voluntaryXchange

Consumers Are Weird: Maker’s Mark Edition

Frequent commenter Jim` sent me this article: Maker’s Mark* changed the formula of their bourbon, and consumers freaked. Management backtracked, and the product is back to what it always was.

Now, right off, let me say that management’s second decision was the right one. It doesn’t matter what the underlying logic is, if the consumer is ticked off about the change, you change back.

Having gotten that out of the way, the whole story strikes me as odd. Maker’s Mark is a bundled product. They own a distillery, but the whiskey that comes out of the barrels is a far higher proof than what is sold to the public (this is standard in the distilling industry). The final product is a mix of what comes out of the barrel, and water.

What Maker’s Mark announced last weekend, and reversed course on this past week, is an increase in the proportion of water.

The thing is, when you do any kind of fermentation, the percentage of alcohol in your final product is variable. It gets worse when you distill, because you may lose some alcohol as vapor too.

In short, Maker’s Mark is in the business of adding more or less water to get the final product to be consistent. Distillates are commonly 65-80% alcohol, Maker’s Mark final product was 45%, so this means taking 20 ounces of distillate, and mixing it with 9-16 ounces of water.

Maker’s Mark big decision was to change the amount of water they added, increasing it to 11-18 ounces, to reduce the new final product to 42% alcohol.

The first thing that’s odd about this is that the first thing most consumers do with their bourbon is dilute it ever further with a variety of water based products: colas, club soda, lemonade, vermouth, Tom Collins-like mixer … or even more water and/or ice.

So, the downstream diluters are upset about the upstream diluters horning in on their territory? Spare me. Now, I understand that some people drink the stuff straight, but that’s probably not a majority for any liquor.

Now, I’ll bet you a buck that Maker’s Mark was going to sell the new product at the old price, and keep the difference. That’s something worth getting angry about.

But it gets even stranger: management blames inadequate supply.

The bourbon category has accelerated tremendously, and as the bourbon category has grown. That has accelerated Maker's Mark growth to a point where the demand for Maker's Mark is significantly greater than our distillery's ability to produce it. …

…

Over the last 100 days there have been many instances where our distributors, retailers, bars—there have been periods where the brand's not available across most every state in the country. …

…

… It's the tasting panel, at Maker's Mark, they tell us when the barrels of Maker's Mark are fully mature and ready to bottle.The seasons vary—intense summers, intense winters will speed up the maturation process a little bit; mild summer, mild winter will slow it down. Under-aging is bad; we think over-aging is actually worse. One of the ways that many other distilleries can extend their supply is through a slight reduction in time spend in the barrel. That's not an option for us, because we know through the many, many years of producing at Maker's Mark, that we don't land on the Maker's Mark taste profile without a minimum of six full summers in the barrel, through the intensity of six summers.

Now, I do get that they’re in bind here. If they ramp up production now, it will be 6 years before they have more inputs, and by then the boom might be over.

But I’m fairly perplexed by the managerial economics here. Clearly they are facing a demand shift. And their supply is vertical in the short run. The textbook response is that price goes up. But, there’s no mention of pricing decisions anywhere.

Instead, they choose to shut down that market (and its supply and demand diagram), and create a brand new one … with a vertical supply line that is a bit further to the right. Presumably the goal of this is to sell the new product at the old price.

The only reasonable reason to do this is because you feel that the (own price) elasticity (of demand) for your product is high. And yet, all the brand development that’s gone into making Maker’s Mark a premium product is intended to make that elasticity lower. So that doesn’t make sense.

And, you know thinking about it as a brand new supply and demand situation makes clear what they should have done: created a new brand name with less alcohol. You know: old Maker’s Mark at 90 proof with red wax on the bottle, and new Maker’s Mark at 84 proof with blue wax on the bottle. Then raise the price of the premium product, market the new product at a discounted price … and clean up with price discrimination. But nooooo …

I’m going to stick my neck out here, and claim that this never would’ve happened if this wasn’t a family company.† Family companies tend to promote based affinity, rather than business sense. Maker’s Mark’s COO is the grandson of the founder. He’s been running the operation for less than 2 years. He made the decision, and his father (the Chairman emeritus) had to undo it. If there wasn’t blood there … the new guy would be fired.

* We had many laughs at a Super Bowl party a few weeks ago at the host’s fumbling over the name. No matter what she tried, “marker’s make” came out of her mouth. Sorry to point this out CK!

