Cost Analysis

Discussion on “The Price You Pay: Why Some Wines Cost More Than Others” (The Wall Street Journal, Sept. 12-13, 2009)

 Summary

The article found in the Wall Street Journal discuses wine and why there is a large variation in the price of various bottles. The author states that economies of scale are the main factors for the price variation found in the wine industry. The price of wine is based on more than the flavor. The value of wine is a result of the costs of production as well. The article describes various costs including fixed costs, such as land. Land is one of the higher expenses that wine makers must incur. The cost of land varies depending on the location of vineyards. Lower priced wine typically comes from regions that are not famous for growing grapes.

There are other variable costs incurred such as the amount and type of grapes used in the production of wine. The price of grapes is very volatile and the swings in price affect the price of wine.  In order to make wine, winemakers need more than grapes and a lot of various costs arise from the need of equipment. Barrels, bottles, corks, labels, bottling fees, and maintenance are some of the other variable costs in the production of wine.

Economies of scale allow some wines to be cheaper than others. Economies of scale increases the efficiency of production allowing companies to lower their cost per unit by increasing production and distributing costs amongst a higher number of goods. The average price of wine decreases as the production increases. Thus internal economies of scale exist in the wine industry because the larger the individual firm is the lower their costs per unit are.

Commentary

The first question posed within this article asks why some wines cost $100 and other wines cost $10, with some wines even being as cheap s $5 a bottle. This may initially seem confusing, especially because of all the components that go into the production of a bottle of wine, such as agriculture, barrels, corks, bottles, labels, bottling fees, tanks, and other various costs that go into the production of one bottle of wine. With all of these costs, it makes sense that various bottles of wine are fairly expensive. In the Napa region, for example, land in which grapes are grown can go for as much as $300,000 per acre, with maintenance costs ranging from $5,000 to $10,000 per year. Barrels can also cost as much as $1,000, and stainless steel tanks can cost between $10,000 and $20,000 as well, with bottling lines possibly costing up to half a million dollars. With all of these costs, it seems near impossible for bottles of wine to be cheap.

However, the main reasons bottles of wine can cost only $5 comes in the nature of economies of scale. As the article states, if a company has a large amount of capital already invested into the production of wines, they have the capability to, over time, decrease their average costs through the mass production of wines. If a winery can produce a lot more than another winery, it can lower its prices in order to sell more wine and eventually cover all of its costs, which is contingent on the increased sales. Another reason that some wines can be as cheap as $5 a bottle is because different wines use different grapes, and some wineries are in less popular areas than others. Certain grapes such as Chenin Blanc and Petite Sirah cost less than other grapes such as Chardonnay and Cabernet. Also, because certain grapes are grown in vineyards in different regions, the cost of acquiring/maintaining these lands are a lot cheaper. Vineyards that are not located within that Napa region, for example, will be a lot cheaper to acquire than lands within the Napa region. The wineries that have these locations also have the advantage of having lower fixed costs, which further creates an advantage with economies of scale—since the costs are lower, they can lower the prices of the bottles without losing nearly as much profit.

Description of a real world application

IKEA is renowned for being a leader in the home furnishing sphere. This is because of their ability to sell decent furniture at a much lower price as compared to traditional furniture stores. Two main factors can be contributed for this success.

Firstly, IKEA has been able to reduce a bulk of its cost through economies of scale. IKEA utilizes its massive economies of scale to secure long term contracts with manufacturers. They also reduce cost of raw materials through bulk buying. The massive size of the company means that they can demand lower prices for material which suppliers can and are willing to give as it guarantees them steady income.

Secondly, all the furniture sold in IKEA is designed to be self assembled. This also helps to reduce cost and the use of packaging. For example, the volume of a bookcase case is significantly less when it is not assembled as compared to when it is assembled, as the volume dictates the price in shipping. Also IKEA only rely on the cheaper cargo container for transportation, totally avoiding the more expensive air shipping. Selling unassembled pieces of furniture definitely help to reduce shipping cost for IKEA. Furthermore, this idea works with the consumers. This is because, the steps to assemble to furniture is easily understood and also most of the consumers, especially in Europe, rely on public transportation which means that the flat pack methods allow for easier transportation.

IKEA has always been a forerunner in cost analysis. This is because through cost analysis and the subsequent cost cutting, they are able to sell their product at a advantageous cost and as such attract more customers. All in all, this results in the increase of the productivity of IKEA.  

Posted by Brian, Eddie, Jazmin and Dorothy (Section 2)

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