Monday, May 5, 2014

What If Distributors Were Optional?

As American laws go, the 21st Amendment to the Constitution is stunningly brief, not even 100 words and most of them are boilerplate. The first section repeals the 18th Amendment. The third section sets out the window for ratification: seven years. It's the second section that concerns us today. What it says in 31 words I can say in eight: states may regulate alcoholic beverages however they want.

Although each state does it differently, a key feature common to most is the three-tier distribution system. The three tiers are producers, distributors, and retailers. The issue with the three-tier system is not whether or not the system provides value, it's whether or not requiring the 3-step process is justified. If I can streamline the process by eliminating the middle man, what is the public policy benefit of preventing me?

Pre-Prohibition, 'tied houses' were a common feature of the retail landscape. A 'tied house' was a saloon owned by a producer. It was widely believed that when producers controlled retailers in this way, consumers and communities suffered because all the far-away producer cared about was increasing sales and profits. After Prohibition, it was believed that preventing the tied house and keeping retailers as far away from producers as possible would prevent those abuses.

Today, because so much has changed, distributors (for beer, wine, and spirits) can sometimes seem like a vestigial organ. Big producers would love to be able to sell directly to large chain retailers. Brown-Forman would love to distribute Jack Daniel's to Walmart through Walmart's distribution system, not through 50 different distributor locations in 50 states. They'd love to be able to do the same thing with TGIF and Chili's. They can't.

Big producers essentially do sell directly to national customers, but distributors have to handle the paperwork and, more importantly, physically move the product. Is there a genuine public policy justification for requiring that? Probably not.

One reason the present system seems like a waste of money is how easily most of the rules are circumvented, at least for some purposes. 'No cross ownership' is a joke. They have to look separate on paper, but distributor/producer cross-ownership is common in fact. Distributors as in-state businesses? Also a joke. Most distributors are national or nearly so, they're just separately incorporated in each state where they do business. Does it make sense that a distillery gift shop has to buy its own distillery's products through a distributor?

Okay, so if the current law makes no sense, why not change it? That's easy to say, virtually impossible to do. Most states have made very few changes to their laws regulating alcoholic beverages since Prohibition ended 80 years ago. That's because distributors and government (both the elected part and the bureaucracy) have a vested interest in the status quo. Small retailers do too.

Producers of all sizes and large retailers would like to see the distributor made optional, not mandatory.

How would small producers benefit? One of the reasons small producer products are expensive is that they need those prices to interest distributors. Most micro-producers in most places have no trouble getting distribution because at current prices it's a very profitable business for the distributor. If micro-producers could sell directly to retailers, some might be able to build a respectable business just by keeping the ten (arbitrary number) bars and liquor stores closest to the distillery supplied and happy.

It could be a kind of partnership, nothing like the tied houses of old. If the producer could charge the same wholesale price to the retailer that they were charging to the distributor, the retailer would be able to charge less and sell more. That scenario does nothing for the distributor but it could be terrific for the producer, its preferred retailers, and their customers. It's not a model that would work for everyone but right now it can't work for anyone because it's against the law.

Our interests as consumers are supposed to be paramount to the regulators, but a more efficient system would surely benefit consumers in terms of lower prices and greater convenience. More liberal laws in general would liberate the creativity of producers, in terms of better fulfillment of consumer wants and needs. Policies intended to limit the harm caused by alcohol abuse could be focused directly on the problem instead of on a very broad proxy for it.

Many of our liquor laws, directed as they are at 19th century problems, badly need a 21st century upgrade.


My Annoying Opinions said...

Amen. And let's not forget what the imapct of this is on Scotch and other imported whiskies where the importer enters the equation as well. Springbank is a high-end whisky in the US because they don't discount to account for the three levels of mark-up (as per Peter Currie on the WWW forums a couple of years ago).

And not that the "they do things differently abroad" approach plays well in American politics but the missing distributor tier in the UK and EU has not resulted in the problematic relationships between producers and retailers that the US law is apparently trying to circumvent (at least in theory).

Mark Gillespie said...

Chuck, you make a persuasive argument. If politics and laws were based on common sense, this would be a slam-dunk. Unfortunately, common sense does not rule in the 50 state capitals.

Justin Victor said...

Preach it my brother!!!!!!

I couldn't agree more. In Oklahoma they add a fourth tier. I wonder if these "brokers" (the added tier) were bootleggers given said positions in appreciation of slaking the thirst of generations of corrupt Oklahoma politicians. Oklahoma entered the union dry (1907) and didn't go wet until 1959. That's right! Long after the 18th amendment was repealed, Oklahoma was still dry. So in 1959 the state penned it's first liquor laws and very little has changed in regard to package sales. This state doesn't like change even when 100% of the voting people agree that something NEEDS to change. It's time to begin the long process of liquor law reform.

