In a recent report, the U.S. Treasury Department observed two major trends in the alcohol industry … the explosion of craft producers of wine, beer and spirits the past 30 years and a concerning level of consolidation in the wholesale and production levels of the system.
What does that mean? It means there’s a concern industry-wide regarding competition in the markets for beer, wine and spirits. More specifically, how do the little guys make it in this business?
At the heart of the conversation is direct-to-consumer shipping of alcohol. Kentucky is fighting for its right, along with a few other states.
The Treasury concluded that many federal and state laws regulating industry relationships are outdated. Specifically, “franchise laws” and the “three-tier system” were written in the 1930s to combat the problems Americans faced in the late 1800s through the end of prohibition.
Many have found these laws are ill-equipped to handle many of the practical business realities that alcohol industry members face today, especially the shipping of alcohol directly to consumers.
And there’s growing concern that larger players at all levels of the industry (such as producers and wholesalers) could use outdated regulations to stifle the growth of smaller “craft” producers.
The Whiskey Wash recently visited with Alcohol and Hospitality Lawyer Rachel Schaffer Lawson, and Law Clerk Jacob White, with the firm Dickinson Wright. Together, they discussed the nature of the Treasury’s report and what the future holds for direct-to-consumer shipping of alcohol and the laws therein.
The Whiskey Wash: Compare the alcohol laws, in particular distribution and shipping, from the prohibition era to now.
Rachel Schaffer Lawson: “In pre-prohibition and early prohibition, most states prohibited the shipping of any spirits, wine or beer directly to consumers. A lot of the laws were ‘all or nothing’ in that alcohol was either completely prohibited or basically open season for manufacture, distribution and sale. This inconsistency was a catalyst to prohibition because those in ‘dry’ states would find new and creative ways to ‘import’ from wet states. After prohibition ended, there were still 30ish states that remained ‘dry’ because of state prohibitions (no longer moot because of the 18th amendment – and expressly not preempted by the 21st). It took until the 1950s before the last prohibition law would be repealed.
In the late 1900s, states began to open up direct-to-consumer, or DTC, for wine. However, most states passed laws allowing only in-state wineries to ship to in-state consumers, but not out-of-state wineries to ship to in-state consumers. In 2005, the Supreme Court found that scheme was unconstitutional under the commerce clause (Granholm v. Heald), forcing the states to choose – either prohibit DTC wine entirely OR extend the benefit of DTC to out-of-state wineries. The key concept was that wine must be treated the same regardless of where it was produced. I figure in-state wineries loved the DTC option so much that it would have been too politically unpopular to take that benefit away entirely (not to mention the loss of tax revenue). As a result, DTC wine opened up BIG in the early 2000s.
Alcohol laws in general haven’t ‘stepped backwards’ since the end of prohibition in that each new law typically loosened the states’ grip on liquor control. Shipping is one highlight in that trend. It started slowly and then boomed after Granholm, and post-pandemic it is even more popular.”
TWW: With two companies maintaining a majority market share in the beer and spirits industry, how does this handicap the thousands upon thousands of craft brewers and distillers in America?
Rachel: “I am going to leave spirits alone here because this issue is better suited for beer exclusively. It’s still a problem in the spirits industry but not to the critical level that it is in beer.
The basic threat of monopoly is present like it is in any other industry: Drop prices to beat out competition in the short term (using your resources to keep you afloat even if you take losses) then raise prices continually once your competition is out of business because consumers have nowhere else to go. And buy out your competition any time there’s a chance they get big enough to compete with you. The biggest companies have the money and resources needed to keep everyone else out.
In the alcohol market, this issue is compounded by ‘franchise laws’ between producers and wholesalers. Producers are forced into exclusive deals with wholesalers in each county or state. These contracts are very difficult for producers to terminate. Basically, they are locked in for life. Only the wholesaler can market alcohol to retailers because producers are, by law, restricted from doing so (to avoid ‘tied houses’ from prohibition). These wholesalers put more effort into marketing higher grossing brands (big brands) and leave smaller brands behind. The smaller producers don’t have the money to fight, nor do they have the resources to terminate the contract. Unfortunately, wholesalers are still a necessary evil, much like us lawyers, in the alcohol world since they are the only folks who can legally traffic in alcohol.
Also, getting into wholesale/retail can be cost prohibitive. Seventy five percent of breweries in the U.S. make less than 1,000 barrels per year. (One barrel of beer can make about 13 cases at 24 beers per case.) Going through wholesale increases cost – more fees, taxes, shipping, insurance, packaging, etc. For a brewer to actually profit from wholesale to retail sales, they may need to provide more beer than it is physically capable of. Add to that the risk that a wholesaler will sign these small brewers to the dangerous contracts mentioned earlier and then fail to adequately promote the brand, and it’s easy to see that some brewers just can’t afford to take the risk.”
TWW: In order to allow for direct-to-consumer shipping, what laws need to change to allow all states access. What exactly has to happen in the public sector? In the political realm?
Jacob White: “The only thing that must happen is we must pass laws which allow DTC … in any case. The 21st amendment makes each state the primary regulator of liquor within its borders. Each state must separately choose to open it up. How we get there is open to many options.
There are two main concerns with open DTC:
- Minors will have easy access to alcohol.
- The state will collect less taxes (whether by outright avoidance by the shipping business, or the inherent lower cost of bypassing the three-tier system).
