Massachusetts Stakeholders Outline Arguments

FILED NOVEMBER 1, 2009

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Here's the quicky background. After Granholm made it apparent that states can't discriminate between in-state and out-of-state wineries, many states scrambled to re-write the part of their alcohol beverage codes which typically allowed in-state wineries to ship direct to consumers, while prohibiting the same for out-of-state wineries. One tactic used by several states not located in big winemaking zones was implementing production volume caps, which means banning a winery from shipping direct if they produce more than a certain amount of gallons of wine per year. The production cap varies depending on the state. Since the vast majority of farm wineries outside of the California-Oregon-Washington winemaking zone are very small, it allowed them to ship direct. Massachusetts was one of the states to enact a volume cap, although they did it with a twist: They allow wineries who sell over 30,000 gallons a year to choose whether they want to sell wine through the licensed three-tier system, or to apply for a license to ship direct. That law was called HB 4498. But instead of making everybody happy, it has succeeded in making almost nobody happy.

After HB 4498 became law, Family Winemakers of California v. Jenkins was filed on September 18, 2006, stating that it violated the nondiscrimination principle of the Commerce Clause. On November 19, 2008, Judge Zobel ruled that the production cap statute was unconstitutional and, later, enjoined the state from enforcing Sections 2, 18 and 19(F) of the Massachusetts General Law Chapter 138. The state appealed Judge Zobel’s ruling, and oral arguments were heard today (November 2) in the 1st Circuit U.S. Court of Appeals.

Wine & Spirits Daily spoke with the two different sides last week in order to gain perspective on this important case, and the wider issue of direct shipping versus three-tier. We spoke with Tracy Genesen (lead counsel); Paul Kronenberg, who heads Family Winemakers of California (plaintiffs); Jeremy Benson, executive director of Free the Grapes (a website dedicated to liberalizing direct shipping laws) and founder of Benson Marketing Group; and we also talked to WSWA chief Craig Wolf.

WHAT THE WHOLESALERS SAY. Craig brought up two basic arguments in favor of the state. (1) On the legal side, Craig says Granholm requires laws to be even-handed and treat in-state and out-of-state wineries the same. “The Massachusetts law treats every winery both in-state and out-of-state at the 30,000 gallon level the exact same way. The law itself is beyond reproach, it is even-handed, it’s what was required by the Supreme Court, so on the legal side of things I think we’re correct.” (2) On the policy side, he said direct shipping laws such as the one in Massachusetts is about offering “another avenue of distribution” to small wineries who can’t get distribution from a wholesaler. He believes the law in Massachusetts does just that because “60%-70% of the wineries in this country” produce less than 30,000 gallons of wine a year.

Family Winemakers and other direct shippers argue the gallonage caps stifles competition but Craig argues the exact opposite: it in fact promotes competition “to the detriment of in-state wineries who had previously had a monopoly on that role.”

“Once you open the door to all wineries under 30,000 gallons, you’re creating competition with those in-state wineries to the tune of thousands of wineries. So it’s not a question of shutting off competition; you are actually opening up competition to thousands of wineries around the country.”

WHAT THE WINERIES SAY. The Family Winemakers believe the law is discriminatory. “The state of Massachusetts in enacting section 19F discriminated in both purpose and in effect against out-of-state wineries over 30,000 gallons. It really forced that group of wineries over 30,000 gallons into making really what is an illusory choice,” said Tracy. She made two main points: (1), if a wholesaler represents one of the winery’s labels but not the rest, the winery is not able to direct ship its other wines because it technically has a wholesaler in Massachusetts; (2) Massachusetts is a franchise state which makes it very difficult for a supplier to terminate its contract with a wholesaler.

“It forces wineries who can actually find wholesaler representation, which is hard in Massachusetts – if a wholesaler takes one of their labels it cannot direct ship any of the rest of their labels at all. That’s what we’re challenging,” said Tracy.

“And that’s assuming they can terminate their wholesaler relationship because Massachusetts is a monopoly protection law state, so terminating your wholesaler is probably almost impossible under that termination law which requires good cause, and good cause does not include direct shipping,” she adds.

Jeremy then chimed in, stating: “We presented evidence that maybe having to forego your wholesaler or forgo direct shipping, one or the other, resulted in lost sales, lack of ability to brand build because wholesalers don’t brand build, and again a functional ban on most of your labels even if you’re carried by a wholesaler.”

“If you move towards the more medium tiered and smaller tiered wineries, the percentage of their sales that come from direct to consumer shipping - be it through the tasting room, online, email, telephone, wine club, etc - is increasingly important,” he continued.

