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General Wine
Thoughts About Buying, Selling and Drinking Wines From Reading "Micro Economics and Behaviour" by Robert H. Frank
Sunday, 20th July, 2008  - David Farmer
Robert H. Frank

The senior business writer and economist for the Sydney Morning Herald, Ross Gittins, occasionally does a piece about how we spend the way we do and how this can vary from the rational choice model of economists. This got me interested enough to work my way through Robert Frank's "Micro Economics and Behaviour" which delves into variances to the rational choice model and other human behaviour to see whether any insights might show what affect's wine buyers and drinking habits.

Here are some of the ideas I gleaned.

The Lemon Principle
"Since good cars are worth more to their owners than lemons are to theirs, a much larger fraction of the lemons finds its way quickly into the used-car market."

"The gap is much more plausibly understood as a reflection of the fact that cars offered for sale, taken as a group, are simply of lower average quality than cars not offered for sale."

We all wish to avoid buying 'wine lemons' and the likely place they hide is in the auction system, including on-line auctions. At least some of the product being sold will be because they have been rejected by the vendor. Cellars in Australia are too warm and there will be a reason for older wine at auction. Auctions are also the clearing house for forged wine although little of this happens in Australia-I assume! Clean-skins are another outlet for wine lemons and for example many cheap Barossa reds have the yeast infection of brettanomyces.

Positional Goods
"A good whose value depends strongly on how it compares with similar goods consumed by others."

"The late British economist Fred Hirsch coined the term positional goods to refer to goods and services whose value is strongly influenced by their relative quality…… The central feature of a positional good is its inherent scarcity. Although it is possible to imagine an environment in which people had more food than they could possible consume, the same cannot be said of a positional good."

It is the desire of every wine company to develop many positional brands as these go beyond the need to supply a decent drink and open up an avenue to make a lot more money. Scarcity must be manufactured and carefully controlled as it is very easy to over produce and slip in positional ranking. Scarcity alone though is not enough to develop a positional good. A 'strangeness' factor is required that elevates the brand into a realm that gives the wine a distinguishing halo. For the wine buyer this is an area fraught with hazard and it is essential that the truths of masked tastings are not ignored. A good example is Marlborough sauvignon blancs where most have a similar taste and the wine on special should be purchased. Many fakes exist in the positioning of wine.

A Case for Gambling
"As a general rule, human nature obviously prefers certainty to risk. People naturally want the largest possible gain and the smallest possible risk… "when only small sums are at stake a compelling case can be made that the only sensible strategy is to choose the alternative with the highest expected value'…. "the long-run opportunity cost of following a risk averse strategy for decisions involving small outcomes is an almost sure loss of considerable magnitude."

You should be prepared to try many different wines at lower price points. How do you get certainty? One way is with a guarantee which may be a high score for a cheap wine from a leading wine writer. You lower the risk by following the advice of a person you can count on or read a wine magazine for tips of new things to buy or shop with a decent wine merchant. The wine scene evolves quite quickly these days so do not get left behind because you are risk adverse. Also when you buy wine you tend to buy what you have knowledge of but in this case there will be a sure loss of considerable magnitude as you will not progress with your wine knowledge. This is no doubt taking Frank's conclusion in a different direction but it is one I do urge on consumers.

Sunk Costs and My Wine is Better than Yours
Frank relates a story about the use of tennis courts to illustrate that once we have paid for the use of something we wish to get our monies worth even if a better free alternative appears in the mean time-the idea of sunk costs. Thus we will go to a lousy movie because tickets have been paid for even if offered free tickets to a much better movie playing at the same time. This got me thinking about wines that have been purchased representing a sunk cost. Someone may offer you a better wine but we insist in drinking what we have brought along to get our monies worth.

This is illustrated by the idea of -my wine is better than yours-which we have all experienced at dinner parties. We tend to think the wine we bring to a dinner party will be the best and get upset when the host does not open it even if the host's wines are far superior.

A Small Loss is Far Worse Than a Bigger Gain
"…people seem to weigh each event separately, and attach considerably less importance to the gain than to the loss-so much less that many people refuse to accept pairs of events that would increase their overall wealth!"

The rational choice model says we should evaluate events or collections of events in terms of the overall effect on wealth. In practise we treat losses much heavier than gains which give the idea of an asymmetric value. The example used is how an unexpected gift of $100 which is consumed by an unexpected bill for $80.00 is seen as tragedy instead of a net gain of $20.00

Thus we avoid risk taking as this may create a loss, For example we will be cautious when buying wines and likely will not risk a new wine if the old favourite is at a fair price.

And this makes me note that while we will get upset by a bad bottle we must take time to enjoy and reflect upon the good and great bottles.

