THE GIST
Soft drink companies have already loosened alcohol makers’ grip on the beer aisle, teaming up with breweries to produce Topo Chico Hard Seltzer, Hard MTN DEW, and Arnold Palmer Spiked hard teas. Now, a company that has historically only focused on non-alcoholic products has the greatest potential to upend brewery-wholesaler relationships, and chip away at principles that prop up the three-tier system of alcohol sales in the U.S.
For more than a year, PepsiCo quietly laid the logistical groundwork for Blue Cloud Distribution, its new alcohol distribution division, which officially launched in February 2022 to distribute Hard MTN DEW. Blue Cloud has since signed on Lipton Hard Iced Tea, a flavored malt beverage (FMB) brewed by FIFCO USA, set to launch in early 2023.
And while Blue Cloud’s portfolio may only include two brands, the mere existence of this company is enough to put industry members on their toes. The greatest threat this newcomer poses is in its potential to change generations of policies and laws that have helped alcohol distributors thrive, disrupting their long-standing position in the market. Wholesalers are worried not only that PepsiCo could break the rules, but also change them.
WHY IT MATTERS
The entrance of one of the world’s largest soft drink companies into the distribution business has created tension with traditional beer wholesalers, many of whom see Blue Cloud as both a practical and existential threat to the status quo.
"Any threat to our tier, I’m clearly not a fan of. I think there are going to be people not taking traditional routes to market in the future," says Don Faust, Jr., chairman and CEO of Texas' Faust Distributing. "I think we’ll see more of it. If you’re in a state that doesn’t have strong franchise laws, you’re in a freakin’ world of hurt."
Blue Cloud was a major topic of conversation at the National Beer Wholesalers Association’s (NBWA) annual convention in early October, and is also at the root of a complaint two beer wholesalers filed this month with the Virginia Alcoholic Beverage Control Authority (VABC).
Wholesalers’ stated concerns center on so-called “slotting fees” that PepsiCo pays retailers to stock food and non-alcoholic beverages, like Ruffles potato chips and Gatorade, but which are not legal for beer wholesalers to pay to retailers for preferential placements. (Blue Cloud has not been found to have broken these laws.) NBWA leadership has also claimed that Blue Cloud has cross-promoted alcohol in stores near items intended for children, such as juice or toys. At the NBWA convention, leadership shared photos of Hard MTN DEW displayed next to products that appeal to kids, calling this “concerning” and “not cool.” (NBWA declined to share full details on the source of the photos, including the names of people who took them.)
Blue Cloud did not make anyone available for an interview, but did provide a written statement that said, in part: “Recent comments at the National Beer Wholesalers Conference misrepresented key facts about Blue Cloud Distribution which was established to operate at the wholesale tier within the parameters of the three-tier system. Blue Cloud Distribution is committed to following all government regulations for licensing and business operations, while providing expanded choices for consumers in this growing market.”
However, success for Blue Cloud isn’t as guaranteed as NBWA suggests, and some analysts think upcoming scrutiny could spell long-term trouble for the venture. Nadine Sarwat, equity research analyst and director of European and American alcoholic beverages at Bernstein Autonomous LLP, speaking during a panel at the NBWA convention, said regulatory delays create “an uphill battle” for Blue Cloud’s long-term success. According to reporting from Brewbound, Sarwat said that Blue Cloud is unlikely to become “a meaningful threat” to the existing beer distribution system.
Distributors’ anxieties over Blue Cloud are numerous, but size is a key factor. Despite being an outsider to alcohol distribution, PepsiCo brings with it the advantages of a massive company, including warehouses and delivery drivers across the country. It also has deep pockets.
“You’re talking about bringing a behemoth into the fold with other behemoths,” says Kevin Anderson, a consultant with BreweryCompliance.com and a former special agent with the VABC. “Blue Cloud is going to be a major competitor because they’re in every single retail business in a state—every convenience store and every restaurant.”
Should PepsiCo continue to invest in it, Blue Cloud could become the first truly national beer distributor by plugging into PepsiCo’s existing food and beverage network. PepsiCo has drivers delivering chips, soda, and sports drinks to virtually every store in every state in the U.S.; via Blue Cloud, it’s putting HARD Mtn Dew and, in the future, other alcohol brands on those same trucks. That factor is something that even the largest existing beer wholesaler, Reyes Beer Division, can’t match: Reyes currently operates in 11 states plus Washington, D.C., with California as its most significant market.
