the task internally, rather than contracting with another firm to perform it, increase all wine firms’ incentive to insource grape growing, wine production, or wine distribution. Non-profit-maximizing proprietors also have more incentive to insource wine-related activities that give them personal satisfaction.

In a wine-market transaction, the utility-bearing characteristics of wine products are known to producers but not to consumers until they purchase and consume them. Because of this information asymmetry, wine firms have an economic incentive to provide quality signals to consumers. Without this information, consumers may not be willing to pay a price commensurate with the higher quality of the wine products that many firms offer for sale. To signal quality, a wine firm can build a reputation based on past performance, take actions to establish a brand-name reputation, obtain high scores from wine critics, and provide quality information on a wine label, as well as other ways. Because many consumers rely on established brand names when making wine purchases, brand names are a stand-alone intangible asset with market value that wine firms buy and sell on a regular basis. The economic value of a brand name can be considerable, as evidenced by the sale of the Mark West brand name for $160 million. Wine firms may also engage in opportunistic behavior and attempt to exploit their informational advantage. This may explain why they make systematic errors when providing information about the alcohol content of wine on the label.

The buying and selling decisions of wine consumers and producers give rise to a demand for and supply of wine products. Prices emerge from the market interactions that take place in this institutional setting; these prices make the decisions of wine firms and consumers consistent so that an equilibrium obtains.

The buying decisions of consumers depend upon the price of wine, prices of goods related to wine, income, tastes and preferences, and the sensory and nonsensory qualities of wine. A typical wine consumer is willing and able to buy more at a lower price and less at a higher price. The aggregate demand for all wine products is price inelastic, and the total amount of wine purchased by consumers in the United States is therefore not very responsive to changes in the average level of wine prices. This suggests that consumers do not view beverages such as beer, spirits, and soda as close substitutes for wine. Within the class of wine products, buying decisions are more responsive to changes in red than white wine prices, and the demand for most varietal products is price-elastic, indicating that consumers perceive different types of varietals such as Cabernet Sauvignon, Merlot, and Pinot noir as reasonably good substitutes. Consumer price responsiveness is highest for the individual commodity-wine products of different wine firms because of the large number of perceived close substitutes that are available in this segment of the market. Wine-buying decisions are quite responsive to changes in income. The business cycle has a big effect on wine demand, because consumers want to buy substantially more during periods of economic expansion, when income is rising, and less when recessions occur and income falls. However, the demand for white wine is much more sensitive to cyclical ups and downs than that for red wine. Many consumers view commodity wine and “fighting varietals” as inferior goods and tend to trade down to these lower-priced products during economic downturns, when they have less money to spend on wine, and to trade up to higher-priced “normal” premium and luxury products during upturns, when they have more cash available for wine purchases. Demographic characteristics and health considerations, as well as factors related to taste and preferences, affect wine demand. Married, middle-aged, white professionals consume more wine than unmarried, nonwhite, nonprofessional, older and younger individuals. Some wine-market observers argue that the perception of wine as a healthy beverage is the most important determinant of the demand for wine.

