Why would you want to invest in wine?

It doesn’t take a finance savant like Geordie to see that the wine industry usually doesn’t make for great investments. It’s like we learned on the first day of class: “the best way to make a small fortune in the wine industry is to start with a large fortune.”

Then why invest? One of my key takeaways from this class is the importance of “non-economic” or “non-market” objectives of firms in the wine industry, informed both by class discussion and Chapter 9 in “American Wine Economics”, about “The Wine Firm”. 

As the book discusses, wine firms that are "legally organized as a public corporation, such as Constellation, Treasury Wine Estates, and Diageo” can reasonably assumed to have a profit maximizing objective. For all others, though, they get utility through non-profit motives like nepotism, pure quality of the wine, artistic expression, status and prestige, wine philosophy and style, and lifestyle (list culled from American Wine Economics). At the very least, the evidence shows that most winery owners make tradeoffs between these incentives and the profit incentive (my favorite statistic was that 80% of owners wouldn’t sell their wineries if they could make more investing in the stock market). 

Another theory is that owners might care less about profits in part because they don’t need the money. It’s no secret that wineries are run by very wealthy and privileged families. While owners of other businesses and real estate in the US are also generally wealthy, it’s more democratized (the US was built by small business owners and small-time land owners). Wineries seem to be less democratized – the families that own wineries, of course, typically have enough to have a good lifestyle without making a killing on the winery. 

Regardless, if successful, the life of a winery can be long, and pass through many stages and generations. Mondavi was a great example of this. It started as a small family operation, expanded over many years, and eventually went public. One day Mondavi was a family winery, and the next it was publicly owned, and one of the “leagally organized public corporations” that American Wine Economics describes. The real challenge with its transition is understanding what its values are at every stage. Could it really retain its originally values and objectives as a public company versus when it was a small family winery? Probably not. But it’s hard to know when to clearly shift directions, especially in family businesses where the “changing of the guards” is a very slow and influenced process.

Maybe I’ll be wealthy enough to one day (a) not worry about profit and therefore (b) start a winery. However, making a big profit elsewhere and using it to buy whatever wine (and vacations to wineries) you want seems like a pretty good deal, too.  

Revisiting Georgian Wine

Almost a month ago, Carrie and I delivered our presentation on the Kakheti region of Georgia as an emerging wine region that could be important for years to come. Some of the things we highlighted were: the country's historical importance as a former country under Soviet control and its historical importance as one of the earliest wine producing regions, the unique style of wine making the country uses (qvevris) and the sheer amount of economic investment that the country is making in the region as it tries to double down on tourism as a source of revenue.

Recently, a friend sent me a documentary called "Our Blood is Wine," by director Emily Railsback. She spent time in rural Georgia exploring the wine making traditions and culture that had almost been destroyed by Soviet rule. The film highlights many of the things Carrie and I discussed in our presentation. However, the documentary also highlights a fact that we didn't know: only one percent of the wine that comes out of Georgia is produced through qvevris. The fact is that most of the bottled exports are produced in accordance with more modern wine making traditions.

The simple reason is that qvevri wines are simply not suited for mass production. The more complicated reason is that the Soviet Union seized control of the land and brought the vineyards in line with more familiar forms of global wine making, with near rows and vines that can be easily harvested by machines.

What's interesting is not so much that this happens but how this may change the country's brand as a historical wine making region. One of the key selling points for Georgian wine is the uniqueness of its wine making process using qvevris. It will be interesting to know how the country's image changes with this fact illuminated.

Wine vs. Beer | Nature or Nurture?

Many surveys of men and women find that on average, men have a preference for beer, while women are more likely to enjoy wine and liquor.  These studies are rightly criticized for failing to control for the socialization distortions inherent in survey studies:  people are often embarrassed to display their true feelings to a surveyor, so instead supply the answer they suspect the surveyor expects.

A study in the journal Addictive Behaviors uses a different mechanism to parse inherent preference from socialized expectation.  The Implicit Association Test (IAT) uses behavior to infer how closely an individual associates herself with a particular stimulus (such as wine or beer) instead of asking directly. 

The 2012 study involved 300 undergraduates aged 18 to 25 and asked them to quickly identify images and words associated with different types of acohol (wine, beer, or liquor).  The faster they identify the alcohol, the closer the association.

The study found that these implicit associations matched the stereotype: women were more closely associated with wine and liquor, while men were more closely associated with beer.  This suggests (but does not prove) that the preferences may be innate.

The original study can be found at the link below.

https://www.sciencedirect.com/science/article/pii/S0306460312001256?via%3Dihub

Wine Subscriptions & the NextGen Critic

Without giving away too many spoilers, our final project will involve a wine subscription service. One of the most famous recent subscription services is MoviePass, a company that allows you to see unlimited movies in theaters for $9.95/month. How can such a company possibly make money, when the average price of a single theater ticket is greater than $10 in many cities?

Part of the answer, according to this article, is that MoviePass doesn't need to be profitable on individual customers. Instead, they're amassing a treasure trove of valuable customer data -- which demographic groups are flocking to which movies, and when?

