Treasury Department Report Endorses Deregulation to Boost the Booze Business

Photo Credit: Getty

It isn’t often that a Democratic administration endorses deregulation, but that is exactly what the Treasury Department does in a new report on promoting competition in the alcohol industry. Although the report decries consolidation among a few large players, it also acknowledges how regulatory schemes meant to prevent consolidation have created many of the problems the administration wants to solve.

When President Biden issued his executive order on promoting competition in the U.S. economy last July, he directed the administrator of the Alcohol and Tobacco Tax and Trade Bureau (TTB) to investigate, among other things, regulatory barriers impeding healthy competition in the beer, wine, and spirits markets. In particular, the order directed TTB—part of the Treasury Department—to identify regulatory requirements that disadvantage smaller actors and new entrants in the production, distribution, and retail of alcohol.

The alcohol market, as the report notes, is very different other businesses. Because of the 21st amendment to the Constitution, which ended Prohibition and handed the bulk of regulatory authority to the states, the federal government has relatively little power when it comes to alcohol. However, there are several important areas in which the federal government has influence, such as federal excise taxes, product and label approval, and oversight of mergers.

As one might expect, given the federal government’s limited role in the indusry, the Treasury recommendations center on greater enforcement of antitrust laws to curtail monopolization of markets and “exclusionary behavior” by a few large companies. For example, the report notes how the beer market is dominated by a handful of players, with Anheuser-Busch InBev and Molson Coors together accounting for an estimated 65 percent of the national beer market in terms of revenue.

This big-sounding figure only tells half of the story.

Amid escalating hostility toward big business, Treasury’s antitrust messaging may be appealing, but, as even the industry report acknowledges, consolidation within the alcoholic beverage industry is decreasing. The biggest players are rapidly losing ground to the rising tide of craft booze. For example, craft beer comprised just 5 percent of the beer sold in stores in 2004 and captured just over 5 percent of market revenue. However, by 2018 craft breweries had more than doubled their volume share of beer sold in stores and quadrupled their share of the beer market revenue to 20 percent.

The number of new entrants in the beer business has also exploded. According to the Treasury report, from just 89 breweries in the late 1970s, America now boasts more than 6,400—a lot more by some calculations—and similar trends are occurring in the craft wine and spirits markets. Despite the presence and power of large, legacy alcohol manufacturers, the U.S. market, as beer enthusiasts will happily report, is more vibrant than ever. Of course, more can be done to promote competition in the alcohol business, but doing so requires understanding why the alcohol market, unlike most other markets in the U.S. economy, is experiencing this sort of disruption.

As an explanation for the “flourishing of small and craft producers in local markets,” the Treasury report cites “tax policy and some state and federal laws and their limits on vertical conduct.” Bizarrely, it sees doubling down on these policies as the route to even greater competition and vibrancy in the market. But it also acknowledges that there are other, arguably more important, factors at play—and addressing all of them, almost without exception, involves deregulation.

In the aftermath of national Prohibition almost 100 years ago, most states set up a scheme to prevent vertical integration. These “three-tier systems” mandated a separation between the production and sale of alcohol, necessitating the use of distributors/wholesalers to act as middlemen between manufacturers and retailers. This forced reliance on the middle tier gave distributors an inordinate amount of power—a position they have ferociously defended ever since.

As a result, many states also adopted and continue to maintain “franchise laws,” which require producers to show just cause before terminating contracts with distributors, and “exclusive territory” laws, which prevent producers from contracting with more than a single distributor to sell a product in a given area.

As I have written in the past, these laws functionally hold alcohol producers captive to their distributor, protecting the middle tier from the normal market forces that foster competition and reduce prices. This setup may have been, at least somewhat, understandable when there were only a few powerful brewers in the country, but today it puts thousands of smaller brewers at a significant disadvantage.

For example, in a competitive market, beer distributors would compete with one another on price and quality of service; if a brewer were unhappy with the prices or performance of one distributor, it could choose to work with another. But, that is not how things work under franchise laws.

Instead, brewers are functionally locked into agreements with their distributors, unable to terminate contracts or choose not to renew them unless they prove their distributor is somehow failing to live up to the terms of their arrangement. While larger manufacturers can easily absorb the cost of lengthy and expensive legal processes, craft producers rarely can.

Often, these laws are paired with a requirement that producers give their distributor “notice” and an opportunity to redress complaints before they can move forward with the attempt to break ties. As a result, distributors are protected from incentives that would lead to better services and prices, reducing “competitive dynamism, leading to higher consumer prices,” as the Treasury report puts it.

Exclusive territory laws, in effect in many states, require producers to sign exclusivity agreements with distributors, ensuring that they cannot contract with any other wholesaler who might distribute their products in a certain area. This, not only holds producers captive, but also retailers, who, if they desire to carry a specific brand, have no choice but to work with the distributor contracted by the producer to sell it in their area.

The current system heavily benefits the largest players in the production, distribution, and retail sale of alcohol. It also increases the likelihood that larger players will be able to establish and hold monopolies.  

For example, most beer markets are dominated by the two biggest producers, InBev or Coors, and their two affiliated wholesalers, “red” for InBev and “blue” for Coors. Smaller producers and retailers have little choice but to contract one of these macrobrewery-affiliated wholesalers, since, with few exceptions, they are barred from selling directly to retailers or consumers, thanks to the three-tier system.

Should a wholesaler who makes most of their revenue from macrobrewery products choose not to invest in promoting a craft brand, the craft brewer would have little recourse. Even if they could muster enough power to put sales quotas or performance standards in a contract with a wholesaler, most small brewers don’t have the resources to prove their wholesaler isn’t living up to the agreement and to be able to terminate the contract. Even if they did, the few alternative options for distribution may not be any better.

One might think this represents a massive opportunity for entrepreneurs to enter the wholesale market and offer these craft producers a better alternative, but exclusively territory laws all but make this impossible. With major brands already locked into contracts, startup distributors have little hope of recruiting from established wholesalers the popular brands that would make such an endeavor viable.

On top of this, many states also enforce “post and hold” laws, which prevent smaller, startup distributors from being able to compete on price. These laws require wholesalers to “post” prices with state authorities and then “hold” those prices steady for a period of time. That gives incumbent distributors a chance to fend off would-be startups who might try to attract brands away with lower prices, by matching that price at least temporarily.

Together, these anticompetitive policies diminish the number of producers and distributors, limit small and new firms’ ability to compete with larger firms and grow, reduce the variety of products available to consumers, and make the options that are available more expensive. A 2010 study, by George Mason Scalia Law School professors James C. Cooper Joshua D. Wright found that “post and hold” laws alone were responsible for consumers spending between $147 million to $478 million more on beer than they otherwise would have.

To its credit, the Treasury report recognizes that these state laws are the main barriers to greater competition in the alcohol market. Many of the recommendations it offers, such as eliminating unnecessarily burdensome labeling requirements, reducing excise taxes for small and mid-sized firms, and using discretion to focus antitrust enforcement on the most powerful entities, would certainly help. But, it won’t solve the biggest barriers to competition created by outdated and discriminatory state laws that favor large, entrenched businesses. Removing these laws would have a far greater anticompetitive effect than anything the federal government could do.