Friday, January 22, 2010

Beeronomics: Signalling Redux

The blogger and graphic artist whose "nom de plume" is Samurai Artist popped me a note to inform me of his very interesting interview with Brett Joyce of Rogue (the above is a sample of his work). During the interview he asked Brett about a post I had done in the past about Rogue and signalling. At the time Brett appeared quite annoyed by my post, and I was completely perplexed. But then I realized the problem, people were not understanding it as an equilibrium concept. Anyway, here is the exchange:

SA: There was another blog post (on the Oregon Economics Blog) that suggested that you guys use the economic term 'signalling' by pricing yourself higher to signal to consumers that your beer is of a higher quality. I know that you said that wasn't true, but I would like to see if you have more of a response to that.

Brett: Yeah, I'm not smart enough to know what 'signalling' is, but I would just say this, there is a lot that goes into the packaging, there is a lot of hops and malt that goes into our products. We have never told John in 21 years what to put into the beer. He is an artist, and it is our job to get out of the way and let him practice his craft, and it is our job to go sell it, go market it. Our beer is not inexpensive to make. It's because of ingredients and because of packaging, not because of 'signalling'. I don't even know what that means!

This is a good illustration I what I mean. I would not say that Rogue 'uses' signalling. What I was trying to provide an explanation for was the popular beer blogger complaint that Rogue is too expensive. Given that the craft brew industry in Oregon is intensely competitive it is hard to see how Rogue's prices are sustainable in the free market of beer. Signalling provides a potential explanation (not necessarily the right one or the only one, but a possible one): if people think price contains some information about the quality of a product that they cannot themselves determine before they purchase it (as opposed to something like a new shirt that you can touch feel, try on, etc.) then they may act on that information by purchasing it. Of course, all beer companies could try this, but the companies with a lesser product would find out quickly that consumers learn and their sales would plummet. Packing plays a similar role - Rogue's packaging is more expensive and a signal of the quality of what's inside. Other breweries could do the sam but if their beer is of inferior quality than their attempt to signal becomes a costly waste of time.

If the consumer tries the expensive beer and likes it then their assumption about the price being indicative of quality is correct. Only though repeated tries would the consumer learn that price is a reliable signal. And this confirmation will happen only if it is truly just the better beers that are more expensive (in general). So you see, signalling is essentially an equilibrium where better beers are priced higher, and consumers act on this knowledge.

This is why I was perplexed about Brett's annoyance with the story: it is an equilibrium story that is not an explicit strategy by Rogue. In fact it happens simply because Rogue responds to the incentives that are already in the market. And it only works if Rogue's beer really is thought of as that good once buyers purchase it. I think he thought I was saying it is an explicit strategy you can use to fool consumers and get a higher price. Precisely the opposite: it is a market outcome whereby better beers price higher and lesser beers price lower and it works because in equilibrium consumers are then correct about how price and quality are related. [Note that good and bad craft beer aren't necessarily any more or less expensive to produce so there is more to price differentials than the cost of ingredients clearly]

Full disclosure, I love Rogue and Brutal Bitter is among my top five favorite beers, but that has nothing to do with it. The answer to "how do they get away with charging so much?" is simple: the market thinks their beer really is that good. And as good beeronomists we should know not to question market outcomes, our task is to simply try and understand them better.

Finally, this model was originally applied to education: people get college degrees because they want to gain more skills and knowledge but (perhaps unbeknownst to them) it also serves as a signal to firms that they are smart and worthy of hiring. Getting a degree is hard, however, but a lot harder if you are not smart than if you are truly smart. So firms take the degree as a signal of quality and they are right to do so - because, in equilibrium, only the smart ones will find it worthwhile to spend the time and effort getting the degree.

1 comment:

Jeff Alworth said...

The plot thickens.

Rogue has a very sophisticated brand, and part of the sophistication rests on resisting meta-analysis. Like other brands--Bud springs to mind--they represent elegance and quality to some of their customers, yet to others they are plucky crypto-socialists.

Everything about their presentation supports and resists these characterizations. For those who think of them like revolutionaries, the Soviet realist labels, the red stars, the upraised fist--these are less than subtle cues. But for those who treat Rogue like rare vintages of Dom Perignon, the ceramic swing-top XS bottles, the technical stats, the emphasis on awards all attest to this.

Bud does the same thing, incidentally. It is the NASCAR beer on the one hand, but also the "super-premium" beer most likely to appear in 5-star restaurants.

All well and good until you try to flush the company out with a direct question about branding and marketing strategies. Brett's aw-shucks, we're-just-bumpkin-brewer routine was a deft dodge. But if you think Rogue doesn't have a very sophisticated marketing strategy, I bet they have a cool bridge outside the brewery they'd be willing to sell you.