Revisiting Mandated Three-Tier System for Alcohol

What is the deal with the Three-Tier system (3TS)? No, this isn’t the beginning of a Seinfeld joke, it’s a legitimate question about 3TS, or a government-mandated monopoly that forces brewers to use wholesale services as the sole middlemen between brewers and retailers – a system propped up by the Wholesale Association lobby and a system that quite frankly gives wholesalers a bad name.

The 3TS was implemented across the country after prohibition ended in 1933 by most states to control the sale of alcohol. The “stated” design was to keep breweries from selling directly to the consumer, stop tied houses from opening, limit consumption, and promote small brewers. The 3rd party wholesaler was mandated as a middleman to be the only way brewers could reach market with their product.

Wholesalers do provide considerable value when producers are able to voluntarily contract their services as the brewer’s growth necessitates it, but that’s not what the debate is. The issue has been to indulge the talking points of a mandated 3TS as if they were beneficial. The idea should be revisited by examining what were its original goals and what this system has truly created some 84 years after its implementation.

There is a quote about bad policy, “Great in theory, but awful when practiced in reality.” The 3TS not only rings truth to this statement, it goes a step further. The theory’s given for the 3TS were never the intent and reviewing the unsupported claims should shed light on the reality it creates; promoting big beer and the status quo at the expense of the small entrepreneur brewer.

Claim No. 1: The Three-Tier System is the reason for the large number of breweries available today.

The facts support just the opposite: The large numbers of breweries in the U.S. are in spite of and shows no correlation with the forced use of the 3TS.

In 1900 there were 2.38 breweries per 100,000 people in the United States; today there are 1.55 breweries per 100,000, with some 5,000 breweries to choose from. The ups and downs along the way are revealing.

Between the year prohibition was repealed in 1933 and today, there have been an average of 0.31 brewers per 100,000 people. A time period uninterrupted by the mandated use of the 3TS.  After the initial jump in breweries the year prohibition ended, from 1941 to 1978 there was an 89 percent drop in the total number of breweries, with only 10 percent of the total number surviving after 37 years under the mandated 3TS.

In the 37 years since 1978 to 2015, the number of breweries increased an astonishing 5523 percent, to a total of 4,269 breweries. These two starkly different results of identical time span under a mandated 3TS reveal that at best the system has no relationship with selection. At worst, it may actually hinder brewery growth. The correlation grows when a comparison is made between states that have no self-distribution cap, and those states that limit or ban it.

This dramatic growth in brewer choice closely related to national legislation legalizing home brewing – which in time drew hobbyists into the business – alongside numerous states reducing regulatory burdens on brewers. For instance, some key states for beer production allowed brewers to sell their own product at market and allowing complete voluntary choice for brewers when they decided to use wholesalers.

Claim No. 2: Without the mandated 3 Tier System, ‘tied houses’ would take over the country.

There is a faulty argument here: The advocates and beneficiaries, the Wholesalers Association, of the 3TS are sounding an alarm that any tied house is evil. A tied house is a bar owned by the brewery that will sell only the owning brewerers products. In an email exchange, researcher Jarrett Dieterle of the R Street Institute said;

“There is no inherent evil in Tied Houses. Tied House fears are anachronistic in today’s economy, which features many examples of producers selling their products directly to consumers without any harm. WE allow Apple to sell their computers in Apple Stores, and many alcohol producers even sell their bottles of alcohol in their tasting rooms.”

The problem in the past 84 years has been the lobbying efforts of giant breweries and wholesaler associations advocating the 3TS status quo. The only brewers active after Prohibition were the corporate giants capable of weathering the drought making other products. These big companies, such as Budweiser and Miller, also had the lobbying power to endorse a system that would keep out competition, thus the mandated use of a middleman under 3TS. Which based on the historic trend in brewery numbers, has done quite well.

It is revealing there was more choice with tied houses per capita before prohibition than any point after and still to this day.

Note:“Breweries/100K people” in blue, is considerably lower than during any point before prohibition, while consumption rates have remained similar or higher before and after prohibition.

Claim No. 3: Consumption rates were incredibly high before Prohibition, and the Three-Tier System controls/ limits the sale of alcohol.

This is “the” case of Bootleggers and Baptists – occasions when one group actually benefits from laws intended to hinder it.

The best part about Claim No. 3 is that it is in complete contradiction to a wholesaler’s business model and claim “[The 3TS] provides the best method for smaller breweries and wineries to get their products into a diverse marketplace.” If this statement were 100% true the law would not be needed. Wholesalers benefit by using government to coerce brewers to use their services by law; meanwhile, temperance groups, oftentimes associated with religious organizations, endorse the 3TS for the sake of limiting the consumption of alcohol. Wholesalers are able to benefit from the temperance claims while distancing themselves to say they are the best way for a brewer to sell their product.

This contradiction aside, perhaps the mandated 3TS does promote large brewery consumption. Using data from the National Institute on Alcohol Abuse and Alcoholism, the highest point of alcohol consumption after 1850 in the U.S. was between 1973 and 1985 – a period that saw the smallest number of breweries per capita than any other time besides Prohibition.

