I got the following sunny comment to my analysis of the Costco decision from SeattleBeerGuy:

Interesting analysis but I’m not sure I agree with the conclsuions. I think the change has the potential to earn wider distribution for many smaller breweries as they can now sell directly. The price issue does not seem terribly pressing as people who drink beer are generally willing to pay slightly more for a better beer anyway–ever plunk down $3 for 12oz? More than twice what you would pay for a macro-lager.

So yes, the big boxes will outcompete smaller stores on cases of Budweiser or Killian’s but that should only encourage smaller breweries to reach sweetheart deals with local, smaller stores. I see a rosy horizon over which small, local groceries sell beer from small, local breweries. Not a bad thing.

I was just going to post a comment responding to his thoughtful, if overly optimistic, take on the judge’s ruling but the more I thought about, the more I realized it required a more lengthy answer. This is necessary, I think, because it is the opinion that many people will likely hold. I want to be clear that I have no disrespect for this opinion but having been directly involved in the beer business at the retail level, I have a unique perspective on how things generally work from brewery to distributor to retailer. It is for this reason I hold a different opinion than SeattleBeerGuy and is why I can not be as sanguine and positive about the future.

So let’s look at SeattleBeerGuy’s assertions:

1. “The change has the potential to earn wider distribution for many smaller breweries as they can now sell directly.” That sounds good on paper but probably won’t work for a couple of reasons. First, that would require each small brewery to have a larger sales force to sell directly to retailers, including trucks to deliver to them, and merchandisers for support. Most small berweries simply won’t be able to afford to add the staff required. You could argue that one of the current brewery employees or the owner could do it, but given the number of locations that would now have to be sold to directly, that doesn’t seem remotely feasible. Second, buyers would be too busy to meet with a different salesman for each individual brewery. They simply don’t have that kind of time. That’s why having just a few distributors representing the majority of the brands makes sense, especially for the smaller players. Buyers only have to meet with a few people to meet all their needs. So that means distributors will still be the most efficient method for both small breweries and retailers. As it stands now, distributors sell to smaller retailers and larger chain stores are called on by what are called “chain reps.” or “chain salesmen” who give presentations to the larger chains. These more than likely already include “special deals” not made available to smaller retailers but now that it will be legal it will undoubtedly get worse. That’s not likely to change, except that the law will now give even more of an advantage to the big box stores. So buying direct will really only benefit these large stores who have trucks to pick up product and store it in their own warehouses. Those retailers will have an enormous advantage at every stage of the distribution path. Will wider distribution be possible for the smaller breweries? There may be a few medium or middle tier retailers looking for a way to distinguish themselves but I can’t see how that would create enough increased business to make much of a difference. At best, it seems like it might be something of a wash if that happens to balance the loss of business that I believe will eventually be caused by this decision.

2. “The price issue does not seem terribly pressing as people who drink beer are generally willing to pay slightly more for a better beer anyway–ever plunk down $3 for 12oz? More than twice what you would pay for a macro-lager.” This assertion ignores one inescapable fact, which is the people “willing to pay slightly more for a better beer” make up only 3.5% nationally of the total beer market. The other 96.5% are the ones buying crap for the most part. That number is probably higher in Seattle and it’s probably higher where I live in the Bay Area, as well. But even if it’s as high as 10% that still leaves 90% of consumers who aren’t willing to spend more. If you drink good beer you tend to live in a bubble — at least I know I do — where almost everyone you know also drinks decent beer. But the vast majority of consumers don’t drink craft beer. It’s weird to think about, but for every ten people you pass on the street, only one of them shares your love of good beer in a best case scenario. Depending where you live, it may be much, much worse. That’s why in a naming doublespeak that would make Orwell proud, Budwieser, Coors and Miller Genuine Draft are called “premium beers” and beers like Busch, Natural Light and Miller High Life are called “sub premium.” Imports like Heineken and Corona are called “premium imports.” Craft beer is called “specialty beer” which gives you some idea of how small a portion of total beer sales they represent. Most of the beer sales data is collected by two companies, Nielsen and IRI Scan Data, and both use these broad catagories to describe the beers they’re tracking. Both, as I understand it, only collect sales data from groceries, convenience stores, chain liquor stores and the like and so they’re not reflective of the overall market since they discount one-off liquor stores and other small retailers. But these are the figures used by most beer buyers and is does show some trends and has some value in that context since the sales data can be compared over time. And one of things they do show is how much price does matter to the 96.5% of consumers that buy beer not categorized as “specialty beer.” One of the reasons given for Anheuser-Busch’s recent drop in income is that they’ve been engaging in price wars, meaning they’ve lowered their price to increase sales at the expense of profitability. This has been going on in some fashion for at least five or six years, possibly more. And it’s kept domestic beer prices artificially low. So I think it is actually fairly pressing since the vast majority of beer drinkers do shop on price. What all this legal wrangling will result in, I believe is an even wider gap between domestic beer prices and craft beer. This gap makes it harder to convince the 90-96.5% to trade up to better beer. Forget all the arguments you can think of, some people are just stubbornly going to shop on price no matter what. At least that’s the way I see it.

