A Corrupt Scheme At The Middle of the American Wine Industry

In a recent interview with Liza Zimmerman at Wine Searcher, Rob Tobiassen, former Chief Attorney for the Federal Alcohol and Tobacco Tax and Trade Bureau, explains the benefits of the Three Tier System of Alcohol distribution. However, in the wide-ranging interview, Rob fails to point out one very important thing: the three-tier system of alcohol regulation is an extraordinarily archaic system of market regulation that has fallen under the control of a cabal of state-mandated and state-protected middlemen whose only interest is their bottom line. That’s a pretty important thing to leave out.

Tobiassen was asked if “the three-tier system really balances interests?” To which he replied, “Yes. It provides an orderly distribution system throughout the United States whereby wineries, breweries and distilleries can make their products available to consumers.”

What he leaves out here is that wineries, breweries and distilleries can make their products available to consumers ONLY IF THE STATE MANDATED MIDDLEMEN WHOLESALERS ALLOW IT. In most states, IT IS MANDATED BY STATE LAW that an out-of-state producer of alcohol MAY NOT sell directly to a retailer or restaurant. Instead, they are REQUIRED TO SELL TO A MIDDLEMAN IN THE STATE. If that winery, brewer or distiller cannot find a middleman to sell their product, they may not distribute their product in that state.

This is not a balancing of interests. In fact, it’s the exact opposite of the “balancing of interests”. This is a protection racket and exemplifies the very definition of “Rent Seeking”. The fact that this kind of entirely unnecessary and discriminatory protectionism is still granted to wholesalers by state lawmakers more than 80 years after the repeal of Prohibition and in an economic climate that bears no resemblance to the 1930s when it was invented, is the best evidence that the most accurate definition of the Three Tier System is “corruption”.

But could we do without this kind of Corruption? Could a state-regulated alcohol marketplace be designed that did not include this kind of corruption? Zimmerman puts this question to Tobiassen when she asks him, “What would the US spirits and wine sales market look like without it [a state-mandated middleman]?” Tobiassen doesn’t think it’s possible:

“It would be chaos for retailers if they had to deal with sales contacts by each producing industry member. According to the TTB Annual Report for Fiscal Year 2017, there were 8949 breweries; 13,107 wine production and storage facilities; and 2982 distilleries, the bulk of which are small. So there are an enormous number of brand names and product types out there competing for retailer and consumer attention….They (producers) might benefit in their local community market (if they were able to distribute their own product themselves) but the investment costs in trying to distribute to retailers nationwide would be enormous in the long run. They also would include not only the cost of the infrastructure but also that of identifying and getting the attention of the retailers in distant markets.”

Here’s what Mr. Tobiassen doesn’t take into account in this response and I’m shocked he doesn’t: If states did not legally mandate the use of a wholesaler middleman, there would still exist middlemen wholesalers to distribute goods within a state, it’s just that their use wouldn’t be required by law. Tobiassen assumes that without the legally mandated use of a wholesaler in states by wineries, brewers and distillers, retailers and restaurants would be forced to deal directly with each individual producer in order to obtain inventory for their stores and restaurants. In fact, within a future regulatory framework that doesn’t mandate the use of a wholesaler, It’s a near guarantee that most retailers and restaurants would obtain the vast majority of their inventory from wholesalers. However, one of the difference would be that the current obscene and confiscatory margins currently able to be taken by state-mandated wholesalers would be much smaller if the state didn’t legally require their use.

Moreover, without a state-mandated middleman tier, entrepreneurs would be free to experiment with a slew of alternatives to traditional middlemen, spurring the kind of technological and logistical innovation everyone knows would flourish. In other words, without a state-mandated use of a middleman, we would in fact not have chaos. We would have more efficiency, more rational pricing, more access to markets for producers, greater inventory selection for retailers and greater product selection for consumers.

Finally, there is a fascinating response by Rob in relation to a question concerning the direct shipment of wine:

Q. How do you make sense of laws that allow wineries to ship into the bulk of the states but do not allow retailers to do the same thing? What are the laws protecting the consumer from?

