Substitution between Mass- Produced and High-End Beers Daniel Toro-Gonzalez Ph.D. candidate, School of Economic Sciences (SES) Jill J. McCluskey Visiting Professor, Cornell University and Professor, SES, Washington State University and Ron C. Mittelhammer Regents Professor, SES & Dept. of Statistics Presented at Beeronomics Symposium UC Davis November 3, 2011
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Substitution between Mass-Produced and High-End Beers Daniel Toro-Gonzalez Ph.D. candidate, School of Economic Sciences (SES) Jill J. McCluskey Visiting.
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Substitution between Mass-Produced and High-End Beers
Daniel Toro-GonzalezPh.D. candidate, School of Economic Sciences (SES)
Jill J. McCluskeyVisiting Professor, Cornell University and
Professor, SES, Washington State University and
Ron C. MittelhammerRegents Professor, SES & Dept. of Statistics
Presented at Beeronomics Symposium UC DavisNovember 3, 2011
• Mass producers’ market share still represents the vast majority of sales, but their sales are flat or declining.
• Trend of consumers switching from mass to craft beers.
• Consistent with general shift in food preferences: Increasing desire for variety, taste, and local products.
We know that consumers shift from macro to craft brews. Does it go the other way?• “…consumers are very loyal to craft beers and not shifting to macro from craft. In economics terms the cross-price elasticity of craft and macro brews appears to be very inelastic, or that beer drinker do not think of macro lagers as a good substitute for micro brews.”
- “Beeronomics: Is Craft Beer Recession Proof After All ?” , The Oregon Economics Blog, Thursday, May 7, 2009.
Project Objectives
•Estimate demand for beer, which is a differentiated product.
•Estimate the own-price, cross-price and income elasticities.
Data
• Scanner data from 60 Dominick's supermarkets in Chicago.
• Seven years of store-level weekly sales data (1991 to 1997)
• 483UPCs for 343 brands.
• Product info and store area sociodemographics
Market and Product Definition• Oligopolistic differentiated product market.
• Each store is treated as an independent market.
• Each brand of beer is considered as a product.
Types of Beer1. Mass produced beers are
defined as those with similar characteristics of lightness, same fermentation method (bottom fermenting yeast) and the use of adjuncts such as corn or rice.
2. Import beers are those produced abroad.
3. The rest of the beers are called craft beers.
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Number of Firms
Source: Calculations by the author. Beer Institute. Brewers Almanac, 2010.
• Long term secular decline in traditional breweries
• Rapid expansion in specialty breweries since 1980
Market Shares by Beer TypeSample Averages for Dominick Stores
Type Share Price Per BottleCraft 5.3% 0.80Mass 86.4% 0.54Import 8.2% 0.95
Discrete Choice Model Issues
• Model weekly aggregate sales at each store, by beer type
• Address dimensionality problem (large number of underlying products) by projecting the products onto a characteristics space.
• Market characterized by differentiated products.
• Prices may be correlated with unobserved demand factors, causing endogeneity problem.
Discrete Choice Model
• Utility of consumer i for product j depends on characteristics of both the product and the consumer:
education (% college graduates), ethnicity (% blacks+hispanics)
( , , )j j jx p
Discrete Choice Model
ij j j j iju z p • Linear specification of utility
• where
• xj is interpreted as the mean of consumers’ valuations of unobserved product characteristics (product quality).
• Error term encompasses the distribution of consumer preferences around xj .
• Errors are i.i.d. with “extreme value” distribution, resulting in a multinomial logit formulation.
j j jz x
Mean Utility Representation
• Simply using dj to represent the mean utility for product j , which is defined as everything other than the error term:
j j j jz p
ij j iju
Multinomial Logit
• The market share of product j is then expressible in term of dj :
N
0k
δ
δ
jk
j
e
es )(
Multinomial Logit
• Assuming the relationship between observed and predicted market shares is invertible, with the mean utility of the outside good (all other than beers) normalized to zero,
• Prices and unobserved product attributes are correlated Endogeneity.
0ln( ) ln( )j j j j js s z p
Instrument for Prices
• Prices in other markets? (Hausman, 1996).
Prices of brand j in two markets will be correlated due to the common marginal cost.
But prices in other markets uncorrelated with the market-specific unobserved product characteristics.
Problem with MNL• Independence of Irrelevant Alternatives (IIA). Example, if a consumer wants to try a beer that is an American lager, he/she may consider alternatives like Coors light or Bud Light, but he will not consider any Stout type of beer.
Nested Logit Model
• The NL preserves the assumption that consumer tastes are extreme value distributed.
• Allows consumer tastes to be correlated across products.
• More reasonable substitution patterns than in the previous model (a priori).
Nested Logit Model
• We divide the products into g different exhaustive and mutually exclusive groups.
• is common to all products in group g.
• (1-σ) is the average correlation in the random utility across products of the same group.
ij j jg iju (1 )
j j j jz p
Nested Logit Model
• Berry (1994) shows that if the errors are i.i.d. extreme value then:
it is also distributed as a extreme value.
jg ij(1 )
Nested Logit Model
• We can represent the NL model as:
where σ measures average similarity of products within each group of beer types.
The new term is the log of the within group share.