Cracking the Coffee-Wine Paradox

My last post, Starbucks and and Coffee-Wine Paradox, raised questions about the relative price of wine. We think of coffee as being expensive, especially coffee drinks at Starbucks and other gourmet espresso bars. But compared to wine they seem like a bargain.

You can get an excellent coffee drink for less than the cheapest glass of on-premises wine. And the price difference between generic coffee and the best (a factor of 16 according to a Decanter article) looks great compared to wine, where the cheapest bottle costs a couple of bucks and there’s almost no upside limit.

Coffee and wine are both simple quotidian pleasures (or should be). Why are their relative prices so different? Several readers and colleagues offered answers to this question.

Cost Plus Wine

Suggestions (click on the article link above and scroll down to the comments section) focused on cost differences . Coffee is cheaper to ship and store, for example, and as Rob Boyd pointed out coffee isn’t typically aged for years like red wine, which increases cost.

Wine is typically bottled at the source, so to speak, which also contributes to the cost difference. Weight gets added relatively early in the wine supply chain whereas coffee gains weight at the point where it is combined with water, brewed and served — a real advantage. “If coffee was brewed in Colombia and then shipped to Starbucks around the world,” Steve DeLong wrote, “the price would be astronomical.” (See note below.)

Steve also had the insight that, while Starbucks-style coffee products are pretty labor intensive to make, this cost also comes at the final stage of production, whereas wine’s high labor costs come much earlier and are magnified by multiple mark-ups in the distribution system. An additional  dollar of labor in the cellar translates to maybe $2 higher retail price for wine here in the US with our three-tier distribution system. An extra dollar of barista wage cost at the end of the coffee product chain has less of an impact on price.

Cost and Price

The comments I’ve received go a long way toward unraveling the paradox. As I expected, however, most people try to solve the puzzle on the cost side — focusing on why wine costs are relatively higher than coffee costs. These are good answers, but it is important to consider the demand side, too. Everyone knows that some prices are determined by production cost, but others are dictated by what people are willing to pay.

Cost rules in highly competitive markets, where products are undifferentiated and good information is readily available. Willingness to pay is more important in imperfectly competitive markets with highly differentiated products and asymmetric information.  The markets for generic coffee and wine fall into the first category, fine wines and specialty coffees into the other.

What Will You Pay?

Why do highly-rated wines cost so much to buy? Production cost is a factor, particularly for generic coffee and wine, but it alone doesn’t explain the big price gap between the bottom shelf and the top. Fine wine and gourmet coffee cost so much because people are willing to pay these prices — and they lack the confidence to pay less in some cases because they associate lower price with lower quality (or maybe lower status).

So I think Steve Kirchner is on to something when he points to differences in marketing between coffee and wine. Gourmet coffee, Steve argues, is a relatively new phenomenon and it is certainly true that the range of choices is still limited compared to wine.

Closing the Coffee-Wine Gap

How many different coffees does your grocery store sell? Probably a few dozen at two or three price points. How many wines? Probably one or two thousand at many more price points!

Fine wine is more complicated than fine coffee and there is more uncertainty surrounding it. This makes the market more “imperfect” in the jargon of economics, and price and cost are more likely to deviate.

Will coffee producers ever catch up to their wine-making cousins? Not soon, I suspect, but I think they will close the gap!

>>><<<

Note: Steve’s comment about brewing coffee and then shipping it reminds me of a story I picked up back when I did tax policy economics.

When coffee was first introduced in Great Britain, it was subject to high excise taxes intended for luxury goods. Coffee shops reacted by adding non-coffee ingredients to the brew to stretch their precious grounds. Adulterated coffee. Ugh.

The tax authorities, seeing a revenue shortfall,  responded by ordering all coffee to be brewed in designated central canteens, then transported full-strength to the shops and reheated there. Twice cooked coffee. Ugh again! More expensive, of course, and adulteration was still possible, but at least the tax was paid.

Thus did high taxation ruin Britain’s taste for coffee, which has only recently recovered thanks in part to market entry by quality sellers like Starbucks.

About these ads

2 responses

  1. Great follow up. I couldn’t agree more with this sentence:
    Fine wine and gourmet coffee cost so much because people are willing to pay these prices — and they lack the confidence to pay less in some cases because they associate lower price with lower quality (or maybe lower status).
    I cannot count the number of times I’ve suggested a very good $10 or $12 bottle to a customer only to be told, “I’d be embarrassed to serve a wine that cheap” or, “No, I need you to sell me a good wine.”

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s

Follow

Get every new post delivered to your Inbox.

Join 1,827 other followers

%d bloggers like this: