How the three-tiered beer distribution system works

Featured, industry — By on February 22, 2009 at 6:32 pm

History of beer distribution

Before prohibition, the large breweries had their own saloons.  If you wanted a Schlitz, you went to a bar which sold only Schlitz.  The large breweries practiced anti-competitive practices by requiring retailers to carry only their products.

The breweries also held ownership stakes in the bars.  They provided the bars not only with beer, but the breweries also gave loans for furniture, beer equipment, and other bar needs.  While this might seem like a great way to start a bar, the breweries required the bars to carry only the brewery’s labels, and they applied pressure to the bars to continually increase beer sales.  The pressure pushed their patrons to the point of constant overindulgence.  Society cried for a solution, and the government gave us the 18th Amendment, otherwise known as Prohibition.

America went without alcohol for thirteen years before Prohibition was repealed with the ratification of the 21st Amendment.  The new Amendment gave the states complete control over alcohol regulation.  To make sure the problems before Prohibition were not repeated, nearly every state adopted some form of the “three-tier system”.

How it works

The three-tier system requires all beer (and other alcohol in most cases) to pass through a middle-man, known as the distributor (also called a wholesaler in some states).  The distributor does the on-the-ground sales and marketing for the producer, and the distributors sells the beer to retailers.

three tiered system

The three tiered system introduces a "middle-man" for alcohol distribution

This system means beer producers do not sell directly to bars, liquor stores, or grocery stores.  It is the responsibility of the distributor to establish the retail relationship.  The distributor is not allowed to purchase shelf space or exclusivity, furnish equipment like draft coolers, offer loans or create a feeling of obligation, or offer discriminatory promotional pricing.  They are supposed to provide all retailers the same pricing.

Distributors also maintain refrigerated warehouses to store the beer, and fleets of trucks to ship the beer around the state.

The benefits of the three tiered system

The original intent of the three-tiered system was to provide temperance, ensure orderly market conditions, and raise revenue (taxes).

The system increases the price of alcohol (since there is a middleman).  In theory, the higher prices discourage over-indulgence, and forces temperance on the society.

Distributors argue the system also benefits small producers.  They say if direct sales were allowed, a small brewery would be at a disadvantage.  Large retailers, like Costco, are used to purchasing goods in very large quantities to get the best price possible.  Larger breweries would be able to undercut small brewery prices, and only macro beers would be available.  Since all brewers are required to go through an independent distributor, this levels the playing field for all brewers.  One distributor can get many beers into a retail store at once, since there is incentive to provide a diverse selection.

The distribution model also benefits retailers.  The distributor reduces inventory costs for the retailer by managing the large portfolio of beers.  This is an advantage because beer is a perishable product.  The distributor makes sure the retailers are always carrying fresh beer.

The three-tier system also provides transparency for taxation.  The government can easily determine how much alcohol is shipped, and where it is shipped to.  The distributor often is responsible for collecting the taxes because they can accurately monitor the shipments.  This creates a paper trail and protects against “gray market” sales (purchases from unauthorized sources).  If the distribution system goes away, the government will be forced to come up with a new system to collect revenue.

Complaints about the system

While the system has been in use for over 70 years, it is not without its warts.  The three-tier system makes sense in the United States, but other countries have open and lightly regulated markets.  We are headed into a global market and international producers struggle with the prohibition-era laws.  They feel the laws interfere with efficient distribution, unnecessarily inflate beer prices, and are possibly in violation of international free trade agreements.

The wine guys are getting around the system

The system is inefficient because everything has to go through a middle man.  Many wineries are contesting this system which they feel was not intended for wine sales.  This problem came to a head when some states allowed in-state wineries to sell wine directly to the consumer, but required out-of-state wineries to go through distributors.  This is obviously a problem, because it violates the Commerce Clause—you cannot pass laws which improperly burden or discriminate against interstate commerce.  In 2005, Granholm v. Heald, the Supreme Court agreed with the small wineries and forced New York to change their laws.  This opened the floodgates, so to speak.

As of April 2008, 35 states now permit some form of direct wine sales to the consumer.  It only accounts for about 2% of the wine sales in the United States, but there is huge opportunity in this market.  The distributors see this as a direct challenge to their place in alcohol commerce.  Craft brewers would love this access to the consumer, and some states are starting to permit it in small quantities.  If everyone can sell directly to the consumer, there is no need for distributors.  You better believe the distributors are lobbying heavily against this!

