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Does the Wine Industry Sell Lemons? Adverse Selection in the Wine Industry 2 nd Int’l Wine Marketing Symposium July 9, PowerPoint Presentation
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Does the Wine Industry Sell Lemons? Adverse Selection in the Wine Industry 2 nd Int’l Wine Marketing Symposium July 9, 2005 Robert Eyler Department of Economics Sonoma State University eyler@sonoma.edu Introduction Wine Industry Economics revolve around niche

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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

eyler@sonoma.edu

introduction
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
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
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 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 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
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
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
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?