A. When the system was created retailers were intended to be locally monitored and weren’t involved in interstate wine and spirits sales. Wineries were initially allowed to ship over state lines as many smaller ones could not find wholesalers who would handle their products either because the winery could not guarantee a sufficient and constant supply and inventory or because there are simply too many SKUs for the wholesaler to fit more into its offerings to retailers.

Tobiassen makes the same category error that most defenders of the three-tier system make. He looks at direct to consumer shipping from the producer’s perspective and not from the consumers’ perspective. Wineries and retailers began shipping wine directly to consumers in other states not because producers could not get a wholesaler to distribute their products in those states. They initiated interstate shipments because consumers could not find what they wanted locally and expressed their desire to purchase products not locally distributed. This may seem like two sides of the same coin but they are in fact two very different issues and two distinct perspectives. Too often defenders of the three tier system, who tend to be regulators (like Tobiassen) or wholesalers, have literally no first hand experience with the “Fourth Tier”: Consumers.

If Tobiassen thought through the issue, I think he’d see that today the only reason states bar out-of-state retailers from shipping wine directly to consumers in the state is because lawmakers have been convinced they benefit politically by creating closed markets that protect undeserving, lazy, rent-seeking wholesalers and retailers from competition. In states like Wyoming, New Hampshire, Oregon and others that allow shipments from out-of-state retailers, local retailers remain “locally monitored”, as Rob puts it. Moreover, these open, free-market states easily collect taxes from out-of-state shippers and monitor the amount of wine that is shipped into the state. What’s happening in these states is that CONSUMERS are benefiting not by lower prices, but by having access to the entirety of the American alcohol marketplace.

Supporters of the Three Tier System back a regulatory scheme that has corruption at its center, that distorts and retards the development of a well regulated, modern alcohol distribution system, and that dismisses the needs of the consumer. Rob Tobiassen is a smart, experienced attorney and regulator. But I believe his history as a regulator has blinded him to the extraordinary problems that plague the alcohol industry due almost entirely to the existence of a state-mandated three-tier system. Moreover, I think if he took more time and effort to explore the needs of the consumer in a 21st-century economy, he’d better understand by the abolition of the three-tier system of alcohol distribution is required.

11 Responses

  1. David Pergl - September 17, 2018

    I have been in the Beverage and Food Industry (Now Retired) for over 40 years.

    I did every type of Distribution and Sales – Here and Internationally.

    II really enjoy your Posts and agree. In 1993 we defeated the “Cabal” for Warehouse Distribution of Beverage Alcohol in California..

    If you look at all other Consumer Goods there are examples of Distribution.

    The Federal and State Alcohol Regulations that became mandated into laws are absurd today.

    The arguments for an Exclusive System are plain wrong. Every tier should have choices.

    David Pergl

  2. John Hinman - September 17, 2018

    Tom, I have known Rob very well for over 35 years, and he is an exceptionally capable lawyer whose vision is through the prism of a regulator. I disagree with his analysis of the net effect of the 3T system on retailers and on consumers. The problem is that the analysis is based on the underlying assumption that all alcohol products are fungible; which is a uniquely regulatory perspective. Alcohol stocks are limited at the upper end (in wine, and especially in spirits) and scarcity drives up value. Wholesalers carry very few scarce and rare products (especially imports; which are only available from retailers) because the volumes are too low, consumer demand is limited and the cost of putting the products into their systems are too high (from the wholesaler perspective – they can only carry so many items). This is one reason why there is a thriving auction and secondary product market that all too few consumers can reach. Moreover, the effect of the 3T system on globalism and the movement of investment capital is a significant US issue. Investors should not be barred from providing capital to entities on different tiers (which is the essence of the Texas cases) simply because they are cross invested. In a global economy, cross-investment is the norm and the US system is the outlier because it prevents small and new supplier access to investment capital. The 3T system is not going away (as you point out) but mandatory margins should go away – compensation for services should be based on performance, not statutes and regulations that restrict market access.

