Wine Prices in Slovenia

In Vino Veritas: Wine Prices in Slovenia AnˇzeBurger and AljaˇzKunˇciˇc∗ University of Ljubljana, Faculty of Social Sciences PRELIMINARY DRAFT July 2010 Abstract Wine market reveals some interesting truths about the pattern of international trade in differentiated goods. We examine a large sample of domestic and foreign wines sold in Slovenian supermarkets and specialized wine shops in 2009. In our sample, imported wine is on average more expensive and of better quality than domestic wine. Higher quality wines sell at higher prices and quality-adjusted prices increase in quality. We present a heterogeneous firms model with endogenous quality choice and non-constant mark-ups that matches the above mentioned stylized facts. The model incorporates quality competition among the differentiated products into the Melitz and Ottaviano (2008) framework and predicts that more productive wine producers choose higher quality upgrade and charge higher prices because they are able to raise their mark-up by more than their marginal cost advantage. Several implications of the theoretical model are empirically tested on the data, using product-, firm-, and country-level information and employing hedonic price function analysis for complete market and predetermined segments of the market. Empir- ical analysis confirms the existing evidence in the literature that quality, objective factors as well as reputation factors affect wine prices. Segmentations of the wine market on the basis of origin, variety and price are examined as well, and we confirm the findings of Costanigro et al. (2007) that price segmentation seems to be the most appropriate judging on explanatory power. Keywords: Wine market, hedonic regression, market segmentation, firm heterogene- ity, quality choice. JEL classifications: L66, Q13, F12, F14. ∗We would like to thank Mr. TomaˇzSrˇsenfor kindly providing the database. Our thanks also goes to undergraduate students Anja Novak and Sebastian Horvat for technical assistance. Contact: Centre for Inter- national Relations, Faculty of Social Sciences, University of Ljubljana, Kardeljeva ploˇsˇcad5, 1000 Ljubljana, Slovenia. Tel: +386-1-580-51-89; Fax: +386-1-580-51-09. Email: [email protected]. 1 1 Introduction Slovenian wine market has never been properly analyzed. There exist commercial guide- books such as Robinson (1999) or Johnson (1985) where general entries on Slovenian wine market and wines can be found, or aggregated statistical data on production and consumption from the Statistical office of the republic of Slovenia, Eurostat, European Commission and the Ministry of agriculture, forestry and food, but no effort has been made yet to examine the interaction of demand and supply on the market for wines and the role of international trade in Slovenian wine market. This paper aims at bridging this gap, using a unique dataset of 925 both domestic and imported varieties of wine available on the market in Slovenia. The aim of the paper is to analyze empirically the relationship between prices and quality, objective and country-specific reputation characteristics. We study a sample of domestic and foreign wine on Slovenian wine market. Being a textbook example of monopolistic competition, wine market allows us to study a product that exhibits horizontal as well as vertical differentiation. The lack of direct measures of quality in other industries has hindered the precise quantification of the role of quality in explaining trade outcomes, forcing researchers to use imperfect proxies such as unit values. Unlike other goods, wine quality has a long and established tradition of being evaluated in a systematic and standardized manner, notwith- standing the subjective nature of wine tasting. The advantage of wine is that no other physical characteristic but its quality varies across varieties. In contrast, industrial products such as cars, phones and medicines bundle together different sets of components and functions so that they do not differ only with regards to quality in a narrow sense.1 As a consequence, the questions about the definition and the boundaries of relevant market arise in many settings, whereas wine market remains immune to such reservations. In terms of theoretical contribution to the literature, we present a heterogeneous firms model with endogenous quality choice and non-constant mark-ups that explains the above mentioned stylized facts. The model incorporates quality competition among the differentiated products into the Melitz and Ottaviano (2008) framework and predicts that more productive wine producers choose higher quality upgrade and charge higher prices because they are able to raise their mark-up by more than their marginal cost advantage. Only the most productive wineries export and their prices and wine quality depend on domestic and trading partner's characteristics. We find some empirical support for our model when the entire sample is studied, namely that the costs of production in the country of origin affect prices positively, market size