[Ed. Note: This post was in response to Mark Brown's Restaurant Wine Pricing and succeeding posts. It seemed a good idea to feature here as a new thread.]
It was very interesting reading the various "cost" and "income" analyses in the several postings on this subject. In my view, some of the postings include relevant points but most miss the big picture entirely. From an income and investment standpoint, Dave's winemaking business (really 3 businesses - growing, "vinting" [manufacturing] and marketing [selling, competitive evaluation, promotion {tasting room, mailings, internet site, events, etc.} and distribution]) is like any other business, (but maybe not as much fun!)
Each of the 3 businesses should try to receive at least an average income for the labor exerted in comparable industries and an acceptable return on investment for the capital invested at the same levels of risk. (Examples of typical risk/return levels are, 2% in a simple savings account [low risk] to 30% - 40% in the high tech stock market [high risk]). A return of 15% to 25% would seem to be reasonable for the wine businesses leaning towards the higher 25% return for the riskier, growing segment of the business to the lower 15% return for the marketing part.
Economics 101 suggests an appropriate cost analysis much like those presented in the postings but which include "pro-forma" entries for the labor factors (including all of the many "labor hats" which Dave and Pat and their staff wear in ALL THREE of their businesses). This should also include the "cost of the invested capital" be it interest costs of a loan and/or the return on investment for Dave's cash capital asset purchases and down payments. It should also include a "depreciation" cost for the capital assets as they wear out and must be replaced due to use.
However, according to Marketing 101 , NONE of these cost factors has anything to do with the selling price with the following qualification. If the selling price is so low that the total of ALL of the costs as noted above is greater than the selling price, then the wise businessmen had better find out some way to reduce his costs or get out of the business. Alternatively, he can regard his activity as a hobby, not a business and consider the excess of cost above the selling price as the cost of his own personal entertainment. (This assumes he already has a nest egg or another source of income to fund his expensive hobby.)
In the final analysis, the wine's selling price is determined ONLY by the price level that most willing buyers will pay for the wine (call them "suckers" or "dummies" if you will, but they nevertheless compete with their buying power for the limited, available supply of the winemaker's product). If the winemaker's product has a quality reputation such that more buyers will pay a higher price, then, as an intelligent businessman, the winemaker should raise his price and have no twinges of guilt. If he raises his prices to an excessive level (gouging), he too will be "leveled" by the market itself. An excessive profit (the market will determine what is excessive) will cause his total sales and his total profits to drop and will "invite" more players to compete with him at the same quality level. Lower price and profit levels will "squeeze out" those competitors who are marginal performers and discourage other potential competitors from entering the business.
Adam Smith called this economic balancing process the "invisible hand" of the free market system.
Ultimately, the winemaker should set his prices, independent of the cost, relative to his competitors at the same quality level. This is the important "marketing" hat that Dave must wear in addition to his growing, vinting, selling, promotion, financing and "chemical engineering" hats. If Dave is cost efficient in the various aspects of all three of his businesses, he will earn and deserve higher "salary" incomes and higher returns (for a given level of risk) on his financial investments than his competitors. If his chooses not to cost optimize all facets of his 3 businesses, his associated incomes and investment returns will be lower than his competitors.
Therefore, as with all free market businesses, prices are NOT BASED UPON COSTS (as long as costs are controlled sufficiently to be less that the selling price). Those who are not aware of these basics of Economics 101 and Marketing 101 should not enter into their own business. Those who would criticize businesses for charging too much based on claimed moral or ethical grounds should look at the standards of living and the economies of non-free market systems in other countries in the world.
The former Soviet Union has adopted a free market system after many years of failed, central planning. A more recent example of the adoption of free market principles is the People's Republic of China.
In my opinion, the quality of Dave and Pat's wine will definitely support their planned price increases and are in the tradition of the time proven free market system.
Viva la free market!
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Free Market Wine Pricing
Mel Amato, April 3, 2002