Thanks for letting me stand on your soap box Chuck.

Tom Wark said...

Very nicely said!

There is very little justification for this system. It retards the development of the market for beer, wine and spirits and the state mandated the 3 tier system does very little to benefit society.

Keep spreading the message.

Unknown said...

At some point could you discuss the problems of politics in distribution to retailers.
Ex: PvW allocation to retailers who sell other spirits from Dist, that the retailer must carry and sell, even if they don't want said products.
Also big box retailers who do get prized spirits because of volume are rewarded over smaller independent retailers during allotments. I think it is really the small shops and specialty bars that are driving a trend and educating consumers to drink better...

Chuck Cowdery said...

That's another good example. The law, of course, forbids that kind of favoritism, which goes on regardless.

Unknown said...

I am not a brand expert, but a novice bourbon drinker that is constantly looking for that next great bottle. I am everything wrong with the current market and the target of the current marketeers. My ignorance is confounded by my easily manipulated pallet. Would I be better served by a shelf choice of fast movers like Makers, Jim Beam and Wild Turkey or by fishing for the next great thing? In truth there is not another Pappy's waiting for shelf space. I understand the craft beer movement, I don't understand the craft whiskey movement (but caught up in it).

Funky Tape said...

A local I've been helping and educating just went large into Fireball to get some BTAC and VW off-season goodies. This is a store who used to get cases of PVW in the past. While I'm 100% for the free market, this is no where near 'free.' Its a joke.

Willett buying their own bottles from a distributor for their gift shop? You have to be kidding me. Absurd!

Anonymous said...

How dare you Chuck; Dollar Bill Wirtz is spinning in his grave. Hahaha
Crown Point Marc

Mat Garretson said...

While you can debate the theoretcal merits of doing away with the three-tier system, the reality is that nobody has been able to suggest an alternative that ensures both consistent availability of product and timely delivery of same. The ONLY folks that will benefit from direct sales to licensees are the 800 pound gorillas...B-F, Diageo, Pernod-Ricard, etc. They can afford to field their own distribution, and in capturing the additional margin, effectively squeeze the smaller producers out of the marketplace.

Retailers and restaurateurs who champion dismantling the three-tier system really haven't thought the issue through. Do buyers REALLY want to deal with hundreds of producers & delivery folks? The constant theme I hear from this tier of the business is that they already deal with too many reps...and most of these markets have less than a dozen distributors in them. All it'd take is a month of not being able to get Friday afternoon will-calls of product for these folks to realize the merits of a traditional distributor.

Similarily, suppliers who think they can realize a larger margin or lower prices are fooling themselves. Any margin/savings they'd realize would be eaten up in the overhead they'd have to carry in getting product to market(s).

Take a look at the food industry...something that's fairly analogous to alcohol. The larger guys self distribute, and the small to mid-tier producers use wholesalers to get their products to market. Sure, some smaller farms/producers self distribute, too...but their businesses a typified by local/regional, not multi-state. If there are true advantages to removing wholesalers from the equation, the food industry would have done so decades ago.

The reality is is that the liquor wholesaler provides a valuable service...and, despite having its flaws and issues, provides access to the marketplace to the widest range of suppliers. At least that's what I've come to understand in my 30+ years in this business. I'm happy to hear dissenting views...just be sure and provide a realistic, economical alternative. ;)

Chuck Cowdery said...

"Removing wholesalers from the equation" is a red herring, Mat. No one is suggesting a ban on wholesalers. Part of what your argument illuminates, Mat, is that the mandatory 3-tier system has very little value when it comes to the purpose for which it was intended, which is mitigating the social harms of alcohol sales.

Mat Garretson said...

The idea of opening up the door to direct distribution would effectively destroy not only wholesalers, but the mid to small-tier producer. It would result in dramatically lower variety in the market and no discerable decreast in retail price. The entire debate on this issue is fueled by big-time suppliers and retailers who get the rest of us hyped up by talk of 'unamericanism' while pushing their agenda forward.

Chuck Cowdery said...

You can't have it both ways, Mat. A more open system hasn't destroyed either wholesalers or mid- to small-size producers in the food business, as you cited above.

Mat Garretson said...

I DON'T want it both ways. I want it to stay as is. My example of the food business was to show that smaller producers can survive in a three-tier system (something many claim they can't). You open the doors on making traditional wholesalers an option, and you'll do more harm than good for everyone with the exception of the big guys.