To Three-Tier or Not to Three-Tier?
It's Not a Really a Question

FILED AUGUST 12, 2009

Dear Client:

Since I've been editing Beer Business Daily, there has been a small but irritating voice in my email inbox many mornings who has kept me honest by always giving me the small brewers' perspective on whatever issue I've waxed prophetic on. It's no wonder: our publication has historically catered to distributors of any size and brewers who sell over 20k barrels a year. Tiny production brewers and brewpubs need not apply, typically. But this voice has always spoken the truth as he sees it, and of course the truth of a true believer is always irritating, particularly early in the morning. Plus, as a consummate editor, he sees fit to correct my commonly poor syntax and typos, which never improves the taste of my coffee. This voice of course is that of Jim Dorsch, editor and publisher of American Brewer magazine.

This month he sent me an extra issue, so as to not miss it, of American Brewer, because its entire contents contained a flowing argument of the pros and cons of the three-tier system, the very theme that Jim and I have most often been at odds. The issue is timely. The three-tier system has come under a lot of scrutiny lately. The pummeling that the 21st Amendment has taken by the courts has been an ongoing theme in my publication, because it has been in my view a slow disintegration of the very magic fabric that makes the beer industry different, special, and diversified compared to other consumer goods, like toothpaste or oranges, which seem so commotisized.

But let's, for a moment, put aside the legal issues aside and consider what are the pros and cons of the system in which we sink or swim, the topic tackled by American Brewer magazine this month. I found the articles fascinating in their content, but most interesting in the differing opinions of beer industry veterans on the subject. [Ed. Note: I chided a Wall Street Journal editor today for using too many commas in her article, and here I am casting them like javelins across the page like a schoolgirl. Today, up is down, right is wrong].

Dick Cantwell of Elysian Brewing writes in American Brewer that the three-tier system is like a television. "It functions, if you let it, without a lot of tuning and effort. Until, of course, it doesn't. Then you get it fixed, or go to court. Either way a lot of money changes hands." He goes on to discredit every courthouse excuse for the three-tier system, from temperance to product safety to access by minors to government control to tied house. At the end his arguments become muddled, mainly because I ceased to understand his writing which may be more a reflection on my lack of intellect than his writing ability. But nonetheless, I point out that if Dick hasn't become moderately wealthy on the back of the three-tier system like many of his compatriots have, it would be a surprise. Regardless, I tend to agree with Dick that these arguments may or may not work well in district courts (mostly they haven't worked well), but in reality they are weak when taken one at a time. More on that later.

The conventional thinking is that craft brewers generally regard the three-tier system with a suspicious eye. The rallying behind the movie "Beer Wars" was a testament to that. But that's not necessarily true.

Consider this quote: "The three-tier system in America is why craft brewers exist." You would think a distributor uttered that quote -- maybe Duke Reyes or Don Faust or Simon Bergson. Well, in this case the quote comes from none other than Larry Bell of Bell's Brewery, the guy who pulled out of the Chicago market to keep Reyes from buying his brands, and who sued his Kalamazoo distributor for trying to sell his brands to the A-B distributor. Larry is no distributor advocate, but he knows how the system works. As Greg Kitsock wrote in his article advocating for the three-tier system, "Bell believes the current system is fundamentally sound. He'd like to make some changes, but has no desire to tear it down." We note that Larry is a large Midwestern craft brewer.

Hugh Sisson of Baltimore's Clipper City Brewing wrote this on his blog last year about the three-tier system: "In my opinion, if large beer (or wine) manufacturers are able to sell direct to the large retailers of the world (Walmart/Costco), it is my opinion that they have enough economic clout to push the smaller suppliers (who would be forced to still deal thru a distributor) right off the shelf. The consumer might see slightly lower prices, but also a much smaller selection of products available. Indeed, it is the very existence of healthy, economically viable SMALL distributors that has made today's vast array of wines, beers, and spirits available. Without a healthy middle tier, I think this goes away."

Kim Jordan of New Belgium said this at the CBC Conference this year, according to Greg: "We've seen a sea change over the last three years. The increase in the number of distributors at this conference is staggering [from 40 in 2004 to 220 this year for the craft wholesalers registration].

Steve Hindy of Brooklyn Brewery said that while self-distribution helped his brands gain a foothold in New York, once you get to a certain scale, it's usually better to use distributors. Says he: "It depends on the market. There's been a sea change in the way large distributors view small brands, particularly local brands in their home market. They are all eager to get their hands on craft brands. Twenty years ago people thought we were a fad. It's not so clear that self-distribution is the way to go."

On the other side of the argument, an article penned by Alan Moen in American Brewer makes the case that the "three-tier system must go." I won't go into his arguments too deeply because most of them are bunk. Never mind, here are a few: He says distributors are a monopoly: "By monopolizing the warehousing and delivery of beer, quality issues are often not his particular responsibility nor his concern. He frequently has no interest in selling beer from small breweries, when big ones pay most of the bills..." I won't go on, because I know this sort of thing makes those distributors who do take product quality seriously and who do take on small brewers and sell them earnestly apoplectic and I don't wish to cause any heart attacks.

He also points out that some distributors take a small brewers' products and then sit on them to keep them away from competitors. Yes, this sort of thing happens -- less so today, but it still happens. It's shameful. When I come across it, I browbeat the distributor in public, and if I'm gouty, prod him with my cane. But it's not the norm -- it's the exception. There are good and bad distributors in every state. But at least there are distributors. The alternative is the closed Coke, Pepsi, or Dr Pepper systems, where there aren't any three-tier laws, or wine and spirits wholesalers, who don't do c-stores and draft is an afterthought. Self distribution? Honestly I think it should be a legal option at the state level in some regard. And I believe craft brewers should be able to sell their beers at their breweries, even in Texas. Jim Dorsch's persistence has rubbed off on me. And I also think franchise laws should be fair and balanced, so that a craft brewer has a chance of ending a bad marriage without going bankrupt. No doubt.

Three-tier needs to accommodate the new reality of small brewer economics, and the new political reality that small brewers have new stroke in state houses as small American-owned employers, just as distributors do. One feeds the other. Distributors and small brewers have more in common today, politically, than they ever have [again with the commas. There must be a full moon] Why not help each other achieve their respective goals?

Look, the three-tier system has created more craft brewer success stories than it has stifled. Forget all that temperance and product quality and protecting the children stuff that Dick Cantwell derides for a minute. The simple fact is that the three-tier system makes hundreds of craft brewers rich in the U.S., in a way that would be impossible in tied-house countries like in Europe or Latin America. That is why I think that established craft brewers, who have reached a certain scale, embrace the system, and why fledgling craft brewers, who can't get an easy seat at the table, hold it in contempt. It's a dichotomy that endures.

GRAHAM: I'M READY TO BUY, AT THE RIGHT PRICE

SABMiller chief Graham Mackay told Bloomberg that he's prepared to make acquisitions, but that the global beer industry isn't going to pull out of this recession soon. He says there's enough "investor support" to do a deal, plus plenty of debt capacity. But it has to be the right deal. "Nothing is stopping us from the right acquisition. There is money available. Even if we had to raise capital, we think our shareholders would agree with it if it was the right acquisition." Indeed, SABMiller's net debt stands at about 1.9 times earnings before interest, tax, depreciation and amortization, compared to 5 for ABI. So there's balance sheet room to acquire.

Bloomberg notes that SABMiller skipped many of the deals in the past two years, including Scottish & Newcastle and Anheuser-Busch. SABMiller also has pulled back on marketing spends, although Graham says that he "would not make a habit of it."

"The downturn was a crash, a cataclysmic event, and the resumption of growth isn't going to be anything like that," says Graham. "We're getting to a stage where people need to build inventories again, but that can't possibly contribute to an uptick which is as rapid as the downturn." Possible takeover targets? Femsa Cerveza, Turkey's Efes Breweries, and ABI's Russian unit.


CIDER: THE LITTLE ENGINE THAT COULD

We've been writing so much about mega-brand softness, that we've neglected our friends in the cider segment. Cider? I know, not a huge segment, but cider is the little engine that could, and it continues to grow year over year, and are continuing to grow this year despite a tough economy and strong pricing.

In fact, 2009 is shaping up to be the fourth consecutive year that cider has outpaced the beer in both dollar and case sales trends in supermarkets, says Dan Wandel of IRI to BBD yesterday. Cider is at a five year high for distribution, at 78.4% despite the total number of cider items selling in supermarkets having remained relatively flat for the past five years. There were 88 cider SKUs selling in soopers in 2005, while in 2009, there are 87 cider items, says IRI.

You want more fun facts on cider, you say? Beg no more. The top two vendors, Gallo and Green Mountain Beverage, account for a combined 95% share of cider volume. Last year Green Mountain acquired Wyder's Cider, gaining 3 total share points for Green Mountain.

But it's not just the big cider makers that are getting into the action. New England based Harpoon and Boston Beer have two cider brands, Harpoon Cider Apple (up 128%) and Boston Beer's Hardcore Cider (up 14%) which are continuing to grow in their core markets. And what are the top markets for cider? I thought you'd never ask: California, Washington, Florida, North Carolina, Virginia, Texas, Oregon, Ohio, New York and Georgia. Five of the top 10 cider selling food states are up double digits in case and dollar IRI scans.

Cider also has one of the highest average prices per case within the beer category, and its price is growing faster than any other beer segment, up $1.67 per case so far this year. Well done, cider.


BEER BRIEFS:

MILLERCOORS CHIEF LEO KEILY told Chicago Business that they are planning on testing Blue Moon ads in select markets (including Chicago) before the end of the year. Says Leo: "What we're trying to figure out there is if television advertising is a good idea to build a craft brand. But this is pretty unique television advertising, so check it out." Leo also commented on the economy, saying: "Beer is relatively a great place in an economic downtown. But it's clearly in our business, we can see it in our category. Our on-premise ....is really challenged. Our take-home business is stronger....but it's definitely impacting our industry."

NO, WE DIDN'T PUBLISH an issue yesterday. I had an issue of sorts prepared, but it was so weak and boring that I ultimately decided it was better to publish nothing than to publish tripe. I can already hear the chorus: "That's never stopped you before." August is indeed always a slow month (see cider article above), surpassed only by late December, but we've got Crown's Bill Hackett coming to the BBD mothership for a beer tomorrow, and ABI releasing its Q2 earnings on Thursday, and some other stuff up our sleeves, so prepare to be dazzled. -HCS

Until tomorrow, Harry

"There are three constants in life... change, choice and principles."
-Stephen Covey

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