INFORMS Open Forum

View this month's President's Pick article for free in December: http://pubsonline.informs.org/stoken/default+domain/president-Dec15/full/10.1287/msom.2015.0529


Wine Futures and Advance Selling Under Quality Uncertainty

Tim Noparumpa
Burak Kazaz
Scott Webster

Manufacturing & Service Operations Management (2015), 17(3): 411-426. http://dx.doi.org/10.1287/msom.2015.0529

Watch the authors’ video from the journal’s webpage for this paper at http://pubsonline.informs.org/doi/abs/10.1287/msom.2015.0529 or directly at https://youtu.be/rbJZvTyNj3g.

This Manufacturing & Service Operations Management paper caught my attention since it presents insights on how wine producers can use wine futures to deal with wine quality risk. I knew a bit about hedging farm yields with commodity futures, but not about wine futures. Tim Noparumpa
Burak Kazaz, and Scott Webster find that “the winemaker can achieve a higher level of profitability when the market is filled with consumers that are heterogeneous.” They test their analytical findings with data from Bordeaux wineries.

Let’s raise a toast to the December holidays.

-How can you hedge against risks in the domain you operate within?
-For operations you study, is it better when consumers are more homogeneous or when they are heterogeneous?

Abstract

This study examines the use of wine futures (i.e., advance selling of wine before it is bottled) as a form of operational flexibility to mitigate quality rating risk. At the end of a harvest season, the winemaker obtains a certain number of barrels of wine that can be produced for a particular vintage. While the wine is aging in the barrel, expert reviewers taste the wine and create a barrel score, indicating the potential quality of the wine and offering clues as to whether, when bottled, it will be superior wine. Based on the barrel score, the wine producer determines (1) the percentage of its wine to be sold as futures and (2) the price of the wine futures. After one more year of aging, the wine is bottled, and the reviewers provide a second review of the wine and assign a bottle score that influences the market price of the wine. Our study makes three contributions. First, we develop an analytical model that incorporates uncertain consumer valuations of wine futures and bottled wine and the uncertain bottle rating that is assigned to the wine at the end of the production process. Our analysis provides insights into how the barrel score, consumer preference (through a conditional-value-at-risk perspective) and the winemaker’s preference influence the winemaker’s allocation and pricing decisions. Our second contribution relates to the impact of consumer heterogeneity on the optimal allocation and pricing decisions. Contrary to common belief that the winemaker may be better off when consumers are more homogeneous, our results demonstrate that the winemaker can achieve a higher level of profitability when the market is filled with consumers that are heterogeneous. Third, we test our findings using data collected from Bordeaux wineries engaging in wine futures. Our empirical analysis demonstrates that (1) barrel scores play a significant role in the two decisions regarding the quantity and price of wine futures, and (2) the wine futures market provides a sizable financial benefit to the winemakers. Our analysis yields recommendations for artisanal and boutique wineries that have limited or no experience selling wine futures.

Keywords: wine futures; advance selling; quality uncertainty; pricing

Robin Keller
http://www.merage.uci.edu/go/Keller; personal site: http://faculty.sites.uci.edu/lrkeller/
Professor, Operations & Decision Technologies
The Paul Merage School of Business
University of California, Irvine
INFORMS President, 2015, president@mail.informs.org

(Here is a plain text version of the President's Pick post, if you could not read the full weblink addresses in the prior post.)

View this month's President's Pick article for free in December: http://pubsonline.informs.org/stoken/default+domain/president-Dec15/full/10.1287/msom.2015.0529


Wine Futures and Advance Selling Under Quality Uncertainty

Tim Noparumpa
Burak Kazaz
Scott Webster

Manufacturing & Service Operations Management (2015), 17(3): 411-426. http://dx.doi.org/10.1287/msom.2015.0529

Watch the authors’ video from the journal’s webpage for this paper at http://pubsonline.informs.org/doi/abs/10.1287/msom.2015.0529 or directly at https://youtu.be/rbJZvTyNj3g.

This Manufacturing & Service Operations Management paper caught my attention since it presents insights on how wine producers can use wine futures to deal with wine quality risk. I knew a bit about hedging farm yields with commodity futures, but not about wine futures. Tim Noparumpa, Burak Kazaz, and Scott Webster find that “the winemaker can achieve a higher level of profitability when the market is filled with consumers that are heterogeneous.” They test their analytical findings with data from Bordeaux wineries.

Let’s raise a toast to the December holidays.

-How can you hedge against risks in the domain you operate within?
-For operations you study, is it better when consumers are more homogeneous or when they are heterogeneous?

Abstract

This study examines the use of wine futures (i.e., advance selling of wine before it is bottled) as a form of operational flexibility to mitigate quality rating risk. At the end of a harvest season, the winemaker obtains a certain number of barrels of wine that can be produced for a particular vintage. While the wine is aging in the barrel, expert reviewers taste the wine and create a barrel score, indicating the potential quality of the wine and offering clues as to whether, when bottled, it will be superior wine. Based on the barrel score, the wine producer determines (1) the percentage of its wine to be sold as futures and (2) the price of the wine futures. After one more year of aging, the wine is bottled, and the reviewers provide a second review of the wine and assign a bottle score that influences the market price of the wine. Our study makes three contributions. First, we develop an analytical model that incorporates uncertain consumer valuations of wine futures and bottled wine and the uncertain bottle rating that is assigned to the wine at the end of the production process. Our analysis provides insights into how the barrel score, consumer preference (through a conditional-value-at-risk perspective) and the winemaker’s preference influence the winemaker’s allocation and pricing decisions. Our second contribution relates to the impact of consumer heterogeneity on the optimal allocation and pricing decisions. Contrary to common belief that the winemaker may be better off when consumers are more homogeneous, our results demonstrate that the winemaker can achieve a higher level of profitability when the market is filled with consumers that are heterogeneous. Third, we test our findings using data collected from Bordeaux wineries engaging in wine futures. Our empirical analysis demonstrates that (1) barrel scores play a significant role in the two decisions regarding the quantity and price of wine futures, and (2) the wine futures market provides a sizable financial benefit to the winemakers. Our analysis yields recommendations for artisanal and boutique wineries that have limited or no experience selling wine futures.

Keywords: wine futures; advance selling; quality uncertainty; pricing

Robin Keller
http://www.merage.uci.edu/go/Keller; personal site: http://faculty.sites.uci.edu/lrkeller/
Professor, Operations & Decision Technologies
The Paul Merage School of Business
University of California, Irvine
INFORMS President, 2015, president@mail.informs.org