JIM KOCH'S OPUS: "Let My People Go"


Dear Client:

Boston Beer Co. founder Jim Koch spoke to a standing-room only room at Caesar's Palace at the NBWA Convention, and he said things that may have been unpleasant, but that only Jim Koch could pull off in his congenial manner. They were things that needed to be said, if only for the sake of open debate. His themes were unity, the value of three-tier, treating craft brewers fairly, and cutting costs out of the system to appease big retailers. There was equal parts sugar and salt. BBD brings you the highlights:

Jim began at the beginning -- his beginning. When he first started Boston Beer and couldn't get a distributor, he leased a truck and distributed his own beer to accounts in Boston. "It was very hard work," he said, and referred to the "suicide steps" in Boston bars. His first distributor, Atlas Distributing, bought 1,188 cases and at that moment Jim thought, "I love distributors." Jim said he "still loves distributors" and acknowledged that "we are all blessed to be in the beer business." Amen to that, brother.

He noted that beer is a healthy product that promotes a long life: "If you don't drink beer you're punished by a shorter life...hopefully you were all out last night extending your life."

CALL FOR UNITY. "We in the US beer business have a very good regulatory framework and industry structure. The current structure works well for nearly everyone: large brewers, small brewers, retailers, wholesalers, regulators and consumers.....This three-tier system is being challenged and going to be in the next two years in the courts and legislators.....as we face those challenges as an industry we need to face them together....through state-based regulation we are all getting what we need and most of what we want...only way we can approve our situation is by working together. If we try to act individually we risk losing what we have in order to get what we don't need." Clearly that was in response toward the trend of distributor independence that surrounded the convention buzz.

THIS IS A GREAT MARKET. "The US is the best place to be a brewer. It contains 15% of the world's beer demand and over 40% of the profit pool...if you're a big brewer you're cutting your slice from the biggest, juiciest piece of pie out there....it's so good for large brewers that our friends from Brazil took $2 billion worth of fat, waste, inefficiency - whatever you want to call it - out of costs of what everyone thought was a well managed company. That's amazing that you can run a company everyone think is well-managed and piss away 1 million an hour everyday of every year. That's a great business structure....Two billion is more than the entire revenue of the 1,500 small brewers in the US.....our life work is their fat and waste. That's a nice business to be in." Ed. Note: That is an interesting and incredible observation, when put in that perspective.

"Big brewers are getting what they need...a state based regulatory framework that doesn't result in a nightmare of conflicting state laws...and doesn't unduly protect in-state interests at the expense of an efficient national market."

SMALL BREWERS AND FRANCHISE LAWS: "LET MY PEOPLE GO". Jim acknowledged that the three-tier system "works well although we complain a lot. Small brewers are just a cranky lot. We name our companies Rogue, Surly or Arrogant Bastard. We are kind of misfits and we complain a lot, but I constantly remind my small brewer colleagues...we are more and more realizing and embracing what we have....in the US small brewers have the opportunity to succeed because we sell to an independent tier of wholesalers no matter how much we complain.....in a free economy small brewers have a 50/50 shot of making it and that's pretty good."

He compared starting a craft brewery to a game of Russian roulette in the past, but now small brewers make up "5% of the US beer business and that's very exciting...I remind my small brewer brethren if you don't like the US then sell in Canada where there are 13 different provinces that act as independent countries. No craft beers do well outside of their province.....It's like selling to the TTB than an AB distributor in order to get to the market."

Alberta, for example, is the only Canadian province that has a three-tier system and crafts make up 10%. In Ontario, where there is no three-tier system, crafts make up 2%. In Mexico there are virtually no craft beers because distributors are owned by the big brewers, he pointed out.

"Small brewers need state franchise laws that protect beer wholesalers from demands of their main suppliers and retailers bypassing wholesalers and buying from suppliers...I don't want to have to sell to Wal-Mart," said Jim, which is what wholesalers are for. "'You don't like my price? Well talk to my 430 wholesalers.'"

Jim again reiterated that small brewers should be supporters of state based regulation, but also said: "We need franchise laws that allow small brewer to pay fair market value and move out of an unsatisfactory wholesaler relationship...small brewers feel very strongly about this."

Jim added: "Small brewers all have horror stories of getting screwed...not everyone behaves when there is absolute power on one side....the wholesaler community has treated me way more fairly than I deserve although even I have had bad experiences...we [small brewers] support the 21stamendment but we also support the 13th amendment which outlawed slavery."

He predicted that in the next few years that "the BA will become a third industry force with the NBWA and BI." He said this will be good for the industry because "we will defend the three-tier system from legal and regulatory challenges.....[but] we need people to think about accommodating small brewers."

"Franchise laws protect you from large brewers who are taking advantage, not small brewers who make up 2% of your business and who are having a miserable time....let my people go when you can."