Blue Cloud has already been issued federal alcohol wholesaler permits in 31 states, according to Beverage Digest, and is seeking to expand nationally. Currently, it has operations in nine states: Florida, Tennessee, Iowa, Oklahoma, Arkansas, Minnesota, Missouri, Nevada, and Virginia. Beer Business Daily wrote in an Oct. 2 newsletter that, “By this time next year, barring any regulatory backlash, Blue Cloud will be a multi-million case distributor with a national footprint, something that took Southern Glazer’s 75 years to accomplish.” (Southern Glazer’s is the country’s largest wine and spirits distributor, with $21 billion in annual revenue, according to Forbes.)
With that size comes enormous influence. The NBWA maintains that a manufacturer like PepsiCo owning its own distribution company is generally against the spirit of the three-tier system, which was set up during Prohibition to prevent so-called “tied houses” between alcohol companies and retailers.
“We don’t mind the competition [from Blue Cloud], but we need to make sure that we are being treated equally,” says the vice president of sales for a beer distributor in the Pacific Northwest, who asked that their name not be used so they could speak candidly about a sensitive industry topic. “Soda can pay for shelf space, so potentially because of Pepsi’s massive influence in large supermarkets, they would probably get a disproportionate share of cooler space, display space, maybe ad support [for Hard MTN DEW] that other brands would not get because of their influence. … It’s not a level playing field.”
This is speculation; the vice president didn’t provide examples of these practices having occurred. In his remarks to the NBWA convention, though, the organization’s president Craig Purser said distribution employees had shared “plenty of examples” of these violations with the NBWA, sharing the two photos of Hard MTN DEW displays. This vice president also raises an issue NBWA leadership had voiced: That PepsiCo’s total ownership of Blue Cloud is “a big fuzzing” of the lines between suppliers and distributors in a way that violates the spirit of the three-tier system.
“Our concern with large manufacturers doing their own distribution and the potential for a ‘company-owned store’ has been well documented,” Purser stated via email. The NBWA has publicly issued support for “statutes designed to prevent vertical integration and preserve the independence of each tier in the alcohol industry.”
Some beer manufacturers do own a portion of their wholesalers: Anheuser-Busch Inbev (ABI) and Molson Coors Beverage Co. outright own some distributorships, but the percentage of their distributors that they may wholly own has been capped by federal regulators. In several states, breweries are also able to self-distribute their beer.
And traditional beer wholesalers themselves have been sanctioned for trade violations regarding the independence of these tiers. In 2020, ABI paid a record $5 million fine to the Alcohol and Tobacco Tax and Trade Bureau (TTB) for, in essence, creating a “tied house” agreement with sports and entertainment venues that suppressed competitors’ products. In 2021, the TTB issued Iowa Beverage Systems a $325,000 fine regarding a “pay to play” scheme at the Iowa State Fair.
Crucially, Blue Cloud’s agreements with Boston Beer Co. (for Hard MTN DEW) and FIFCO USA (for Lipton Hard Iced Tea) are structured so that PepsiCo is not the manufacturer of either product. It instead enters a licensing agreement with Boston Beer and FIFCO, who make and package the actual liquid.
“These companies developed the formulas, own all of the intellectual property, and control the marketing of the products,” Blue Cloud said in a statement. “Blue Cloud is only the distributor.”
Some industry observers see the licensing agreement between PepsiCo and beer makers as a mere technicality. Sean O’Leary, president of O’Leary Law and Policy Group and former chief legal counsel to the Illinois Liquor Control Commission, says that Blue Cloud represents an entirely new paradigm for beer distribution that brings the supplier and wholesaler tiers closer together. And that, O’Leary says, is what really has the potential to shake the foundations of the wholesale business. If regulators find that Blue Cloud is breaking no laws, and the marketplace welcomes this new entrant, then O’Leary says Blue Cloud is simply a case of a disruptive company rankling established players.
“One day you’re going to get someone who’s big enough to challenge the system and say, ‘Why can’t we vertically integrate?’ ‘Why is the three-tier system necessary?’” O’Leary says. “Innovation is always in a gray area.”
So far, distributors have publicly pointed to more immediate concerns about Blue Cloud, including issues of public health and safety. The existence of alcohol wholesalers is essentially guaranteed by U.S. law, which requires a middleman between alcohol producers and retailers. Part of the justification—by law and in wholesalers’ own words—is to protect the public, who could be threatened by an unregulated system of alcohol sales that allows counterfeit alcohol and sales to minors to occur. Critical to this mission is keeping alcohol from being marketed to children.
