My working life inside the three-tier system started in 1997 when I was a strategist at a small firm in Chicago working on packaging innovation for Miller (back before they became MillerCoors). Every quarter we submitted a hundred ideas for their considerations, some that went on to become gimmicky mountains that turn blue in the cold, and some that will remain inside jokes among the alumni of that team forever. And still others that stood up as profoundly unique ideas but were impossible to implement.
Two big things stood in the way, and those two things were 1) the insane economics of packaging at that scale, and 2) the three-tier system that works like a lumbering dinosaur at the peak of inertia. As for the latter? Well, it tends to stay firmly at rest.
Rather than dissuading me, this gnarly system of checks and balances that gives birth to so many workarounds and exploits somehow attracted the puzzle-solving part of my brain instead. To this day, I’m more inclined to noodle on the edges of the three-tier system than I am to take my ball and go home when it gets in the way of a great idea. The three tier is the parliamentary system of beer. If anything is going to get through, a lot of palms need to be greased and a lot of beaks need to get wet before a path will be cleared for most innovation outside the beer itself, and sometimes even then.
Since prohibition, most of three-tier laws, both federal and state-to-state, were largely understood to be employed in the prevention of monopolies. Indeed, many small brewers would cite three-tier enforcement as the single most important reason that our craft beer segment has seen periodic booms over the last 30 years, and fairly nominal busts. Three-tier laws protect retailers and consumers from being dominated by the largest corporate brewers who could otherwise overwhelm the value chain end-to-end. They're protected by mandating that the middle distribution tier exist and operate independently. State by state, that’s interpreted very differently, sometimes to the point of giving up the idea of independence altogether.
As a result, we’ve seen innovation in the beer product—broadly defined as “craft” beer. But not much else. The things we so strongly associate with craft beer today—the festivals, taprooms, same-day freshness, self-distribution, specialty shops that do release parties, and more—are happening in spite of three-tier laws, not because of them. Indeed, most of these elements now seen as so fundamental to the success and joy of craft beer required painstaking lobbying on behalf of craft brewers that loosened those laws.
It’s been a lot of push and pull.
More recently, delivery services like Drizly, potentially Amazon, and a host of others who are gearing up to enable direct-to-consumer delivery of alcohol, are banking on a future where three-tier laws are much looser. They’re betting on this future even though we still can’t get mail-order beer from artisanal brewers like we can with wine, and the trading circuit that makes the USPS and FedEx a couple of the largest distributors of beer in the country is still mostly an illegal behavior.
Late last year, Oliver Gray wrote in All About Beer that this practice is prolific: "on its website, BeerAdvocate claims that ‘hundreds of trades are conducted on a daily basis by thousands of members around the word,’ and the ‘Beer Trade ISO:FT’ Facebook group (one of the largest dedicated to beer trading) has more than 7,000 members. The /r/beertrade Reddit thread has more than 14,000 subscribers, and new trades are listed almost every hour."
All of which is to say: most of the innovation we’re seeing in the beer experience is a result of chipping away at three-tier laws that once made market-entry possible for small brewers, a benefit that may have run its course. Now, those laws are potentially hampering industry growth instead. It’s like a sidewalk that used to be the quickest path from point A to point B. Once people find the shortcut through the woods, the original route becomes obsolete.
“How do we legalize a dark economy that produces millions of dollars in a state each year, and little in the way of social benefit through its illicitness?”
It’s worth noting that, in my 20 years in beer, I’ve never met a person who would consider themselves an expert in all aspects of the three tier. And I’m not claiming that either. What I’m about to offer is a perspective not specific to any one tier’s particular nuances, which are legion—there are plenty of people gainfully employed in the management of those laws. Instead, I’m trying to take a step back and think about what would happen if we just blew them the fuck up entirely.
If we’re going to eliminate three-tier laws, it’s worth asking ourselves if the monopolies they were meant to prevent are actually being held in check. After all, I wouldn't want to blow up a system that was actively holding back a monster.
It’s obvious to anyone paying attention to the beer segment that following its recent massive diversification to 5,500+ breweries, the largest players of the category are still overly consolidated, influential, and encroaching on a free market for beer. While Anheuser-Busch InBev still sells the lion’s share of beer in the U.S., it’s objectively not a monopoly with major competitors like MillerCoors and Constellation still quite active and growing. And in a few years, with the success of increasingly powerful players like these, not to mention Japanese, Spanish, and Belgian corporations now entering the U.S. market, and up-and-coming private equity holdings companies like Fireman Captial and Oskar Blues, it’s unlikely to ever fall into true monopoly status. That being said! Even the Department of Justice saw fit to promise increased scrutiny into any new acquisitions from ABI.
