Cost Analysis Real World Application Blog Post

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

 Summary

The Price You Pay: Why Some Wines Cost More Than Others explores both the supply and demand side determinants of wine pricing.  Anyone who has ever purchased wine has most likely been faced with confusion over the vast discrepancies between cheap “two buck chuck” wines and wines that are priced into the hundreds.  According to the article, the expensive wines aren’t simply taking in massive profit margins based on brand name.  In reality, the land that the brand name grapes are grown on can cost $300,000 per acre with $5-10000 per acre per year in upkeep.  Moreover, a barrel can cost $1000 and a tank $10000.  Many other fixed costs such as bottling systems and variable costs such as corks and labels also contribute to the price of wine.  On the other hand, some regions which lack the brand name command cheaper real estate prices.   The article notes, however, that there are plenty of cheaper wines that taste good and more expensive wines that aren’t much better than the cheap stuff.  This all relates directly to classroom production theory, consumer theory, and supply demand equilibrium- wealthy wine consumers are willing to pay top dollar for the prestige and brand image of some grapes and that drives these grape’s prices sky high.  On the other hand, people just looking for a cheap bottle of wine are willing to settle for whatever is reasonable – keeping that vineyard land low priced.

 Commentary

The article notes the extremely high fixed costs of producing wine.  As mentioned earlier, barrels and tanks as well as bottling systems cost tens of thousands of dollars.  How, then, are some brands of wine so cheap?  The answer is that these wines are from lesser known regions where land is cheaper.  In addition, these suppliers take advantage of economies of scale in order to pay less cost per bottle of wine.  The article doesn’t mention this but they are also most likely aged less since aging has a high accounting and opportunity costs by holding them in barrels for so long.

 Another Application

In this article, Eric Bleeker discusses the cost of the iPad 3 and argues that it will remain at the same entry-level price as the iPad 2.  Even though the iPad 3 will consist of more advanced technology, Bleeker suggests that Apple will keep the entry-level cost the same because there is too much risk to raising the price.  There are many arguments as to why Apple must raise the price of the iPad 3.  For example, the iPad 2’s display was 39% of total material costs.  It is almost basically confirmed that the iPad 3 will have a retina display, which includes two to three times the pixels per inch which would obviously drive the costs up.  Bleeker points out that Apple could make the price more expensive than the iPad 2 because they have used a very aggressive pricing strategy since its introduction.  He also notes that the iPad has commanded a comfy profit margin, but it was priced at a level that sacrificed margins for rolling up market share.  However, companies do not always make more profit by placing a higher price on their products.  There is risk to that strategy.  If Apple did end up pricing the iPad 3 higher, it would only widen the gap between the iPad and lower-priced tablets such as the Kindle or Nook.  Further, Apple has not yet completed their full transition into the tablet market as they believe to still be in the very early stages of a shift.  That being said, Apple’s long terms goals would best be suited towards concentrating on that shift using strategically competitive pricing.

Posted by James and Jordan (Section 4)

Resources:

“The Top 3 iPad 3 Storylines: First, How Much Will It Cost?” – Eric Bleeker, The Motley Fool, financedaily.com

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