Drinking Made Easy
The Three Tier System

The Three Tier System

December 16, 2011 0

December 5th marked Repeal Day, the Anniversary of the repeal of Prohibition.  For those of you who weren’t around in 1933, let us take a quick refresher course.  In 1919 as a result of a vocal movement by a relatively small minority, heavily based on a female population who had just won the right to vote and were exercising their new found freedom, congress passed and the states ratified the 18th Amendment.  This amendment prohibited production and sale of alcoholic beverages in the United States.  Thirteen years later the 21st Amendment was ratified which repealed the 18th Amendment.  The result of Prohibition, or the Noble Experiment as it was sometimes called, was exactly the opposite of what was hoped for.   Crime ran rampant; more people than ever were drinking as a result of illegal bootlegging operations, many of them controlled by organized crime…The Mob if you will.  Poverty increased and by the end of the 1920’s we had seen the stock market crash and the beginning of the Great Depression.  During the period of Prohibition it is estimated that the United States lost $11,000,000,000 in tax revenue from the sale of alcohol and spent another $500,000,000 in enforcement of Prohibition…and back in that time a billion dollars was real money.

In 1932, Franklin D. Roosevelt was elected president, partly because the impoverished American public would no longer accept Herbert Hoover as their president and Roosevelt promised a “New Deal”.  He also promised to end Prohibition.  He did that swiftly; within months of his inauguration beer was once again flowing as a result of the Cullen-Harrison Act and on December 5th 1933, Utah voted to ratify the 21st Amendment ending Prohibition.  Thus, with 75% of the states having voted to ratify, Prohibition was over.  As with anything political, the opposition had to be given some concessions in order to move this vote along, and such was the case with the 21st.  One of the things put in place was the Three Tier System for distribution of alcoholic beverages.  The system was designed for several purposes.  One was to allow states the ability to control their liquor laws, including who could sell and distribute, and to collect taxes due.  Another purpose was to prevent “tied houses” where a retail establishment is either owned or controlled by a supplier thereby eliminating competition in that establishment and effectively killing off any opportunity small brands have to get a foothold in a bar or restaurant.

The three tiers are simple.  There is the producer…the brewery, winery, distillery, meadery or other entity that controls the production of the beverage.  Importers also fall into this category since they are the business in the United States that first handles the product.  The second tier is the distribution or wholesale tier which purchases the product from the supplier and in turn distributes it to the third tier, the retailer.  A retailer is a state licensed (or state owned in some states) business that is permitted to sell alcoholic beverages directly to the end consumer, also known as you folks out there reading this.

The supplier and the retailer tier are pretty simple to understand, so there is not much need to spend time on them.  It is the middle tier, the wholesaler, which creates confusion and sometimes controversy.  Before we move forward, as fair disclosure, my real job (the one that I get paid for as opposed to writing this article for nothing more than the love of you good people) is with an Arizona beer distributor, so I am naturally skewed towards the value of distributers as part of the system.  Notwithstanding, I don’t get most of the arguments against the three tier system in general.  Most are specific as regards certain state laws or enforcement.  Many of them actually have nothing to do with the three tier system but it all gets tied in with that.

Briefly, here is what a distributor does – for simplicity sake, I am using a beer distributor since we are in the beer section.  A distributor contracts with a supplier to buy beer in bulk for distribution in a specific geographic territory.  As part of that agreement the distributor will ship the beer (sometimes the supplier handles that), warehouse the beer, sell the beer, deliver the beer, maintain the beer (stock rotation, install draft handles, even clean tap lines as permitted by law), execute marketing programs and special events, pay state taxes on the beer, serve as a local point of contact for the supplier, ensure quality standards are met and much more.

So, how do they do all this?  They purchase or lease a warehouse, buy or lease trucks, hire salespeople, warehouse people, administrative people, drivers, merchandisers, accountants, HR, invest in an infrastructure that allows them to do everything they have to do as effectively as possible.  Different size distributors make different size investments, but they all need the same basic tools to do the job.  The investment is large and the ones that do it right spend what they have to in order to bring the best possible beers to your favorite restaurant, bar or liquor store.

There are arguments against the middle tier; most common are increased costs and decreased variety.  Neither of these arguments makes sense.  Let’s address the cost issue first, and, as you will see, that naturally dovetails with the variety issue. Of course distributors tack on an added cost over the prices they pay from the brewery, but is it more expensive with a distributor?  In Arizona, we get Bell’s beer despite being about1900 milesaway from the brewery.  In Philadelphia they get Russian River despite the2900 milesbetween the locations.  It goes on and on.  Let’s assume Bell’s had to sell and deliver all the beer they sold in Arizona.  Now they need a fleet of trucks, they need salespeople, they need people to monitor the stores the beer is sold in to ensure quality, they need a substantial increase in their current expenses to cover the added costs of selling to the retailers across the country.  And, unless they intend to ship everything directly to the retailer, they need warehouses located throughout the country to store product in, all at a great expense.  What about the direct ship option. To ship a full keg of beer from Michigan to Arizona would cost almost $140 and take seven days; to ship a case of beer would cost about $38.  In other words, shipping alone would add approximately $1.15 to every pint of beer from the keg, or $9.50 to every six-pack.  Clearly direct shipping to the retailer would not work, so we are back to building an infrastructure at substantial cost increase.

The net effect is that it will cost far too much for breweries to operate in all states so the logical assumption is that they will limit their distribution as much as possible.  A brewery like The Bruery is not going to ship beer to the East Coast if they have no way to monitor quality, so they will limit their area of distribution to the areas surrounding their location in Placentia, California.  There are very few breweries that could afford to distribute to the territories they are now selling to if they had to provide all of the service that their local distributor does.  The other thing that will discourage far reaching distribution is the inability of a remote shipping brewery to confirm local licensing and laws pertaining to alcohol which are outside of the three tier system.  Things like taxes, licensing, marketing restrictions would all have to be handled locally.  And if you think about how that would impact craft beer, imagine trying to get a high end Belgian import without the three-tier system.

What are some of the other things that distributors do?  They employ about 100,000 people nationally so they contribute to their local economy.  They handle all of the legalities of distribution, including (most importantly to the states) the collection and payment of state and local taxes. The clear chain of custody that is maintained by a locally based distributor handling the product directly from the supplier to the retailer under a licensed and accountable system protects the consumer.  There are numerous instances of counterfeit spirits in other countries, some of which just impact the cost, others which have actually killed people.

So as you can see there are numerous advantages to the current three-tier system.  Are there things that need to be fixed?  Of course there are.  Many of them are state specific issues and would require fine tuning at that level.  On the whole, the three-tier system works.  Beer gets where it needs to be, the proper taxes get paid, and, most importantly, quality standards are maintained.  If there is another system that works better, I can’t think of it.

Chuck Noll
Cave Creek, AZ

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