ON BRAND VALUES. Jim showed a slide indicating that brand value is worth more to wholesalers than they are to suppliers with the exception of ABI. "I'm happy with that," said Jim. "It would be wrong to be jealous. I'm even happier if you guys have more and it's a good thing if my brand has more value to you than to me." He then brought out the experience last year when Boston Beer had a problem with its bottling line and found bits of glass in a few bottles. The distributor network made it possible for all bottles to be returned to the brewery in less than a week. "The FTC doesn't have that level of compliance," Jim pointed out. Therefore, "I'm happy you have value in Sam Adams."

He believes there will be continued growth of "better beer," including domestic specialties, crafts and imports. "If you make more money then I think that's better beer," said Jim. Nowadays "better beer" makes up 19% of industry volume but was nonexistent in the 1970s. Jim predicted that it will someday make up 35% of the US beer business. "I learned from an economist to give them a number or give them a date but never give them both. I don't know when but it will get to 35%."

If beer is led by high end brands like the spirits business, it will increase wholesaler profits. However, if it is led by SKU proliferations and weak brands like the wine business, distributor profitability will decline. "Nobody wants to be a wine wholesaler," said Jim. "There are no brands, just SKUs." In the wine world "the retailer can trade the customer on anything it wants to just because it gets an extra buck on a case."
Another great point.

CUTTING COSTS OUT OF THE SYSTEM. "The current structure works for retailers: retailers get the best service from wholesalers.... retailers like what they get from their beer wholesalers." However, there are still threats to the three-tier system from retailers.

"Retailers are happy for the most part. Some retailers aren't getting needs well-met by the current distribution system. As a result, they're the people attacking us and taking us to court." Those retailers include Costco, Total Wines and Jim predicted that "Wal-Mart may be next."

"This will piss some people off," Jim admitted, but "my belief is in order to continue to meet the needs of the consolidation of the retail system, wholesalers need to redesign their business to take 20% out of current cost structures in order to be competitive with the warehouse system of the consolidated retail channel...if we can do that they will embrace us."

"I know it's scary when I say lower margins but remember that Sam Walton became the richest man in the world by reducing margins," noted Jim. He encouraged wholesalers to "get outside of your comfort zones." As a small brewer he's witnessed the "dysfunctional relationship with big brewers and wholesalers...as evidence I see brewers and wholesalers fighting over forced consolidation when there are greater savings to be had." Jim said he "wants more wholesalers. I don't want to have Southern Wine and Spirits to have 60% of my business, I'd be screwed....it's painful for me to see people forced out of the business because consolidation to save costs..... I see 75 cents a case of deliberate inefficiencies in the distributor system." Jim believes that "we have a moral obligation to serve customers and consumers as efficiently as possible" because the beer business is more protected than other industries.

IDEAS FOR A DIFFERENT MODEL. Then Jim outlined some of the inefficiencies he sees in the beer business, although acknowledging that they are usually demands that wholesalers have to meet per their agreement with large brewers. "Why do wholesalers need their own line cleaning services? Why can't there be a joint service? Why are multiple merchandizers doing weekend pull up at the same account? They don't want multiple beer deliveries.....we are adding costs that reduce value to retailers....why can't there be one warehouse in a community?"

"I know why," he said. "You'd violate your contract with suppliers..... You are great at logistics. Why can't you own one trucking and delivery service and one warehouse in a market?"

With regards to service levels, Jim asked: "Why should small retailers with small orders get weekly deliveries?" He pointed out that 20% or 50% of your stops lose money. "That's stupid but you have to because your brewery contracts require it...we should find a more cost effective way to do that." He also noted that "in many states they do not have quantity discounts."

"Why can't we rethink the brewer/supplier relationship...why can't they manage your inventory levels? Wal-Mart doesn't manage their inventories, vendors do."

"Why are brewers allowed to use your warehouse just to make their bottling lines more efficient? Why should you have to buy old beer back when it is usually the brewers' fault? Why aren't suppliers charged a warehouse fee per SKU? Your warehouses are free so of course we stick them in there."

"Why is there no industry standard freshness dating on beer? Why isn't the expiration date monthly not daily? Beer doesn't just explode at some point." To this statement Jim received a loud applause. "Let's make this simple.....you'd only have to check freshness 12 weeks out of year, not 52 weeks a year."

"Why is there no industry wide task force to improve inefficiencies in the three-tier system" that would explore ways to take 75 cents a case out of costs? "Why not invite Wal-Mart, Costco and Kmart" to this task force. "We've learned we can do business with MADD, why can't we do business with our biggest customers?"

"We are a little insulated from competition but we have a responsibility within this regulatory framework to take costs out of the system that would [ordinarily] be competed out...give customers the same level of efficiency that would be given in free market system."

OUR TAKE: Wow. That's a lot to process. Jim was worried that he pissed people off, and he may have, but at least the ideas are out there to ponder. There's no use closing our minds to new ideas just because they may be unpleasant. I think this speech will go down as an important one, and one to truly ponder.

Until tomorrow, Harry

"Winning is habit. Unfortunately, so is losing."
-Vince Lombardi

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