The Challenges Facing Craft


Dear Client:

One of the many behind-the-scenes conversations people were having at the Craft Brewers Conference centered around "is this a bubble?" and "is it sustainable?" With so many new brewers and so many SKUs, distributors and even craft brewers are wondering if we are going to see a late 1990s situation again, with a return to low volume growth, excess brewing capacity, and no pricing power.

With 15% volume growth and accelerating, I don't think the craft segment is going to see a bubble burst per se, where consumer demand suddenly drops off. In fact, I don't see any problems in craft getting to ten share. The consumer's appetite for craft only seems to be getting started. The question is, with an additional 1,000 breweries in planning, who is going to get a seat at the table when the music stops?

Matt Gordon at Brooklyn Brewery said that the new brewers with high access to capital and high knowledge of the industry will have the best chance of making it. Conversely, those who have limited access to capital and not much knowledge of the beer industry will have a tough time. Unfortunately, I think many of the 1,000 breweries coming online are in the latter group.

So yes, I do see some issues, or challenges, that the successful craft brewers will need to manage to get through to the other side:

-Excess Capacity and Pricing. Most new entrants into this business are too young to see what excess brewing capacity can do to this industry. I remember going ten years without an effective price increase in the 90s. Then as legacy regional brewers (Stroh, G. Heileman, and Pabst) started shuttering breweries, and then craft brewers that didn't make it closed up shop, the pricing situation returned to normal (although still not exceeding CPI until InBev bought A-B).

But hardly a day goes by that we don't report on a brewer either expanding or opening a new brewery. We're looking at millions of barrels of capacity coming online in the next few years, from the largest to the smallest craft brewers. "Excess capacity will lead to prices being flat or down for 5 years I fear," craft brewer Rich Doyle of Harpoon told BBD. "Our margins are in for a rocky time due to both cost pressure and excess capacity limiting price increases. The low debt efficient brewers will survive."

Boston Beer has said it expects revenue per barrel to be only 1 to 2% this year in quarterly calls. In addition, craft has increasing competition from A-B and MillerCoors with their craft brands, which typically sell at a lower price, as well as their growing premium plus brands, which sell in the sweet spot between premium and craft. Put it all together and you have a situation where pricing may not keep up with COGS, so margins get squeezed.

-Capital. "Bankers are lending without adequate cash flow or equity," one prominent craft brewer told BBD over the weekend. And then you have private equity getting into the game. There's good money and there's bad money. My observation: if you're going to use private equity, use a firm that has a track record in the beer industry and is willing to think long term. There's a long history of brewers who have been ruined by taking bad money. Craft beer is cool. Banker's generally aren't. So it's no wonder they don't always mix well.

-Sense of Entitlement / Smugness. Do any of you watch Game of Thrones and see how the Khaleesi, the young princess, stomps around with her pretty petulant frown demanding thrones and crowns and respect and yet she lacks any money, experience, or an army? Yes, she has young dragons (good beer), but that's table stakes and nothing else. (For those who don't watch Game of Thrones, Khaleesi has these dragons you see, and..... nevermind, it's too nerdy to reproduce on the page). I've met a few new craft brewers over the last year, and I get the sense lately that many think they invented beer. That's okay -- that's just youth -- they'll grow out of it.

But there's another issue that I will say is NOT the majority of new craft brewers but it's still an issue: there's an awful lot of holier-than-thou smugness among certain brewers and beer enthusiasts that borderlines on d-baggery. You can really see it manifest itself on blogs and bulletin boards. My point in bringing this up is that I can see that it turns a lot of people off and we open ourselves up for claims that the industry is too precious by half.

There's some blowback on that lately. It was refreshing to read a recent blog post by Kim Schimke against beer snobbery. I agree (here ). Good beer is good beer. We're not saving babies in Haiti.

-Bad Beer. With 2,400 brewers, there's going to be some bad beer. It's already a problem, we're hearing. If there's enough of it, Brand Craft will get sullied again. And not just bad beer, but old beer. We've seen this before, and it ended badly. When brewers get in a financial pinch, they start sending beer all over the place, never to check on it again.

-Tax Policy. Craft brewers don't have a tax problem, they have a Jim problem. Extending the barrelage exemption to 6 mil barrels raises the ire of not only the small brewers in the BA, but the large brewers not in the BA. Besides, I can't think of a worse time to intro a tax relief bill. As one politically savvy distributor put it to me: "I know of a couple of Senators named Blunt and Feinstein who will never let it see the light of day." I know, I know: they're playing defense by playing offense. I'm hearing of another idea to do away with ANY excise taxes for really small brewers, say under 5k barrels, to assuage the small guys. Still, it's a tough sell in this fiscal environment.

-Succession. As Peter Egelston of Portsmouth Brewery said, everyone from his "class" in the industry is nearing 50. Meanwhile, private equity circles above. Next chapters will come in many forms -- some will flourish and some might not work, but succession from founder to others is never without pain.

-Expanding Markets too Quickly, without enough feet on the street to support sales, babysit tap handles and improve retailer focus. Opening up new states is a great way to grow, but it has its drawbacks the farther you get away from the brewery (see old beer above).

-Flagship fatigue. Seven out of the top ten craft brewers lost dollar share of craft in IRI scans in 2012 (those who didn't are Sierra, Lagunitas, and Bell's). We are starting to see more and more red numbers for old flagship brands in mature markets. When flagships suffer at the expense of one-offs or rotating taps, the winification of beer becomes complete and it becomes increasingly difficult to make money.

-Related to this is the issue of SKU proliferation. The average number of SKUs a distributor can handle has doubled over the last four years, and it will likely double again. Distributors don't like handling so many SKUs because it's costly, but with advanced picking systems and racking, it's definitely doable. Where the bottleneck truly occurs is at retail. Distributors in some markets can't physically put every craft brand they carry in every account they want to be in. So there's a constant shuffling of brands going on depending on which brewer is "on focus" that month at the distributorship. It's not a fun or effective way to sell beer.

-Craft vs Crafty. The industry infighting over definitions and labels is getting a lot of media play, and the consumer is listening. Everybody including myself has spilt a lot of ink over this so I won't rehash except to say that it's still getting quite a bit of play in the media, not all of it great.

Having said all that, craft is still the most dynamic, healthy, growing, and coolest part of bev-alc industry these days. And if the above challenges can be managed well, we will see many more years of growth. The Khaleesi, in the end, may just prevail.


FOR A GREAT READ regarding a craft legend, Inc magazine covers an average day for Sierra Nevada's Ken Grossman.

THE EMPIRE CRAFT ALLIANCE, a group of mostly A-B wholesalers and two MC distribs in New York State, has announced that The Fort Collins Brewery will be entering New York State with its network. The ECA was established in early 2012 by 18 different wholesale operations.

Until tomorrow, Harry

"To succeed in the world it is not enough to be stupid, you must also be well-mannered."

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