ABI and MillerCoors control the vast majority of the U.S. market. (The DOJ forced a divestiture of MillerCoors from the South African-owned SABMiller to Canadian-owned MolsonCoors after the world’s largest beer merger earlier this year.) Indeed, Bud Light is still close to one in every five beers drank in the U.S. today. That, in and of itself, is an incredible feat that tells you as much about their market power as it does about the mainstream American palate. But brewery acquisitions aside, ABI has been much more aggressive about value chain control than any of its large competitors, picking up distribution houses in states that will allow it, and venturing into the hospitality/retail sector in a variety of ways, which, of course, gives it a stake in all three tiers. In terms of survival, it’s critical for ABI to do this. As the beer category shrinks, they need more margin from less beer than ever before, something Constellation itself has explicitly stated as its strategy since picking up Ballast Point for $1 billion last year. Neither of these corporations think the volume is coming back any time soon.
ABI needs both high margin and high volume success because its portfolio is so wide it’s essentially an index of the beer category overall. The company is like a mutual fund for the value, premium, super premium, and craft segments. As a result, it needs to place smart bets on every one of those segments and hope to grow the size of the pie while dominating as much of it as possible.
“The biggest expansion of pay-to-play tactics is, indeed, small craft brewers and their wholesalers, some of which aren’t even aware that what they’re doing is illegal because it seems so innocent in practice.”
So, how do we break up a near-monopoly? And should we? History teaches us some lessons on both sides of this argument with one of its most impactful anti-trust conflicts ever.
In 1974, the U.S. government was dealing with a lawsuit against the dominance of the AT&T Corporation, who was invested in, and controlling, both national and local telephone companies through the Bell Operating Companies as well as manufacturing most of the hardware through its subsidiary, Western Electric. They were so dominant that new carriers and manufacturers couldn’t enter the market competitively, develop technologies, or offer innovative services. As a result, the DOJ decided to break up “Ma Bell” in 1982, giving them the freedom to dominate long-distance, while returning local and regional services to the Bell Companies, and divesting from Western Electric. The “Baby Bells” formed separately, and AT&T’s value was reduced by about 70%.
Following the break-up, Sprint and MCI entered the market with gusto, and AT&T was given permission to enter computer systems as a new venture for their technology and hardware. Western Electric split into Luscent and Nokia, which became hardware competitors offering new choices. Prices for local rates went up because they were no longer subsidized by long-distance rates, but long-distance rates dropped and we got Voice over Internet Protocol (VoIP) technology out of the deal.
Meanwhile, television broadcast had to shift toward more local delivery channels, which created demand for satellites. And as dial-up internet entered the marketplace, one of the Baby Bells, SBC Communications, became profitable enough against AT&T’s more confined operations that it was able to purchase it and form what we now know as the legacy AT&T provider.
All of these things are currently happening organically in the marketplace for beer. And it’s not because we’re breaking up ABI. It’s because we’re breaking up three-tier laws. And that’s naturally eroding ABI’s market share—in some cases, significantly—because it's spurring on new competition. But it's not creating new beer factories, it's creating new models and paths to market that compete for the same consumers.
Comparing the AT&T scenario to ABI in the beer industry, there are significant differences, but also similar demands. ABI’s ZX Ventures is its own attempt at creating innovation and disruptions, at times even to its own core business. The very existence of such a group is a telltale sign that ABI isn’t in monopoly/protect mode. Rather, it’s seeking new ways to stave off stagnation and stay ahead of competition.
[Disclosure: ZX Ventures is an investor in October, a project owned by Conde Nast in which GBH serves as Executive Producer. We have no working relationship.]
Indeed, many of the companies ZX has invested in are intended to lead the next wave of consumer experiences through digital platforms like RateBeer (the jury’s out on what that value might be) and digital delivery services like BeerHawk in the UK (that one is convenience if nothing else). They seem to favor investments in non-U.S. countries where three-tier laws are looser or non-existent, and where those investments are able to re-shape the value chain. These are the kinds of things legislators want to see if they’re to be convinced that the market is dynamic and productive despite the apparent threat of dominance and vertical integration.