† Maker’s Mark is part of Beam Inc., but that is a brand management company, not a producer. My guess is that if the Samuel’s family delivers the cash flow, that Beam will let them pretty much do what they want. But that raises another issue … why were they so hell bent on increasing cash flow? Where’s all the money going?

Technorati Tags: maker's,mark,bourbon,proof,change,alcohol

Time Is Money: The Real Reason That Managers Are Concerned About What Employees Do On Office Computers

From I Love Charts:

I once heard from a manager at one of our local factories that the biggest reason for firing Mormon employees was viewing porn on the job, while the biggest reason for firing non-Mormon employees was positive drug tests (and the attendant safety risks to other employees).

ManEc students should note that both increase costs but not revenues.

Technorati Tags: search,view,porn,office,job

How Much Does Pharmaceutical R&D Cost?

Megan McArdle:

Now along comes a new method, from Matthew Herper at Forbes.  It uses only public, audited data, and it's breathtakingly simple: over a 15-year period, they divided each company's R&D spend by the number of drugs they got approved.  The result: DiMasi is also way too low.  For every approved drug, pharma spent between $4 billion and $11 billion on R&D.  Yes, there's probably some wiggle room on the accounting …

Technorati Tags: new,pharmaceutical,R&D,costs

Group Projects In Business School

Business schools love teamwork. Here’s what one student thinks:

What’s that thing economists are always worried about? Ah yes … unintended consequences.

Via I Love Charts.

Technorati Tags: group,team,project

No Steering Wheel ???

I’d like a car with a system like what is shown below.

In class, when discussing income and substitution effects, I point out that drivers are typically more aggressive than their passengers would like. This is because they are holding onto the steering wheel: the costs to the driver of driving aggressively are lower than they are for the passenger. It’s also why passengers like to grab onto what is sometimes known as the “Oh Shit Bar” (the hand hold/hangar above the interior of car windows).

The video is no longer politically correct, but still, it’s a pretty cool system:

Via FOXNews.com.

Technorati Tags: car,steering,wheel,wrist,twist,income,substitution,effects

Matrix Management vs. The Cloud

Sorry Scott — I couldn’t find this on your website on the date listed on the gif file.

Finally, someone says it: matrix management is what we call it in a business school when we can’t figure out whether a firm has any structure at all.

P.S. Do you think it is coincidence that fewer people have outlining skills, or can construct an argument in prose, and the fact that business structures have gotten more disorganized?

Technorati Tags: matrix,management,cloud

Systematic Unluckiness

I never cease to be amazed at people who tend to think that they’re repeatedly unlucky. It’s possible, but not likely.

We see this a lot from bureaucrats: repeated claims that their program didn’t work because of unlucky circumstances. When children make that excuse, we know better than to believe them.

But, in the private sector, we get the opposite problem. Since free exit is possible in many lines of business, it’s distinctly possible that those that are still in business were the luckier ones. Read between the lines and don’t believe all those claims of great decision-making when making your investments.

This post is sponsored. For a short term loan give www.jaguarpaydayloans.co.uk a try.

Technorati Tags: systematic,unluckiness,dilbert

I Laughed So Hard at This

Words that English needs but doesn’t have. Many people know and use the first one, along with the rest of my favorites:*

1 Age-otori (Japanese): To look worse after a haircut

2 Arigata-meiwaku (Japanese): An act someone does for you that you didn’t want to have them do and tried to avoid having them do, but they went ahead anyway, determined to do you a favor, and then things went wrong and caused you a lot of trouble, yet in the end social conventions required you to express gratitude

4 Bakku-shan (Japanese): A beautiful girl… as long as she’s being viewed from behind

7 Forelsket (Norwegian): The euphoria you experience when you are first falling in love

11 L’esprit de l’escalier (French): usually translated as “staircase wit,” is the act of thinking of a clever comeback when it is too late to deliver it

19 Schadenfreude (German): the pleasure derived from someone else’s pain

21 Taarradhin (Arabic): implies a happy solution for everyone, or “I win. You win.” It’s a way of reconciling without anyone losing face. Arabic has no word for “compromise,” in the sense of reaching an arrangement via struggle and disagreement

22 Tatemae and Honne (Japanese): What you pretend to believe and what you actually believe, respectively

23 Tingo (Pascuense language of Easter Island): to borrow objects one by one from a neighbor’s house until there is nothing left

I don’t like # 21 that much, but it is the essence of economics … in fact, there’s a similar meaning to the title of this blog.

