Does the Wine Industry Sell Lemons Adverse Selection in the Wine Industry 2nd Intl Wine Marketing Sy

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Does the Wine Industry Sell Lemons?Adverse
Selection in the Wine Industry2nd Intl Wine
Marketing SymposiumJuly 9, 2005

• Robert Eyler
• Department of Economics
• Sonoma State University
• eyler_at_sonoma.edu

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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.

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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

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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.

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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.

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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?

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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.

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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?

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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?