A wine subscription service that sold its product to customers at or near cost would also amass valuable customer data. It could understand which wines are currently trending at restaurants and with consumers, and pair that with demographic data. Part of Google's appeal is to understand what consumers are searching for at a given moment, while Facebook's appeal is to pair customer demographic data with product interests. A wine subscription service could potentially collect both demographic and temporal (timely) data.

Up-to-date information on customer trends -- both what your friends and influencers are drinking, and what the hottest restaurants are serving -- could provide transparency in the industry and eventually supplant critics like Wine Spectator or Wine Advocate.

Why Do We Regulate Wine?

In many ways, our class has been an exploration of the failures of regulation in the wine industry.  Our first guest from a winery, Caroline Wente, discussed her frustration with the outsized power of distributors largely attributable to their favorable regulatory position.  Tracy Genesen litigated a case before the United States Supreme Court successfully loosening the states’ vice grip on out-of-state imports.  Ann Baum contributed a great blog post called "Canned Wine -- More Obscure Regulation Hampering the Industry."

All agree that without the labyrinthine framework of state, federal, and Constitutional law to deal with, wine would ship more freely to more people, and producers and consumers would be better off.  So why do we regulate wine?

James Thornton, in American Wine Economics, sets forth an economic and public interest theory as to why we regulate wine.

From an economic perspective, Thornton raises three justifications for government interference with the wine market.  First, wine creates externalities.  A consumer who enjoys a bottle of wine at a restaurant then causes an accident while driving home due to her impairment does not internalize the cost of her actions absent perfect insurance markets.  She pays for the price of the bottle, but not for the medical costs and repairs associated with the accident.  Extrapolating from this example, these externalities indicate that too much wine would be produced and consumed in the United States without regulation.  Tools like taxes and regulatory restrictions allow the government to bring consumption back in line with the socially optimal level. This is illustrated by the graph below where the PMB line indicates demand with externalities, and the SMB line indicates demand with the costs of such externalities internalized by the consumer.  The dead weight welfare loss created by the difference between these two lines is indicated as well.  Regulation, when done correctly, can bring these two curves closer together, and bring society to a more optimal place.

Second, to make the rational choices that lead to efficient markets, consumers need cheap information.  If they do not have access to complete information or are not able to understand it, they will make irrational choices.  For example, if people are unaware of the health benefits of drinking wine in moderation, they may abstain, which would lead to higher healthcare costs.  The government can intervene by investing in research and publishing information to educate consumers.

Finally, Thornton points to the antitrust case for wine regulation.  Absent interference, producers, distributors and retailers may engage in anticompetitive behavior and gain damaging market power. 

Our current system of regulation may succeed on the first and second poinst but fails on the third. 

Regulations and taxes certainly increase the cost to the consumer of drinking wine.  Quantifying whether the level of cost increase is in keeping with the actual externalities associated with drinking wine is challenging, but it is likely in the right direction.

On the information production front, government regulations do require wine manufacturers to state the risks of drinking while pregnant and of operating heavy machinery while inebriated.  There is also much public investment in consumer education about the dangers of drinking and driving.  The public media takes care of informing readers about new studies about the health benefits of wine in moderation.

Finally, the system utterly fails on the antitrust front.  The wine wholesaler market is dominated by Southern Glazer’s, and revenues at the top three wholesalers equal half the total value of the U.S. wine market.[1]  The market power effects of this structure are evident at every tier of the United States system.  However, contrary to the tone of our class previously, this may call more government involvement, not less, in the form of antitrust action.

---

[1] https://www.forbes.com/sites/thomaspellechia/2017/09/20/revenues-at-three-wine-distributors-tally-almost-half-of-the-u-s-wine-market-value/#37b43113299f

Is wine tasting a sham?

The most surprising article from this class was from two weeks ago by Roman Weil: "Debunking Critics' Wine Words: Can One Distinguish the Smell of Asphalt from the Taste of Cherries? (No Accounting for Taste)”. In it, the author, who is Co-Chair of Oenonomy Society of the US, gives empirical evidence that wine drinkers cannot match wine with professional tasting descriptions any better than guessing at random. He goes on to say that "Wine words used by critics to convey analogy to fruits, vegetables, minerals, and odors are worthless.”

Secretly, I found this article satisfying. In part, this is because I often struggle to match tasting descriptions to wines, and end up caving in and just going along with things. This research suggests that it’s not just me. So that’s nice. But how can an entire army of professional tasters and sommeliers be using words that are “worthless”? 

This article is all the more interesting when juxtaposed with the speaker for that class, Alder Yarrow, founder of Vinography.com. He is clearly very passionate about tasting wine, and has built an entire website and following around his tasting descriptions. His commitment to tasting notes comes through in the wallet-sized cards that he handed out in class, which state, “We can taste so much of the world in a bottle”. Can he really taste anything in particular in a bottle? Or is he just guessing at random?

Maybe it doesn’t matter. Maybe the experience of trying to match flavors in wine with flavors in the world is the real experience. Perhaps that is why on the Vinography.com tasting cards he handed us, they also say, “Words are not an end to themselves. They are merely tools for describing experience, for telling stories, and for creating memories.