Sensory and nonsensory characteristics related to wine quality also affect wine-buying decisions. Because consumers make buying decisions with imperfect information about the appearance, smell, and taste of wine, they use a variety of nonsensory characteristics as quality indicators to provide them with information about uncertain sensory characteristics. A typical American wine consumer is willing to pay a higher price for wine products that are assigned higher scores by wine critics. Exactly why this is so is unclear. Consumers making first-time buying decisions may use scores to obtain quality information consistent with their preferences, or these scores may persuade them to buy products preferred by the critics. Wine scores may reflect the quality preferences of well-informed consumers making repeat purchases. Consumers may be willing to pay higher prices for wines with higher scores, because they are perceived as more prestigious. All of these are plausible explanations. Consumers use grape location and variety as quality indicators. A typical consumer is willing to pay a higher price for red wine and wine made with grapes that come from geographic locations with a reputation for high quality and favorable climatic conditions such as Burgundy and Bordeaux, the Napa Valley, and Tuscany. Consumers are also willing to pay higher prices for products of wine firms with a reputation for high quality, possibly reflecting viticultural practices, winemaking techniques, and winemakers’ skill. Finally, there is strong evidence that vintage-related weather is an important determinant of wine quality, particularly for age-worthy wines often bought and sold on the secondary auction market. Vintages with warm, dry growing seasons and wet winters tend to produce the highest-quality wine. However, consumers and investors appear largely to ignore information on weather conditions when deciding how much they are willing to pay for young age-worthy wine products on the auction market. It may take a decade or longer for auction prices to incorporate information about vintage-related weather. When age-worthy wines exceed from twenty to thirty years, their sensory qualities may begin to decline. However, wine collectors are willing to pay an increasingly higher price as they continue to age for the sake of the prestige of owning a venerable rare wine.

The selling decisions of grape growers and wine firms are influenced by their profit or nonprofit objectives, available winegrowing technology, government regulation, and the structural characteristics of the market in which they operate. The quantity of grapes that growers supply in the current year depends in large part on decisions they made in prior years. When grape prices in previous years are high, growers have an economic incentive to plant new acreage. However, these new vines do not bear fruit for at least three years. When the grapes from this new acreage are eventually offered for sale in the current year, wine firms are willing to pay low prices because of the abundant supply. When grape prices are low in prior years, growers have an economic incentive to take acreage out of production, which eventually results in a scant supply and higher prices in the current year. As a result, the supply decisions of growers result in a repeated wine-grape supply cycle of rising production, falling prices, and below normal profits, followed by declining production, rising prices, and above normal profits. Because grapes are the most important input used to produce wine, the wine-grape supply cycle can generate wine-supply cycles.

The price and quality decisions of wine firms depend largely on the market environment in which they operate. The commodity segment of the wine market approximates an oligopoly dominated by a small number of large profit-maximizing wine firms such as Gallo, The Wine Group, and Bronco Wine Company, which strategically consider how rivals will respond to their price and quality decisions. They tend to avoid aggressive price competition and are more inclined to compete by building the reputation of their existing wine brands and introducing new brands with characteristics that better satisfy consumer wants. The premium and luxury segment of the wine market, where thousands of profit-maximizing and utility-maximizing wine firms act independently in competition with one another, resembles monopolistic competition. High-end premium and luxury wine products are produced by utility-maximizing wine firms whose owners enjoy making high-quality wine and are willing to trade off profit for the opportunity to do so. Even though they tend to have higher costs and charge higher prices than profit-maximizing wine firms, their willingness to sacrifice profit for quality enables them to drive most profit-maximizers out of the luxury segment of the market. Profit-maximizing proprietors find that they can make the most money by producing lower-end premium wines. The luxury products that utility-maximizing proprietors choose to produce reflect their tastes and preferences as well as those of consumers.

The market for bulk wine is a little known but important submarket within the wine industry. Most wine firms participate in this market, at least on occasion, as buyers or sellers to eliminate a wine surplus or shortage, which inevitably occurs from time to time. Some firms specialize in producing bulk wine, while others use it as a permanent source of wine products. As a result, it allows wine firms to increase production efficiency and offer a wider variety of products to consumers. Foreign producers located in Australia, Chile, and Argentina are important suppliers of bulk wine in the United States. A number of retailers demand bulk wine for their private-label products. Private-label wine is a fast-growing segment of the wine market and an increasingly important source of business for wine firms. Private-label wine simplifies wine choices for consumers with limited information who must select a wine from the large number offered for sale on the retail market. Many consumers view the private-label brand name as a signal of consistent quality at a bargain price. The most prominent example is the Charles Shaw wine sold by Trader Joe’s supermarket, which has won a number of medals at wine competitions and can be purchased for as little as $1.99 per bottle in California.

