Case Study
Pasteurization & Refrigeration
This detailed Case Study and Market Simulation workflow follows the overview called: CS-101 Rise of the Microbrew.
Part 04 of the Market Simulation models the USA Beer Industry from around the beginning of the 20th Century when leading brewers introduced pasteurization and refrigeration technologies into their process.
While these new technologies were initially expensive, their integration into the brewing process immediately lifted the quality of the beer and gave leading brewers a competitive advantage based upon Vertical Differentiation.
Over time, the scale of these technologies increased and the cost declined. The resulting competitive advantage of these leading brewers pushed out the smaller players.
This Case Study provides a high-level overview of the workflow without detailed explanation. It assumes you are already somewhat familiar with KNIME and Market Simulation. If not, start by reviewing the Building Blocks and Community Nodes.
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Video
Market Simulation of the beer industry when improvements in pasteurization, refrigeration, and other brewing technologies provided Vertical Differentiation.
The video contains a brief presentation covering the 3rd economic phase of the beer industry along with an explanation of the KNIME workflow. More detail can be found in the explanation below.
#1 Decreasing Costs
While Geographic advantages were declining and the power of local monopolies were dissipating, new technologies were being employed to make beer a better product – namely Pasteurization and Refrigeration. These technologies gave manufacturers Vertical Differentiation that allowed them to win over lagging brewers.
This Market Simulation assumes Pasteurization and Refrigeration adds immediate value to the Beer, but that it takes time for the cost of the technology to drive down.
The Market Simulation takes place over 21 iterations (representing 21 years). At first, pasteurization and refrigeration adds $0.70 to the per-unit cost of the beer (relative to today’s prices). But this cost steadily declines over each iteration until it drops to only $0.10.
An Ordered distribution from the Customer Distributions node starts the workflow. It is used to generate the steadily falling cost of the advanced process.
Click on an icon to see and scroll through the enlarged version of the images.
#2 Product Generation
In the USA, the vast majority of beer is lager which offers very little difference in flavor. Mass marketing has not yet been introduced, so customers select between near-commodity products.
The Market Simulation creates two beer Product:
- Product 01 = [ Beer + Pasteurization ] x [ higher Cost + higher Price ]
- Product 02 = [ Undifferentiated Beer – Pasteurization ] x [ lower Cost + lower Price]
The Customers Willingness To Pay (WTP) for Beer is set to have a Mean of $2.00 with a Standard Deviation (SD) of $0.20. The Customers WTP for Pasteurization has a Mean of $0.50 with a Standard Deviation of $0.20. There is no correlation between how much Customers value Beer and how much they value Pasteurization. The model simulates the behavior of 10,000 Virtual Customers.
Pasteurization offers different levels of value to different Customers. Customer who prefer the higher quality Product with a longer shelf-life will select Product 01. But other Customers who do not value the benefits of pasteurization will select the cheaper Product 02 that doesn’t offer pasteurization.
The decreasing cost of pasteurization over time is introduced into the middle port of the ‘Product Generator’ node. This optional middle port allows the model to inject additional information about each Feature into the Products. In this case, additional information about the Cost of Pasteurization is being added.
#3 Trend Charts
The Price of the Products do not change, nor does the value of Pasteurization. Hence Quantity and Revenue are constant for Product 01 and Product 02. But as the Cost of Pasteurization is decreasing, the Profitability of Product 01 increases.
The nodes following the ‘Loop End’ re-arrange the results for Product 01 and Product 02 so they can be compared in the Quantity, Revenue, and Profit Trend charts.
Economic Theory
Vertical Differentiation
Vertical Differentiation exists whenever all Customer would agree that one Product or Feature is better than another. For example, all modern consumers would agree that having 4 GB is better than having 2 GB.
Vendors offering Vertical Differentiation have a competitive advantage that can force other lagging vendors to drop out of the Market.
For beer, all Customers agree that pasteurized beer is better than unpasteurized beer. This increased quality has the effect of shifting the Willingness To Pay (WTP) curve to the right.
In the charts above, Customer A hates the original Product #1 but, after pasteurization, is moderately satisfied with Product #2. At the same time, Customer Z is even more delighted with Product #2 than Product #1. Note that in these charts the WTP for all Customers is shifted to the right by the same amount.
Market Simulation Profit
But in the Market Simulation, while Customers agree that pasteurization is better, Customers disagree as to how much value pasteurization adds, and whether higher prices are justified. The WTP of all Customers is still shifted to the right, but by different amounts.
This Market Simulation models the consolidation that happened within the brewing industry from around the beginning of the 20th Century. Competitors that integrated newer technologies increased the value offered to Customers. Over time, the costs of those technologies decreased and allowed relative profitability to increase.
The Market Simulation demonstrates how increasing Vertical Differentiation gave leading vendors a competitive advantage that drove the laggards out of the Market.