negatively, trade costs positively and wine quality positively. Theoretical model of heterogenous wineries in international trade is combined with a body of literature on hedonic price functions in order to disentangle the determinants of wine prices in Slovenia. Empirically, this paper contributes to the literature by analyzing the hedonic wine price function and adding to the evidence on wine quality and objective characteristics such as age and cellaring potential being significant determinants of wine prices. The results sug- gest that wine from more distant countries is more expensive relative to wine from nearby countries and domestic producers, controlling for other relevant factors. Larger export countries provide lower wine prices while more developed countries export more expensive wine than less developed exporters. These findings are in line with the existing empirical evidence 1In that sense, wine can be considered as a one-purpose good, whereas more complex goods such as cars, phones, etc. can be considered multipurpose goods. For example, phone can also double for an mp3 player, photo camera or personal organizer. 2 on price-quality relationship and confirm the Alchian and Allen (1964) effect: "shipping the good apples out". We also discover a country specific reputation effect, with some countries having a price premium and some a price discount compared to domestic wines. We pursue the interesting question of Costanigro et al. (2007) on whether the market for wines should be segmented according to price, rather than the more usual segmentation on variety. We test segmentation on prices versus alternative segmentations based on origin and variety and confirm that statistically, price segmentation trumps the others. The paper is organized as follows: in section 2 we present some facts about the wine industry in Slovenia, section 3 develops the theoretical framework, section 4 outlines the data and discusses the results. Section 5 concludes. 2 Wine market in Slovenia in numbers and comparison There were 17 thousand hectares of vineyards registered in Slovenia in 2008 (although the aerial footage reveals more { about 22 thousand), which is only about 0.5% of total vineyard area in the EU-27 (Ministry of agriculture, forestry and food (2009c), Eurostat (2008)). The prevailing modus operandi is fragmented production: as much as 88.9% of producers utilize an area of 1 hectare or less, yet they represent only 35% of total vineyard area. The largest vineyards of more than 5 hectares belong to 1.4% of producers, but their combined acreage is 5,756 hectares or 34% of total vineyard area (Ministry of agriculture, forestry and food, 2009c). Despite its apparent small size, the wine industry in the last few years (all from 2004- 2007) produced over 800,000 hectoliters of wine annually (70% being quality wine, and less than 30% being table wine)which represents a healthy 8% of Slovenian agricultural production value (Ministry of agriculture, forestry and food, 2009b). This amount corresponds to barely 0.5% of EU-27 production, however, at 40.1 liters per capita exceeds the EU-27 per capita production of 35.4 or EU-15 of 32.9 (Eurostat, 2009). Wine producers cultivate over 50 different varieties of wines, but the prevailing sorts at over 70% are white wines (Ministry of agriculture, forestry and food, 2010). On the consumption side, similarly as domestic production per capita, domestic consumption of wine per capita exceeds EU average. Best consumption estimation take into account both registered and unregistered production of wine, as well as stocks, imports and exports. The estimate of around 40.5 liters of wine per capita2 consumed ranks Slovenia consistently near the top of EU-273 and heavily exceeds the EU-27 average of 26.5 liters (European Com- mission, 2008a). Interestingly enough, comparing the Harmonized indices of consumer prices item weights, which imply the average share of income spent on a particular good, reveals that the wine share for Slovenia in 2010 is 0.552% while it is higher for both the EU-27 and EU-15 at 0.719% and 0.865%, respectively4. With wine production practically matching consumption in the last few years, the total wine trade balance is never far from equilibrium. In the period 2004-2007, the average yearly trade was more than 100,000 hectoliters or over 10% of total domestic wine production. Average wine imports on a yearly basis were 58,500 hectoliters, exports 46,250 hectoliters, 2Average of years 2000-2003 due to data availability 3It seems that only people in France, Luxembourg, Portugal and Italy are keener on wine than Slovenians. 4Taking the average weights for the last 10 years instead of 2000-2003 reveals a different image, with values 0.745% for EU-27, 0.803% for EU-15 and 0.788% for Slovenia. 3 yielding a trade balance deficit of 12,250 hectoliters. In terms of monetary value, average yearly imports were 5.5 millions EUR, exports 6.7 millions EUR and the trade balance deficit 1.2 million EUR.

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