During the NBWA convention and in a subsequent statement to Good Beer Hunting, Purser questioned whether Blue Cloud’s distribution of Hard MTN DEW was adequately following the advertising and marketing code adopted by the Beer Institute (BI) trade group, which states in part that: “Advertising or marketing materials should avoid elements that appeal primarily to persons below the legal drinking age.” The NBWA alleges that Blue Cloud can’t be trusted not to cross-promote alcohol and products intended for children. Blue Cloud is not a member of the Beer Institute and has never agreed to the BI’s self-created codes for members. A spokesperson for the BI says Blue Cloud is not a member because the BI “does not represent distributors.”
At this year’s NBWA convention, Purser shared two photos of Hard MTN Dew store displays. One showed cases of Hard MTN DEW next to packages of Kool-Aid Jammers flavored drinks; the other showed cases of Hard MTN DEW beneath a display of Hot Wheels toy cars.
An NBWA spokesperson says the Hot Wheels display was located in an Albertsons in Las Vegas, while the Kool-Aid display was in a Target in Henderson, Nevada.
The spokesperson says the former photo was taken by a beer distributor; the latter by “a member of the public health community.”
The NBWA did not offer any additional information, so it’s not clear who set up the two displays or what company employs them.
Still, the photos serve to illustrate the organization’s argument that their members alone have the expertise to ensure alcohol isn’t marketed or displayed improperly.
A representative of the Nevada Alcoholic Beverage Control said the office was not aware of the incidents and was unsure whether they violated state laws. The office of Clark County Business License Enforcement, which has jurisdiction over the two retailers in the photos, did not return a request for more information.
Blue Cloud, in a written statement, said that the company “maintains very strict policies on placement to ensure there is no consumer confusion between alcoholic and non-alcoholic products. Blue Cloud gives specific guidance that alcoholic and non-alcoholic beverages should not be merchandised or advertised together.”
Blue Cloud also notes in its statement that traditional beer wholesalers themselves carry non-alcoholic products, including energy drinks, while Blue Cloud handles only alcohol. The subtext here appears to be that if traditional wholesalers can adequately separate alcoholic and non-alcoholic options at retail stores, so can other distributors.
Right now, Blue Cloud distributes just one product: Hard MTN DEW. But it’s a wildly successful product, selling out in some stores upon its February debut, and continuing to post big numbers in its limited number of states.
Through mid-October, the Hard MTN DEW collection of brands sold $36.3 million in chain retail stores tracked by market research company IRI, more than Wicked Weed Brewing ($34.3 million) and just behind Golden Road ($36.9 million). It's essentially a top-50 "beer" brand.
On Boston Beer’s Q3 earnings call, CEO David Burwick said that the brand family has managed a 12% share of chain retail FMB sales in the nine states where it’s available.
But that momentum could slow because of a regulatory challenge over the way Hard MTN DEW is sold in the state of Virginia. The outcome is likely to have the largest effect on Blue Cloud’s stakes nationally.
The complaint before the VABC is specific and technical, but will have far-reaching ramifications. That’s because Virginia is considered a model for other states’ alcohol regulations, Anderson says, noting that the president and CEO of the National Alcohol Beverage Control Association, J. Neal Insley, was formerly chairman of the VABC.
What the VABC is being asked to decide regarding Hard MTN DEW is a matter of franchise law:
Franchise laws govern the contracts between distributors and beer or malt beverage suppliers, establishing the balance of power between breweries and the companies who distribute their products.
Virginia law states that a brewery can sign with one distributor in a given geography: “No brewery shall enter into any agreement with more than one beer wholesaler for the purpose of establishing more than one agreement for its brands of beer in any territory.” Other states have similar provisions.
In early October, two wholesalers—Blue Ridge Beverage and Premium Distributors of Virginia— brought a complaint to the VABC after Boston Beer Company assigned distribution rights for Hard MTN DEW to Blue Cloud. Those wholesalers, who had existing contracts to distribute Boston Beer products, say Boston Beer violated the state’s franchise law by assigning Hard MTN DEW to a second distributor. The two wholesalers are asking the VABC to nullify Boston Beer’s agreement with Blue Cloud. (Boston Beer declined to comment for this story, citing ongoing legal proceedings.)
Why does this matter for Blue Cloud, which isn’t even a named party in the complaint? Because Blue Cloud’s business model in Virginia and across the country relies on existing breweries—Boston Beer, FIFCO, and potentially others—to distribute products through Blue Cloud, not beer wholesalers with whom they have existing relationships. Because other states look to Virginia for guidance, the outcome of this challenge is likely to determine whether other states interpret their franchise laws similarly. Blue Cloud will either have a smoother path to a national rollout, or encounter more regulatory speed bumps.
