Critical Drinking

Watch the Hands, Not the Cards — The Magic of Megabrew

The sale of craft breweries to AB InBev is becoming more and more common, and just like anything, the more common something becomes, the more normal it starts to feel, and the more people start to wonder, does it really matter? It all depends on why the craft breweries are being bought by AB InBev, and I think the answer is much more complicated, if conservative, than we realize. While we’re distracted by the loss of a popular card in the craft beer deck, everyone is looking at the wrong hand in a magic trick. And a fairly conventional one at that. 

Chris Herron is CEO and Co-founder of Creature Comforts Brewing Co. in Athens, Georgia. 

I spent three years at Miller Brewing Company, and then another 9 years at Diageo, doing 6 years in sales, 2 years as a National Pricing Manager, and 4 years in a variety of finance roles, before finishing my career as Finance Director for Diageo’s US Spirits and Wines. I was lucky enough to work with and learn strategy from some of the absolute brightest leaders and minds in the beverage alcohol industry. I jumped into craft three years ago with the start of Creature Comforts, putting all that experience to work in a different part of the industry, and one thing I have loved is the culture of collaboration over competition. Being small and independent is not a requirement to partake in the collaborative spirit, it just takes caring about what is good for the beer industry in conjunction with what is good for your brands.

But if you’re a company like AB InBev, it’s all about the equity in those brands in a very real, and very costly sense. 

Before I go any further, there are a couple terms everyone needs to get a bit familiar with:

Brand Equity – Basically the value that consumers place on your product or brand. There is a direct correlation to the price you can charge a consumer for your product and the strength of your brand equity with consumers. Brand equity has a very real impact on a brand’s value.

Goodwill – Goodwill might sound made-up, but it’s an actual line item on a balance sheet for a company that represents the value paid for a brand above the value of the assets and liabilities. It is essentially the intangible value of a brand. For an over simplified example, if I buy a craft brewery for $20m, and the value of that brand’s tangible assets (steel, taprooms, etc.) are $1m, I would put $19m on my balance sheet as goodwill. That number is considered a real thing my company owns, even though it’s intangible, and I must continuously prove it.

Impairment Charge – This is the term for writing off goodwill in a brand, or to say it different, a one-time penalty or re-adjustment that companies must incur if they deem the brand value to be overstated on the balance sheet. From the example above, if it was later deemed that the brand’s value given performance was now only $15M, I would lower the value/goodwill on my balance sheet for that brand to $15M, and take a $4M loss on my income statement. Taking an impairment charge is very bad news, it’s acknowledging lost value in a brand, and it can drastically affect the value of the company. It must be avoided at all costs.

If you are a publicly traded consumer products company, such as AB InBev, you care a lot about your brand value. AB InBev’s 2016 balance sheet shows that their “goodwill” represents nearly 53% of their assets on the balance sheet, approximately $136.5 Billion (Yes, Billion). That brand value ties to consumer perception, which is why AB InBev cares so much about how you perceive their brands.

The Budweiser brand is the 25th most valuable brand in the world, valued at $23.4 Billion in 2016, according to Forbes.com and ~40% of the brands’ volume is in the United States. Unfortunately for AB InBev, the Bud Light brand in the US has gone from a 19% share in 2010, to a 16% share in 2016, and Budweiser is not performing much different. If AB InBev cannot correct the trends in the US, the Budweiser brand could end up facing potentially huge write downs from an impairment charge in the future (think billions). The resulting impact on their share price and market value could be enormous. They simply cannot let that happen, they must protect the enormous value of these legacy brands above all else.

When Bud Light launched 35 years ago in 1982, it went into the beer category called “premium.” Today, this is still the name of the category in industry reports. It was named “premium” for a reason — these new brands were on the high end of the price spectrum, which in turn communicated to consumers that they were at the high end of the quality spectrum. As craft slowly started to edge its way onto the scene, there would have been negligible impact on these brands, as there was minimal crossover between consumers and even smaller conversion of the Bud target audience. However, over the last five years, craft has started to grow share quickly, both in their distributors warehouse, their consumer’s consideration set, and on retail shelves. Worst of all for AB InBev, craft has gained this market share at a higher price point.

Price matters because as consumers have grown accustomed to seeing $10+/ six packs of craft beer on the shelf at their local retail outlet, the $7/six pack of AB’s “premium” beer risks becoming “cheap” or “discount.” When a brand moves in a consumer’s mind from premium to discount, there is an erosion of brand equity, which leads to an erosion in brand value, which could lead to a real loss on the bottom line for a publicly traded company. Unfortunately for AB, they cannot simply increase their price to close the gap. Their consumer base is highly price sensitive, and as they fight for the massive volume represented by this mass market consumer base, and try to compete with MillerCoors, they cannot risk the volume loss associated with a price increase.  Therefore, they are stuck, sitting at the lower price, watching their brand equity erode as craft grows. If that happens long enough, you guessed it — they could face an impairment charge (still talking billions).

