Why Do We Pay High Price for Wines in Restaurants?

Consider the following  three scenarios  and see if you can think of the answers

1. Wine by the bottle: Why do restaurants charge such a high price for wines that you could buy cheaper retail (and even lower price in wholesale clubs)?
2. Wine by the glass: How do restaurants price wine by the glass? Why does a glass of wine costs so high? Why not all varieties are available by the glass?
3. Wine corkage: Why do restaurants charge corkage fee? Why allow customers to bring their own wine at all?

A common theme in all three scenarios is we are parting with lot more of our consumer surplus than we would in other situations. More bluntly, we leave with lighter wallet and not really know the value we got.

A recent analysis of wine prices in Manhattan restaurants found restaurants markup wine prices by 4-5 times the wholesale price they paid.

Restaurant Sciences tracks thousands of wine, beer and liquor brands across tens of thousands of restaurants, nightclubs and bars in the U.S. and Canada, and in the past six months, the company’s researchers found an “absolute increase” in wine markups.

But why? That article, while expressing anger at such high markups, did not take to task the wine guys who tried to justify the high markups with their costs.

Wine markup has to cover other costs

As a revenue center, wine has to support several other costs, said Mr. Sun. For example, there is the expensive stemware (Riedel), the salaries of the sommeliers (Jean-Georges has four) and even the cost of the wine list itself. For example, the 16 leather wine-list binders at the Jean-Georges flagship cost $500 apiece and every page in the book costs 15 cents a sheet. The list is 32 pages long and changes almost daily.

And then there’s the cost of inventory, particularly with wines that are kept for a period of years before they’re placed on the list. It’s expensive to buy wines and then store them. While these wines may be more pleasurable to drink after a few years of age, they restrict cash flow—and take up precious cellar space.

First customers do not go to restaurants or order wine to cover the restaurant costs. Customers hire restaurants for many reasons – none of which is to cover its costs.

So what the wine was served in Riedel? Did the restaurant buy the stemware just for this customer? Will they give a discount if I ask for my wine to be served in ordinary stemware?  NO and NO. The restaurants realized either they have to justify the higher prices by using value signals like Riedel stemware or found that using expensive stemware (one time fixed cost to the restaurant) helps set higher prices for the same bottle of wine. So to say the prices has to be high because of expensive stemware is an illogical argument that one would buy only after two bottles of wine (inside them).

So what the salaries of the sommeliers are high? Did they hire the sommeliers just for you?  If you know the exact wine you want to order and did not ask the sommelier do you get a discount? NO and NO. Once again the restaurant would not have hired four high-paid sommeliers had it not been sure that would help with higher price premium.

Same argument for $500 a piece wine-list or the decision to stock up an inventory. You get the idea of why a fixed cost component does not matter. In the absence of absolute value from a bottle of wine the restaurant is relying on all these external signals to bump up customer willingness to pay (which is malleable) or justify a higher markup using cost as as the argument.

To say these are valid reasons to justify 2-3 times but not 4-5 times markup is just plain wrong. As the article indeed does just that,

Take, for example, Montmartre in New York. This simple French bistro doesn’t have a wine list in a fancy leather binder (it’s one page in a plastic sleeve) or a team of sommeliers, and I doubt that it has the wines in its cellar for more than few weeks. The restaurant has been open for only a few months, after all. And yet, the markup on its wine list is close to four times wholesale—and often more.

There is no validity to the argument that  certain markup is good but anything higher than that is not.

So why are wine prices so high in restaurants? Two reasons, either it is a mistake or done with diligence.

Restaurants can set whatever price they believe will help maximize their profit. They can set this high price because they have no clue  and simply doing it because someone else is doing it or because they have done the math on how many will choose wine at what prices and what that means to profits.

It is possible most restaurants don’t know better. From the anecdotal evidence I have seen they do adopt the 3x multiplier blindly without understanding customers they serve, their preference, what budget are customers paying for wine and their willingness to pay.

That evening at Montmartre, I noticed that both of the couples on either side of our table were drinking, respectively, water and cocktails. And that’s not a scene that any wine director, winemaker or wine lover is ever happy to see.

So what some customers do not choose wine? Other restaurants know their customers and are okay if not all of their customers choose wine because the profit from those who order wine is more than what would have been had they set the prices lower with larger sales.

If you think wines are overpriced in a restaurant, do not order it. If the occasion warrants it or some else is paying for it, you will, regardless of the price.

Regarding wine by the glass?

Wines by the glass are priced to make it attractive for customers to buy the full bottle. For those insist on buying by the glass the restaurant is only happy to oblige and capture higher customer surplus. Here is the skinny on wine by the glass pricing,

 the conventional rule of thumb calls for the price of the glass to equal the wholesale cost of the bottle, plus, often, a few dollars more. And with five glasses in a bottle (or four, at a more conservative measure) that’s a profit margin so large that only the greediest restaurateurs would dare to charge a similar markup on a full bottle.

Regarding corkage, see what I wrote before.