Beer costs more money

Since there is a middle man in the system, the cost of beer in America is higher.  There is a whole industry between the producer and consumer that employs over 92,000 jobs and generates almost $8 billion (USD) annually.  The added costs are passed to the consumer by design.  The original intent of this system was to discourage over-indulgence, but now it just makes our beer cost more.

It might violate trade treaties

Budweiser dominates in world sales, and was the number one selling beer in the world until recently.  Part of the reason for their success is it is much easier for Budweiser to penetrate foreign markets than it is for foreign beers to penetrate the American market.  The most likely reason InBev pursued the purchase of Budweiser was to gain better access to the distributors, not for the “great taste” of Budweiser.

International producers are challenging the three-tier system, and the EU has requested the United States conform our distribution system with the requirements of the General Agreement of Trade and Services (GATS).  If the American laws are not liberalized, the issue may be forced by the World Trade Organization (WTO).  By treaty, the WTO does have the authority to challenge and possibly dismantle the distribution system.

Corruption was just moved, not fixed

Another big problem with the distribution model is the abuses before Prohibition are just moved to the distributors.  Corruption now exists at the distributor level.  Powerful distributors determine which beers make it to the shelves.  For example, Bell’s Brewery in Michigan gave up trying to penetrate the Chicago market and pulled out of Illinois completely.

A small brewery has almost no chance of reaching the Chicago market.  In fact, while craft breweries flourish across America, very few craft breweries exist in Chicago.  They just can’t get their beer to market.  Two Brothers, founded by Jim and Jason Ebel, split their efforts to save their brewery.  Jim kept the brewery and Jason formed Windy City Distribution to distribute the beer.  Even then it took many years for any retailer to take them seriously.

The smaller distributors (especially in Chicago) are getting squeezed out of the business, because the larger distributors are also offering illegal perks.  It could be as simple as running an extra tap line “to try out a new beer” to installing entire tap systems costing thousands of dollars.  Retailers in Chicago are even requesting freebies since the practice is so commonplace.  It’s illegal but in most cases it is overlooked.  The distributors are employing the same tactics the breweries used before Prohibition.

Distributors are not neutral parties anymore

The original intent of a neutral middle party is long gone as well.  The macro breweries may not own the distribution channels, but they might as well claim ownership.  Distributors align themselves so much with the big brewers, they even self-identify as an “A-B Distributor” or “Miller Distributor”.

In 1997, Anheuser-Busch had their distributors sign an “exclusivity incentive program” which didn’t require the distributor carry only A-B products, but gave huge benefits if they did drop all competitors.  It even offered lines of credit and cash to those distributors joining the program.  This is exactly what the breweries were doing to bars before Prohibition.  When the demand for craft beers took off, the distributors rebelled and A-B relented.  The U.S. Justice department launched an anti-trust investigation of these practices in 1998, but closed the investigation the same year without doing anything.  There isn’t anything to stop A-B InBev from trying again when market conditions are favorable for them.

beer shelf

Beer distributors can control what beers reach your stores

Where do we go from here?

It’s clear the three-tiered system is not perfect, but it is not clear how to fix the system.  On one hand a distributor can help smaller breweries get their product to market, but in cases like Chicago the system actually hampers small brewery distribution.  The Federal Trade Commission (FTC) concluded in a report the three-tiered system limited consumer options and increased the price of alcoholic beverages.  The commission stated temperance and revenue collection could be met by other less intrusive regulations.

Markets are becoming more open for wine, so it is a matter of time before the beer producers demand the same treatment.  The distributors will fight for their existence, but the US government may have already signed their death warrant with world trade treaties.  No matter what happens, eventually the path beer takes to your glass may change.

I am a avid homebrewer and winemaker. I’ve been making my own beer and wine for many years. I started making beer when I was in college (mostly because the drinking age in the United States is 21). My first few beers were horrible. The beers are much better now, and I often supply my neighborhood with free beer!

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  • Jgasek

    I think, perhaps understated here, the reason why the governemnt LOVES the current distribution system, that it makes them a fantastic amount of money, and makes avoiding the tax impossible.   I just did a quick back of the envelope calculation regarding the last 30 pack I bought, and (state) tax on the brew was nearly 20%!!!   Not to mention the $1.50 per 30-pack bottle bill “tax”, for which many do not return, and the state keeps.  By the logic of the state, why not make sugar taxed at 20% so we don’t get fat?    Keep your eye on the ball-  M O N E Y $$$$$$.   Trying to change this monopolistic system, even by the EU will fail.   The money is just too big.