Why do restaurants charge such high mark-ups on their wine lists? We had this beauty in our micro class last week, and by god it’s a good way to trick the armchair economist among us. Typically, the casual price theorist has two tools in their belt for amending puzzles like this; marginal cost and price discrimination. In this case, they nearly always grab the later, and rarely ever find a reasonable solution.
The usual explanation goes something like this: a lot of restaurant goers have a high value on drinking good quality wine with a good quality meal. By restricting patrons to buying wine on the premises (or charging a prohibitively high corkage) they can siphon this value through higher prices without taking significant hits to their patronage: economists call this third degree price discrimination.
But to say these restaurants can price discriminate is to say they have market power i.e. they have few (or no) competitors and a wide base of loyal patrons who don’t mind being gauged. Unless we’re talking about the one in a million restaurants like Tetsuya’s or The Fat Duck, this is a difficult argument to make. In Canberra we are flooded with high quality restaurants (we’re pretty famous for it actually) all charging excruciatingly high mark-ups on wine – four to five times the price you can get at the local bottlo. If one of these eateries offered even a marginally reduced price list for their wine, I suspect they would see a flock of transferred customers willing to spend their hard earned cash on their celebratory nights out. So, why don’t they?
Whilst it may not appear to be the case, wine is a very expensive commodity to provide. The most immediate cost is the expensive liquor licences required as well as the accompanying serving certificates for each employer. Once the respective permits have all been obtained, any top restaurant needs to hire a sommelier to recommend a wine list and an accompanying blurb describing the fruity and/or nutty aromas of each vintage. After this, they need to buy the wine. This involves sacrificing the interest earned on any capital they sink into this often very expensive purchase that may not yield a return from sale for months even years after the investment. They then need to portion out a valuable area of their shopfront to securely store the wine and finally, when they get to sell the wine, if a patron only has one or two glasses, the rest of the bottle is wasted – it can’t be re-corked and must be thrown out or downed in misery after the whole affair.
But after accounting for all of these reasons, there is yet another cost to providing wine, that I suspect drives up the price by at least the same magnitude as the others combined, if not more. One of the most overlooked costs that a restauranteur faces is the cost of the table. Not the physical value nor the upkeep, but the opportunity costs that come with renting out that table for a couple of hours each night. There may be nothing more costly from the point of view of the manager than the time you spend at the table that night – not the service cost, the cost of the food nor the cost of the alcohol, but the time you spend in the restaurant taking the space where another patron could be sitting and spending their money.
But how do you charge those who hang around? Sitting a chess clock on their table probably won’t be very popular, offending most and ruining the experience for some. But there is another, more palatable solution that the restaurant can use – a boozer tax. To target these hang on customers, taxing the good that makes them stay around the longest is an effective way of recovering these opportunity costs. Staying an additional hour at a restaurant could cost the business half to a full meal per person. If they pay an extra $50 per bottle of wine however, this cost may be negligible. Further, this rule would stand to the competition test – reducing the price of alcohol would attract a flock of customers, but the costs of those who take up the valuable space on the dinning floor would not be recovered, and thus this move could be unprofitable.
When seen in this light, it’s quite reasonable that wine mark-ups are so high in good restaurants; for high quality eateries to remain competitive and recover the additional costs associated with hang-on patrons, they charge these patrons accordingly by taxing the commodity that keeps them there the longest – booze. And whilst this doesn’t seem to stop the waiter from hanging around your table when you’re finished eating, it does tend to stop them kicking you out, giving you more time to drink up on the expensive wine and chow down on the overpriced dessert.
Thinking back on it now though, I haven’t mention the third trick the armchair economists hides beneath their cushion – behavioural effects. But then again, no-one believes that nonsense anyway.