The Three-Tier System and Consumer Access To Wine

Posted by Tom Wark on Jun 24, 2009

The three-tier system of having a “distributor” in between the producer of wine and the wine retailer was put into place after prohibition to prevent the abuses associated with “tied houses” prior to prohibition. Unfortunately this system has merely served to duplicate the corruption that it was created to fix.

Prior to prohibition, suppliers wielded so much power they could control retailers by threatening not to supply them. Retailers became “tied” to particular alcohol producers. The “tied” retailers were forced to sell a single manufacturer’s product. Producers also forced retailers to promote their brands without regard to public safety. These circumstances exasperated alcohol abuse problems and were often cited by Prohibition’s advocates as one of the key problems with alcohol in America.

To assure this measure of control and this kind of abject corruption would not happen after repeal of prohibition, most states mandated the “second tier” to sit between the producers of alcohol and the retailers of alcohol. They created the state-mandated monopoly known as the “wholesaler tier”.

Today, almost 75 years after the Repeal of Prohibition, every state has only a very small number of wholesalers that control the flow of alcohol. They determine which brands will be sold in wine stores and restaurants. The obscene power once wielded by producers of alcohol over 70 years ago today is in the hands of alcohol wholesalers.

Because most states mandate that alcohol flow from the winery to distributor to retailers, distributors find themselves in the enviable position having a monopoly on how wine is distributed in each state. This, for obvious reasons, has made them enormously powerful and wealthy. As the numbers of wholesalers in America has dwindled, usually as a result of buyouts and mergers, that enormous power has concentrated in a handful of distributors that operate in multiple states.

Additionally, because there are such a small number of alcohol wholesalers in each state that must, by law, be used by producers to get their wines to retailers and restaurants, the wholesalers are under no pressure to provide high quality service, as they would be if they were subjected to competitive market forces.

A number of consequences flow from these circumstances:

-In most states few wholesalers are responsible for “marketing” hundreds, if not thousands, of wines, which they are unable to do for all the brands with any care or success

-Retailers and restaurateurs are at the mercy of the small number of wholesalers who provide them with wine. The retailers and restaurants must choose only from the wines that wholesalers provide. This is despite the fact that there are many other wines they’d like to carry on their shelves and menus but are by law prevented from purchasing because they must deal only with wholesalers.

-Restaurateurs and retailers, just as in pre-prohibition times, often feel obligated to not criticize and follow the directions of the wholesalers for fear they will be “cut off” from the limited supply they actually have access to.

In essence, the corrupt circumstances that the three-tier system was meant to clean up after Prohibition ended now exist again, only with the wholesalers in charge.

While the corrupt circumstances of pre-Prohibition are with us again, much else has changed. Today there are upwards of 5000-plus wineries in the United States, with producers located in every state. America has become a wine-drinking nation with per capita consumption continually rising over the years and with America poised to overtake France in total consumption.

Yet, just as more wholesalers are needed to handle the demand and the growing number of producers, their number has been reduces to usually no more than three or four distributors in each state handling all distribution. In some cases, such as Texas, two wholesalers (Glazers and Republic) control 99% of the market.

An ‘hourglass” scenario has been created whereby the wholesalers occupy the squeezed middle of the glass. This position of enormous control has generated massive profits and has made them so powerful they are now able to completely control not just the distribution of wine, but the laws that are created to govern the distribution of wine.

Since 2000, Wholesalers, their political action groups and their associations have spent nearly $60,000,000 in campaign contributions on the state level. In addition, millions of dollars more have been spent on lobbyists on the state and federal level.

In 2006, for example, in Texas, alcohol distributors contributed more than $3,750,000 to political candidates and politicians. The only economic interests that outspent alcohol distributors in 2006 were Attorneys and Law firms, Oil & Gas, and Home Builders. Alcohol wholesalers outspent all unions combined in Texas, securities and banking interests, and insurance interests. Alcohol wholesalers in Texas outspent the combined contributions of gambling interests and casinos, retailer interests, all food and non-alcoholic beverage interests, tobacco interests, and tourism interests.