What Boston Beer is likely to argue, Anderson says, is that distribution rights can be assigned to wholesalers by brand, not by brewery: In essence, that Hard MTN DEW is a distinct brand from Sam Adams or Truly, though it’s owned by the same parent company, and that Boston Beer should be able to assign distribution of each brand to different wholesalers. Anderson notes that the phrase “brands of beer” in the state’s statute is vague and the VABC has never issued a clear directive on its definition.
“It comes down to: Is the code truly saying that franchise agreement is by the brewery that produces it, or by brand?” Anderson says. “It would be nice for the VABC to come out with a true definition as a result of this [challenge].”
The vice president of a beer wholesaler in the Pacific Northwest says that if the ABC rules in Boston Beer’s favor here, granting distribution rights by brand rather than brewery, that “doesn’t seem right” in terms of how franchise law has generally been understood.
“Maybe they’re getting by on a technicality but in the spirit of the agreement, they’d be violating that,” this vice president says. “To use the relationship analogy, [Boston Beer] just seems like they’re cheating on you, like saying, ‘Oh, Hard MTN DEW? We’re just friends.’”
It’s unlikely a resolution to the VABC complaint will come soon, though. Anderson says it’s typical for an officer to issue a ruling months after a hearing is held; according to the VABC’s schedule, a hearing date hasn’t even been set yet. Appeals of rulings are also common, which could prolong the question for months or years, with the potential for the case to reach the Virginia Circuit Court. In the absence of a ruling against Boston Beer, Blue Cloud is currently able to continue distributing Hard MTN DEW in Virginia, as its franchise agreement was already approved by the VABC. In the meantime, Blue Cloud is likely trying to expand into the 22 states where it’s received federal wholesaler permits but does not yet distribute beer.
But there are snags, as some states have delayed approval of its wholesaler’s license pending regulatory review. On an earnings call this summer, Boston Beer’s CEO Dave Burwick said the rollout of Hard MTN DEW wasn’t as fast as the company would have hoped, citing a “slower than expected regulatory process” for its distribution partner. (In August, Blue Cloud passed regulatory muster and received approval in Nevada.) It’s this slow pace that Bernstein analyst Nadine Sarwat cited as one of the major headwinds facing Blue Cloud.
But despite delays, Blue Cloud has vowed to hang in there.
“Blue Cloud has secured licenses in nearly a dozen states and only received two denials,” the company said in a written statement. “In the states where we have been denied, we continue to speak with local government officials to clarify any questions they may have.”
This waiting game becomes more costly, though, every day that regulators delay approvals for Blue Cloud. Blue Cloud general manager Emiliano Di Vincenzo told Beverage Digest in September there’s no ticking clock and the company is “in it for the long haul.”
But delays in getting Hard MTN DEW onto trucks and into stores in more states can’t make PepsiCo—or partner Boston Beer—happy. Customers may not be happy, either, if they can’t get their hands on the FMB that’s taken other states by storm. A Hard MTN DEW-sponsored contest culminated earlier this month with an Indiana man “marrying” a can of the drink in Las Vegas. In response, a Twitter user on Oct. 5 tweeted at the brand’s account: “What’s ridiculous is that most states still can’t get Hard Mtn Dew! Are you trying to win a #GuinnessWorldRecord for slowest rollout of a new product?”
Alcohol distribution is a tough industry to break into generally, as evidenced by craft distributor layoffs and scale-backs in the Northeast this summer. Scale and efficient logistics are critical to success, so the biggest key to Blue Cloud’s fortunes will be the amount of money and attention PepsiCo is willing to put behind it and the timeline in which it expects to see results. Blue Cloud has reportedly hired 200 employees as of September and is in the process of building out its own trucking fleet. Those investments are either a sign of the company’s confidence in the venture, or a significant expense that needs to be recouped soon in order for it to prove itself.
The fate of Blue Cloud, a well-funded upstart with great potential to shift the power dynamics in U.S. alcohol distribution, depends on the findings of a Virginia regulatory board, the depth of PepsiCo’s patience, and just how successfully it balances relations with a wholesalers’ trade organization that is openly taking shots at how Blue Cloud does business.
"I’ve got a lot of faith in the people at NBWA. That is what we pay them for," says Faust, the chairman of the Texas' distributor. "They’re on it and they’ve got to be able to see down the road about what threats might look like."
Words by Kate Bernot