3. “So yes, the big boxes will outcompete smaller stores on cases of Budweiser or Killian’s but that should only encourage smaller breweries to reach sweetheart deals with local, smaller stores. I see a rosy horizon over which small, local groceries sell beer from small, local breweries. Not a bad thing.” The problem with this, as I’ve said before, is that small breweries are not really in any position to make “sweetheart deals” with smaller retailers. I can’t tell you how many meetings I’ve had over the years when I was a beer buyer with small breweries telling me how they simply couldn’t match the big breweries on post-offs (posted discounts that are scheduled throughout the year), scans or scanbacks (another way to offer discounts that are tied to actual sales during a given period of time) or other incentives for hitting sales goals such as contests for stores, etc. And that’s because their business is tied to hitting some formula of volume of sales to the brewery’s capacity in order to be profitable. The amount of leeway they have for advertising or other sales incentives is miniscule compared to the larger breweries who have exponentially larger volume. Only the regional breweries, such as Anchor, Sierra Nevada or New Belgium have enough volume to do anything meaningful on a regular basis. And actually, Sierra Nevada did not discount their beer very often for many, many years. It really wasn’t until they’d built the new facility and introduced twelve-packs that they began doing a regular year-round schedule of discounts. The other problem is that many smaller retailers are also not going to be beating down their local brewery’s doors looking for them, either. There may be a few retailers who actually care about craft beer but in my experience each community only has a couple and usually only one or two that really specializes in having an outstanding beer selection. In Seattle I only know of Bottleworks. There may be another, but I don’t know of it. There’s probably a couple of stores where there’s an employee who’s really into good beer who’s made a difference at one store and who has a small following of customers. And that’s for a city of a little more than half a million people. In the nine counties that comprise the greater Bay Area there are just under seven million people and no dedicated beer store like Bottleworks, despite a vibrant beer culture. My point is that the number of places truly dedicated to the craft beer culture is fantastically small. And that fact makes it very difficult for me to see a “rosy horizon” when an enormous advantage is handed to a handful of big businesses whose sole goal — like all corporations — is domination of their market. I hope I’m wrong and it’s “not a bad thing” as SeattleBeerGuy believes, but my spidey sense is tingling and I can’t see any good coming from this long term, especially once this decision is used as a precedent and spread by Costco throughout the rest of the states.

In one of the most watched legal battles in recent years, the judge yesterday in the Costco case in Washington state may have signaled bad times ahead for small retailers and small breweries. Her short-sighted ruling followed most courts’ bias in recent years that favor big business over the consumer or small local businesses.

The specific state regulations dismantled by Judge Pechman are:

1. Bans on volume discounts and credit sales of beer and wine.
2. Minimum markup requirements, which force manufacturers to charge at least 10 percent over cost when they sell beer and wine to distributors. Distributors face the same rule when they resell the products to retailers.
3. Mandates that manufacturers and distributors post product prices with the state, and keep prices the same for a month afterward. Distributors must charge that price to each retailer, and retailers can’t get discounts for paying for freight or picking up the product themselves.
4. A ban on retailers storing or receiving beer or wine at a central warehouse.

So let’s look at each of these:

1. Volume sales. This, of course, benefits the huge box stores like Costco and Wal-Mart and will make it increasingly difficult for smaller retailers like family-owned mom and pop liquor stores to compete since they cannot buy in the large quantities of a Costco. This gives a huge, unbalanced advantage to the big retailers. Will these small stores go out of business as a result? It’s hard to say, but it certainly won’t make it any easier on them. It probably won’t happen right away, but it doesn’t seem a stretch to say a few years from now consumers will have less choice because there will be fewer places to buy beer. It would be easy to blame this all on the big stores but unfortunately consumers are at least partly to blame for this. The big stores merely exploit most people’s belief that low prices are the only criteria worth considering in purchase decisions. Stores like Wal-Mart could not destroy whole towns if their customers didn’t flock to them zombie-like in search of the latest bargain. As long as people shop on price alone without regard to the consequences of their choices, small businesses will continue to die out and our consumer landscape will become more and more homogenized with the same handful of national retailers dominating. Think I’m paranoid? Look at the state of music radio today now that Clear Channel owns most of the radio stations. The only way to combat this is to think about where you make your purchases and to be willing to pay a few cents more to support small, local businesses. The benefits to your community are huge even if they’re not immediately apparent. But if you don’t, you’d be naive to believe that the low prices that you were lured in by will continue once they’ve put your corner liquor store out of business. Not only will prices shoot up again dramatically but the number of available beers — and especially the non-national, local brands — will shrink precipitously. So if you value good beer, please think as much about where you buy your beer as what beer to buy.

