Is It Time for the Three-Tier System to Go?

Most people don't realize how different the beverage alcohol business is from other consumer products businesses. The fact that beverage alcohol products carry a much higher tax burden is just the beginning.

The 21st Amendment to the Constitution, which ended Prohibition in 1933, is short and sweet. The second section is the important one. It gives states the right to control "the transportation or importation" of alcohol within their states. States do not similarly have the right to control "the transportation or importation" of Coca-Cola or Twinkies, as in most cases the Constitution's Commerce Clause assures a nationally-regulated market.

One of the ways states control alcohol is through the three-tier distribution system. The tiers are producers, distributors, and retailers. Other businesses have similar channels of distribution but with alcohol, it's not optional. The essence of the system is that producers (i.e., distilleries, bottlers, importers) cannot sell directly to retailers (i.e., bars and stores). They must sell to an intermeidary, the distributor, and all retailers must buy from that intermediary. Furthermore, a producer can't have an interest in a distributor or retailer and distributors and retailers are similarly restricted.

One exception to the no-cross-ownership rule is for the state itself, which can be both distributor and retailer. There is no state in which the state operates bars but several operate all of the state's liquor stores.

The other exception to the no-cross-ownership rule is distillery gift shops. In that case, the producer can own a retailer, but the gift shop still has to buy the merchandise from a distributor. It does not, however, have to be shipped from the distillery to the distributor's warehouse then back to the distillery for sale. The transaction is all on paper, but it's still absurd.

Since each state can set its regulatory scheme up however it wants, each one does and they are all different. Each state makes producers jump through a different set of hoops.

The producers wish they could sell directly to major chains, and even directly to consumers through their own retail stores. Big retailers wish they could move their alcoholic beverage merchandise across state lines as easily as they do everything else. Producers can talk to retailers and they do, to set up promotions and such, but every deal has to go through a distributor, state by state.

The purpose of these systems was to prevent the perceived abuses that led to Prohibition in the first place and in order to get back in business, alcoholic beverage producers were willing to agree to just about anything. The system has changed little since it was established 80 years ago.

Today, the system has broken down in the sense that rules against cross-ownership are easily gotten around, and the local companies distributors were supposed to be are now legal fictions, since most distribution is done by national or large regional companies. The idea was that a producer could be remote and hard to touch legally, but a distributor would be local and thus more readily brought before the law. It's still true in the sense that distributors are required to have in-market assets, and operate through state-by-state subsidiaries, but for the most part they are massive and remote, larger than all but the biggest producers.

Today, the mandatory distribution tier merely adds cost without providing any benefit to anyone except the distributors themselves and their political patrons, including the state's Alcoholic Beverage Control agency (ABC), which itself is an anacronistic boondoggle.

Like a lot of Prohibition vestiges, the problems these systems were meant to solve don't seem like problems anymore, but the system doesn't change because there are people who have a powerful financial interest in keeping things the same. It's the kind of government waste that always seems to have bipartisan support.