A Night at Upright

 

Okay, so maybe I am a "beer economist" after all turns out it is working out pretty nicely for me.  I was, for the first time, invited to a media preview event involving beer. Ezra and Alex of Upright Brewing did me the honor of inviting me to the 1-year Anniversary and Four Play release media preview and I had an altogether delightful time attending, tasting the wonderful beer, chatting about the business of beer and meeting many folks that make up the beer-o-sphere for the first time.

Since my readers are mostly not regulars in the beer-o-sphere I suspect, a little background on Upright is in order.  Perhaps the best introduction from the early days is Jeff's.  It is located in the basement of the Leftbank project and focuses on Belgian-inspired farmhouse ales.  Upright's owner and brewer Alex Ganum is a Belgian beer enthusiast, but it was my impression that he was more a fan of the Belgian brewing ethos than the specific style (as much as there is one - see: ethos).  He brews beers in the Belgian tradition but is inspired by local ingredients and uses mostly Willamette Valley grains and hops.  He also uses the tricky open fermentation method and his house yeast is a curious beast - but I am getting ahead of myself.  For a while Upright's beers were only to be found on tap, but now they are turning up in such places as New Seasons in the bottle. The standard line up includes the delightful Four, the more robust Five and the darker Six.

Upright will be a trend-setter, I believe.  The number of breweries that start up, produce a hoppy pale, a very hoppy IPA and so on are myriad - Upright represents a clear break from the trend and a local beer that is truly unique and representative of an entirely different type of beer.  I'll talk about those beers in a future post, but different than most of the beer writers/bloggers in attendance I was interested in the economics of the industry and the niche that Alex occupies.

Brewing such an open style can be a tricky business proposition. Using open fermenters adds some risk to the whole endeavor (though Alex doesn't apparently think it ads much) and building and maintaing a climate controlled and sterile room is expensive.  So in a business sense, Alex is banking on people appreciating his efforts, being able to tell when tasting the beer and being willing to pay a small premium for it.  It is thus unlikely that many other places in the US would support such efforts (though I may be selling other beer communities short).  Alex also uses a yeast that is amazingly hungry but remarkably slow.  It takes weeks for the yeast to go through the primary fermentation stage, and then it just keeps on going during secondary fermentation and in the bottle or keg (so when it goes out the door, he is not entirely sure what it will be like upon opening/taping).  Keeping the beer around for weeks upon weeks is costly and not being able to completely control precisely the finished product is a risk that most business people like to avoid.  I am tempted to make the comparison to wine production, but the dirty little secret there is how much wineries can manipulate the final product with additives.  Not so here.  This just shows you how different this type of truly craft brewing differs from industrial brewing where the bottom line rules and the product is never, ever supposed to taste any different.  Alex admits that it tests his devotion to his yeast, but he hasn't lost faith yet.

The other interesting thing about Alex's yeast is how efficient it is in the end: it eats just about all of the available sugar.   Most yeast in the beers we regularly enjoy will achieve 70-75% attenuation, but the good Brothers Widmer analyzed the yeast in the lab (and did so pro-bono - cheers Widmers!) and found that Alex's was achieving up to 97% attenuation. Wow.  Jeff has a nice post on the implications of the yeast in the brewing process.

I had a chance to ask Alex the question that I find most interesting: how do you decide on price?  I like this question because for a standard business the textbook answer is clear: you charge the price that maximizes profit.  But in this business - with experience goods and where price is a signal of quality - you want to be careful about what price says about your product.  Alex talked about the 'right' price and I don't know what was in his head but this was my interpretation.  For example, you might think a new brewery would think about pricing very cheaply to get people to try the product so that they could learn about the quality, but doing so might leave the impression that it is not a quality beer (otherwise how could it be so cheap?).

I'll post on the beer later, but for now, it is definitely worth your while seeking out the beer - perhaps the good folks at Taplister (one of whom, Kerry, I met that night) can help you out.  I have seen bottles in New Seasons and I have a suspicion that Belmont Station and the Beermongers might also have a bottle or two in stock.  They are also now at the Portland Farmers Market so you can find yourself some tomorrow while you are there.  You will not be disappointed.  Cheers.

Signalling Redux

The blogger and graphic artist whose "nom de plume" is Samurai Artist popped me a note to inform me of his very interesting interview with Brett Joyce of Rogue (the above is a sample of his work). During the interview he asked Brett about a post I had done in the past about Rogue and signalling. At the time Brett appeared quite annoyed by my post, and I was completely perplexed. But then I realized the problem, people were not understanding it as an equilibrium concept. Anyway, here is the exchange:

SA: There was another blog post (on the Oregon Economics Blog) that suggested that you guys use the economic term 'signalling' by pricing yourself higher to signal to consumers that your beer is of a higher quality. I know that you said that wasn't true, but I would like to see if you have more of a response to that.

Brett: Yeah, I'm not smart enough to know what 'signalling' is, but I would just say this, there is a lot that goes into the packaging, there is a lot of hops and malt that goes into our products. We have never told John in 21 years what to put into the beer. He is an artist, and it is our job to get out of the way and let him practice his craft, and it is our job to go sell it, go market it. Our beer is not inexpensive to make. It's because of ingredients and because of packaging, not because of 'signalling'. I don't even know what that means!