2. Minimum mark-ups. At first blush, this appears to make no sense. Remove it and prices will drop, right? Maybe at first, but not for long, because this is very deceiving. You can see why Costco went after it, since they work on volume sales that allow them to have lower margins overall. Small businesses don’t have that luxury and most businesses don’t — and can’t — use that business model. Even so, 10% is nothing. Most businesses mark up their goods 40-50% and the beverage retailers I know about shoot for a markup of around 20-25%, less for sale and loss leader items. So on a per-item basis, the markup on alcoholic beverages is already lower than the market in general. So what will removing the 10% markup accomplish? It will allow the big box stores to get even deeper discounts which will assist them in their efforts to squash their competition. Will prices to consumers go down? Probably at first, but it will primarily be the big domestic and import brands that will have lower prices. It’s unlikely to have much effect on craft beers and smaller import beers. So the gap between the two will continue to widen, which is bad for everybody.

3. Price posting and freight discounts. Posting prices at a central location is to insure a level playing field. Removing it, of course, makes the playing field uneven. If there is no longer a requirement to post prices, then all manner of back room deals become possible … and legal. Again, this may lower some prices for some retailers for some period of time. But it will hurt the small retailers who won’t be offered any back room deals, and the small breweries who can’t afford to offer any back room deals to retailers. As to the frieight discounts — are you sensing a pattern yet? — this will only benefit the companies large enough to have their own fleet of trucks and you can probably figure out who they are.

4. Central warehouse ban. Again, the only businesses that have central warehouses are the very large, multi-location big box stores. The warehouse allows them to buy in extreme bulk. Not only does this give them yet another unfair advantage, but it also removes any incentive to sell fresh product to the consumer. Of course, since most of the brands that will be effected by this taste pretty bad already, maybe that’s not such a bad thing.

Both the national press such as AP and the local papers such as the Seattle Times and the Seattle Post-Intelligencer are reporting this as a victory not only for Costco but for consumers as well, saying that the decision will lower beer and wine prices in the state. But that’s just propaganda, it doesn’t really examine the long term ramifications of the decision. Short term, prices may indeed go down but that’s not always a good thing. But selling a bill of goods to the public by saying one thing when another is more likely true is what our media does best. Large city newspapers — who are big business themselves — generally always take the side of business in their reporting and are one of the many ways information consumers receive is managed. This is a terrific example of collective restraint by the media to not actually examine what this decision means for the average consumer preferring instead to spin it in a way that actually downplays its negative aspects.

What’s more troubling is that with this victory, Costco will be examining the remaining forty-nine states to decide if — or more likely when — they can screw consumers in those states, too. Our only hope is to spend a little more for better beer before it’s too late. Support your local businesses as much as possible. Don’t be pennywise and pound foolish.

An editorial in today’s Seattle Times discusses what they refer to as the “outdated economics of beer and wine sales.” This is in the context of local lawsuit that was originally filed in early 2004 involving Costco and the Washington State Liquor Board (WSLCB). Costco is seeking to dismantle the three-tier system in place there because to do so would give them — and other large retailers like Wal-Mart and their ilk — an enormous advantage that would effectively let them damage or destroy countless small businesses. The argument against that line of reasoning is, of course, that diversity would not suffer. In an earlier article about the case, “Dave Burman, a partner with the firm Perkins Coie LLP, which is representing Costco in the suit, said, ‘Costco believes that consumers are better off when there is vigorous competition. People who don’t want to compete always say that competition is unfair, but we want the kind of competitive environment where people are rewarded for being smart, not where the state says who should make how much money.'”

The other side replies “that if the regulations were lifted, it would lead to less choice for the consumer. This whole system affords the public a great amount of choice in product. If Costco prevails, they and Wal-Mart will dominate the retail sale of beer and wine, and there won’t be the selection that is currently available.”

“Burman disagrees, stating, ‘It certainly wouldn’t wipe out local businesses. There are plenty if [sic] distributors and small wine shops in California, where this kind of legislation does not exist.'” I mention all this background because I feel compelled to point out what went unquestioned by the Seattle Times, that “this kind of legislation does not exist” in California. California does have a very similar three-tier system, however, and Burman’s statement is about as blatant a falsehood as I’ve seen unquestioned in print.