In addition, comparing 18th and 19th century consumption to 20th and 21st century use may be like comparing cider to Orange Belgium Ale. Alcohol was more so socially acceptable because of its necessity for survival. With little to no access to sanitary water, Americans and alongside the world used alcohol to fend off disease. Consumption rates in any area with poor sanitization should be taken with a grain of salt, or, if I may, an ounce of rum.

Final Thoughts

Be on the lookout for additional unsubstantiated claims by the Wholesaler Association advocating for the forced use of their service. These top three arguments of the wholesalers reveal it to be a forced system wrought in cronyism, sustained by lobbyists, and persistent in misleading claims. These unfounded claims need to stop being promulgated as fact.

A system of free choice and association does not necessitate that small brewers win out, but it does ensure consumers receive the value they desire, wholesalers attract business based on the value they provide, and entrepreneurs have equal access to markets free of coercion based on the value they produce.

*Graph information is derived from the NIAAA, Brewers Association, and US Census Data.

The Government Destroyed Another Beneficial Relationship

Breweries and Distributors Are Not at Odds, When Markets Are Voluntary

  • A healthy relationship between adults is no different than a relationship between two businesses.
  • Brewers and distributors are natural companions when left to voluntary means.
  • Government involvement creates adversaries.

Relationships should be built upon voluntary choice, promoting mutual respect and mutually beneficial outcomes. In these unions both parties are better off with each other, than they are alone. Voluntary relationships can create tremendous value to this world, however these only exist when parties are free to associate, finding cooperation at the right time, place, and manner.

If this makes perfect sense in personal relationships, why then is there disconnect when we think about business relationships, such as breweries and distributors? More specifically, the25,000-barrel self-distribution cap involuntarily imposed on local brewers by North Carolina.

North Carolina state law forces brewers to hand over 100 percent of their distribution rights to a third party once they produce 25,000 barrels.

In the voluntary market, breweries oftentimes find themselves in need of distribution services outside of their own capacity. Breweries may be growing too fast for their self-distribution efforts, they may be unfamiliar in a new market, or decide they can cut costs by using a third party.

Other entrepreneurs see this opportunity and offer their expertise in distribution, competing against other distributors to help solve this problem confronting breweries. Oftentimes forgotten, distributors are also competing with the breweries’ right to say “no” should they not benefit and keep distribution in-house in a voluntary market.

Forcing relationships between breweries and distributors makes at least one party in the relationship worse off. But that is exactly what North Carolina has mandated upon brewers via multiple antiquated regulations. Wholesaler and big-beer company lobbyists are using the law to benefit themselves at the expense of smaller brewers and consumers. These groups have framed the debate, pitting what should be two mutually-beneficial parties against each other as adversaries.

Lobbyists and legislators have utilized adversarial tactics to make brewers and distributors look as if they are at war with each other. There really is no other outcome if policy continues to use the strong arm of the government to penalize and take away the rights of brewers to self-distribute their product over 25,000 barrels.

Relationships in which one party benefits only at the expense of the other party are often referred to as “zero-sum” relationships. A zero-sum-game mentality fails to see how both parties actually benefit from voluntary interactions.

Absent coercion, zero-sum relationships rarely if ever exist. If one party were to suffer or be made worse off in a relationship, then it wouldn’t happen or it would quickly end.  Mistakes are made and bad things do happen, though in a voluntary market there are always choices elsewhere.

In addition to self-distribution, there are many other liquor- and beer-related laws needing to be reconsidered. As it stands now, breweries have little to no rights if they make a mistake when forced to pick a distributor. Laws supported by the wholesalers’ union make ending a relationship with a distributor either illegal or so expensive the brewer is forced to maintain the inefficient partnership.

“In a free market, the two industries can benefit tremendously from each other.”

The difficulty when talking about this issue is that no brewer wants to make it look like distributors are not wanted in some capacity. In a free voluntary market, the two industries can benefit tremendously from each other.

However, wholesale union leaders are very happy to make it look like the breweries are the problem. Wholesalers fought raising the alcohol limit cap that passed in 2006. Now they allege brewers at the 25,000 cap are trying to push out smaller brewers and destroy public health all because it is apparently “greedy” to want to sell and market your own creation the way you as a business owner see fit.

It seems hypocritical to insinuate another party as controlling or greedy when in fact it’s wholesalers utilizing the force of the government to push brewers around. And it’s not just in North Carolina. Check out wholesaler claims in Florida, Massachusetts, and Texas in the past few years.

As long as we allow government the power to destroy beneficial relationships, lobbying will go on. It’s time for brewers to get their rights back to choose their own methods of distribution. Then, once the government is out of the way, distributors and brewers can finally find the relationship they are looking for at the right time for both – ensuring our beer is made and distributed by a happy marriage, not one born of cheap political tricks.

What is the 3 tier System? W/ guest Baylen Linnekin

Guest Baylen Linnekin,  Food law policy expert, joins the Free To Brew show to discuss what the 3 tier system of distribution really is. We will take a look at how this impedes the free market, distorts where resources are allocated, and hinders growth of small craft brewers attempting to enter into the market.