It is difficult to correlate campaign contributions with favorable treatment in the halls of government. However, it should be noted that in numerous states, legislation that can only be called favorable to alcohol wholesalers is regularly introduced and passed.

This trend is particularly clear in the areas of consumer access to wine. Alcohol wholesalers have proven to be advocates of the consumer, but only as long as the consumer is purchasing alcohol that wholesalers first made money on by distributing it to retailers and restaurants.

Throughout the 1990s and 2000s, as the number of wineries in America skyrocketed, consumers became interested in buying the wines produced by these new producers. The products of small, specialty wineries in particular were coveted. However, a large number of these wineries could not find a wholesaler to distribute their wines. And even when they were distributed, wholesalers in individual states usually only bought very small amounts of the wine.

Yet with the advent of the Internet and the consumer’s ability to use search engine technology to locate the wines they wanted from wineries and retailers, it became possible for a wine lover to track down the wines they wanted. However, purchasing directly from wineries and retailers located outside the state in which the consumer resided meant that wholesalers in those states where wines were being shipped into would not make any money on the transaction. Alcohol wholesalers responded to this development by instituting a massive campaign to stop direct shipments of wine.

At alcohol wholesalers’ requests, a number of state legislatures passed felony laws aimed at vintners and retailers who were shipping directly to the consumer and who were filling the growing demand for wines that wholesalers were incapable or unwilling to distribute.

The all-out attack on direct sales of wine by the wholesalers came with dire warnings that if it were allowed to continue minors would eventually start ordering alcohol over the Internet—even though that meant paying the additional cost of shipping and waiting at the door for the delivery in order to hide the purchase from their parents. The Wine & Spirit Wholesalers Association, a national association of alcohol wholesalers headed by one-time pro-tobacco activist Juanita Duggan, led the campaign to prevent consumers from obtaining the wines that wholesalers could not or would not supply.

The wholesalers were met by stiff consumer and winery-led opposition. Wineries and consumers argued that wholesalers were merely fighting to preserve enormous profits made from being at the center of a monopoly-based system that could no longer serve a market that had evolved considerably since the end of Prohibition in 1933.

Eventually wineries led by the newly formed Coalition for Free Trade, and consumers l
ed by an advocacy organization called Free The Grapes followed a litigation strategy that focused on using the Commerce Clause of the Constitution.

Throughout the 1980s and 1990s, states besides California began to sprout their own wine industries. Oregon, Washington, New York, Virginia, Michigan and many other states found themselves with burgeoning wine industries. The states, wanting to cultivate these new industries that added value to agricultural pursuits, attracted tourism, and brought prestige to the state, enacted exceptions to the three tier system that allowed its wineries to sell directly to consumers rather than forcing them to always sell to wholesalers. By doing this, the new wineries were able to produce greater revenues for themselves by selling their wine at full retail price, rather than reducing the retail price by half when sold to a wholesaler, who then tacked on their cut when they sold to retailers, who in turn tacked on their cut when selling directly to the consumer.

However, this “direct-to-consumer” exception in the law was rarely extended to out-of-state wineries.

Legal challenges to this blatant discrimination against out-of-state wineries started popping up around the country. In court battles across the country the argument was made that a state may not allow its own wineries to ship to its state’s residents, yet prohibit out-of-state wineries from doing the same. It was a matter of the Commerce Clause of the Constitution and its demand that states not hamper interstate commerce, trumping the states’ ability to regulate the distribution of alcohol based on the second paragraph of the 21st Amendment.

The issue finally made its way to the Supreme Court, which in May 2005 rendered a 5-4 decision favoring the wineries and free traders in its Granholm v. Heald decision.

There was an immediate assumption that states across the country would loosen their laws to allow consumers to buy wine from out-of-state wineries. Many reports heralded a new era in consumer access to fine wine.

While a number of states did change their laws, the era of free trade in wine was not quite at hand.

If wholesalers found the courts a difficult venue to try to protect their economic interests, legislatures proved a more fertile ground for them. From 2005 through 2007 states legislatures began re-writing their wine shipping laws. In the course of doing so many of the laws contained wholesaler-requested restrictions that kept direct shipment of wine limited.

