If you are a starting brewery looking to get your beer to market, the three-tiered distribution system can be dizzying. Here's how everything works, and in some cases doesn't work.
History of beer distributionBefore prohibition, the large breweries had their own saloons. If you wanted a Schlitz, you went to a bar which sold only Schlitz. The large breweries practiced anti-competitive practices by requiring retailers to carry only their products.
The breweries also held ownership stakes in the bars. They provided the bars not only with beer, but the breweries also gave loans for furniture, beer equipment, and other bar needs. While this might seem like a great way to start a bar, the breweries required the bars to carry only the brewery’s labels, and they applied pressure to the bars to continually increase beer sales. The pressure pushed their patrons to the point of constant overindulgence. Society cried for a solution, and the government gave us the 18th Amendment, otherwise known as Prohibition.
America went without alcohol for thirteen years before Prohibition was repealed with the ratification of the 21st Amendment. The new Amendment gave the states complete control over alcohol regulation. To make sure the problems before Prohibition were not repeated, nearly every state adopted some form of the “three-tier system”.
How it worksThe three-tier system requires all beer (and other alcohol in most cases) to pass through a middle-man, known as the distributor (also called a wholesaler in some states). The distributor does the on-the-ground sales and marketing for the producer, and the distributors sells the beer to retailers.
This system means beer producers do not sell directly to bars, liquor stores, or grocery stores. It is the responsibility of the distributor to establish the retail relationship. The distributor is not allowed to purchase shelf space or exclusivity, furnish equipment like draft coolers, offer loans or create a feeling of obligation, or offer discriminatory promotional pricing. They are supposed to provide all retailers the same pricing.
Distributors also maintain refrigerated warehouses to store the beer, and fleets of trucks to ship the beer around the state.
The benefits of the three tiered systemThe original intent of the three-tiered system was to provide temperance, ensure orderly market conditions, and raise revenue (taxes).
The system increases the price of alcohol (since there is a middleman). In theory, the higher prices discourage over-indulgence, and forces temperance on the society.
Distributors argue the system also benefits small producers. They say if direct sales were allowed, a small brewery would be at a disadvantage. Large retailers, like Costco, are used to purchasing goods in very large quantities to get the best price possible. Larger breweries would be able to undercut small brewery prices, and only macro beers would be available. Since all brewers are required to go through an independent distributor, this levels the playing field for all brewers. One distributor can get many beers into a retail store at once, since there is incentive to provide a diverse selection.
The distribution model also benefits retailers. The distributor reduces inventory costs for the retailer by managing the large portfolio of beers. This is an advantage because beer is a perishable product. The distributor makes sure the retailers are always carrying fresh beer.
The three-tier system also provides transparency for taxation. The government can easily determine how much alcohol is shipped, and where it is shipped to. The distributor often is responsible for collecting the taxes because they can accurately monitor the shipments. This creates a paper trail and protects against “gray market” sales (purchases from unauthorized sources). If the distribution system goes away, the government will be forced to come up with a new system to collect revenue.
Complaints about the systemWhile the system has been in use for over 70 years, it is not without its warts. The three-tier system makes sense in the United States, but other countries have open and lightly regulated markets. We are headed into a global market and international producers struggle with the prohibition-era laws. They feel the laws interfere with efficient distribution, unnecessarily inflate beer prices, and are possibly in violation of international free trade agreements.
The wine guys are getting around the systemThe system is inefficient because everything has to go through a middle man. Many wineries are contesting this system which they feel was not intended for wine sales. This problem came to a head when some states allowed in-state wineries to sell wine directly to the consumer, but required out-of-state wineries to go through distributors. This is obviously a problem, because it violates the Commerce Clause—you cannot pass laws which improperly burden or discriminate against interstate commerce. In 2005, Granholm v. Heald, the Supreme Court agreed with the small wineries and forced New York to change their laws. This opened the floodgates, so to speak.
As of April 2008, 35 states now permit some form of direct wine sales to the consumer. It only accounts for about 2% of the wine sales in the United States, but there is huge opportunity in this market. The distributors see this as a direct challenge to their place in alcohol commerce. Craft brewers would love this access to the consumer, and some states are starting to permit it in small quantities. If everyone can sell directly to the consumer, there is no need for distributors. You better believe the distributors are lobbying heavily against this!
Beer costs more moneySince there is a middle man in the system, the cost of beer in America is higher. There is a whole industry between the producer and consumer that employs over 92,000 jobs and generates almost $8 billion (USD) annually. The added costs are passed to the consumer by design. The original intent of this system was to discourage over-indulgence, but now it just makes our beer cost more.
It might violate trade treatiesBudweiser dominates in world sales, and was the number one selling beer in the world until recently. Part of the reason for their success is it is much easier for Budweiser to penetrate foreign markets than it is for foreign beers to penetrate the American market. The most likely reason InBev pursued the purchase of Budweiser was to gain better access to the distributors, not for the “great taste” of Budweiser.
Markets are becoming more open for wine, so it is a matter of time before the beer producers demand the same treatment. The distributors will fight for their existence, but the US government may have already signed their death warrant with world trade treaties. No matter what happens, eventually the path beer takes to your glass may change.
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