Via bookofjoe.

* My 5 years of K-12 Spanish must’ve been OK, because I already knew # 6.

Technorati Tags: no,word,equivalent,meaning,in,english

Monopolistic Competition, Brands and Economies of Scope

In Managerial Economics, one of the points that’s hard to get across is that most business are composed of multiple product lines, most of which are competitive and earn zero economic profits, mixed together with a handful that have some transitory monopoly power.

I’ve found that students are often unaware of consumer brand conglomerates. Here’s an image to help them see these connection.

Here’s the full size original. Via I Love Charts.

Technorati Tags: brand,conglomerate,monopolistic,competition

Sell Your Delta Stock

It’s been a long time since I’ve heard of a management decision this dumb; Delta Airlines is buying an oil refinery from ConocoPhillips.* Some disagree, but I think it’s going to be in ManEc texts in a few years. This has all the hallmarks of management that worries too much about accounting and not enough about economics and finance.

First, the facts:

Delta claims it is doing this to save on fuel costs. Fair enough.

ConocoPhillips is selling the refinery because they can’t make money off of it. Their alternative was to shut it down.

The government is involved too: Delta is getting the refinery in a 10% off sale sponsored by the Feds.

There were no other bidders besides Delta.

First, a little finance (because so few people get the message on this one).

Conglomeration, the purchase of another firm outside your core competency, is not in the interest of investors. Diversification is the usual justification given, but investors can diversify more cheaply on their own. Delta is covering its butt, wisely, by using a different excuse. But, you should always be suspicious of this sort of move.

Also, Delta is worried about volatility of fuel prices. Except that there’s this thing called hedging: locking in prices to reduce volatility. I’m quite sure Delta does this. Everyone does. But people outside of finance tend to think this is either voodoo, or too difficult to understand. Here’s the thing: it works. It isn’t perfect, and it isn’t always cheap, but it does work. Delta has been doing it, and Delta is going to continue to do it. So, this is definitely not about prices, since Delta is already doing what everyone else is doing. It’s about trying to do better than everyone else. Fair enough.

Now, for the economics. Is there a plan here that is likely to do better than everyone else? I don’t think so.

First off, ConocoPhillips was going to shut the refinery down. Shutdown is a decision based on straightforward cost economics: you shut down if your revenue doesn’t cover your average variable costs. So, Delta either must have a plan to raise revenue or reduce variable costs.

But, variable costs in refining come mostly from crude oil prices. Delta’s announcements contain no information about how they are going to control those any better than an oil company would.

So, they must be planning on increasing revenue. Except that their announced plan is to reduce revenue. Yes, that’s right. Delta is worried about the high mark-ups on jet fuel, and the fact that jet fuel profits are supporting the rest of this refineries business. So, their plan is to reduce jet fuel profits, so that their main business can make more money, while killing their refinery business. Yeah … right.

This now gets into an area of ManEc called transfer pricing. this is how management should price a potentially profitable output from one division when it gets sold to a second division. Managers like to screw up their transfer pricing when they’re either: 1) a product of one division of the firm that really doesn’t care if they suck the blood out of other divisions, or 2) don’t have much experience in business.

So, it’s time to take many seconds to search out the bio of the CEO of Delta. It’s Richard H. Anderson, and his expertise in flying planes and refining oil is that … he’s a lawyer. Ah yes, someone who thinks that command and control trumps economics. Sorry Dick, I think we talk about that in 3000 level classes.

Anyway, back to transfer pricing. This really isn’t that hard. If the refinery can sell the jet fuel at a mark-up, this is because there’s firms willing to pay the mark-up. Selling at a mark-up is what every manager dreams of doing. So, the appropriate managerial response is to … keep selling at a mark-up. Even if it is within your own firm.

That sounds a bit like cannibalism, and maybe it should. But, it’s still good business sense: to not sell at a mark-up is to just avoid making the choices that make you profitable.

So, there you have it. Delta, for better or worse, has a business model that doesn’t work well. And their strategy in this case is to buy something that isn’t profitable to begin with, and reduce its profits, to better support the main division of the firm, which also isn’t profitable.

And the government thinks this is a good enough idea to throw money at.

Yikes.

* I do not have an investment position in any of the companies involved. Of course, we all have an investment position in our government, but those people don’t get that at all.

Technorati Tags: delta,conocophillips,refinery,transfer,pricing,mark-up,managerial