So, what do you do if you are AB InBev? I imagine 5 years ago, Carlos Brito, CEO of AB InBev, walking into the board room in New York and asking this three-part question: “How do we both capture some of craft’s growth and simultaneously slow it down, and even more important, how do we regain the lost brand equity and value in our premium legacy brands?” In this new world of craft beer, that’s a more challenging question than ever before. Regardless of the ultimate complexity of the strategy, one solution is what they have done: buy craft breweries across different regions of the country. 

To understand why this works, first it is necessary to understand the things that are vital to be able to grow a beer brand. First is access to the raw materials you need, second is the need for effective distribution of your brands, third is the ability to get your products at retail, and fourth is effective marketing to consumers. I realize I did not mention “good beer.” In the end, that seems like a given, but it’s also not well-defined. I can’t help but wonder sometimes: if good beer is what is required to succeed in the mass market, then why is nearly 90% of the beer sold what craft consumers would consider sub-par? There’s an enormous perception gap, and it’s highly subjective. 

The answer to the first part of that imaginary “Carlos Brito question” seems somewhat obvious. Although many diehard craft consumers will shy away from the purchased brand, which inherently lost value the moment the buyout was announced, AB InBev can easily lower the prices to reflect the reduced brand equity, and a large group of consumers who don’t consider themselves “craft” or care about ownership will happily buy it at the lower price. We’ve seen that with the core brands from those craft breweries in short order, especially among the IPAs and core beers. They can easily secure additional raw materials to produce more beer if needed, they have distribution networks across the entire country, and strong relationships with chain retail account to get distribution. Short-term fast growth is not a problem for AB InBev.

At the same time, they’ve explored the upper reaches up price for brands like Bourbon County Stout and Goose’s sour Sisters. This might seem counter to the larger strategy, but really, it only furthers the contrast between “premium” where they’d probably prefer Budweiser and Bud Light to sit next to IPA and 312, and a more “high end” set that won’t affect that core brand equity. It enables them to protect the core and explore craft’s new white space at the same time. 

What is a little less obvious, but still easy to get our head around, is how them buying craft breweries can slow the growth of the entire craft category. When it comes to raw materials, it was only a couple of years ago that craft breweries were having very little competition from the multi-nationals when it came to sourcing their favorite hop varieties. Craft breweries are even known to regularly help each other on sourcing varieties if someone is in need, which we have experienced first-hand at Creature. It is just an example of the spirit of the industry: collaborators vs competitors. I’m not saying the people at the craft level of AB InBev don’t or can’t continue to behave this way — old habits, even good ones, die hard — but most of that resource sharing I suspect is happening internally between AB InBev brands now. 

As the mega breweries buy smaller regional craft breweries, and quickly accelerate their growth through expanded geographic distribution, incremental chain retail placements, and increased marketing support, they are bringing their buying power into the craft beer space, and using that purchasing power to secure large quantities of difficult-to-source varieties of hops and potentially other raw materials. If AB InBev can grow these breweries fast enough, they can impact the overall ability for other craft breweries to grow by limiting access to the raw materials market. That’s happening even from larger craft breweries who want to protect their future resources. Buy now, share later. From that perspective, growing these craft brands may not be about a nice long-term steady growth plan for the brands, but rather a quickly executed defensive play to slow the growth of competitive independent craft breweries in the short-term. 

Another place they have been aggressive is in influencing distributors. It was only about a year ago that AB InBev introduced an incentive to their distributors, where AB InBev would refund 75% of distributors required marketing spend on AB InBev brands (up to $1.5 million) if AB InBev beers make up 98% of that distributors’ sales. The incentive was tiered, so that the greater the share of non-AB InBev sales, the less money the distributor would get. Those incentives were aimed at the larger craft brewers like New Belgium, and mid-size fast growth breweries like Creature Comforts, as they promised not to count sales of breweries with smaller (less than 15k bbls) production levels (which is often smaller local brands). Clearly, this was an incentive designed more to inhibit sales of craft beer than to increase sales of AB InBev — it likely would have only kept the status quo for AB — and thankfully the department of justice stepped in to investigate. 

From a retail perspective, AB InBev can utilize their influence to get their new “craft” or “high end” brands into retail store sets, eliminating space for local craft brands. This is truer at big chain, liquor, and convenience stores, but that’s where the new growth is coming for craft breweries beyond the taprooms. They can further offer price promotions to secure key ad windows to drive sales of their “craft” brands. This creates downward pressure on the craft beer category price, a game that local craft breweries have a tough time playing, given their higher cost structures for operations. They are forced to choose between lowering their price to preserve their volume, resulting in less money to fund future growth, or hold their price, risking volume, which puts their ability to maintain their position at retail at risk. In this way, AB InBev is pushing price the way Wal-Mart did, systemically, and likely with similar effect for local producers and retailers. 

