The Time Has Come

The whole point of the implementation of the 3 tier system of alcohol that was put in place after Prohibition ended was to assure that no sector of the alcohol industry amassed so much power that it could control the other parts of the industry. The idea was to disperse power within the industry by separating the producer from the retailer/restaurant by putting the wholesalers in the middle.

That plan has failed.

Today’s news that Southern Wine & Spirits has merged with Glazers Wholesale to create the most powerful entity ever to emerge in the American alcohol industry demonstrates that the three tier system has failed in its original mission. The current utility of the state-mandated three tier system is limited, at best.

This single company will, in some state, have the power to decide what brands consumers may have the privilege of purchasing. They will have the power to decide which outlets or restaurants may sell these brands. And, they will have this power for one reason: The government grants it to them.

If the residents of the state actually got something of value from this highly unusual grant of power to a particular sector of an industry, it might be worth considering keeping the system in place. Yet in the 38 states where this new "Southern/Glazer" company operates, the company is charged literally nothing for the power they are granted by these states. Neither are any of the other wholesalers who’s profits are guaranteed by the same politicians that take their money.

They don’t pay additional taxes. They are not required to promote wide consumer access to goods. They are not required to fund anything of benefit to the state. Instead, they are granted absolute protection from competition. And yet the people get nothing in return.

Worse, the wholesale tier has become the epitome of what the three tier system was supposed to protect against: near complete control by one sector of the alcohol industry.

There is no question about it. The time has come for each state to investigate whatever remaining utility there is in the state-mandated three tier system and to implement radical change.

Posted In: Wine Business


20 Responses

  1. Andy - August 12, 2008

    One piece of this I don’t understand is that, at least up here in Washington state, wineries can self-distribute. That’s how a lot of this little guys get into retailers. Unfortunately, wineries in nearby Oregon can’t seem to get that same deal (for Washington distribution).
    Wouldn’t self-distribution, however difficult to maintain for smaller producers, knock one tier out of the three-tier system? It’s entirely likely I simply don’t understand some point of the law.

  2. Tom Wark - August 12, 2008

    Very astute. Self distribution should be a right any winery should have, whether it be distributing in their own state or into other states. The record keeping would not be a problem. And the logistics to do this exists.
    As you might imagine, the wholesalers are not very fond of self distribution.
    However, one thing is clear. If a state allows its own wineries to sell direct to retailers and restaurants, it must allow out of state wineries to do the same. Unfortunately, states often put severe restrictions on the amount of wine that can be self distributed. For example, in IL you can’t produce more than 25,000 gallons to be eligible to self distribute, and then you can only sell 5,000 gallons per year direct to a retailer or restaurant.

  3. Thomas Pellechia - August 13, 2008

    It is incredible that state legislators are either in the dark or in the pocket over this issue, but some of the wineries aren’t. Just last week the owner of a few hundred thousand gallon winery in NY State told me that they went with Southern because soon that will be the only outlet for national distribution–the wine is sold in 30 states.
    A close look at the situation shows that the three tier system creates more power and corruption than bootleggers ever achieved.

  4. Jeff Carroll - August 13, 2008

    I couldn’t agree with you more on this one. This is bad news for the small producers in the short run. It’s already nearly impossible for half of the wineries in the U.S. to find distribution, and this will make it harder. But, in the long run, this could be the fuel that we needed to get legislation changed in the states. If the wholesalers are not holding up their end of the three tier bargain, then states should absolutely reconsider the system.

  5. Tish - August 13, 2008

    THis is scary. I don’t know how to do the math, but with Southern/Glazer’s in 38 states, what percentage of the nation’s wine pipeline overall do they control?

  6. Tom Wark - August 13, 2008

    Good question. It will vary from state to state. I suspect one of the reasons the “joint venture” is not applicable to IL is because in that state a combined Glazers and Southern would control over 90% of the market…Not sure that would pass muster if it needed to go through regulatory clearance.

  7. Jeremy - August 13, 2008

    As much as the glowing press release tries to convey a sense of excitement and positive change for these two companies, there can be no doubt that this is indeed a melancholy occasion for the players involved.
    Consolidation is a sign of weakness, not strength. There are many reason for two entities to tie the knot, slowing growth, increased competition, and deregulation among them. The latter is and will continue to be the driving force here as the wholesaler’s have seen the writing on the wall and the negative implications for their profits. They need to establish the economies of scale now, so that when sales begin to decline the margin erosion in their businesses can be minimized. The problem however is that you can’t consolidate forever and at some point you must pay the piper. This pattern repeats itself over and over, across all types of inudstries, with those artificially protected seeing the hardest falls.
    Anyone for open and free markets should be doing cart wheels right now, as this is represents the continued unraveling of the wholesaler monopoly and a move one step closer to leveling the playing field for the sale and distribution of wine in this country.

  8. St Vini - August 13, 2008

    Tom: Are you saying that regulatory approval isn’t required? How can they deny Whole Foods/Wild Oats but allow this? I don’t get it….
    Jeremy: I confess I’ve read your post thrice and I don’t understand it. Can you explain why “consolidation is a sign of weakness” and give some examples of how consolidators “pay the piper”?

