Pricing strategy for wine in today's marketplace

Wines & Vines, March, 1994 by Carl R. Dillon, Justin R. Morris, Carter Price

Ultimately, the pricing strategy used for marketing wines should be a function of the demand for wine. Consumers are not directly concerned with the cost structure inherent in producing a commodity they are interested in purchasing. However, the manager of the winery is concerned with the underlying profits and must therefore consider cost alterations in their marketing strategy. Especially to the extent that increased costs influence the price of all wines, the decision-maker attempting to price wines should reflect the alterations in cost resulting from different technological and economic conditions.

As the managers of wineries are well aware, the prices of grapes and other raw materials are not stable but fluctuate from year to year. In addition, alterations in grape yield per acre or wine yield per ton of grapes represent technological factors which fluctuate substantially across years and across wineries and winery equipment. Whether price variations come explicitly from direct purchase of grapes or implicitly from the technological side through fluctuating yields in the winery's vineyards, the underlying economic cost per bottle is affected. In addition to grape prices, changes in other input costs (e.g. - corks, labels, bottles) can have a significant effect on underlying cost to production. The purpose of this research study is to provide basic wine pricing guidelines to managers of wineries based upon the effects of several factors (grape prices, other raw material prices, advertising expenses and wine yield per ton of grape) upon average cost per bottle and overall net returns.

MODEL DESCRIPTION AND EXPERIMENTS

In this study, the decision-making environment facing the manager of a small winery is represented within an economic model. Mathematical programming techniques common to agricultural economic analysis are used to develop the computer model which projects realistic alternatives. The model's objective is to maximize net returns above total cost by choosing the optimal levels of management decisions. Readers interested in more detailed discussion beyond what is provided herein may contact the authors or refer to previously published, related articles (Dillon, Price, and Morris; Dillon, Morris, and Price).

Optimal levels of various production and marketing decisions are chosen by the mathematical programming model. The majority of the relevant decision-making activities within the model are: (1) the quantity and timing of the purchase of the various grape cultivars, (2) the quantity and timing of production of the various wine varietals, and (3) other input purchases and (4) wine sales. Several technological and marketing limitations are also imposed upon the model. These constraints included in the model are: (1) juice yield from grape crush, (2) maximum and minimum percentages of sales volumes, (3) maximum retail sales usage, (4) appropriate wine-aging requirements and (5) the need for adequate equipment capacity, labor and supplies.

Four different white wine varietals (i.e.--Chardonnay, Vignoles, Riesling, and Vidal or Seyval) and two different varietals of red wine (i.e.--Cabernet Sauvignon and Cynthiana) are reflected within the model. To increase the generality of this study, Cynthiana can be viewed as a red wine vinifera which is common to the local environment for the winery in question. This study includes case scenarios for four winery sizes with annual fermenting capacities of 40,000; 20,000; 10,000 and 5,000 gallons.

Base case results for a standard situation are presented next. After a brief discussion of the production and marketing strategies for the base case scenario and the resulting economic consequences in terms of net returns and costs, the computer model is rerun under several experiments to represent alterations in the economic and technological environment faced by the manager of the winery. Sensitivity of the economic results to the technological factor of wine yield per ton of grapes from the base wine yield of 165 gallons per ton of grapes is studied first. The combined technological and economic component of grape prices is studied next including the economic effects of individual price variations for red wine grapes, for white wine grapes and for all grape prices. Next, the effects of alterations in the base advertising expense assumption of 5% of gross revenue upon net returns and average cost per bottle is examined. Finally, the effects of other raw material product prices (e.g--corks, labels, glass bottles) are discussed.

RESULTS FOR THE BASE CASE

The base case scenario projected winery sales of 60% in white wine and 40% in red wine. The most popular varietal wine, Cabernet Sauvignon, accounted for 30% of total sales volume for all winery sizes. Net returns above annual costs were forecast to range from $4,491 for the 5,000 gallon winery to $59,906 for the 40,000 gallon winery for the base case (Table 1, 165 gallons/ton column). These results highlight the potential profitability of a winery because the objective function considers all expenses including personal labor and capital and excludes only taxes on inventory and income. The returns to capital were also quite favorable at 2.95%, 7.05%, 5.77% and 6.13% for the 5,000 to the 40,000 gallon winery sizes respectively. With sales projected to be 100% retail and a relatively labor intensive operation, the 10,000 gallon winery model results were the highest return to capital.