1. The Cost of Ignorance: Reputational Mark-up in the Market for Tuscan Reds Karl Gunnar Persson and Paul Sharp Department of Economics University of Copenhagen Trier Enometrics May 23-26,2007 The paper is available at my homepage www.econ.ku.dk/kgpwww.econ.ku.dk/kgp under Workshop papers

2. Motivation Anecdotal evidence suggests that new denominations in Tuscany suffer from price discrimination, that is they are, ceteris paribus, under-priced relative to prestige denominations such as Brunello di Montalcino and Chianti Classico. Is that right? Yes it is! We will explain why.

3. Propositions Consumers are imperfectly informed about characteristics (quality) of individual wines. Information about average quality of denominations to which individual wines are affiliated is widely accessible and easy to memorize and consumers can rank denominations in terms of (perceived) average quality. Consumers use imperfect information on individual wines and more accurate information on the average quality of the denomination of a particular wine to infer the quality of individual wines. If consumers pick wines randomly within a denomination they are willing to pay a mark up which corresponds to the (perceived) difference in average quality between denominations.

4. Stylized facts Average quality of a denomination increases over time since conzorzio members know that price is related to average quality in the denomination and purge below average members. Denominations in Italy typically develop from DOC to the more rigorous DOCG. Accurate information about the quality of a denomination takes time to get established since media penetration takes time. For wines without denomination affiliation consumers will need to learn about the characteristics specific to the individual wine. This might be a market for relatively well informed consumers.

5. Implications Price of an individual wine is determined by specific sensory characteristics of the wine and the average perceived quality of the denomination. Price of individual wines not affiliated with a denomination is more strongly related to the specific sensory characteristics of the wines than denomination wines. Wines in older denominations will enjoy a price mark up relative to new denominations, sensory characteristics/quality held constant.

6. Data Price and critics’ evaluation of quality of more than 450 Sangiovese based red wines in Brunello di Montalcino and Chianti Classico DOCG and a number of recent DOC denominations in the Grosseto province, bordering Montalcino. A control group of 200 non-denomination affiliated (IGT and Vino da Tavola) red wines from the same geographical area and producers.

7. Tuscan DOC and DOCG

8. Model

10. Results and interpretation The mark up of Brunello over Grosseto is almost € 15 or 65 per cent, and about € 7.5 or 25 per cent over Chianti Classico for a wine that has a score of 91. The mark up over Grosseto is constant but falls over Chianti C. as quality increases since Chianti C. has a stronger price-quality relationship. New vintages(2003-2005) are discounted by about € 6. Non-denomination wines (IGT) have a stronger price response to quality and almost all of the Brunello denomination effect disappears. Mark ups are reduced to 1/3 compared to DOC and DOCG wines. Consumers tend to exaggerate the quality difference between top range denominations and lower rank denominations.

11. Further results Estimates of the price change triggered off by a unit increase in quality varies between € 1.07 and € 2.4. The recorded mark ups are only compatible with the highest estimate of price responsiveness. It is likely that consumers exaggerate the actual quality gaps between prestige denominations and new denominations.

12. Selected estimation implications

13. Concluding remarks Large price differences between wines, which are independent of quality, are believed to be compatible with rational consumer behaviour if search costs are high. Denominations reduce search costs but carry mixed blessings. The mark ups recorded in this study for the purchase of a single bottle of wine amount to about half the price of a well recognized wine guide. The cost of ignorance is significant and rational consumers could do a lot better - provided they are literate. Such consumers will gain a lot by visiting the book-shop before they go to the bottle-shop.