Thursday, June 2, 2011

Hey Barkeep! What's This Bit About The Three-Tier System?

I've gotten a lot (a lot) of questions about the new proposed, as yet invisible, legislation regarding changes to the beer wholesale laws here in Wisconsin. Indeed, I made an off-hand comment in that regarding whether it would be entirely awful if AB had its own distributorships here in Wisconsin. In other words, what if we simply do nothing? No new legislation to try to prevent something that may or may not happen. No changes to how distribution works. No changes to how brewers licenses are structured.

Here's a sample of the comments related to this that I've gotten: "You might have already seen it, but what do you think of these arguments?".

Written by Milwaukee-an Michael Horne in 2009, it talks about the distributor consolidation that has been going on for the better part of half a decade at this point and the jump by AB-InBev to do more self-distribution.
   Anheuser-Busch InBev, the "leading global brewer," hopes to self-distribute up to 50% of its products by consolidating and acquiring wholesalers, according to a report issued yesterday, June 24th, 2009, by London-based UBS analyst Melissa Earlam.
   That's up from the 20% share predicted when A-B and InBev merged last year, and much more than the 7% A-B InBev already distributes in the US via company-owned wholesalers.
The first thing we need to talk about is the three-tier system and how it works. Many years ago, the end of Prohibition to be exact, states came up with the idea of a three-tier system for the distribution of beer (and other alcohol) and it works like this: no tier can own or perform another tier. Tier 1 is manufacturing (breweries), Tier 2 is Distribution, and Tier 3 is retailers (liquor stores and bars, etc.); so Breweries can't distribute or sell at retail, Distributors can't brew or sell at retail, and Retailers can't brew or distribute. This is the general rule.

There are many exceptions. Indeed, one might say that there are so many exceptions that the rule is mostly a guideline at this point. Breweries can self-distribute (in WI up to 50K barrels of beer), Retailers can brew (Brewpubs and Tasting rooms), and Distributors have numerous investments in both breweries; just to name a few exceptions.

But this is the rule and it exists for any number of reasons that sound good on paper, but frankly are little else now than an artifact of the power of the distributors' lobbyists. Ostensibly the rules exist to prevent the monopolies that exist in Europe. For example, in England, craft beer is (was) virtually non-existant due to the existence of "Tied Houses" - pubs owned by breweries where only that brewery's beer is available.

With the news about the new potential legislation that would change the distribution laws here in Wisconsin, this subject has again reared its ugly head. But, frankly, I'm not quite so doom and gloom about it.

The fear is that AB-InBev would come in and have its own distributorship. To, again, quote Mr. Horne:

   A look at the A-B InBev distributor's product lineup for New York City shows just how limited -- and how corporate -- a selection of beer is available to residents of the nation's most populous city.
   In addition to the usual Bud offerings, the NYC distributor offers such craft beer-sounding products as Stone Mill Organic Pale Ale. Sounds nice and old-Vermonty, but Stone Mill is an A-B InBev product.
   How about a Kona Beer -- from Hawaii! Once you cut through all the hula nonsense, you'll find that the Kona Beer sold in New York City comes all the way from Redhook, New Hampshire.
   That's because it is produced by the Craft Brewers Alliance -- a lovely sounding organization that just happens to be 36% owned by A-B InBev. The CBA also gives us Red Hook, Goose Island and Widmer Brothers beers. [Ed Note: AB now owns Goose Island]
   The tough guys in New York City also can buy Bare Knuckle Stoutfrom its corporate-owned distributor. This beer is made by A-B InBev. How about a Winter's Bourbon Cask Ale. That sure sounds Honest-Abe authentic! Sorry! A-B InBev again.
A-B's distributor would sell AB-InBev products and others would sell their own products. I'm not sure much would change from a consumer standpoint to be honest.

I'm not sure using NYC as an example is really helpful - some of the best beer bars in the world are in NYC, not to mention Brooklyn Brewing Company - one of the largest craft brewers on the East Coast.

Choice on the shelves exists. In fact, it could potentially be better for craft beer as distributors would actually have to do some work to sell craft beer which might, shockingly, I know, result in more sales of craft beer. The reality is that if A-B came in tomorrow and purchased River City (for example), New Belgium, New Glarus, Potosi, Upland, (and their other crafts) would find another home and still get distributed. [Ed Note: I feel I can pick on River City a little because they do such a great job selling craft beer; if every Bud distributor had a similar craft portfolio and knowledge, craft beer would have little to complain about]

The writing has been on the wall for a long time now. Bud/Miller re-wrote their distribution agreements back in 2007(ish) with extraordinarily one-sided terms and said "take it or leave it". In response, those distributors started buying up craft brands. The distributors haven't been selling them very well (see the note above excepting River City, among others - I recognize that there are some great distributors out there that juggle their major-label obligations with craft beer very well), but they had them - and that was enough of an instigation to get AB and Miller to back off on the terms - distributors saw they had a viable third option.

On the other hand, if AB came in and started a new distributor and dropped River City, River City would suddenly have a lot of incentive to get out and sell more Moylans, O'So, Bear Republic and other craft brands. A great example is Chicago where Two Brothers' Distributorship that only sells craft beer is one of the best distributorships in the Chicago area.

Sure, self-distribution improves A-B's bottom line, but they also have to run a distributorship. There's a reason many craft breweries go out and find a distributor at the first available point in their growth - distribution is really hard. And, in fact, AB-InBev would have to run a lot of distributorships spread out all across the country.

Can AB-InBev run a more efficient distributorship than GenBev or Frank or River City? Maybe. InBev clearly thinks so. But, the 30% markup exists for a reason; it takes around 60-70% of that markup to run the distribution operations.

So, Bud gets a 10% discount on the store shelves? No. AB-InBev will pocket it and buy-out more breweries - is that a bad thing? Well, let's see how the Goose Island thing turns out before we rush to too harsh a judgment. Besides, AB (and Miller and Coors and Schlitz and PBR and Blatz and Busch and Beer Thirty and Minhas) is already 50% cheaper on the store shelves than craft; and guess what? People keep buying craft.

I am generally a fan of competition in the marketplace provided it actually takes place on a level playing field. And, for that, the state needs to start enforcing the laws that it has that prohibits the discounting and out-right bribery going on between BMC, the Distributors, and Retailers. The practical reality is that bars don't really even own their own tap lines (illegally paid for by the distributors with discounts) and turn over their sales to whatever distributor offers the best free stuff (also illegal).

So, I feel for the craft brewers. I'm not saying that AB-InBev owning all of its own distributorships is a good thing. Indeed, there is plenty to hate about it. There is a good chance that AB-InBev owning a distributor will really screw craft breweries and set them back a full decade for growth. But, it hardly changes the competition on the shelves, except to give AB a bigger price break than it already has; nor does it eliminate all of the hard work that craft brewers have done over the past decade to build the brand recognition and premiums that they have earned.

Of course, it's not the Craft Brewers that are pushing the changes through the Legislature, it's the Distributors. They don't want to compete with AB-InBev. It might just mean that they'd actually have to do some work.

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