But because ABI is now acquiring and exploiting smaller parts of the ecosystem in a decentralized method of growth and influence, a new understanding of the ecosystem is needed for the original intent of three tier and anti-trust to continue being realized. It’s not just producers, wholesalers, and retailers anymore. It’s as gnarly a web as ever, and ABI is far ahead of the game in that respect—an advantage of their large pockets and tolerance for risk. As a result, they will likely define it for the next decade.
“They created that value, not a wholesaler. And the willingness to pay for it is demonstrable proof. ”
So while it might seem like we need to break up a monopoly, this isn’t 1974. The way in which ABI has impacted the market is much more complicated than a conventional dominance play, and three-tier laws aren’t sophisticated enough to prevent the kind of consolidation and exploitation of the evolving value chain that’s coming next.
But! We should also not over-regulate how it works, because it’s still evolving and small, independent brewers are finding growth precisely where cracks in the three-tier system have emerged. One of the lessons of the current system is that, while it protects access to market, it also limits grown and innovation, and that’s what every mid-size and large craft brewer should be most concerned about. What we need is the kind of anti-trust-busting deserving of 2017 commerce. Which is to say: laws that reflect our more direct way of doing business with producers, enabling small ones to be more creative and gain access to consumers on consumers’ terms. In that way, the laws that will likely be written around Amazon’s continued dominance of our everyday lives are more relevant to the dangers posed by ABI’s dominance of the traditional three tier system.
Many states have rules for wholesalers that enable them to take on a beer brand for distribution and hold it indefinitely—sometimes forever. Illinois is a perfect example. Often, the only way a brewery can exit a contract is to prove negligence or illegal activity, or find the cash to buy back their rights at an exorbitant cost, sometimes at a five-times multiple or more. These rules are meant to protect the wholesaler from investing in a brand and then having it move to their competitors, but all too often for small producers, it’s a way for wholesalers to round up small breweries, bury them in a book with too many SKUs (sometimes even unwittingly), and then hold them ransom. As we’ve seen with some breweries, the only choice is to pull out of market for up to five years to reset the contracts or, as was evidenced by a case still pending in Wisconsin, making the hard decision to kill their brand outright.
This is all possible because wholesalers have internalized the mistaken belief that they’re brand builders. That, or they’ve cynically sold it to breweries despite knowing it’s just not true. At the Wholesalers Symposium last year, I was invited to speak to a few hundred guests who wanted to know how distributors could be better at this brand-building thing. Much to their dismay, I asked them not to try. Brand building and sales are two wildly different things. In 2017, with few exceptions, a distributor’s portfolio is too large and diverse to effectively be anything other than an attentive logistics network that supports a producer’s own brand-building efforts and sales team. Indeed, these days, a brewer tends to spend more money to sell the same amount of beer, and many of them are happy to do so if they could recoup more of the margin on a keg that currently goes to a distributor for those “brand building” efforts.
What’s needed is a readjustment of the leverage a producer has in a wholesaler negotiation.
If we end state-mandated franchise laws, brewers can then properly negotiate their contracts with distributors that better reflect the value of the brand that brewers themselves have created (through taprooms or self-distribution) or will create going forward. In Indiana, for example, Sun King self-distributed nearly 30,000 barrels of beer statewide before negotiation with distributors. As a result, they were able to sell their rights for a sizable value and use those funds to become debt free and plan their expansion. They created that value, not a wholesaler. And the willingness to pay for it is demonstrable proof.
More breweries will put in the upfront effort to establish themselves rather than hoping a distributor will do it for them. It’ll create patience and that patience may create sustainable momentum through expansion and new markets like we see with Sun King. And if a wholesaler runs the risk of losing a brand because of their own poor performance, they’ll have incentive to offer a better service.
The risk in this scenario is in the largest brewers gaining considerable mindshare leverage over their wholesalers. In some Bud-aligned houses, for example, 70% or more of the sales come from a single producer’s portfolio, and as ABI already showed last year, they’d like all of it. Incentives are a danger to smaller brands in big houses.
However, just because state-mandated franchise laws aren’t in effect doesn’t mean that useful and fair components of those laws can’t be contracted independently and a’la carte, or have timelines that create a vested interest. Any wholesaler with an ABI contract would be well-served to protect their investments through contract stipulations. But because these state laws negotiate that power for them, indiscriminately giving wholesalers leverage against both ABI and smaller indie brewers, they do little more than protect multi-generational wealth amongst wholesaler families that rake in the largest part of the collective pie with the smallest amount of risk.
The definition of a wholesaler or distributor needs to diversify if we have any chance at all of regulating how it works.
