Returns To Scale in Beer and Wine: A P P L I C A T I O N 6 - 4

228 PART FOU R Production, Co st s , and Supply
A P P L I C A T I O N 6.4
Returns to Scale in Beer and Wine
Returns to scale have played an important role in the evolu- Wine: Product Differentiation to the Extreme
tion of the beer and wine industries in the United States and Although wine production might have followed beer pro-
elsewhere. In principle, both of these industries exhibit duction and taken advantage of economies of scale and
increasing returns to scale as a result of the geometry of national marketing to become increasingly concentrated,
their production methods. Because both beverages are pro- that did not happen. In part, this can be explained by pro-
duced by volume but the capital involved in production duction technology. Maintaining quality for high volumes of
(brewing kettles, aging casks, and so forth) has costs that production has been a recurring problem for winemakers,
are proportional to surface area, larger-scale producers are even though there are cost advantages. Most production
able to achieve significant cost savings. Of course, there are problems arise because wine grapes can have widely differ-
differences between beer and wine in the nature of the raw ent characteristics depending on precisely when they are
material used (wine grapes are much more variable in quality harvested, how much rainfall they have had, and the nature
than are the ingredients of beer) and in the nature of demand. of the soil in which they are grown. Blending grapes from
These have produced rather significant differences in the many areas together can be technically difficult and will
evolution of each industry. often result in a wine that represents a ‘‘lowest common
denominator.’’
Increasing Concentration in Beer Production The impact of these difficulties in large-scale wine
Prior to World War II, beer tended to be produced on a local production are exacerbated by the nature of the demand
level because of high transportation costs. Most large cities for wine. Because wine has a relatively high income elasti-
had three or more local breweries. Improvements in shipping city of demand, most wine is bought by people with above
beer together with national marketing of major brands on average incomes. These consumers seem to place a high
television caused a sharp decline in the number of breweries value on variety in their choices of wine and are willing to
after the war. Between 1945 and the mid-1980s, the number pay quite a bit for a high-quality product. Demand for a
of U.S. brewing firms fell by more than 90 percent—from 450 low-quality, mass-produced wine is much less significant.
to 44. Major brewers such as Anheuser-Busch, Miller, and These observations then reinforce Adam Smith’s conclu-
Coors took advantage of scale economies by building very sion in The Wealth of Nations that the ‘‘division of labor
large breweries (producing over 4 million barrels of beer per [that is, economies of scale] is limited by the extent of the
year each) in multiple locations throughout the country. Bud- market.’’1
weiser became the largest-selling beer in the world, account-
ing for more than one-third of industry output. TO THINK ABOUT
Product Differentiation and Microbreweries 1. How do transportation costs affect attaining economies
Expansion of the major brewing companies left one signifi- of scale in brewing? How might a large beer producer
cant hole in their market penetration—premium brands. decide on the optimal number of breweries to operate?
Beginning in the 1980s, firms such as Anchor (San Francisco), 2. Laws that limit interstate sale of wine over the Internet
Redhook (Seattle), and Sam Adams (Boston) began produ- were relaxed significantly as a result of a Supreme Court
cing significant amounts of niche beers. These firms found decision in 2005. How would you expect this to affect the
that some beer consumers were willing to pay much higher scale of production in the wine industry?
prices for such products, thereby mitigating the higher costs
associated with relatively small-scale production. The 1990s
saw a virtual explosion of even smaller-scale operators. Soon
even small towns had their own breweries. A similar course
of events unfolded in the United Kingdom with the ‘‘real ale’’ 1
For more on the technology of beer and wine production (together
movement. Still, national brewers continued to hold their with information on other alcoholic beverages), see Y. Xia and
own in terms of their total shares of the market, mainly S. Buccola, ‘‘Factor Use and Productivity Change in the Alcoholic
because of their low costs. Beverage Industries,’’ Southern Economic Journal (July 2003): 93–109.

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228 PART FOU R Production, Co st s , and Supply

Returns to Scale in Beer and Wine

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