  9. Jeremy - August 13, 2008

    St Vini:
    Companies typically consolidate when they can no longer grow organically, this is not always the case but usually it is the single most important factor. Take your example of Whole Foods, which is a good one. Part of the reason they went after Wild Oats was to keep sales growth on track. Organic growth at Whole Foods was starting to slow and has since collapsed. The upside in sales that Whole Foods could have recognized at the Wild Oats locations could have helped preserve margins and profit growth–at least in the short term.
    However, margins have collapsed, competition from traditional grocery stores–they have greatly improved organic offerings–is and continues to eat into Whole Foods business at an alarming rate.
    The desire to merge was spurned on by a negative change at the margin, in this case, greater competition from the supermarket players, as well as, the local farm stand.
    Consolidation in the face of weakenss happens in countless industries-airlines, telecom, steel, paper, and other commodity businesses. Again, consolidation–in most cases–is not a sign of strength.
    And by “pay the piper,” I mean that you can only consolidate so much of the industry before you become the industry! And when growth slows, as it always does, profits will fall. Take a look at Whole Foods stock price over the last several years, that is “paying the piper.” Relatedly, take a look at Budweiser’s chart prior to the merger with InBev, similar dynamics are at play there, except on a global scale. Remember the Coor’s-Miller merger? Ask yourself why that occured.
    For the wholesalers there is increased “competition” in the form of more powerful, global multinational wine and spirits companies, but also, and in my view more importantly, impending changes in the regulatory structure of the industry that will cause dramatic share shifts to arise.
    And this is what has these folks scrambling to defend their businesses via consolidation.

  10. Liz - August 13, 2008

    How poetic would it be if this did indeed cause states to look at the traditional three tier system and disband it, opening the way for more DTC and DTR? The distributors’ greed and anti-competitive nature leads to a level playing field? Sweet justice after all!

  11. Strappo - August 13, 2008

    Excellent editorial, Tom. And, Jeremy, I totally got your thing about consolidation as weakness and paying the piper. Opportunities will shake out of this, I’m sure of it.

  12. ozzie - August 13, 2008

    It still comes down to the question “what’s good and what’s good for the politician” and we know who wins that battle. The more than equal partner in selling a bottle of wine who has no hand in making it is the middle man. We don’t need no stinkin middleman.

  13. St Vini - August 13, 2008

    Jeremy: In your mind then, companies that are small but growing quickly are “strong” and large but stable companies are “weak”? Would you say that your analysis aligns with a risk-based model of such companies?
    When growth slows, most companies (of any size, whether public or not) shift from equity growth to a dividend-paying model as they start to throw off cash. This is a natural evolution, I don’t see this as a weakness.
    Why did Coors-Miller happen? Simple, both companies felt that they could add shareholder value through a merger in the US market as the beer industry is quite mature here. I don’t see that as a sign of weakness, just an evolution of a mature market.
    Bottom line is that I hope you are right about this clearing a path toward a truly free market. However, I don’t think Southern/Glazer’s is big enough to make that happen. I estimate they’re still far less than 50% of the wholesale market.

  14. Scott - August 13, 2008

    So, if the merged gigantor company isn’t interested in carrying, promoting and distributing any but the big mega wine company’s “wines”, doesn’t that swing the door wide open for small start-up distributors to pick up the small- to middle-sized wineries and importers?
    And if Walmart/Target/Kroger/Albertson’s only want to do business with Southern/Glazer, doesn’t that swing the door wide open for small, idependent wine retailers to further solidify their niche in the marketplace?
    More and more, there are actually two wine economies in America: corporate grocery store wine economy and independent hand-sold real wine economy. I’m not arguing that they are equal in terms of dollars and liters represented, but they are both viable and can co-exist without the sky falling on us.

  15. Tom Wark - August 13, 2008

    It appears that together Glazer and Southern represent about 27% of the market with about $11 Billion in revenue.

  16. Jeremy - August 13, 2008

    St. Vini
    In my mind every company–small or large faces certain risks. I don’t subscribe to a rigid system that says a large company is riskier than a smaller firm since there are so many variables that come into play. There is a difference though between a large cash cow that is growing slowly in what could be called a steady state and a larger cash flow generative firm that is about to face a deceleration in it’s growth rate because of increased competition due to deregulation. And this is what I believe is driving–at least partly–the consolidation at the wholesaler level, I guess time will tell.
    And to Scott’s point, the sky does not have to fall, but it would be nice if ALL players played by the same rules.

  17. perlhaqr - August 14, 2008

    So, if the merged gigantor company isn’t interested in carrying, promoting and distributing any but the big mega wine company’s “wines”, doesn’t that swing the door wide open for small start-up distributors to pick up the small- to middle-sized wineries and importers?
    Depends on what limitations the State government places on the creation or licensing of new distributorships.
    And it’s interesting to hear talk about Whole Foods / Wild Oats, because here in NM, they did take over. I wish they hadn’t, as prices have all gone up about 25% with the new sign on the door.

  18. nhwineguy - August 14, 2008

    On one point i would tend to think that your mistaken. Each year in NH ( a control state) each distributor must renew its license to distribute ( a tidy sum depending on #of sku’s) as well as stock product in the warehouse ( a 3rd party, yet mandated only authorized storage facility of more than personal use quantiies) The fees associated with the storage can run into the hundreds of thousands of dollars a year. Wineries can change thier pricing on a order by order basis if they desire, truckers and rail lines change their fuel surcharge every Monday, however the price you pay at to purchase the product from the state can only change 4 times a year. In order to play in this league, you have to be a big boy or a direct shipper with a wine liscense in another state

  19. Scott - August 14, 2008

    Wow. That does sound like a costly and onerous bunch of hoops to jump through there in NH. I’m sure it is difficult and expensive to lesser or larger degree to start a new wholesale wine company in any state. But are you suggesting that these requirements aren’t and weren’t made of the Big Guys when they entered into business in the state?
    It’s hard. That’s why they call it competition.

  20. Butler - August 14, 2008

    Isn’t that too much power for one company? It also reminds me a big question in other European countries of who can make wine…can even wine be sold in plastic bottles by farmers? I think yes. It’s much more unique!

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