Monday, June 25, 2012

Breweries vs. Distributors

Here is a relatively interesting blurb about an interesting fight playing out in Arizona between Four Peaks Brewing and their distributor Alliance Beverage Distributing.

As a general rule (indeed, I am unaware of any exceptions) distribution contracts are perpetual - meaning they have no termination date. They are for a defined geographical region, and they are exclusive to the distributor for the geographical scope and duration. Typically a geographical region is defined in counties, not in states, or even particular cities. This means that once a distributor agrees to distribute your beer in a particular region, they have the exclusive right do so for all eternity. Incidentally, this excludes even the brewery itself from distributing inside that territory.

As you can imagine, this sets up quite the conundrum for breweries. Unless they want (and are allowed) to set up their own distribution network, they need a distributor to get beer to the retailer and ultimately to you, the consumer. The price you pay at retail, let's say $9.99 for a 6-pack, represents not only the brewery's profit, but also a markup for the retailer and the distributor. Let's say the retailer is marking up 30% from distribution (x + .3x = 9.99), that means the retailer is paying something like $7.68 for that 6-pack. If we also assume that the distributor is marking up 30% that means that the distributor is paying approximately $5.91 for that 6-pack. Or, stated alternatively, the brewery is selling each six-pack of beer to the distributor for $5.91 and the distributor is making approximately $1.77 on each six-pack sold.

Thus, the brewery can only a make a profit out of the $5.91. Out of that must come cost of goods, marketing, administrative, and taxes. Unfortunately for breweries, this is also a relatively constrained cap, since consumers don't like to pay more than $9.99 for a six-pack; which means if their costs go up, the brewery can't really raise prices.

So, that is all a long-winded way to say that breweries give up considerable flexibility in pricing and profits by choosing to give up 30% of the retail price to distributors. So, when a brewery feels that the distributor isn't doing right by the contract, it makes for a very strained and difficult relationship. 

Admittedly, by engaging a distributor, breweries are also freeing themselves of the need to take on all the costs of getting beer to the retailer, including the costs of delivery reps, delivery vans, gas, storage and warehousing costs. This post is not saying that distributors don't provide value - they provide a lot of value. Except when they don't. 

The real point in all of this is how to resolve this tension - when the distribution relationship goes bad. The natural inclination is to say "find a new distributor" or "distribute it yourself". Except, the distribution laws have made this a false option. 

The brewery cannot simply unilaterally cancel the contract. In some cases, like in Arizona, the contract simply can't be cancelled without "good faith and with good cause". What does that mean? Your guess is as good as mine - it will probably take a court and 2 teams of lawyer to work that out in each case. And, that is exactly what the distributors want; the distributors know that, for the most part, the breweries simply cannot afford to litigate this point even if it might result in a favorable victory for the brewery [side note: distribution contracts tend to say that each side bears their own costs of litigation; in many other contracts, the loser may have to pay for the winner's attorneys fees, making this battle much more likely to be taken on]. 

Thus, the first law of contracts: the contract is only as good as your ability to enforce it. Thus, in Arizona, unless you have "good faith and good cause" to get out of the contract, you are stuck for now and all eternity. [ed note: this isn't strictly true, but the costs of breaking the contract are extremely high and often require leaving, not providing beer to the distributor, for a significant period of time - generally a full year or more].

In Wisconsin, this devil's deal is a little more subtle. The distribution contracts here allow breweries to terminate the contract at any time, typically with a few months' notice. Yay! Except, see Wisc. Stat. 125.33(10) - Compensation for Termination of Wholesaler Distribution Rights. Without boring you with the technical detail, Wisconsin law basically says that any "Successor Wholesaler" must pay the "Terminated Wholesaler" for the "fair market value" of the terminated distribution rights. So, yeah, you can get out of the contract, but whoever your next distributor is (including yourself if you self-distribute) has to pay "fair market value" for the distribution rights to the distributor you just canned. 

You're probably asking what "fair market value" means. Well, good question. It's usually negotiated between the new distributor and the old distributor, but tends to fall somewhere around 3 times gross revenue of the brewery's brands. 

I'll finish with an example: Brewery signs a contract for distribution with Distributor A [ed note: we'll ignore for the moment that Distributor A rarely compensates Brewery for its distribution rights; I can talk about this stupidity for hours, but we'll ignore it for now because compensation might actually come in other forms than a simple lump sum payment]. After 3 years Brewery feels that Distributor isn't doing its job - Distributor A is not timely in filling retail orders, when it does fulfill orders the orders are wrong, and the product is out of date*. But, nonetheless, over the 3 years Brewery goes from $30,000 in annual sales to $100,000 in annual sales. Brewery finds Distributor B who promises to be the best distributor ever. Brewery wants to switch from Distributor A to Distributor B. 

Here in Wisconsin, Brewery is free to cancel the contract with Distributor A at any time for any reason (not true in Arizona, apparently). However, if Brewery wants Distributor B to distribute its beer, Distributor B must pay Distributor A "fair market value" for the distribution rights; in this case, somewhere near $300,000. 

So, how badly does Distributor B want to distribute Brewery's beer? This is a giant barrier, perhaps even a bigger barrier than the outright ban because Brewery needs to find a distributor willing to shell out $300,000 for the right to distribute its brands. Incidentally, even if Brewery wants to self-distribute, Brewery is considered a "Successor Wholesaler" and must compensate the "Terminated Wholesaler" for the right to distribute its own brands - hopefully Brewery has $300,000 laying around.**

* Note: most distributors are really good, knowledgeable beer people. To the extent they screw up, it's no more frequently than breweries trying to pass off a bad batch and all the other numerous ways that breweries screw up too. I'm not trying to paint distributors in a bad light; I'm just tying to point out the tensions that this law creates and how it ends up being, on a whole, worse for breweries than for wholesalers when the deals go bad.

** These are contended points and my positing them here doesn't necessarily mean that I'm willing to admit them as absolutes. My point is only that this is how the industry treats these rules and until a brewery actually sues a distributor over this, we'll assume this is how it works.

1 comment:

  1. Excellent post. The issue of distribution and distributors is more important to the brewing industry than any other. Great Dane, on one hand, sells almost exclusively direct to the consumer (save the barrels now sold at One Barrel Brewing and maybe a few others) to hybrids like Ale Asylum (sold both direct on premise and via bottles) to New Glarus (sold primarily as packaged only). All this means that aspiring brewers need to design contracts with distributors with their long-term distribution strategy in mind. I'd be curious to find out if Gray's has to pay a distributor to deliver to its "tied" house in Verona, or if Capital has to for its downtown pub.


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