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.

The Simplest of all Business Models

Wi-Fi Signal logo

If you want to use Wifi at Pete’s Coffee & Tea you will have to buy something first.  At the counter they give you a code to use, that allows you about an hour of surfing time.

In many local coffee stores you technically have to buy something but once you do, you can stay parked in their tables for hours without buying anything. In Pete’s bigger competitor, Starbucks coffee, it is the similar unlimited free access plus access to premium extras like The Wall Street Journal.

Coffee shops complain about those who occupy tables for hours at a stretch, buy little or nothing and mooch on their bandwidth as well as electricity. Customers who do spend money at coffee shop and need good connectivity for an hour or two complain about the poor speed and difficulty in finding tables near outlets. General customers (who hire the coffee shop for, coffee) complain about the crowd and lack of seats to simply sit and enjoy their brew or have a conversation.

Free Wifi became a popular perk for coffee shops, restaurants and hotels to attract customers and keep them in their shops. If the customers chose your business over others because of free Wifi, you win. If the customers stay because of free wifi and continue to spend during their stay, you win. You have successfully used free wifi as lead generation tactic and customer retention  tool. (Freemium?). For instance, Panera bread saw its sales increase by 15% when they introduced free wifi.

On the other hand, what is free to customers, is not so to businesses. There are costs of operation (making sure there is enough capacity) and opportunity costs (both for the money spent on their big pipe broadband and the moochers). When everyone else offers free wifi it becomes difficult for a business to either stop offering it or start charging for it. Add to this customer dissatisfaction from providing poor internet service.

Look at where we are in the discussion. We are not talking about the compelling value proposition a coffee shop (or a restaurant) offers but talking about a perk. Let us not forget the primary job these businesses wanted customers to hire them for. If customers’ choice is made based on secondary and tertiary factors, the primary value proposition has become irrelevant. If a business fears their customers will walk next door for free wifi they are admitting that their product is an easily replaceable commodity.

That is a bigger problem they ignore while fretting about wifi costs. In focusing on free wifi as lead-gen activity they ignored the core customer segment they started with and the customer jobs they hoped to serve. While some may call free wifi (and Freemium?) as business model innovation, this is essentially losing sight of customer needs and your core competence.

If the customers didn’t hire your coffee shop for coffee, should you tie your business model to selling coffee? That is an incongruence between value creation and value capture.

On the other hand your strategy – to serve the most amazing coffee – need not be fixed. You can see the customer shift and decide your strategy is to serve those customers who have a connectivity need and are not satisfied with existing alternatives. You recognize customer issues with poor speeds in free wifi places and provide reliable speeds as differentiated feature. In such a case you cease being a coffee shop and become a workspace provider. And guess what, you now can charge for that value delivered.

The business model is back in sync with value capture matched to value creation.

That is exactly what is happening in Russia’s Clock Cafe.

“You don’t have to pay for coffee or tea or cookies. You should pay for time, and time costs — I hope — [are] not that expensive.”

And their target segment? Students and business folks who hire them for connectivity and hence pay for the value they get.  Nicely done. However, I think they fixed one mistake but introduced another – making coffee free. There really is no reason for them to offer free coffee, especially the premium kind they claim they deliver,

We have cappuccino, latte, espresso, Americano, and our coffee is not the cheap one

They are committing the flip side of free wifi at coffee shop mistake. Sooner or later they will run into the free wifi problem in reverse. Why bother with coffee or why not charge for it? Especially if the customers didn’t hire you for coffee?

When it comes to business strategy, starting with customer needs and choosing the ones that you can serve better than others remains the best approach. And when it comes to business models, charging for value you deliver remains the simplest of all approaches.

What is your strategy? What is your business model?

Answer to Pricing Puzzles – Restaurants Charging Fee for Sharing

I tweeted a series of pricing puzzles. This series is my interpretation of what the answers could be. Do not treat them as absolute answers. Alternative explanations are possible.

There are two parts to this question.

  1. Why do restaurants charge a fee for sharing?
  2. Why do they charge two different prices based on what is shared?

It is safe to say that those willing to share are most likely couples and they likely pay for it from the same shared budget. For everyone else, those not sharing budgets, the question of sharing does not even come into play.

A restaurant’s goal is to maximize spend per table.  Their wait-staff are essentially the sales team trying to generate more sales per table during the period it was occupied.

So when customers share, it cuts (almost in half) the spend (and hence profit) per table. To discourage customers from doing so, they make the price of the single entree look a little more unattractive by adding the split fee. This is second degree price discrimination. With the split fee, customers may see higher value (consumer surplus) when they order two vs. one.

For those who still want to share for any number of reasons including limiting portions, even with added fee sharing will provide higher consumer surplus and the restaurant gets to recoup profit.

Why charge different split fees? Price discrimination done right. If you charge one split fee, you might as well charge two.

Should they do it? What about customer backlash?

To repeat my earlier point, this is a limited segment that will share food. The rest won’t even notice the split fee.  So by all means do it as this is money that flows straight to bottom line. However they should consider their customer mix and capacity utilization.

What does this mean to you as a Tech Product Manager?

I do not recommend you following in the restaurant’s footsteps. Start with the customers and their needs. Consider how your webapp is being used by your customers.

  1. Do they share login?
  2. From what budget are they paying for it?
  3.  Is there value for them in keeping separate logins?
  4. Do they want to keep their Netflix video queue/history or Evernote clip archive separate?
  5. Do they consume your limited capacity without adding to revenue?

My recommendation: Instead of trying to tack on split fees, make the price of adding second (or third) user attractive that most will do it.  (Like SurveyGizmo did)