Maybe Napa Cabernet Sauvignon Prices Aren't That High!

July 10, 2017

My two favorite people from Uppsala are both named David.  The first is David the Gnome and the second is David Morrison at The Wine Gourd blog.  I’ll refrain from extolling the virtues of David the Gnome for now and focus on David Morrison.  Frankly, he does some of the best quantitative analysis of any wine blogger out there.  If you would like to understand the economics of the wine industry, his blog is a must-read.

 

His latest post, “Napa cabernet grapes are greatly over-priced, even for Napa“ is no exception.  If you care at all about Napa Cab pricing, you should read it.  As an added bonus, one of his commenters added a reading list about the subject.

 

But I’m not posting this to bolster his argument.  He does a laudable job of making his point.  I am going to play Devil’s Advocate. 

 

SO, IS NAPA CAB OVER-PRICED?

No, it’s not.  All participants in the market are, presumably, consensual.  Their willingness to pay, in aggregate, determines the market price, which is the true value of a ton of Napa Cabernet Sauvignon grapes.  Or, at least, that’s the economic theory if we assume an efficient market.  But that’s not really an answer, so let me ask a question that is more to the point. 

 

WHAT ABOUT THIS CHART OF DAVID’S?  HOW DOES IT MAKE ANY SENSE THAT NAPA CAB WOULD BE SO FAR OFF ITS EXPECTED MARK?

 

This demonstrates a similar dynamic to CEO and NFL quarterback pay.  Pay scales rise in some predictable relationship to skill.  But not for the very top.  Having one of the very best quarterbacks greatly increases a team’s likelihood of winning a championship.  This causes salaries for those QBs to seriously deviate from the typical pay curve.  Similarly, even if the best CEO is only slightly better than the #2 CEO, he is, according to typical pay dynamics, worth a great deal more.

 

For instance, if CEO #1 can increase profitability by an expected 1.1% vs. CEO #2’s expected 1.0% and the company produces, on average, $60B in profit per year (Exxon Mobil), then that CEO delivers $60M in marginal benefit.  If half of that marginal productivity accrues to CEO #1 and half to the shareholders, he will be paid $30M more than CEO #2, who probably makes tens of millions or more, already.

 

Napa Cabernet Sauvignon is CEO #1.  At $6,830 per ton, it beats CEO #2, District 3 (Sonomarin), $2,965 per ton, by $3,865 per ton.  That sounds ludicrous.  And for my taste in wine, it is, as I sense no difference between Alexander Valley Cabernet Sauvignon and Napa Cabernet Sauvignon.  At 650 bottles per ton, however, that’s only about $6 per bottle. 

 

That $6 buys you the perception of quality; branding power in the form of the appellation on the label; arguably, it also buys you marginal quality improvement; and it may better your marketing in general (the story/experience.)  Only Napa Cab can do that as effectively as Napa Cab.  What is that worth?

 

The average score and price of all Napa Cabernet Sauvignon wines reviewed by the Wine Spectator, from the 2012 vintage, was 90.15 and $124.07, respectively.  For Sonoma County, it was 89.20 and $69.80.  The sample size approaches 700 wines. 

 

First off, let me be clear that this is far from a scientific sample – there may well be some skew.  Second, there are confounding costs/variables, the most important of which may be vinification.  Still, it is hard to imagine a scenario in which that $6 per bottle seems like a bad deal when it opens the door to, or is a prerequisite of, a $50+ increase in your bottle price.

 

OK, BUT PRICES HAVE BEEN RISING, AREN’T THEY OUT OF CONTROL?

They're high, but not out of control.  Prices can be very volatile in this business. To really look at the factors that determine prices for Napa Cabernet Sauvignon would be a huge project (of the type that I do).  And if I had done it (I have in the past), I wouldn’t just make it public.  But, I did perform a simple, quick, linear regression for this blog.

 

The dependent variable is price per ton for Napa County Cabernet Sauvignon.  The independent (predictive) variables are the trend (years since 1993) and total bearing acreage, as reported by the USDA-NASS.  If we assume that Napa County Cabernet Sauvignon is becoming more and more popular over time, in this country and worldwide, then we can interpret trend as a proxy for demand.  Acreage is a good estimate of supply.

 

Here are the details of the regression:

 

I know, it’s not a pretty chart, but this way my analysis is transparent.  The Multiple R is very close to the one David’s model had (note that this regression is analyzing price and not price rank.)  That means it is about as strong as the model he used for the earlier graph.  Look at the column labelled “Prediction”, that is the value predicted by the regression.  Compare this to the “Price” column and you get the values in the “Error” column, which indicates that there is no serious, statistical bias.  The AbsErr column is the absolute value of the error.  Here’s a pretty graph to visualize this:

What you see here is mildly cyclical price movement.  In the 90s we were below historical norms.  In the first half of the 2000s we were above those norms.  Prices started to take off, but the Great Recession coincides with downward price pressure.  Now, we are above historical norms again.  But prices are only about 6% higher than one would predict.  And that is part of a steady climb, not some irrational spike.  In 2002, prices were over 20% above the predicted price. 

Now, this is not the end-all be-all of studies.  Bearing acreage is not predictive enough at anywhere close to a level I would use. 

 

In fact, growth in bearing acreage has been anemic for years and a linear regression without that variable is, arguably, superior to this model.  But it will show you the same thing: price movement is mildly cyclical and current prices are well within historical norms.  I would guess that, while the grape market cycle and macroeconomic events will sometimes depress prices, Napa Cabernet Sauvignon prices will continue to rise at historical rates.  Prices like these are not crazy, they’re just a bit on the high end of the long-term normal.

 

 

Listened to while writing this: Nahko and Medicine for the People and David the Gnome Theme Song

 

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