The last part of the imaginary “Carlos Brito question” relates to the most important task of all: stopping the brand equity erosion of their core premium legacy brands. How buying a craft brewery solves this issue is not so clear, but stick with me. Given the enormous, multi-billion dollar values of the Bud and Bud Light brands carried on AB InBev’s balance sheets, an erosion to any one of them, which would require a write-down in goodwill (an impairment charge), would make the money they are paying to acquire craft breweries insignificant. Think I am making this stuff up? Here is a line from their annual business report in 2016: 

“If the business of AB InBev does not develop as expected, impairment charges on goodwill or other intangible assets may be incurred in the future which could be significant and which could have an adverse effect on AB InBev's results of operations and financial condition.”

The billion-dollar question AB InBev must answer is: how do they stop their most prized brands’ volumes and values from eroding due to a significant price gap at retail vs craft, when they cannot take the brands’ prices up without risk of losing even more significant volume to their competition given their consumer and competitive set for those brands? Answer: they bring the price of craft down.

By purchasing regional craft breweries, squeezing their distributors on margins for those brands, reducing raw materials costs due to buying power, and centralizing business functions (i.e. reducing overhead, employees), AB InBev can influence a reduction in the price-to-consumers of that craft brewery’s beer, while increasing, or at a minimum holding, their margins. This downward pricing pressure accomplishes three main things: 

  1. It better aligns AB InBev’s “High End” craft brands’ price-to-consumer with the brands’ new brand equity (which got diminished when they bought the brewery), and
     
  2. It forces other craft brands to consider lowering their prices, and
     
  3. Most important of all, it shrinks the price gap between craft beer and their legacy “premium” brands, which over time will psychologically influence consumers to see those “premium” brands, as more in line with “good craft beer.”

Did you catch that last point? That is the sleight of hand we’re not watching with the rest of the show going on. By buying craft brands and lowering the price, they can reduce the price-to-consumers, and force the hand of other craft brewers (particularly large regionals) to lower their price-to-consumer to compete. These price reductions on craft beer shrink the gap between AB InBev’s premium legacy brands and craft brands. Overtime, minimizing this price gap increases the brand equity of their legacy premium brands (Bud and Bud Light), since these brands no longer appear to be at a significant discount. The increase in brand equity for these legacy premium brands suggests consumers should eventually become less price sensitive and AB InBev can take a price increase (claim even more value in brand equity) to generate value. Some consumers may even start trading back down from craft, as they perceive the quality of the AB InBev’s premium brands to now be more closely aligned with that of craft brands given the closer price parity. The result is that AB InBev generates additional volume and value for their premium legacy brands as their share increases, thereby saving them from impairment charges.

While everyone thinks that AB InBev is truly interested in getting into craft and building these brands (which is a secondary goal at best), I submit that maybe buying craft breweries is more of a tool to devalue the craft category and increase the brand equity of their core legacy beers. The impairment charges AB InBev could face are worth billions more than any craft brand they have purchased, and those purchases would be a small price to pay to save a legacy brand. These craft brands, whether they realize it or not, may just be pawns in the AB InBev game of chess. AB InBev is not a collaborator, they are a competitor, and a damn smart one. If one of these craft brands they buy is a successful long-term brand, great, but more important to AB InBev, is the vital role they play in the short-term of ensuring that their premium brands retain long-term value. 

From my time in the board room with senior executives at multinational companies, I learned that there is a lot more strategy going on than the public thinks. Impairment charges scare everyone, and rightly so. It’s the single biggest risk-factor for the 25th most valuable brand in the world. Everything else they do to create value must protect the core value first and foremost. 

This is why, from a business prospective, it sucks when an independent craft brewery “sells out” to AB InBev. For us in the industry, we are trading out a collaborator for a competitor, and I personally just don’t believe the repetitive press releases that say the deal is best option for the craft brand and for the employees. Maybe everyone really believes that from the middle on down at AB InBev. But ultimately, it has a much bigger purpose to serve first, before the value it creates for itself can ever be appreciated.

Having worked for the big guys, I believe their focus remains squarely on how they protect their legacy brands, and I remain steadfast in my belief that we can set our young brands up better for long-term success and create significantly better work environments for our employees by staying independent from Mega breweries. However, we must start thinking differently, become more strategic, and be intentional with our decisions and our actions.

Words by Chris Herron
Graphics by Hillary Schuster