HAS THE ARGUMENT CHANGED? Craig said the original argument that direct shipping helps small wineries has since been lost: “It’s no longer a question of meeting the original problem. The original problem was that small wineries could not find distribution. That problem has been solved in Massachusetts. They’ve changed the argument. Now the argument is, ‘well everybody should be allowed to ship, period, regardless of the distribution. Well that’s not what this whole issue is about.’

“If they want to change the argument, that’s fine. All I will say in response is that all the big wineries have distribution and at that point it’s up to them to convince the distributor and consumer that their products are going to be in demand. That’s a business call that everybody has to make; what is in demand what is not.”

GRANHOLM NOT JUST ABOUT SMALL WINERIES, SAYS PAUL: “The debate about what Granholm means and all the litigation that has followed as well as the legislation seems to always fall prey to an interesting level of interpretation. To our mind as one of the key players in the Granholm case, it’s not about just small wineries. It’s clear that small wineries are the ones most affected by this but in our mind discrimination is discrimination. It doesn’t matter about size and that’s what we’ve been saying in Massachusetts and what we’ve been saying all along,” said Paul.

SO DOES 30,000 GALLON CAP COVER MOST SMALL WINERIES? The direct shippers say no, and that it’s not even the question at hand. “If you look at where the common law has set the small wineries standard, they mysteriously set it at the highest level of production of any Massachusetts winery,” said Tracy. “So they’re all covered. 30,000 gallons is not the industry standard nor is it the TTB standard for what constitutes small for other purposes.”

“The key to the discrimination here is that this law allows 100% of Massachusetts wine access to three distribution channels, and 98% of wine in inter-state commerce is restricted or completely banned by the law, and our argument is that this gallonage cap is a pretext. It’s some arbitrary distinction based on size that has nothing to do with any activity occurring in this destination state that the wine is going to.

“Of the say 5,000 wineries out there probably over half are less than 30,000 but that’s not the point here. The point is what wines are getting to consumers? [...] You’re a consumer in Massachusetts and you want to order a specific wine, you’re not worried about which winery it came from. The winery isn’t the article of commerce, it’s the wine,” said Tracy.

WSWA’S OFFICIAL STANCE ON DIRECT SHIPPING: “Our official stance is we’re opposed to it [direct shipping] and we’ve made it very clear,” said Craig. “We think it is simply an uncontrollable, unaccountable practice. You can say what you want about requiring online verification but it just doesn’t work. You can say what you want about requiring verification through the shippers; we know that doesn’t work.”

“We just think it’s a bad practice. We understand some of the concerns of the smaller wineries that say they can’t get distribution. We try constantly to work with them best we can. We also recognize in the marketplace that not everybody makes the market and that’s one of realities of any marketplace.”

“If you can’t establish demand for your product in the three-tier system then the problem is on your shoulders as well, not just the distributors......There’s more to it than just simply saying ‘the distributors are the problem here,’” said Craig.

WHY WINERIES SHOULD HAVE THE OPTION TO SHIP DIRECT: Jeremy from Free the Grapes presented his argument from the consumer side. “It’s remarkable how frustrated consumers have been over the past decade...Just as an example, the Free the Grapes website gets 15,000 to 25,000, 30,000 visitors every month,” said Jeremy. Consumers also send about “12,000 to 25,000 letters a year to states legislatures.....Those are some pretty big numbers for what is an important issue.”

Says Paul from Family Winemakers: “From the winery’s perspective.... there became a tipping point where the number of wineries...started to outstrip wholesalers...we call it the hour glass problem. We have a lot of producers now with more every year. There are 6,000 nationwide and a consolidating wholesaler tier which serves as a bottle neck between consumers who want and deserve more choice.”

From a business perspective, Paul pointed out that wineries want the change to sell their product and let the market decide if it will be successful or not: “Why shouldn’t someone from another state find me, try me, and let my product succeed or fail in the marketplace based upon my ability to produce a wine that tastes good and is priced right?..... What we find is a three-tier system, which doesn’t serve us particularly in a consolidation mode, as the big players get even bigger, we’re frozen out of the retail segment because of the economics of serving 6,000 producers. We’re pre-ordained to fail unless we find another sales channel to do that. That’s why we’ve been pushing direct shipping as an augmentation to the existing three-tier system that refuses to serve us.”