Of course, it’s not hard to figure out the newspaper’s agenda. No author is listed for the editorial, so I infer that it’s the official position taken by the paper. I don’t have a copy of today’s paper in hand, but I’m willing to bet finding an ad by Costco will be a whole lot easier than finding one by the WSLCB or a local beer distributor. They’re undoubtedly pro-business, like most daily newspapers, because they rely on advertising revenue, which is funded almost exclusively by the business sector.

The editorial accuses the state of “saying it wants to keep wine and beer expensive so that the people will drink less of it. To that end, in the wholesale market the state bans volume discounts, sales at negotiated prices, sales on credit and delivery to a customer’s warehouse.” But of course, that’s not the only reason. The more commonly understood reason is that it levels the playing field for retailers and does not give an advantage to large retailers like Costco. And large retailers generally enjoy a huge advantage in most other types of products since there are few restrictions in other classes of goods that prohibit volume discounts. And that undoubtedly pisses them off, because they naturally want to dominate everything they can. In an earlier editorial piece, I stated that I don’t always agree with the NBWA. Well this is one of the times that I do agree with them. Not allowing large box retailers to bully lower prices for volume buys may indeed lead to incrimentally higher beer prices, but the difference is worth it. Because the real benefit it that small retailers theoretically pay the same wholesale price as the big guys do. That allows at least a consistent price and reduces lowballing and squeezing competition out of the market. I say theoretically, because at least in California I know of several ways in which the big retailers get around these restrictions.

Costco’s paltry beer selection generally favors the big three and a few giant imports like Heineken and Corona. Larger Costco’s in certain places also often carry a couple of regional players like Sierra Nevada or Anchor and maybe one or two local breweries that are chosen on a market by market basis. We’re talking about a dozen or so skus. To give that some perspective, when I was the beer buyer at BevMo, at its peak, I had over 1400 beer skus. So Costco wants to change state law — and is willing to spend legal fees by the keg — over a pretty miniscule percentage of the available packages in the state. Changing this law the way they want to, may have the effect of lowering the price of a few beers, but that will undoubtedly widen the gap between craft beer and large brewery products. And that makes it harder for brewers to induce consumers to trade up for better beer.

I know I may be in the minority on this one, but I think beer should be more expensive. Good brewers make great beer, work very hard and should be rewarded for their efforts. But the drive by large brewers to keep volume up also keeps prices artificially lower than they should be. As I’ve said before, this also has the effect of keeping the gap between craft beer and mass-produced unnaturally wide, and this causes craft beer sales to suffer, in my opinion. But until we can persuade the average consumer that it’s very much worth their while to support good beer by being willing to spend a little more for it, this will continue to be a Sisyphus-like struggle.

I don’t know where the Washington State Brewers Guild, a trade organization of small brewers within the state, comes down in this debate, but in my opinion they should be supporting the three-tier system, at least for now. There are definitely reforms that are needed to the present system, but the changes this suit is seeking will benefit only a small number of businesses, and the state’s craft brewers won’t be among them.

The editorial continues:

The effect of these bans is to keep prices high. Maybe that encourages a few of the penurious to stay sober, though we don’t think the state’s attorneys who make this argument really believe it.

Certainly it is not the motive of the distributors who have lobbied the Liquor Board for years. The Liquor Board does them a favor by forbidding them to cut prices, forcing them to mark up their bottles by at least 10 percent and forbidding them to sell below cost.

These are not health restrictions to benefit the people. They are economic restrictions to benefit the beer and wine distributors at the expense of the people.

…

There will remain a high-end market, though small producers, distributors and retailers may have to scramble. That is business. The extent of changes will depend on how many customers are motivated by price — and that should be up to them.

A fallacious component of their argument is that when they refer to customers with varying motivations by price, they’re talking about the same customer — they’re clearly not. Not all consumers of beer and wine are after the same thing, of course. Some may be looking for the cheapest possible package of lawnmower beer, some for a decent craft beer to pair with a home-cooked meal, while still others may be looking for the experience of enjoying a limited vintage barleywine. While the first may only care about price, the second may have some concerns about it within a certain range and the latter is more interested in acquiring a fine beer, with little regard to the price (within reason, of course). Removing the price controls as Costco envisions will clearly effect the first group, may have some limited effect on the second, but almost no effect on the last group. But the only change we can pretty much guarantee is that cheap beer will get cheaper and good beer will remain largely unchanged, thus widening the gap. And that’s bad news, I think, for the small craft breweries.

The argument that these “economic restrictions … benefit the beer and wine distributors at the expense of the people” certainly sounds like a lofty principle is at stake. But a closer inspection of the way the beer business works reveals that really only the big box retailers like Costco and Wal-Mart will benefit. Things may not be perfect the way they are — and they certainly aren’t — but Costco envisions a world in which they make more money and everybody else loses. And that’s certainly not good for “the people.”