This is a good illustration I what I mean. I would not say that Rogue 'uses' signalling. What I was trying to provide an explanation for was the popular beer blogger complaint that Rogue is too expensive. Given that the craft brew industry in Oregon is intensely competitive it is hard to see how Rogue's prices are sustainable in the free market of beer. Signalling provides a potential explanation (not necessarily the right one or the only one, but a possible one): if people think price contains some information about the quality of a product that they cannot themselves determine before they purchase it (as opposed to something like a new shirt that you can touch feel, try on, etc.) then they may act on that information by purchasing it. Of course, all beer companies could try this, but the companies with a lesser product would find out quickly that consumers learn and their sales would plummet. Packing plays a similar role - Rogue's packaging is more expensive and a signal of the quality of what's inside. Other breweries could do the sam but if their beer is of inferior quality than their attempt to signal becomes a costly waste of time.

If the consumer tries the expensive beer and likes it then their assumption about the price being indicative of quality is correct. Only though repeated tries would the consumer learn that price is a reliable signal. And this confirmation will happen only if it is truly just the better beers that are more expensive (in general). So you see, signalling is essentially an equilibrium where better beers are priced higher, and consumers act on this knowledge.

This is why I was perplexed about Brett's annoyance with the story: it is an equilibrium story that is not an explicit strategy by Rogue. In fact it happens simply because Rogue responds to the incentives that are already in the market. And it only works if Rogue's beer really is thought of as that good once buyers purchase it. I think he thought I was saying it is an explicit strategy you can use to fool consumers and get a higher price. Precisely the opposite: it is a market outcome whereby better beers price higher and lesser beers price lower and it works because in equilibrium consumers are then correct about how price and quality are related. [Note that good and bad craft beer aren't necessarily any more or less expensive to produce so there is more to price differentials than the cost of ingredients clearly]

Full disclosure, I love Rogue and Brutal Bitter is among my top five favorite beers, but that has nothing to do with it. The answer to "how do they get away with charging so much?" is simple: the market thinks their beer really is that good. And as good beeronomists we should know not to question market outcomes, our task is to simply try and understand them better.

Finally, this model was originally applied to education: people get college degrees because they want to gain more skills and knowledge but (perhaps unbeknownst to them) it also serves as a signal to firms that they are smart and worthy of hiring. Getting a degree is hard, however, but a lot harder if you are not smart than if you are truly smart. So firms take the degree as a signal of quality and they are right to do so - because, in equilibrium, only the smart ones will find it worthwhile to spend the time and effort getting the degree.

Beer Prices and Signalling

The discussion about beer pricing strategy continues at the Beervana blog with an interesting comment from one of the pre-eminent beer retailers in the nation: Belmont Station (no longer on Belmont, but why quibble?). Here is an interesting tidbit:

Some breweries (like Rogue) are quite proud of their beer, and regardless of
whether or not Dead Guy cost significantly more than Inversion they want to
project an image high quality, expensive beer, so they price it higher.

Nobel prize winner Michael Spence won his prize for developing the theory of signalling. The idea is this: if you are a high productivity person (because perhaps you are especially smart), how to you credibly convey this to a prospective employer. You can't just say "I'm very smart" because if this increased the likelihood of you being hired or getting a higher wage, everyone would say it even if it were not true. So you have to find other ways to let them know, or 'signal' your type. One way to do this is to obtain more education. This works because acquiring this education is easier for those that are smarter. Less smart individuals will decide not to invest in education, because it is costly and, after employed, employers learn your true type. So in equilibrium there is a natural sorting, smart people get educated and less smart people don't and, here is the punchline, employers can use education as a real measure of smarts.

[By the way I tested this model (with Mike Conlin now at Michigan State) using new players in the NFL and found that players with some private information about their ability can signal this through holding out and delaying agreement on a contract. The idea is that missing some training camp is more costly for less able players than for more able players.]

This basic model has been translated into advertising. Why do some manufacturers spend a lot of money on ads that tout the superior cleaning ability of their laundry detergent? Any manufacturer can claim this but consumers figure out whether this is true. Since what manufacturers of laundry detergent want is to get customers to become loyal to their brand, if spending a lot on ads does not get consumers to keep coming back, it is pretty wasteful relative to those brands that do get consumers to become repeat customers. Thus, again, there is a natural equilibrium, high quality brands will do a lot of advertising and lower quality bands will not and, again, the punchline is that the ads themselves are credible signals of the true quality.

What does this have to do with beer? Well, if Chris of Belmont Station is right, high price is itself a signal of true quality. Since consumers figure out beer quality by trying it once, price itself may be a reliable signal of the quality of the beer. To put it another way, if consumers didn't think Rogue was exceptional beer, they could not get away with their high prices, so the fact that they can is a signal that they do indeed make exceptional beer.

So it is not necessarily just a matter of projecting high quality, but informing consumers about quality as well...