Baylen, among his many titles, is also an author with a new book coming out next month that is sure to challenge your perspective of how government is meddling with our food!

Be Sure to pre order “Biting the Hands That Feed Us”

Your brewery is successful. Now hand it over!

  • North Carolina state law forces brewers to hand over 100% of their distribution rights to a 3rd party once they produce more than 25,000 barrels
  • This cap hurts a growing industry by artificially favoring the large brewing companies
  • Government has no right to tell businesses how to sell and distribute their products

Can you name an industry that is forced to hand over all sale rights if too many people enjoy its product? That is, punished because it’s too creative, innovative and successful?  In North Carolina, it is the local craft brewing industry being punished with a state law handcuffing its very growth.

Craft Freedom events held across the state of North Carolina last week turned out opposition to North Carolina’s archaic distribution cap law. The law places a 25,000-barrel cap on self-distribution. Once a brewery produces 25,000 barrels of beer it is forced to hand over 100% of all distribution rights to a third-party distributor.

This cap is anti-competitive from its roots, as it stymies growth for all North Carolina brewers, violates the rights of brewers and beer drinkers, and undermines the freedom of association.

Just what is the distribution cap? Since Prohibition ended in 1933, the federal government left states to largely regulate alcohol on their own with some exceptions. Nearly all states adopted a three-tier distribution system, supported in part by large breweries in the name of tax revenue and safety. This three-tier system forces the producers of beer to use a middleman – or wholesaler/distributor – to deliver their product to a retailer instead of direct sales from brewer to retailer. The pretext was that without it people would drink way too much, small brewers couldn’t reach market and it would be impossible to collect taxes.

The real effect of the system was a huge decline in the number of breweries in the United States, from 766 in 1935 to 89 total in 1978. It was not until the government legalized home brewing in 1978, along with many states adopting brewpub exceptions and increasing or eliminating distribution caps to the three-tier system, that we began to see the surge in micro-brewing. Now the nation boasts 4,000-plus breweries.

As you can imagine, the middlemen must get paid, and in addition federal and state governments collect taxes on both ends of the transaction. Laws requiring third-party distributors impose greater costs on brewers. This money ultimately comes out of beer drinkers’ pockets, while hampering craft brewers from growing and selling more product to people who want it.

Additionally, the law hinders small brewers’ marketing and ability to stand out. A distributor will also carry between 50-150 products from other companies. It is hard enough to build brand loyalty for one product, let alone 100. Getting the word out about your company, your unique story, and why someone should buy your product in the first place may be the toughest part of a business, even on top of the onerous laws and regulations small businesses have to navigate through. If a growing craft beer is forced to be just one of a hundred brands the third-party wholesaler distributes, there is little chance its story will be told. Adding more hurdles to an already competitive market is no way to start and grow a company.

Then there is the question whether a distributor will favor a small, growing company over a giant competitor? Recent news suggests InBev (Budweiser) is financially incentivizing distributors to carry over 98 percent InBev product, then buying up larger craft brewers so local distributors can achieve the 98 percent-plus mark by still offering some type of micro brew but still paying InBev. With limited shelf and tap space available, small brewers are at a disadvantage when they are forced to use a middleman being incentivized by Budweiser. Think they’ll get a fair shot at prime shelf space?

That’s why craft, micro-brewers and customers so strongly oppose North Carolina’s 25,000-barrel distribution cap: They are forced to use a monopolistic system controlled and supported by the state government and large crony corporations. These small businesses have unique products and systems of distribution, they have created unique brand loyalty, and they are growing exponentially due to their success (which was not guaranteed). Their success is in part due to their ability to self-distribute, but once they become somewhat successful, brewers are faced with an arbitrary government-forced cap.

These laws can even hurt small, growing brewers well before the 25,000-barrel cap. Brewers may be forced to make costly growth decisions, opting for lower-capacity equipment instead of growing with the expectation of higher volume.

The owner of Brooklyn Brewery, Steve Hindy, in a 2004 interview with Beverage Industry Magazine stated he did not think he could have competed against the large giants in the Brooklyn market without self-distribution. It is not surprising that large well-known craft brewers originated in states like Colorado, California or Washington that have either no distribution cap or one much higher.

It is the success afforded under self-distribution that promotes growth of the company and the economy in the region. Self-distribution allows brewers to share their story, create brand loyalty, ensure product quality, hear directly from their customers, and be a part of the community wherever that may be.

The law even hurts the state as a whole. North Carolina brewers in general, like Fly Trap in Wilmington, agree that a rising tide lifts all boats, with thriving North Carolina brewers attracting more tourists and name recognition to local cities.

Small breweries create a product and atmosphere that customers enjoy tremendously and therefore pay for gladly, they create value where before there was none, and they utilize innovative and new ways to create a product that 30 years ago we thought could only come in regular and light. It is as a result of all this that we see economic growth and productive jobs in the end.

Government caps on self-distribution of beer harms productivity, creativity, and job growth across the state. Government at any level has no right to interfere with how a small business can sell its product at market, and tend to only create unintended consequences far worse than the original so-called problem. Let the brewers choose their path, not be forced by politicians to conform to a government-sponsored monopoly.