America Should Reconsider the 3-Tier System

As American laws go, the 21st Amendment to the Constitution is stunningly brief, not even 100 words, most of them boilerplate.

The first section repeals the 18th Amendment (i.e., Prohibition). The third sets out the window for ratification: seven years. It’s the second section that concerns us. What it says in 31 words can be said in eight: states may regulate beverage alcohol however they choose.

Each state does it differently, but a common feature is the three-tier distribution system. The three tiers are producers, wholesalers (aka, distributors), and retailers. ‘Retailers’ includes both off-premise (bars and restaurants) and on-premise (stores that sell beverage alcohol by the bottle).

3 tier system
An Oregon liquor store (image via OLCC)

The issue with the three-tier system is not whether or not it provides value, it is whether or not requiring the 3-step process is justified. If I can streamline my business by eliminating a step, what public policy interest prevents me?

Before Prohibition, ‘tied houses’ were a common feature of the retail landscape. A ‘tied house’ was a retail outlet (a bar, typically) owned by a producer. It was widely believed that when producers controlled retailers in this way, consumers and communities suffered because all the far-away producer cared about was increasing sales and profits. If lives and even whole communities were destroyed, so what?

More importantly, what could the affected community do about it?

After Prohibition, it was believed that preventing the tied house and keeping retailers as far from producers as possible would prevent most abuses. The wholesaler would insulate the retailer and retail customers from the depredations of rapacious producers. The wholesaler would be an in-state company with seizable in-state assets, which would keep wholesalers on-side.

Most states also separated the two types of retailers. Bars can’t sell bottles and bottle shops can’t sell drinks. Both types have to buy from wholesalers. They can’t buy directly from producers, nor each other. In many states, chain retailers are prohibited even from transferring merchandise from one store location to another.

Today, because so much has changed, the mandatory wholesale tier can seem like a vestigial organ. Big producers would love to sell directly to large chain retailers. Brown-Forman would love to distribute Jack Daniel’s to Walmart through Walmart’s distribution system, not through 50 different distributor locations in 50 states. They’d love to do it with Chili’s, Applebee’s, Hilton, and Marriott too.

Big producers do sell directly to those national customers, and even many smaller local and regional customers, they just run the paperwork through distributors, who also do the physical distribution. Is there a genuine public policy justification for requiring that, despite the obvious inefficiency?

One reason the present system seems pointlessly wasteful is how easily rules are circumvented. ‘No cross ownership’ is a joke. The businesses have to look separate on paper, but distributor/producer cross-ownership is common in fact. Distributors as in-state businesses? Also a joke. Most distributors are national or nearly so, they’re just separately incorporated in each state where they do business. (For more about this click here.)

Does it make sense that a distillery gift shop must buy its own distillery’s products through a distributor?

The system has changed little since 1933. In the last decade or so, a few states have changed their laws to allow craft producers to do many things large producers cannot. Otherwise, the laws have been virtually impossible to change. That’s because distributors and government (both the elected part and the bureaucracy) have a vested interest in the status quo. Small retailers do too.

Wholesalers in this system are so coddled that in some states it is virtually impossible for a producer to fire their distributor and sign-up with a different one.

Because each state’s laws are unique, sometimes in subtle ways, regulatory compliance is maddeningly difficult and wastefully expensive.

Producers of all sizes and large retailers would like to see the distributor made optional, not mandatory, or modified in some way to reduce its wastefulness.

The interests of consumers and of the public at large are supposed to be paramount to regulators. A more efficient system would surely benefit consumers in terms of lower prices and greater convenience. More liberal laws in general would liberate the creativity of all industry participants to better fulfill consumer wants and needs. Policies intended to limit harms caused by alcohol abuse could be focused directly on the problems instead of a very broad proxy for them.

In defense, distributors will trot out the vague claim that they protect children from the harm of underage drinking, but precisely how the 3-tier system is uniquely effective at preventing underage drinking is never explained.

C. Jarrett Dieterle, a Resident Senior Fellow, Competition Policy, at R Street Institute, specializes in alcohol policy. He writes often and well on this and other matters.

America’s liquor laws, directed as they are at 19th century problems, badly need a 21st century upgrade.

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