AN ISSUE OF MINORS GAINING ACCESS. Another argument often used by wholesalers is that minors can get their hands on alcohol more easily through direct to consumer shipping. Oftentimes direct shippers consider this argument a cop-out but Craig explained why the WSWA think it’s a very serious concern. “We agree with them that minors are not going to buy a $150 bottle of chardonnay, we never argued that point...but you can’t forget that if you open direct shipping to a bottle of wine, you’re opening it to everything else too because nobody is checking what’s in the box.” Wholesalers fear that not only could a minor kill themselves or someone else by driving under the influence, but also that the alcohol beverage industry would get the blame. “Our fear is that some kid is going to order a bottle of alcohol online, going to have it delivered to their house without a signature or age verification, they’re going to drink it, get into an accident and kill somebody.

“And then the regulators and the media are going to be saying: ‘how did this happen? How could the industry allow this practice to be going on?’ And we’re going to at least be able to say at that point - even if we don’t win the policy battles at the legislative level - that we were on the right side of this issue. We believe it’s important that you have a very controlled, accountable distribution system.”

He acknowledged that “most reputable retailers and wineries in this country don't want to ship to minors. That’s not our point. Our point simply is that they are engaged in a practice that inevitably leads to minors getting alcohol in an uncontrolled way.”

“By the way, there was a Bart Simpson episode just the other night where there was a question about how you get alcohol and even Bart Simpson said ‘hey, you can buy it online,’” said Craig.

NO ISSUES WITH MINORS GAINING ACCESS. The direct shippers, however, argue that if minors gaining access was a big problem, states would have repealed their direct shipping laws by now. “This came up big time in Granholm and this is what the wholesalers really thought was their winning argument to paint direct shipping as an avenue for underage access. The FTC report really put, I think, that whole myth to rest,” said Tracy, the attorney representing the Family Winemakers. “They surveyed states, they found there were few if any enforcement problems in respect to minors and we still see that. I guess 38 states now have a model direct shipping bill. None of those have been overturned because there’s a minor access problem......

Paul of Family Winemakers concurs: “The proof is in the pudding. Those bills got signed into law. Basically it says ‘look, okay we heard your argument but basically we don’t think it’s a problem.’ The incidents of minor access and sales to minors through normal retail channels is very real and trackable in each state...what about the very real problem of minor access through retail that states and local authorities have to deal with all the time?”

WHOLESALERS HELP CREATE VARIETY. “We’re not saying the system is perfect by the way,” Craig acknowledged. “But it’s the best system in the world; the most consumer friendly system in the world; the most innovative system in the world as well. Every system is designed to strike a balance and our system has done extremely well.”

We then brought up the alcohol system in the UK to which we replied: “We have greater control, definitely, and we have greater variety. England is very big-box retail dominated where the cost for alcohol sometimes in the big box stores are less than water, and you don’t want that obviously. But more importantly you lose selection, variety. And remember, one of the things that we do and work with retailers to do is build brands. The whole idea is to have us work with the retailer to find products that the consumer will find attractive, so it’s a very innovative market.”

“If you look at today’s world, in the average marketplace today you see thousands of SKUs of wine and spirits and beer. They could not possibly get to the consumer without wholesalers. If you’re a retailer and you deal with thousands of different suppliers, do you know how costly that would be to get it done several times a week? And you’re a supplier and want to get your products out to hundreds of thousands different retailers in this country and do it several times a week, do you know how costly that would be for you?” continues Craig of WSWA.

“What is lost among these discussions online and in the blogs is the tremendous efficiencies we create that are very consumer friendly.... The cost of a bottle of vodka, or any type of variety at all, if we didn’t have wholesalers would be very, very high. And if you went the big box route you’d have very little selection. You might have low prices initially by the way with the big box route but that would go away once they dominated the marketplace.”

ALCOHOL DISTRIBUTION IN A PERFECT WORLD. We asked Tracy, Paul and Jeremy what alcohol distribution would look like in a perfect world. The answer, quite simply, was California. “I think it would look a lot like California where there is a three-tier system, but there are many channels open to wineries and consumers that get to avoid some of the bog-down effect of the three-tier system,” said Tracy. “One additional change that is really going to become necessary in the age of the internet is the reform of the tied-house laws, and that’s not involved in this litigation but it certainly is coming up in a serious way. In terms of ways to market wine on the internet, it is becoming extremely difficult because of tied house. In terms of direct shipping, I think wineries are always going to need wholesalers for certain things and there are things wholesalers don’t do well that they admit they don’t do well that wineries are going to need coming from different channels. California has pretty much struck that balance.”

So there you have it folks. WSD has brought you the arguments from both sides. Distributors say the three-tier system strikes that crucial balance between market forces and regulation, while winemakers say they need a more open hybrid system to market their wares. What do you think? Ping me at megan@winespiritsdaily.com.


Until tomorrow, Megan

“A sound mind in a sound body is a short but full description of a happy state in this world.”
John Locke

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