Cost Analysis

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


The article, “The Price You Pay: Why Some Wines Cost More than Others,” explores the range of price differences in wine, which delves into the upcoming unit of Cost Analysis.  Brand name wines may not be the most delicious wines, according to the article, as much more than the name of the wine goes into the pricing of a bottle.  The difference between the inexpensive $5.00 bottles and the bottles that cost upward of $100 depend on costs like land and bottling systems.  Vineyards located in regions like Napa Valley have high real estate costs, with land priced at almost $300,000 per acre, along with five to ten thousand dollars per acre in upkeep a year.  Wines that are grown in regions that are less popular and recognized tend to have lower real estate costs, dropping the price of their bottles.  Also, grapes like Petite Sirah tend to be used for less expensive wines in comparison to Cabernet grapes.  Variable costs like corks and labels are relatively expensive, and the fixed costs associated with wine, like the French barrels and wine presses can cost over $20,000 in total.  Consumers are willing to pay top dollar for the prestigious image that some wines offer, yet there are still many more moderately priced alternatives that are still delicious. 


Cost analysis helps to determine the cost of production, including implicit and explicit costs, that vary with output.  In class, we also touched upon returns to scale.  The wine bottles that cost $5-10 probably have increasing returns to scale.  They use less expensive inputs, such as the cheaper land and grapes, and over time, will be able to produce more wine for less.  These companies are able to invest in the same technologies that the expensive wine manufacturers are using, such as the bottling system, but they have cheaper variable costs due to the inexpensive land and grape breeds.  As a company produces more wine, the less it becomes to manufacture the bottles.  The lower priced bottles of wine will typically sell more as the quantity demanded rises, allowing these companies to cover their costs of production.

 Real World Application

McDonald’s is one of the world’s largest fast food restaurants and its success can largely be attributed to its ability to control costs.  The restaurant is able to deliver food in a very short amount of time and for a comparatively low price—two aspects of the business that have made it so successful to date.

Much of McDonald’s success can be attributed to its economies of scale. The company’s competitive advantage with respect to sit-down restaurants is obviously its price point. The firm is so large in size, has such easy access to capital markets, and great bargaining power with suppliers that it is able to purchase production inputs at a drastically lower price than family owned restaurants.  This in turn affords McDonalds the ability to charge low prices and attract a large consumer base—something that has been imperative in its growth. 

Another manner in which McDonalds controls costs and thus has been able to stand out in the fast food space, is through low labor costs.  Because McDonalds has done such a wonderful job in streamlining the making of its various products, McDonalds does not need the skilled chefs that other restaurants would require to remain in business.  Through years of experimentation, McDonalds has the process down so well that nearly anyone can learn how to make a hamburger in a short amount of time (similar to Toyota’s lean manufacturing idea).  Restaurants in South Bend, such as the Mark in Eddy Street, require highly skilled chefs to produce the food that is on their menu.  More highly skilled chefs obviously have to be compensated accordingly and thus the Mark may have a more difficult time controlling labor inputs than McDonalds. 

Overall, McDonalds has been a highly successful franchise for over 50 years and it is imperative to recognize their cost control ability as a key driver in this success.  Their economies have scale have allowed them to purchase inputs at a much lower price than family owned restaurants and their ability to streamline the production process has allowed them to pay their workers comparatively less than other stand-alone restaurants.  

Posted by Lexi, Hannah and Ryan (Section 3)


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