Monday, February 8, 2016

Signalling With a Bottle

If you didn't know anything about the beers, which one would you assume is the lowest quality?


I am sure I have written about this before, but I am too lazy busy to look, but this New York Times article about craft breweries move to bigger bottles seems to resonate with the economic theory of signalling.

In the signalling theory it is the act of signalling itself (thought replicable by anyone) that provides credible evidence of quality. 

The classic example is in education:  One reason we go for higher degrees is to demonstrate that we are smart and productive workers to would be employees.  We can show them a college degree, for example, and from this they can take away that I must be a  high 'quality' worker.  Why? Well it is not the stuff I learned necessarily but that getting a degree is costly, it takes time and money.  But it is MORE costly for less smart and motivated people because they make take longer, have to study harder and so on.  In equilibrium it turns out that the degree is indeed a signal because only the smart productive types will bother to get them.  The lower types will not because if they do they will have wasted time and money because once they join in the degree getting crowd, the degree is no longer a singal of quality.

[Clever theory eh? Clever enough to win the Nobel prize...]

What does this have to do with bottles?  Well, suppose that bottling in fancy bottles with corks and foil and stuff is more expensive.  Good breweries want to signal their high quality by packaging their beer in fancy bottles.  Bad breweries would like to do the same.  The problem is that bad breweries face the exact same cost of sticking it into a fancy bottle (and even the premise isn't always correct - a simpel 22oz bottle is cheaper to sell beer in than a 12 ounce bottle).

So signalling alone doesn't explain this but the idea of experience goods can potentially reconcile the theory.  Since beer is a repeat purchase, consumers are quick to learn abut the type.  So packaging in a fancy bottle might work once, but not over time.  In the end the low quality brewers abandon the big more expensive bottles because they are not fooling anyone anyway and it is more expensive, while high quality maintain it because after the low quality ones leave a fancy package is, in fact, a credible signal of quality. 

The subtle point in all of this is that these are equilibrium outcomes - that in the end there is an equilibrium where high quality brewers choose fancy bottles and low quality brewers do not and both are content with their decisions. 

For me though, I tend to concur with the big bottle critics: I am the only beer drinker in my household and thus I cannot buy more than 12 ounces of a big beer without wastage (of either the beer or me). 

Friday, February 5, 2016

What Something is 'Worth' - The Westvleteren Question

Update: Here is one from the archives that matches the recent pod.  With an update at the end. 

Sometimes being an economist makes life very simple (some might say overly simplistic) but I am amused by the frantic talk about the release of the Westvleteren 12 in the US.  I'll riff off of Jeff at Beervana:
The cost is dear ($85 for six), but it goes to the monks at Sint Sixtus as a part of their capital fundraising effort to build a new roof. So you could think of it as a donation in which the monks give you a token for your support. I would strongly urge you to consider that when weighing the question of "worth." (You might also compare it against the price of a plane ticket to Brussels.)
Fortunately, the question of worth is something long ago settled by economists. Worth is a function of supply and demand.  There is nothing intrinsic to gold that makes it worth more except the fact that is is malleable, shiny and rate.  So demand is high because of its good attributes and supply is scarce making it an expensive little item.  Water is absolutely vital to life but not very scarce and so we buy it very cheaply and so on...

So is Westvleteren 12 worth $85 for six?  Well that is for you to decide, for some it will not be and for others it will. This will be a function of how much enjoyment you'll get from drinking it, how much you cherish the opportunity to try it and your ability to pay for it (among other things).  Whether the market thinks it is worth it depends on whether there are enough people who think so relative to the amount for sale.  I suspect the answer will be a resounding 'yes.' 

Class dismissed.

This is also apropos to the discussion in the previous podcast, is there a craft beer bubble.  If it is the market and the market alone that establishes the market value of a good. In this sense if the market price of something seems absurdly high it is odd to call it is bubble.  

But here is a thought question: Do you value something simply because of its scarcity?  Would you, for example, be willing to pay extra for a bottle of beer simply to be able to say you have tried it?  I think that for a number of consumers the answer is yes and this inflates the price?  But is this any less of a reason to play for a beer than the actual quality of the beer inside?  To an economist the answer is no.  It doesn't matter.  We are agnostic about where preferences come from.  Which is why I say sometimes being an economist makes things simple - we tend to look at the world without any judgement, we just try and explain the phenomena we see - for better or worse.  

Friday, December 11, 2015

Craft Beer Bubble Redux

I was quoted in a Los Angeles Magazine article that makes me sound like a doomsayer when, in fact, I am still quite bullish on craft beer so I just thought I'd share the Q&A I had with the writer to make sure my opinion is clear.

- Is it possible to have too many breweries in a given market?

Yes, of course, it is possible but I don’t think we have reached that point in even the most mature markets like San Diego and Portland. The main reason for this is the fact that it is not just the supply of craft beer that is growing, the demand itself that is growing dramatically and this growth shows no sign of slowing down. Until we reach the point where demand appears to be leveling off, I think it is premature to talk about too many breweries. Now, this doesn’t mean that we won’t see a lot of failure along the way, there will be increased competition, and this competition will result in weaker breweries exiting the market because of poor relative product quality or lack of business acumen. But this is more a sign of a robust market than of an ailing one.

 - If so, how do you know that the market has reached brewery carrying capacity?

You don’t and never really will because there are a lot of dynamics in the craft beer market that make it very hard to predict what the mature market will look like. There is the increasing demand, as I mentioned before - who knows where it will level off? But then there are a couple of competing trends as well. One, brewing is an industry that has massive economies of scale, meaning that the bigger the brewery is, the more efficient it is and thus big breweries can produce at a lower cost per ounce. This means that there is incredible pressure on breweries to grow and suggests that in the end there might be only a few breweries. However the second trend is the strong demand for local and more artisanal beer which is associated with smaller more personality-driven breweries. This suggests that smaller boutique brewers might be able to continue to charge a premium for their product which can compensate for their relative inefficiency - they can sell their beer for more because of their connection to the local market.

- Early Los Angeles breweries were mostly hobby home brewers looking to go legit. But the breweries opening today are investor-backed ventures with a lot of money behind them. Is the era of the home brewer going legit over in places like San Diego, Portland and LA?

 This is the most fascinating trend in brewing today, the question of what all this macro brewing industry money and venture capital money will mean to craft beer is an open one. It also speaks to my point about local versus big - what we don’t yet know is if these investors can turn a local brand into a successful national brand. As they grow big will the consumers lose their appetite for the beer? I think there may be a few more national craft beer brands on the horizon along the lines of Sierra Nevada, Sam Adams (Boston Beer) and New Belgium but I think in local markets there will be a lot of room for small, local breweries. In fact, AB appears to be placing their bets on establishing a stable of local brands rather than trying to take one or two and turn them into national brands, which to me suggests that they believe in the inherent local-ness of craft beer. I do think that the marketplace will become more and more competitive over time and these breweries will no longer be can’t-miss opportunities and the new generation of successful breweries will be characterized by great beer, great marketing and great business acumen. It will no longer be possible to fumble your way to success. That said, I think in most markets, with the year over year increase in demand, there is still a lot of room for new ‘homebrewer gone pro’ businesses.

Pod 14 - Flavors in Beer: From Brewhouse to Bottle