Tuesday, November 27, 2007

Beeronomics: Vertical Differentiation

The trusty John Foyston was back in the Oregonian on Sunday (on the front page no less) with what amounts to a very nice overview of the whole hop and barley shortage problem and what it means to Oregon breweries. It got me thinking, what would economics say about brewery strategies and how might strategic decisions already made affect breweries through this period?

One common product strategy that is often employed by macro-breweries is vertical differentiation. This is where you create different products or different varieties of products for consumers of varying income and affluence. Thus Toyota has its Lexus cars, the Apple iPod comes in cheap, stripped-down versions and sleek fully functional versions, and Budweiser makes Michelob. This is not a strategy we had seen from the micro-breweries until Full Sail introduced Session. Session is a light lager in the Bud tradition, and I have been critical of the decision to introduce it because I fear it blurs the line between craft and industrial brewing, which may cause an erosion of the loyal following craft breweries have created for themselves. (This is why, I believe, the Full Sail name and logo are not easy to find on a bottle of Session)

But this decision could end up being an inspired one if it turns out that consumers do not reduce consumption of beer in the face of higher prices, but instead turn to cheaper beers (as I suspect they will). It also could make sense in the chase for scale efficiencies. For these reasons I think the introduction of Session is probably a very shrewd short-run decision. However, I still fear the long-run consequences of this blurring of market boundaries.

Update: Though there are no studies I could find that looked at cross-price elasticity estimates between macro and micro brews, the short-run price elasticity estimates for macro brews is about -0.3. This is, I suspect, a lower bound for the more pricey craft beers, but means that for a 10% increase in price, brewers can expect about a 3.3% drop in demand. This is good news, but not, as I mentioned, what I consider the danger point for craft breweries - we need estimates of cross-price elasticity for that.


mwalla said...

I have to disagree that session lager represents a departure from craft brewing, or blurs the line between industrial and craft brewing.

For one, while a 12 pack of 11oz bottles of session might be a touch cheaper than a 12-pack of IPA, it sure ain't Pabst.

As I understand it, session is an all-malt lager. One defining characteristic of American macro-brews is that a big portion of the recipe comes from grains like corn or rice, instead of barley malt. This is one reason it's so much cheaper.

Also, I think a great many craft beer drinkers recognize that there's a time and place for 'lawnmower' beer. And as a homebrewer, I can tell you that it's a pretty difficult style to get right.

There are a lot of reasons besides beer style that so many people prefer craft brews, including a reputation for high quality ingredients and, especially in Oregon, it's much more likely to be a local product.

Just my $0.02

Patrick Emerson said...

I agree that Session is not necessarily a departure from craft brewing per-se, but I do think it represents an attempt at gaining a different consumer, mainly those that regularly buy macro-brews. I agree that Session is a far superior product and I myself am a consumer that does not purchase macro-brews but has been seduced by Session's many charms - particularly evident on a hot summer day.

My point is that from a market standpoint it represents a big movement toward the middle, the mass-market. This may be a good thing to allow your customers more latitude within the brand, but also may be a bad thing if it means competing more directly with the big boys whose economies of scale, marketing and financial resources make them a very formidable opponent.