Margin Call: a Few Thoughts on Pricing and Profit

Robert Joseph questions the way wine is priced, and some lessons the industry might learn from Starbucks.

Reading time: 4m 30s

If Starbucks made wine...
If Starbucks made wine...

Given the number and range of topics about which people argue, it’s always good to find one on which almost everybody will happily agree. Just say the words ‘restaurant wine mark-ups are outrageous’ and I can pretty well guarantee that you’ll find no dissent.

I have to confess to being fascinated by profit margins of every kind – from the ones applied to skimpy underwear, Evian water and Gillette razorblades, to the razor-thin or frankly non-existent examples applied by retailers when trying to attract customers into their stores.

And I’m just as fascinated by the varying responses we all have to those margins. How often do the people who chorus their annoyance at restaurants multiplying the price of a bottle of wine by three or four times, pause to consider the multiple that’s applied to the salad or omelette they eat without complaint? Or the gap between the 31 cents worth of coffee in a Starbucks cappuccino and the $3.65 you pay for it.

How many who criticise the best-selling ghosted celebrity biographies and trash novels in a bookshop window consider the role those profitable items have in subsidising all the loss-making, beautifully written books you and I might prefer to read?

Science or Art?

Most successful retailers and producers understand that pricing products is – or should be – a science that involves the broader profitability of a business.

The supermarket chain offering ludicrously cheap Prosecco, for example, is banking on shoppers also picking up some highly profitable chocolates or detergent. The ludicrously-priced $50,000 handbag’s only role is to boost sales of the ‘attractively-priced’ $25,000 bag sitting beside it in the same store.

Charging a high price for something in order to make potential buyers value it more is a classic strategy, but even the rich and extravagant like to imagine that they’re not heedlessly profligate.

Buying the ‘cheaper’ bag may not be a logical action of course, but even at less lofty prices, how many people really apply logic when spending their money on non-essentials?

There is no rational reason to buy a $40 bottle of Grande Marque Champagne when qualified tasters have established that a $20 supermarket own-label effort tastes as good or better. But plenty of people do. Because it makes them feel better.

Much of the traditional wine industry often prefers to ignore these questions. Ask most European producers, in particular, how they chose their price of a particular wine and they’ll more than likely either reply that they added a basic percentage to their production cost, or chose a figure that was comparable to what their neighbours charge.

Flawed Model

Neither of these models is ideal for an agricultural product whose production volumes – and quality - may vary enormously from one year to the next. Making €1 per bottle may work perfectly well when you are selling 100,000 – but not when nature only allows you to make half that many.

But they are flawed for other reasons. Wine producers are not competing on a level playing field. A big European cooperative – or a merchant buying from one - may have a far lower cost base than a small family estate in the same appellation. Producers paying off loans taken out to buy vines and build wineries are up against others with inherited land and facilities. And, in any case, even when lower yields and new oak barrels are taken into account, the difference in the cost to a producer of producing a basic village Burgundy, for example, and a Grand Cru bears little resemblance to the retail prices the two wines will command.

You can spend the same amount producing wine in Moulis as in Margaux a few kilometres up the road, but you’ll struggle to get anyone to pay you as much for it, even for owners with ambitious standards, deep pockets and professional marketing skills.

But, in any case, most of us aren’t fortunate enough to have vines in Margaux or a Burgundy Grand Cru, or possibly even Moulis, so it’s not a question on which we have to linger for very long.

But  when a brave producer outside those areas has the temerity to charge a higher price than their neighbours, there’s a strong likelihood that eyebrows will be raised – as they were, for example, when Gérard Bertrand launched Languedoc single-vineyard red and rosé wines for which he wanted over $100 a bottle.

Interestingly, the people questioning whether these wines were really worth that price were not only critics doing their job. It was also professionals, including other producers and distributors who might be expected to welcome the notion of making more money in a part of France that has always struggled.

Both wines are actually very good. They’re probably not twice as good as examples selling for half the price, but I doubt that will matter to the people who’ll happily buy them with their spare change, rejoicing in their purchase of something rare and expensive.  

You Had Me at Halo

Just as important for Bertrand is the halo effect these wines will have on the others he makes and sells in far larger volumes, and at far more affordable prices. Those super-premium bottles few will ever even see, let alone sample, may make it easier to charge an extra euro for the Corbières and Minervois and IGP d'OC rosé that actually pay the bills.

But it’s not just the halo effect. Even within an apparently similar range of products – like wines from the same producer - some can carry higher margins and, just as importantly, bigger price rises, than others.

Last year, Starbucks raised its prices in  the US by an average of one percent. If a 1992 study of 2,463 companies by Michael Marn and Robert Rosiello (published in the Harvard Review) is to be believed, this apparently tiny change will be enough to yield an 11% hike in overall operating profits. But the increase was not applied across the board, and many customers may not even have noticed it. In some regions of the US, prices didn’t change at all, while in others only a third of the coffees became more expensive - principally the smaller servings, some of whose prices leaped by 10%. Increasing the cost of these not only made them more profitable in themselves; it also helped drive customers to switch to the higher-margin larger cups.

How many wine companies understand their customers well enough to apply this kind of sophistication to their pricing strategies? How many would like to enjoy the same kind of profitability as the coffee giant?.

Those ‘excessively marked-up’ small cups of cappuccino are performing precisely the same task as the apparently overpriced bottles are doing for restaurateurs who have to bank a certain amount of cash every week simply to rent, heat and light their establishment and to pay their staff.

Of course, we’d all love it if the Chablis on our restaurant table only cost twice as much as it does in the shop on the corner, but for a restaurant that wants to survive, cutting the margin on wine would only mean raising it on something else. Like the salad, for example. And I’m sure we’d all agree on not wanting to pay more for our Niçoise, Caesar’s or Waldorf.

 

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