Distortionary Effects of Three-tier Liquor Regulation, Wisconsin Edition

Lynne Kiesling

As Jonathan Adler notes at the Volokh Conspiracy, the Wisconsin legislature is considering a piece of legislation that would change the regulations governing the production, wholesale distribution, and retail sale of beer in Wisconsin. The controversial provision in this legislation is one that prevents brewers from owning wholesale distributors, and the controversy arises primarily because of the possible effects on small craft brewers of a piece of legislation that is intended to blunt the market power of Anheuser-Busch. As described in a recent Milwaukee Journal-Sentinel article:

The legislation, approved Tuesday night by the Legislature’s Joint Finance Committee, is designed to stop Anheuser-Busch from buying wholesale distributors, say its supporters, including a beer wholesalers lobbying group. Opponents say those fears are exaggerated, with craft brewers saying the legislation would hamper their growth prospects.

Most of the nation’s beer is sold by brewers to independent wholesalers, which earn a profit by reselling the beer to supermarkets, taverns and other retailers. That three-tier system has operated since Prohibition’s repeal, and was created to prevent brewers from forming monopolies making, distributing and selling beer – which existed before Prohibition. …

The proposal endorsed by the Joint Finance Committee is needed to avoid a similar court challenge in Wisconsin, and to prevent Anheuser-Busch from buying distributors, says Tim Roby, spokesman for the Wisconsin Beer Distributors Association. The proposal also is supported by MillerCoors LLC, Anheuser-Busch’s chief rival, and groups representing retailers, including the Tavern League of Wisconsin and the Wisconsin Grocers Association.

The legislation prohibits brewers from buying wholesale distributorships, while allowing brewers that produce up to 300,000 barrels annually to do their own wholesale distribution.

Some Wisconsin craft brewers do their own wholesale distribution. Others sell their beer primarily through wholesalers, while also doing limited self-distribution by selling beer at festivals or filling emergency orders from taverns. The state’s largest independent craft brewer, New Glarus Brewing Co., sold about 92,000 barrels in 2010.

MillerCoors, with its deep roots and strong market and employment presence in Wisconsin, supports the bill, while Anheuser Busch argues that the bill stifles competition.

The economics and politics of vertical integration are the issue here. Summarizing from a long post I wrote describing the three-tier system in 2002: before Prohibition, brewers did their own distribution to their own bars, pubs, and taverns, and profited handsomely with this strategy. With the repeal of Prohibition, federal law stipulated that wholesale liquor distribution must not cross state lines (I think of this as the Al Capone rule!), so with the growth of national-market brewers came independent wholesale distributors within each state. Over the past several decades, though, wholesale distribution has seen consolidation to the extent that even large states like Illinois have very few wholesale distributors. Moreover, those distributors are politically powerful, and use their profits and their political connections to maintain their market power, to the frustration and economic detriment of both brewers and retail outlets.

Thus one way to interpret this proposed legislation is as the Wisconsin wholesale distributors acting politically to retain their substantial market power by excluding potential competition from vertical integration of large national brewers.

But the controversial and interesting/disturbing interpretation involves small craft brewers such as New Glarus Brewing (which makes some truly outstanding beer, particularly their Stone Soup). Incidentally, New Glarus used to be distributed in Illinois, but as the political and market power of Illinois distributors grew they increased distribution fees sufficiently that New Glarus pulled out of the Illinois market, so now we have to stock up whenever we’re in Wisconsin. New Glarus currently makes 92,000 barrels/year, so they would be exempt under this bill and allowed to do their own wholesale distribution. However, for small brewers this vertical integration is costly, so, as this OpenMarket.org post suggests,

Brewers of less than 300,000 barrels annually will still be able to self-distribute, but current brewers and new wholesalers would be required to have 25 independent retail customers prior to being granted the right to distribute. According to a MillerCoors spokesperson, these new rules would also prevent small brewers from banding together to form their own distributorship. In addition to all of that, the measure would prevent brewers from owning retail licenses, meaning that they could have a brewpub, but they would only be allowed to sell their own product. Breweries that already own retailing outlets would be allowed to retain one.

I think this is the material issue — not only does this legislation insulate wholesale distributors from vertical integration by large national competitors, it also insulates them from contracting among craft brewers to form their own wholesale distributor to compete with the incumbents. The economic theory underlying this argument comes from the Klein, Crawford, Alchian (1978) article on contracting as a substitute for vertical integration, in situations of low transaction and monitoring costs. As New Glarus owner Deb Carey said in this Madison Cap Times article,

“We are losing assets and we are losing control over our products,” Carey says. “This debate boils down to the fact that the wholesalers do not want a drop of beer going to market in Wisconsin without them making their 30 percent profit from it. That’s it.”

That’s the economic argument supporting the craft brewer’s position in this debate; the proposed legislation is anti-competitive, distorts the market, and hampers the business potential of craft brewers in Wisconsin not by preventing them from self-distributing, but by preventing them from contracting to create a craft wholesale distributor to compete against the politically powerful incumbent wholesale distributors.

One thought on “Distortionary Effects of Three-tier Liquor Regulation, Wisconsin Edition

  1. I started homebrewing this Spring. It is remarkably easy to make some darn tasty beer.

    Start-up costs are about $200 for equipment to make 5 gallon batches.

    A five gallon batch costs about $25 in ingredients, plus the energy for heating and boiling.

    This works out to less than $1 per half liter, for very high-quality beer.

    An interesting option….

Comments are closed.