Does the Wine Industry Sell Lemons?Adverse Selection in the Wine Industry2nd Int’l Wine Marketing SymposiumJuly 9, 2005 Robert Eyler Department of Economics Sonoma State University email@example.com
Introduction • Wine Industry Economics revolve around niche • Marketing key in this industry for three major reasons: • Many beverages outside the wine industry to from which to choose; • Many wineries competing for the same shelf space and consumer; and • Global competition and markets on the rise.
Adverse Selection • Quality is a constant worry for winemakers • Change in quality can immediately change consumer tastes. • Many substitutes for specific wines. • Reputation seems to be a larger focus. • All wineries preach high quality in their wines • What rational winery would say their wine was “low” quality? • Given this, consumers face an adverse selection problem. • Consumer does not know ex ante wine quality. • Imperfect information exists concerning wine quality
Adverse Selection (cont.) • “Lemons” Problem • Akerlof used-car market, no equilibrium exists due to lack of information. • Consumer “adversely selects” car, and thus demands a lower price to compensate risk. • Applications widespread • Finance and Labor markets the most abundant • Spence (1973), Rothschild and Stiglitz (1976), Stiglitz and Weiss (1981), Shapiro and Stiglitz (1984), seminar in their fields.
Signaling using Wine Tasting Scores • Signaling a large part of the producer avoiding the adverse selection problem. • Without it, adverse selection should lower revenues for firms. • Signaling provides consumers with some knowledge of quality • Much like labor markets, where worker signals to firm. • Seller signals buyer in hopes of not lowering price.
The Model • The price of a wine, especially inside a certain price point, is determined by quality. • The average quality is what the consumer is willing to pay when quality unknown. • Under these conditions, no equilibrium exists. • In the wine industry, quality information does exist • Can it be used to increase price, if perceived as a positive signal?
The Conundrum • If wineries pay for third-party quality assessments, must expect some return. • Price increase, increased sales, or both must outpace cost of tastings. • If average consumer uses this information as a signal of quality, return to wine tasting results should exist • The “signal” differentiates one wine from the other.
Separating Equilibrium • What every winery wants • To price based on perceived quality • Consumer tries to maximize utility, based on info. • Low quality wines separated from high quality based on signal? • This is the big question • Theories from other markets help provide some insight • In labor, market may be better or worse with signal. • In finance, market generally better off with signal. • Are efficiency gains guaranteed?
Questions and Conclusions • Do signals in the wine industry provide wineries and consumers with efficiency gains? • Do media sources, online and print, provide appropriate market signals? • Publications, like the Wine Spectator, operate in a signaling market • Is this market efficient? • What are the threshold scores for the average consumer? • Do wineries have power to change price when this signal is provided?