What Would Happen Without the Three Tier System?

FILED MARCH 23, 2011

Dear Client:

With the CARE Act 2011 upon us and various attempts at privatization and direct-to-consumer shipping throughout the country, one major theme is at the forefront: The Three Tier System. As you know, the system is sometimes controversial as some strongly support it and others oppose it. Rabobank's Stephen Rannekleiv recently surveyed suppliers, distributors and retailers of all sizes to gauge their feelings on the system. He found that while most believe the system "won't be eradicated any time soon," the majority of respondents "believe that suppliers and retailers will increasingly find ways around" it. That includes things like direct to consumer sales.

You probably won't be surprised to learn that small wineries are the most frustrated with the system due to limited access to wholesalers and state laws that prevent them from shipping direct. Meanwhile, a number of retailers and some suppliers "take exception to the added layer of costs that the three-tier system imposes," which they believe could be reduced if you take out the middle man.

IT DEPENDS ON THE SIZE OF THE SUPPLIER. On average, suppliers' view on the value of the system was "neutral to slightly favorable." But results depended on the size of the supplier. Small suppliers "tended to have very negative views of the three-tier system while those of large and medium suppliers were generally more favorable." Large suppliers "tended to agree that the three-tier system benefitted their company and disagreed that the industry would be better off without it."

Comments from large and medium suppliers included: "Good distributors are crucial nowadays..." and "provides stability and broad product availability to the consumer". While small wineries said stuff like this: "It hurts small, high-end wineries" and "It benefits large organisations only."

RETAILERS FOCUSED ON COSTS. While most retailers "feel the system had no impact on their ability to access brands, some felt that the system actually increases access to the brands they desire." And what about the impact on shelf space? Retailers say the amount of shelf space currently allocated for beer, wine and spirits would stay the same. The industry was neutral on whether it would increase competition with imports.

The main point of contention for retailers "relates to the costs involved." The report states: "Retailers complain that having to go through a wholesaler is often an inefficient process, and costs could be cut by allowing shipments directly from the supplier." But that depends on the size of the retailer. The report notes that while "larger retailers would likely be able to extract greater pricing efficiencies," smaller retailers "would likely see an increase in costs." Why? Because large retailers would have negotiating power with suppliers, while smaller retailers and on-premise accounts "would likely continue to require the services of wholesalers," which would cost more money because wholesalers would no longer make large deliveries to major retailers to help cover costs. The report predicts that if the three-tier system were to ever disappear, wholesalers' main customers would be smaller retailers and on-premise accounts. "Efficiency at serving these accounts could well become the key to the long-term survival of wholesalers."

THREATS FACING WHOLESALERS. Wholesalers, who are presumably in favor of the three-tier system, were asked to rate the level of threats they see. They consider DTC sales by small suppliers "somewhere between no threat and a mild threat." Similarly, they view consolidation by large suppliers "only a mild (though somewhat greater) threat." The biggest threat? Consolidation of retailers was "almost unanimously viewed as a significant threat."

WOULD ELIMINATING 3-TIER BOOST WINERY SALES? According to the survey, small wineries believe they would experience a "substantial increase" in sales, while large suppliers disagreed. Interestingly, the report notes that opinions of small wineries "appeared to differ markedly from the rest of the industry" on a number of occasions.

Rabobanks points out that while eliminating the three-tier system may help small suppliers increase sales, "the extent of any increase would likely be limited." True, "greater freedom to self-distribute would likely create some ad hoc opportunities, sales of any volume would still require the services of a distributor." For example, in states like New York that allow self-distribution, "small suppliers generally prove unable to harness the opportunity to gain greater market penetration." And don't forget that most retailers suggested in the survey they would not increase shelf space with the elimination of the three-tier.

There is "also a risk that elimination could create downward pressure on industry pricing over the long term, particularly for wine." Pricing in the US is generally more favorable than other countries because the "three-tier system creates a significant barrier to entry. which lowers rivalry among competitors and eases price competition," according to the 'Five Forces' theory of Professor Michael Porter of Harvard Business School. In other words, the wholesaler bottleneck allows "for greater pricing power and profitability" among suppliers. Removing the system "would lower barriers to entry, increase rivalry and likely increase pressure on pricing and profitability." Just look at pricing in UK grocery stores.

In total, Rabobank feels "it is unlikely that elimination of the system would lead to a broad-scale increase in sales for small suppliers" in the long term. But there are still opportunities to meet halfway. The report points out that "DTC shipping in particular may be an area for increased dialogue" since wholesalers consider it a "very low-threat, and their support for looser DTC restrictions could generate better relations with small suppliers."


Succession plans are a hot topic for any small company, including craft distillers and wineries. But legendary craft brewer and distiller Fritz Maytag of Anchor Brewing Co did it the simple way: He sold it outright to Keith Greggor and Tony Foglio, mostly known as spirits industry gurus of Griffin Group liquor consultancy/investment fame. Could such leadership usher in the iconic brewery's next golden age? Our sister publication Craft Business Daily is currently attending the Craft Brewers Conference in San Francisco and got the scoop.