Middlemen and information specialists such as brokers, distributors, retailers, fulfillment agents, and wine experts perform valuable economic functions by organizing the wine market, reducing transaction costs, and creating information to facilitate exchanges between producers and consumers. The information specialist that has received the most attention is the wine critic. The role of this expert is to perform a sensory evaluation of wine products to determine their quality. Information on quality is then provided to consumers in the form of a description of a wine’s sensory characteristics and a quality score. However, the value of this information to consumers is unclear. Studies suggest that the preferences and quality ratings of consumers are often significantly different from those of experts. Moreover, experts are often inconsistent in the quality scores they assign to the same wines, and different experts assign significantly different scores to identical wines. It may be that wine critics provide little useful information to consumers in choosing the wines they prefer. The biggest impact of wine critics may be to affect and shape consumers’ wine preferences, and by doing so create a demand for wine products with characteristics that the critics themselves prefer.

Left to its own devices, the market for wine may fail to achieve an efficient allocation of resources. The major reason is that the benefit that accrues to individuals who transact in it may exceed the benefit to the nation as a whole because of the existence of external costs wine consumers impose on other members of society. Wine is an alcoholic beverage and heavy consumption of alcohol results in automobile accidents, violent crime, child abuse, disorderly conduct, and lost productivity. This provides an economic rationale for government regulation of the wine market. However, regulation itself can be viewed as an economic good. The regulations that are instituted are the outcome of the interaction of demand by special-interest groups and supply from legislators, both of whom are rational and act in their own self-interest. As a result, government regulation may enhance the welfare of particular groups at the expense of wine consumers, and possibly reduce socioeconomic welfare. While the original intent of government regulation of the wine industry following the repeal of Prohibition may have been to enhance social welfare, there is little evidence that states have been pursuing the public interest in instituting wine regulations over the past fifty years. The vast majority of these regulations appear to be designed to benefit special-interest groups like distributors, retailers, and in-state wine firms at the expense of consumers by inhibiting competition and improving the profitability of wine suppliers. It has become increasingly difficult for regulators to justify treating wine as just another alcoholic beverage like beer and spirits, because many people choose to consume wine as part of a healthy lifestyle. Moreover, there is reason to believe the external cost of wine consumption may be smaller than it is for other alcoholic beverages. A compelling argument can be made on economic grounds that the public interest would be better served by modifying or repealing many existing wine regulations, the cost of which to the nation exceeds the benefit.

Today, the U.S. wine industry is part of an integrated global wine market. Much of the world’s wine is produced in one country and consumed in another. A variety of wine products, including global wine brands characterized by an international wine style, are available to consumers worldwide. A host of multinational wine firms and winemaking consultants operate in multiple countries, spreading the latest winegrowing technology. One of every three bottles of wine consumed in the United States is an imported product, and retail store shelves are filled with wine from all over the world. Not only do U.S. wine firms compete indirectly with imports, they compete directly with foreign wine firms that own wineries in the United States. Three of the eleven largest producers in the U.S. wine industry operate under foreign ownership. Wine exports account for twenty cents of every dollar of wine sales, and foreign consumers purchase about one of every seven bottles of wine produced in the United States. Wine firms in the United States own wineries in countries around the globe, and many U.S. winemakers are also international wine consultants. From an economic perspective, the globalization of the wine market and increased foreign competition have made U.S. wine consumers better off, because they have a wider choice of wine products of improved quality at different price points, giving them a “bigger bang for the buck.”

Wine can be, and has been, studied from a number of perspectives using different approaches. These include historical, cultural, sensory, legal, political, and business orientations. This book has investigated wine in America from an economic perspective, applying concepts and principles that define the economic approach to the study of organization and behavior. It is my hope that this approach, along with the accompanying descriptive material, have contributed to the reader’s knowledge and understanding of the fascinating subject of wine and the U.S. wine industry.