Some laws allowed direct shipment, but only if the winery produced very small amounts of wine. These “production cap” restrictions were aimed at California, Washington and Oregon, where most wineries resided. The production caps were usually set just high enough to include the largest of a state’s wineries (often no more than 5,000 cases annually). The caps prevented medium and large wineries from shipping into states that had these restrictions and forced them to stay in the three-tier system if they wanted to sell wine in that state.

Other types of restrictions were also created at the behest of wholesalers in a variety of states. Wineries and consumer advocates have begun to challenge them in court, setting off a new round of court battles.

In the meantime, alcohol wholesalers across the country began to work to exclude retailers from shipping direct to consumers altogether. In many cases the prohibition they sought on retailer-to-consumer sales were pushed as part of legislation that opened up states to wineries. California, Texas, Ohio, Oregon and Illinois all passed or have attempted to pass legislation that at once allows out-of-state wineries to ship into their state, but exclude out-of-state retailers from doing the same.

While no good estimates are available as to the amount of wine that is purchased direct from retailers and shipped over state lines, many observers of the wine industry agree that far more wine is being purchased by consumers via the Internet from retailers than direct from wineries.

Retailers, led by the Specialty Wine Retailers Association, are now fighting the wholesalers largely on the same legal grounds as wineries did. In many cases in-state retailers are still allowed to ship to consumers while their out-of-state brethren are prohibited from doing so. Wholesalers argue that the principle of a level playing field for both in-state and out-of-state interests explained in the Granholm decision does not apply to retailer-to-consumer transaction, but only to winery-to-consumer transactions.

Lawsuits challenging discriminatory legislation were introduced in Michigan, New York and Texas. While positive outcomes have resulted from these lawsuits, this has not guaranteed positive changes where consumer access to wine is concerned. In Michigan, for example, a Federal District Court Judge ruled that the state unconstitutionally discriminated against out-of-state retailers by barring them from shipping wine to Michigan consumers, but allowing in-state retailers to do so. Immediately, the Michigan Liquor Control Commission, working in concert with the Michigan Beer & Wine Wholesalers Association and supportive legislators who had received significant campaign contributions from Michigan wholesalers, introduced a bill that barred all shipping of wine to Michigan consumers by retailers, whether located in-state or out.

This move in Michigan highlighted another issue affecting the cause of retailer-to-consumer shipping: collaboration between alcohol regulatory agencies and wholesalers. In the case of Michigan, the Michigan Liquor Control Commission lobbied for passage of an anti-shipping bill, advocated that it be passed quickly and without debate, and made arguments in favor of the bill without presenting supporting materials. It should be noted that alcohol regulatory agencies are not generally thought of as policy-making bodies, but rather agencies that carry out the will of the legislature. This kind of alliance between agency and wholesaler is not unusual.

In the case of the retailers’ battle against the wholesalers, a new dynamic has emerged. Unlike the wineries’ battles that usually had the support of wineries across the country, retailers often take a provincial position, with the hope of keeping out-of-state retailers from shipping into their own home state and thereby protecting themselves from competition. Also, many retailers are not willing to fight on behalf of free trade in wine for fear they will be retaliated against by their state’s wholesalers who supply them with products. Ironically, the situation is identical to that which existed with Tied House retailers prior to Prohibition, but with the pressure now being put on by the wholesalers rather than by producers.

The power that exists in the hands of a very few (no more than 10) alcohol wholesalers operating in markets across the country cannot be underestimated. In nearly every state few wholesalers control the entire apparatus of alcohol distribution. Legislatures continue to enact laws that favor wholesalers to the detriment of retailers, wineries and consumers. In nearly every state wholesalers are in the top ten industries for campaign contributions. Between 2000 and 2006, America’s alcohol wholesalers delivered $60 million dollars in campaign donations to state political campaigns, dwarfing that contributed by either retailers or wineries.

What’s most clear is that wholesalers are using their power to maintain a system of alcohol distribution created to address a society, culture and market that existed three-quarters of a century ago. This United States no longer exists. Yet the system it created is still in place, to the detriment of wineries, retailers and particularly consumers.