A lot of states note that prohibiting DTC is done in the interest of ‘promoting the health, safety and welfare’ of residents, but that’s such a broad standard that it makes no sense. I think states use this phrase as a pretext – boilerplate language to pass rational basis review if the law is ever challenged – when the real reason is tax revenue. If the interest is really health and safety, there are plenty of ways we can serve that interest and allow DTC.
In the public sector, about 20 states still have ‘state monopolies’ in that the state exclusively owns at least one tier in the three-tier system. But most limit that to spirits or wine (or both). Only three states have total control of beer, wine and spirits. The ‘public sector’ in the alcohol market is quite limited in scope.
Mississippi is a good example of a fair balance. Technically, they allow a consumer to order wine for delivery. But the producer must sell that wine to a state-owned wholesaler, who will then sell it to a state-owned retailer, who then delivers it to the consumer. This is an attractive option for states that want to try opening DTC to beer or spirits.
In the political realm, good old-fashioned lobbying is the popular way to do it. Whether by large companies, trade associations or even consumers calling state representatives, the way to pass laws is to pressure representatives to do so. Show the lawmakers that DTC is a good thing.
Every study that has been done in DTC states found that minors using DTC to get alcohol has mostly not been a problem. Similarly, there are plenty of ways that states can continue to collect tax revenue or enforce civil/criminal penalties on those that try to avoid the taxes.
All alcohol runs through permits. Most states force out-of-state wineries to get “direct shipper” permits or something like it. These permits are conditioned on paying taxes, confirming age on sales, paying HIGH fees just to hold the permit, reporting sales, etc. Violating these permit conditions already carry heavy penalties – there’s no reason we can’t apply these principles to open up DTC for spirits and beer.
With every tax, there is a risk that some will avoid it. It’s basically guaranteed that somebody will try, but at this point, the interest in stimulating the U.S. alcohol market and promoting competition in the global market outweighs any state interest in collecting taxes.”
TWW: How can the consumers take part in changing these laws?
Rachel: “Consumers drive demand. When the demand gets high enough, the state government will notice and will be forced to do something about it.
If I ran an online whisky shipping company (ShipWhiskeyToMe.com) and I noticed that 40% of my customers are in state X, but it’s illegal for me to ship into state X, I will spend money and resources to convince state X to make it legal. Even if the consumer does nothing directly, showing that they want DTC will pressure governments to allow it. Most likely, consumers already do this every day. It just needs to hit a tipping point in each state.
It’s the same way we moved to legalize cannabis and gambling. These things were illegal only because people thought they were ‘bad’ (immoral, etc.). But the demand for those things never slowed. Eventually, people convinced their state government that it’s not so bad or that it would make more sense to legalize/regulate than try to prohibit.
There’s always the ‘call your state representative’ tactic, but that’s pretty unrealistic for the everyday consumer. It’s much easier for consumers to click on ads or view ordering pages and speak with their wallets.”
TWW: What is a realistic timeline for legislation that would open up the new markets for the thousands of craft brewers and distillers?
Jacob: “We could very well be in the middle of it right now. It’s tough to say when these things have a defined beginning or end, it’s just the market moving. With that in mind, we should continue to see this growth coming out of the pandemic. So, in the next 3–5 years, 10 for sure, we should see a big change in small businesses in general but definitely in manufacturing alcohol. People don’t want to go back to their old jobs. They feel they are ready to start their own thing and be their own boss. A lot of people like booze, so they figured they’d start making it. One thing leads to another and now they have a full-on brewery.
We will probably see the same trend for DTC. What may have looked like a 10–20-year timeline became a 3–5-year timeline because of the pandemic. E-commerce, in general, shot 500% in 2020 and it’s not going back down.
Ten to 15 states have legal DTC for beer or spirits. Ten more are considering bills for it this year. It could be more next year. The more opportunities small businesses have in the market, the more confident people will feel starting one. As a result, we will get more small businesses breaking into the market. It’s a domino effect.”
TWW: What are the challenges to overcoming antiquated alcohol laws?
Rachel: “Every change is uncomfortable. People think ‘if it’s not broke don’t fix it,’ but many fail to see the breakage or ignore things that are capable of improvement. Some of these laws have been around for over 100 years, so the biggest challenge will be convincing people that the laws can be improved or should be revised.
The three-tier system has been called ‘unquestionably legitimate’ by the Supreme Court, and DTC has the potential to turn that entire system on its head. That scares many, and to some degree they are right to be scared. If we could order booze from Amazon, and have it delivered within hours, that could go bad in many ways. On the other hand, if somebody wants a special bottle for an occasion, a gift, or because they have an unusual preference for a small or foreign brand, those consumers should not be penalized for it. We need to find a balance.”
TWW: Where does competition fit in to the equation?
Rachel: “Alcohol has a checkered past in the U.S., and that baggage comes with every new law that touches the substance. We can’t apply traditional economic principles to alcohol because it always has that extra layer of ‘intoxicant’ attached to it. Too much garlic will make your breath smell bad, too much ice cream will make your stomach ache, too much alcohol will kill you.
‘Competition’ in the market played a big role in causing all the problems that initially took us into prohibition. After prohibition, we intentionally made the market less competitive because we didn’t want traditional market forces taking over and making liquor prices too low. We wanted alcohol less accessible to ensure we stemmed the negative effects of overconsumption. Now, the balance of access and consumption is inherent in any consideration of new liquor laws. It is a delicate balance to consider as we move forward.”