Brewers are now making one-time container drops in a city where they want to have a temporary impact. Delivery services are picking up growlers at brewpubs and dropping them on your doorstep. Amazon is expanding its considerable e-commerce experience to same-day delivery of alcohol. Small independent brewers are taking less margin and performing logistics-only services for their friends and colleagues to get them into market. And through all this, producers are able to protect more of their rights and margins than ever. This represents an opportunity to diversify the middle tier with a wider range of service options that fit the needs of smaller brewers without having to directly battle the consolidation of bigger distribution houses, or running a conventional fleet of trucks against them. It’s playing a different game altogether.
In addition to new routes and experiences for the product, producers who are so inclined can maintain stricter control over the product’s quality end-to-end. We’re already seeing a major shift in consumer behavior toward direct interaction, sales, and consumption on-site in the own-premise disruption. This isn’t just a cool-factor opportunity for brewers. It’s quality control. Those beers are more often kept cold and served fresher. Plus, with most Americans being within 10 miles of a brewery, those beers are more conveniently accessed than ever before.
Beer, like any other beverage, even of the alcoholic persuasion, should have the freedom to access the market and the consumer by any reasonable means without delay.
There’s a lot of gusto out there for small brewers as fans cheer on any sort of win in the market that feels like it gets them more and better beer. It’s hard to argue. Perhaps the biggest win for consumers are taprooms and satellite brewpubs. But it’s not just the locals that are getting into the taproom game—national brewers are using satellite retail outlets to create local relevance far from home, too. This retail expansion from region to region is potentially critical to the largest producers and, in some cases, it’s welcome. Other times? It’s not. The jury’s still out on whether these localization strategies have much impact on sales, but it’s clear breweries are willing to spend big on this kind of expansion into hospitality right now.
If we’re not careful in how we roll out this new generation of beer hospitality (which is a direct violation of the intent of three-tier laws), we’re going to see the brewpub chains of old—Rock Bottom, for example—become chains of Goose Island, Lagunitas, and Ballast Point pubs instead. Maybe that’s a net win. After all, there are pros to having these brands set up shop in any given city. Rock Bottom Chicago, for example, helped create a generation of smart, capable production brewers in the Midwest who went on to run successful companies like Surly, 3Floyds, Wiseacre, Solemn Oath, Sun King, and more. They employ people and pay taxes like anyone else, and can often be credited with revitalizing neighborhoods that need a nudge.
“Corporate success should be a win-win for the communities in which they extract their value and in the localized sectors of the industry in which they represent a potential threat of dominance.”
But the cons are worth considering as well. They affect real-estate pricing in neighborhoods just like any national chain would, significantly inflating values and preventing local breweries from competing for those spots. They directly compete with bars and restaurants around them (which is part of what the three tier tries to prevent) and return less (but still some!) profit to the local economy.
They can also diminish the diversity in available tap handles per liquor license in a neighborhood where a craft-focused bar or restaurant would support a dozen or more producers at once. According to a Brewbound Nielsen study, 12,766 have closed in the last 12 years, representing a “long term decline of key drinking channels” and “a hard one to bear” for the beer industry. In other words, unencumbered chain hospitality in craft is a double-edged sword and could quickly overwhelm the system. Even amongst smaller craft brands we’re starting to see bar owners get anxious and vociferous. It’s only a matter of time before they consolidate their own power and push back hard on breweries competing for their customers.
We should be mindful about how producer-owned hospitality is expanded or restrained in order to support a healthy ecosystem which should support both national and local brands—a national limit on retail licenses for producers would force brands to choose their expansions wisely against limited options. Conversely, if that’s a bit too top-down for you, local incentives could offset the potentially unfair competition among national and local brands by connecting the two via a sort of development fund that ensures corporate brand growth contributes to local opportunities as well.
If a Golden Road pub opens in Oakland, for example, there could be mechanisms in place for infrastructure improvements, zoning upgrades, guild support, small business incentives, or any number of impactful things critical to the local economy that can be directed from tax revenues or attached to the success of that particular link in the corporate chain. These are common incentives tied to corporate growth and we should be looking at those same things in the beer industry now.
Corporate success should be a win-win for the communities in which they extract their value and in the localized sectors of the industry in which they represent a potential threat of dominance.
When I first shared this list on Twitter recently, this line item got a perhaps-unsurprising amount of backlash. Most people focused on this exclusive to the others, not realizing that I was attempting to show a dependent list of priorities in an order that I thought made the most sense systemically. In other words, legalizing pay-to-play in a vacuum would be devastating (or at least continue to be as devastating as it currently is). But I’m about to argue that legalizing pay-to-play in the context of all of the above might actually be quite beneficial to all involved.