One major focus that Fritz pioneered is craft distilling. According to chief John Dannerbeck, Fritz really thought craft distilling could "set the world on fire." But it's been a long, hard slog since Fritz fired up his first still in the 1990s. But as usual, Fritz was before his time, because as Keith mentioned when he took the stage at a media event at the brewery yesterday, artisanal products are up across every segment, period. And craft distilling is starting to take hold across the country, and naturally craft brewers have the skill set and some of the equipment to take part. Anecdotally, already being in the San Fran area for CBC, we've heard that Sonoma-based Bear Republic is ramping up to do some distilling with local winemakers, involving some hopped liquid. So the craft brewery/distillery is a much bigger - and fragmented - market that can be accurately quantified at the moment. Rogue and Dogfish Head have been doing it for years, among others. It's a trend to watch

Anchor is no exception. The brewery makes a little less than 1,000 six-barrel cases of three varieties of Old Potrero whiskey, to include a straight rye, 18th century style, and 15-year bourbon barrel aged Hotaling's, named for the whiskey warehouse and only institution saved after the 1906 fire ravaged San Francisco. Currently they're only distributed in NYC, Chicago, Boston, and a few one-off markets. John says they can't keep up with demand for the small-batch products, but when distilling production move across the street, output will ramp up and new markets - or at least deeper forays in existing ones - are likely . (The company's artisanal Junipero and Genever-style gin products enjoy a much wider range of distribution around the world at around 5,000 cases; that could be bumped up, too.)

PREISS IMPORTS ABSORED BY ANCHOR. Before the Anchor purchase, Griffin Group owned Preiss imports, importer of Scotland's infamous BrewDog and Australia's Coopers. As of last month, Anchor got a warehouse for the latter two brands, and is now the official importer. Lots of changes to structure and ownership of the company, per John. Stay tuned.


The Pennsylvania Liquor Control Board is taking steps to modernize its system as a way to combat potential privatization attempts by Gov Corbett. During a budget hearing this week, LCB officials said they want the legislature to give them more flexibility in pricing and hiring, let them stay open later on Sundays and allow state stores to deliver products to customers' homes. Currently they are required to impose a 30% markup on all products. But officials are asking for the opportunity to tax wine and spirits differently, which means spirits would see an uptick in pricing.

Recall that the Washington State Liquor Control Board is also working to modernize its laws, which includes adding more stores and allowing direct deliveries to restaurants.


Speculation that Ohio Gov John Kasich was interested in privatizing the state's wholesale operation has been proven wrong - at least partly. He's set on keeping government control largely in tact, and plans to use profits to help with job creation. Kasich's state budget proposal includes a plan to lease the state's distribution system for 20-25 years to a private economic development corporation called JobsOhio. The price has yet to be determined. It is a private, nonprofit entity the legislature created last month at his request and will eventually replace the Ohio Department of Development, which is currently responsible for job creation and retention. An eight-director board appointed by Kasich, who would be chairman, would lead JobsOhio. The agency would issue private bonds to pay the state a one-time infusion of $500 million and use $700 million to pay off state bonds now backed by alcohol money. JobsOhio will not issue liquor permits to bars, restaurants and other on-premise establishments.

To view more in-depth coverage, check out this article in Cleveland.com and this article in Bloomberg.


THE MARYLAND LEGISLATURE is considering SB 994, which would create a second tax on alcohol, says DISCUS. The group testified today in opposition to the bill, calling the added levy "an unfair burden on consumers and distilled spirits merchants whose products are already heavily taxed at 52 percent of the purchase price for an average bottle."

MEANWHILE, PROPOSALS TO ALLOW direct to consumer wine shipments have passed the Maryland House and Senate committees. Under the House version of the bill, Maryland residents could order up to 18 cases of wine per year directly to their homes.

THE UK GOVERNMENT has continued with plans to raise taxes on alcohol by another 2% above inflation, despite pleas from the industry.

SIDNEY FRANK IMPORTING CO has donated $100,000.00 to Mary Young, ceo of the Greenwich Connecticut Chapter of the American Red Cross with a special earmark for the Japan Earthquake Relief Fund.

Until tomorrow, Megan

"Idealism is what precedes experience; cynicism is what follows."
David T. Wolf

SUBSCRIBE to Wine & Spirits Daily today: http://www.winespiritsdaily.com/subscribe.php
Email us for CORPORATE PACKAGE rates

Make yourself heard, your opinions count. Feedback and tipster form: http://www.winespiritsdaily.com/hotline.php

--------- Sell Day Calendar ----------
Today's Sell Day: 17
Sell days this month: 20
Sell days this month last year: 20
This month ends on a: Mon.
This month last year ended on a: Fri.
YTD sell days Over/Under: 0

Subscribe or check back issues at: www.winespiritsdaily.com
Send news and comments in confidence to: megan@winespiritsdaily.com

� 2011 Wine & Spirits Daily, all rights reserved. Please, no forwarding or copying. May quote with attribution.

Follow me on Twitter http://twitter.com/WineSpiritDaily

Editor: Megan Metcalf - megan@winespiritsdaily.com
Customer Service: Jennifer Waddill - admin@beernet.com

Check winespiritsdaily.com for back issues or to subscribe or renew. Phone: 210-805-8006. Email: admin@beernet.com

SchuPub, LLC, 601 E. Ashby Place, San Antonio, TX 78212, USA

Go back to listing Go to next article Go to previous article


Top Secret News Hotline:

Got wine and spirits news for WSD?

Submit Anonymously
twitter facebook