  3. SafeProof.org - September 17, 2018

    Tom your point about the “Fourth Tier”/consumer is where our organization SafeProof.org has the most concern domestically. The mandated distribution (2nd tier) does provides an effective control on counterfeit alcohol bottles.

    However that inventory oversight ends when the bottles are delivered to the retailer (3rd tier). It is at this level where bars, restaurants, clubs, casinos, country clubs, caterers, hotels… have been fined for adulterating bottles. Enforcement has limited resources and too many of the tips local agencies receive from consumers directly or by SafeProof go without investigations.

    The TTB is at the Federal level and their resources are not dedicated to alcohol enforcement at the retail level. The brands (First tier) do not have relationships with their retail buyers, this places an obstacle when SafeProof works with brands to investigate tips like diluting and refilling inferior bottles into premium brands.

    If we can all agree that the consumer should be poured the authentic beverage they purchase, visit SafeProof.org and search the alcohol violations in your state.

  4. Wade - September 18, 2018

    I graduated from Texas A&M with BS degree in Industrial Distribution and spent 25 years working in sales of electrical & telcom products on the manufacturing side. I worked for 4 different companies and they all sold through local distributors. There was no law requiring this; they did so because it made business sense. Our distributors provided 1 stop shopping, stocked products local, delivered, and handled billing. That all adds value. The wine, beer and spirits should be no different. It should not be mandated by law.

  5. Stan Duncan - September 18, 2018

    Rob Tobiassen’s Orwellian comments are both laughable and a big middle finger to American consumer freedom. Poison spewing gangsters like this have no place in this day and age. Let Americans live free, get rid of the three tiered system, and allow free trade, which is the way it’s supposed to be.

  6. VVP (veux, veux-pas) - September 18, 2018

    The Essay from Center for Alcohol Policy below is a good thing to read for everyone including Tom, whenever he wants or no (veux, veux-pas)


    It explains three-tier system very well, however, it clearly describes DIRECT SALE or DIRECT SHIPPING as the sale or shipping from a PRODUCER to a CONSUMER or a PRODUCER to a RETAILER. There is nothing about shipments from third-tier retailer to a consumer, which by the Granholm decision is economically infeasible and if exists then shouldn’t rise any questions. This theme (third-tier retailer “directly” to consumer shipping) must be closed and prohibited in any and all future discussions as none-existing subject.

    States may not use the three-tier system as an instrument for discriminating against
    certain products available to consumers through tree-tier systems of other states in their local retail markets.

    “Tobiassensinuations” could not be considered as trusted source, since WSWA is only 0.3 miles walking distance from TTB, but both too far away from consumers.

  7. Peter Przybylinski - September 18, 2018

    One potential solution is to allow producers to sell direct to trade if they can show that they have been turned down by a number (three?) of distributors in that state. Then the distributors would no longer be limiting choice to the consumers.
    I also agree with Jon Hinman (above) that franchise laws and mandatory margins should go away.

  8. David Barnes - September 18, 2018

    Like many states, Ohio has the three tier system for beer and wine (liquor is a state monopoly). However, it is different in that the law mandates minimum markup. That markup is 25% at the distributor tier and 50% at the retail tier. A wine sold to the distributor for $20.00, becomes $37.50 to the consumer. Side note: one of the largest political donors in Ohio is the wine and beer trade. Coincidence????

  9. Mike Conway - October 6, 2018

    Whatever anyone thinks of the three-tier system, alcohol production and sales fall under the 21st Amendment, which is generally outside of the commerce clause. It really is up to each state, and all states aren’t equal. Each state has its own demographics, history, culture, etc.

    The opinions on this blog will mostly mocking of the “demon rum” perspective, but it does indeed exist, and in some states it is indeed makes distribution grotesquely unfair. Had the 21st Amendment not been written the way it was, the Commerce Clause would have swept much of this away in Federal courts.

    As a matter of fact, in 2018, sometimes the only way you can differentiate states from each other is the liquor laws. As each state now has the same Walmart, selling the same things, and the same Comcast cable service. It makes one wonder, not about the three tier system, but about a new trust busting era on the horizon.

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