Make no mistake, pay-to-play as it currently operates harms our industry immeasurably. But why? Precisely because it's immeasurable. It’s a common practice in the form of slotting fees, wholesaler incentives, and other mechanisms for just about everything else we eat and drink. And American grocery store shelves are more associated with a paralysis of choice than starving for options. I’d argue that the most damaging part of pay-to-play in the beer industry is that it’s forced into the shadows.
Consider the legalization of marijuana. At no point did anyone ask for unregulated freedom to produce, sell, and use an illicit drug. Rather, the question was, "How do we legalize a dark economy that produces millions of dollars in a state each year, and little in the way of social benefit through its illicitness?” The answer was to create a system whereby a formerly-illegal activity that was somewhat benign could be used to channel massive amounts of formerly-illegal funds into a system that supports those involved, but also positively impacts the larger social net surrounding the activity that could benefit from the mainstreaming of the practice. In this case: schools, roads, healthcare, etc.
“Laws that are more consistent across state barriers would make investment in breweries, distributors, and retailers more predictable.”
Pay-to-play has many of the same components. It’s illegal, but still rampant. It’s inconsistently enforced and never a true deterrent to those with the means. The expense of investigating it far outweighs the occasional small fines. And, increasingly, the illegal practices are being employed by the smallest players in the ecosystem because there’s increasing demand with little ramifications.
In case that last part wasn’t clear enough, let me explicitly say that the biggest expansion of pay-to-play tactics is indeed small craft brewers and their wholesalers, some of which aren’t even aware that what they’re doing is illegal because it seems so innocent in practice.
And the investigations rarely produce anything of value in the form of fines or actions. One of the largest cases uncovered in the past two years was deemed essentially unprovable and the fines dismissed. And when the fines are actually levied, as in the case of ABI's Southern California wholesalers this year, they’re meager. In the two times GBH researched and wrote about pay-to-play, an Illinois investigator told us it was the most information they’ve gotten on potential pay-to-play activities in the three years he was on the job. I was happy to have done our part in shining a light on it, but I was more concerned by how pathetic that was in practice.
We need to move the goal posts on pay-to-play to open up more inventive producer marketing and incentives that benefit the rest of the value chain, make it easier to promote a brand at the retail level, and funnel a good portion of that illicit cash already being spent into more productive channels like cold-chain investments, agricultural expansion and diversification for beer, and improving state and federal processes.
It could also make it possible for small producers to buy their way into a competitive market where access is impossible otherwise. For example, enabling slotting fees in a grocery store or a Costco (as is done with any other beverage) would mean that 1) small upstarts could pay to get exposure in front of new consumers and gain traction by paying for it, and 2) dollars from larger brands, if regulated, could help offset the costs of smaller brands gaining similar access.
If Bud wants to buy up handles at a Ballpark, let them. But cut them off at 25% and require the bar to include small local brewers in the other 75% with no sponsorship required. This certainly isn’t a “resist” mentality that’s pervading the market right now where there’s a sort of no-compromise attitude toward corporate dominance—this is judo. Let the big guys throw around their weight (Spoiler alert: they’re going to anyway!), and let that massive amount of energy parlay into equal wins for small, independent brewers who struggle to gain access.
Want to sponsor a street fest with Lagunitas kegs? Fine. They have to cover the expense of a local brewers guild tent, too. Let the money flow, and kill the exclusivity lockouts. I’ve seen hints of this in action with municipalities requiring that festivals receiving special event licenses and sponsorships commit to serving beer from more than one distributor portfolio to prevent exclusivity. In the end, if the big guys have to spend more money to sell the same amount of beer, that’s a win for the ecosystem.
No doubt you vigorously disagree with some of these ideas. In a couple weeks, I might as well. The three-tier system is a gnarly beast that threatens your livelihood one day and defends it the next. But most of us can probably agree that it’s outdated, evolving too slowly, and far too inconsistent state-to-state.
Which brings me to my last bonus-round idea: Create regional agreements that enable more consistency between a group of states to increase the freedom of movement and commerce within the value chain in a more predictable way. Laws that are more consistent across state barriers would make investment in breweries, distributors, and retailers more predictable, it’d provide consumers with a more consistent experience and free up spending, and it could catalyze a new round of growth in the industry through the simplicity of its regulation.
All right! That’s plenty to chew on for now. Please @ me.
Words by Michael Kiser Graphics by Mike Duesenberg