The Idea of 'out of pocket expenses are coded losses' while 'opportunity cost as forgone gains'
Our irrational views show that we will not ignore sunk costs even if a better alternative comes along that is free. By that the economists are saying we want to use at all costs something we have paid for even if the action is irrational.

"Consider a person who in 1955 bought a case of wine for $5.00 a bottle. Today the same wine sells for $100 a bottle. His wine merchant offers $60 and he refuses, even though the most he would pay for the same wine today is $35 per bottle." The rational choice model rules out such behaviour.

Perhaps this is why many wine people are generous with old expensive wines as they were bought when much cheaper and they do not worry about the forgone gain. For a retailer it is likely that a customer will pass up an offer of a free item with an expensive wine but the temptation grows the cheaper the wine offered.

Our Tendency to Segregate Small Gains from Large Losses
The example used is the practise of 'cash back' of say $1200 when buying a new car. This is better than a price reduction as the purchase is seen as a large loss while the cash back is a small gain thus it's an offer to our irrational way of buying.

While not quite the same thing, for many years retailers have given free magnums and glasses as bonuses when wine is purchased. This is also the idea behind frequent flier points, green stamps as used in the U.S., and various reward points.

Bias in Judgements
"We often estimate the frequency of an event, or class of events, by the ease with which we can summon examples from memory...... It is easy, after all, to recall examples of things that happen often."

"A large body of research indicates that people tend to assign too much weight to recent information when making assessments about relative performance."

Do we drink what we have recently tried? The evidence is strong that we repeat purchases of wines that we have liked. There is a significant clue in this for me to be able to manipulate you wine buyers but at the moment I just cannot see it.

The Process of Anchoring and Adjustment
"In one common strategy of estimation, known as 'anchoring and adjustment', people choose a preliminary estimate-an anchor- and then adjust it in accordance with whatever additional information they have that appears relevant."

"..this procedure often leads to biased estimates for two reasons. First the initial anchor may be completely unrelated to the value to be estimated. And second, even when it is related, people tend to adjust too little from it."

Frank follows with several scary experiments which show that if the initial anchor is generated as a random number this affects the final 'adjustment'.

The immediate relevance to wine is not obvious but it makes you think that as a buyer we all come up with a rough idea of what something is worth by a first impression; in this case the wine bottle. If it looks cheap we will not want to spend too much and if it looks expensive will expect to pay more. This is logical and is of course what actually happens. We try to dress up the better wines the most. The trap is that a lot of wine sold does not warrant the fancy package and is in fact nothing more than a fancy dress. We also know from other studies that paying a higher price for a wine makes it taste better than a cheaper wine because you have been conditioned to expect it to be better.

Perception is Everything
"Weber and Fechner set out to discover how large the change in a stimulus had to be before we could perceive the difference in intensity. (They) found that the minimally perceptible difference is roughly proportional to the original intensity of the stimulus."

This is a most absorbing chapter and deals among other things with the pricing of items. In particular it asks-what is the required difference in price for the same item to make us shop at one shop over another. We get annoyed at paying $15.00 in one shop when it could have been bought for $13.00 in another but when the item is say $200 versus $198 we do not care. The dearer the item the less the worry that we have lost money which explains the quote at the start.

It simple, when buying wine all savings at any price point are good savings. Despite many reports to the contrary I have always felt that price in liquor retailing is the prime driver of customers.

The Difficulty of Deciding
"If the choice between two alternatives is a close call-then it should not make much difference which is chosen...if one of the options clearly has a higher expected utility, the choice should again be easy. Either way, the chooser has no obvious reasons to experience this anxiety and indecision."

"Finally, departures from rational choice may occur because people simply have difficulty choosing between alternatives that are hard to compare."

The example used is choosing between two apartments (A and B) with the variables being that the monthly rent declines the further you move from the campus where you are studying. By altering either variable, high rent but handy or low rent but travel time you can get a rough 50%-50% split in what students prefer. When you add a third place to rent (C) that is close to one of the other options, and the example used is both further from campus and costs a bit more than (B), there is produced a strong bias to prefer (B) over (A)-50% goes to 70%. This is the 'halo' effect.

We all want to buy a wine like Grange, in its 'halo effect', but at a cheaper price and alas this is very hard to do.

The main two variables at play when you buy wine are cost and quality and a rational choice customer will always buy the best quality at the cheapest price. We have just learnt why we often do not do this. For such a regular item purchased I cannot think of a more demanding and confusing product to make a decision about than buying a bottle of wine. The average quality isn't too bad but the price for the same quality can vary from $10.00 to $40.00 and while there are books galore and wine ratings aplenty-when you need advice you will not find it easy to apply. Happy bargain hunting.

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