Speakers just couldn't help turning to 3-tier and franchise issues facing beer industry at our conference early in the week. Tho "rhetoric" pointed to by many, folks mostly shot from the hip on stage, offering honest appraisals and perspectives, many expressing sincere interest in finding compromise.

Boston Beer founder/chairman Jim Koch didn't shy away from laying out "facts and realities" of where potential for franchise reform is now and where he thinks it's headed during conversation with Bill Hackett of Constellation Brands Beer Division. Jim had 4 points: 1) There's "a lot of rhetoric," but "we should all just chill." Jim pointed to "great interdependencies" between brewers and distributors, who are "natural allies" to him. 2) That rhetoric is "not going away." When Jim got into beer biz 30 years ago, rhetoric and worries about collapse of system just as common when wholesalers worked to gain franchise protections in first place. So debate, tussles likely to continue, Jim claimed and the "business is better for it." The existence of tough franchise laws "takes out between a half and a third of the exit value" of small brewers, he argued here. 3) "The balance of power in the industry is shifting." Craft brewers are "going to be more powerful" and will "probably prevail," just "as the wholesalers did" earlier, according to Jim. "This is a public policy issue," and small brewers likely to keep conversation public because "they generally benefit from it." 4) "It might take 5 years, it might take 10 years," Jim predicted, but "most states are going to have franchise law carve-outs." He suggested that production caps will likely be based on the size of the "largest brewer in that state." Unstated by Jim, but legislators would need to be careful not to obliquely provide benefit to in-state players to not run afoul of Granholm decision. But Jim's point seems apt considering at least a few states have passed laws providing rights to brewers of a certain size after examining current production of in-state brewers.

After Jim made his points, Bill suggested that some craft brewers are "going to market before they really know what they want to be when they grow up." Suppliers should have a "stronger game plan on the front end...before they make decisions on who they want to go with." While franchise carve outs would "put an end to some of the whining," Jim said, the industry has "the benefit of a pretty damn good regulatory environment." After all, "no three-tier, no craft beer," he repeated.

Tales from Before "Monumental Change" in Market and After Allagash founder Rob Tod agreed with Jim's "no three-tier, no craft beer" line adding that "every one of the checks we get in the mail is from a distributor," during panel discussion moderated by Bump Williams. But when the discussion turned toward opening new markets and, in turn, franchise law carve-outs, Rob reminded that "ten or so years ago," Allagash "really didn't have a choice with who we went with." Distribs didn't return calls from small brewers, so if they wanted to open new markets, brewers "just kind of went with who would take" them. So "there's a lot of us who have a lot of stories, tough stories about being burned, usually a few times." He told one from 15 years ago, when "despite" Allagash's "30-day terms," one distrib in a "tough franchise state" regularly paid in 100 days. Rob called once, "trying to make payroll," saying he'd have to put the wholesaler on cash. After a pause, the distrib (no longer in the biz, per Rob) said if "you put me on cash, you'll never sell an effing case of beer in this territory for as long as you live." In such cases "there's nothing you can do" and "you're just kind of stuck."

But since then, there's been a "pretty monumental change in the industry," Rob said. Average pace of brewery openings means 1 or 2 breweries opened during the time of the conference, "statistically" at least. "The landscape's changed and there's going to be pressure for the system to change and adapt to it." The other panelists on stage with Rob - Odell co-founder Wynne Odell, Ninkasi co-founder Nikos Ridge and Devils Backbone founder Steve Crandall - attested to this change. "We are still getting distributors camping out on our doorstep" to get Devils Backbone in nearby markets, Steve said. Each of the panelists expressed "optimism" for their bizzes specifically and craft generally, looking forward.

Mazzoni and Tony Question "So-Called Franchise Reform," 3-Tier Like Oxygen, "Partners You Ain't" Indeed, craft cos (like those run by above panelists), have been "wildly successful" under current system, consultant Mike Mazzoni said during presentation including 10 rhetorical questions about "so-called franchise reform." So "something must be right if one looks around at the wealth created at both the supplier and distributor tier," Mike said, "unquestionably" a result of "risk, investment and hard work over many years." Three-tier limits access? "Give me a break!" While many describe system as "unfair…maybe the underlying issue is that some brands are simply better than others and that's why some brands sell better than others?" Mike asked pointedly. And by the way, "when did access to a distributor's organization and retail relationships become a right rather than an opportunity?" he continued. A distrib taking "a brand with the intention of trashing it" simply "defies business logic," in his view.

But Mike threw small brewers a bone too: a "supplier should have the right to move," he said, based on a "valuation matrix that takes into account how long the distrib has had the brand, trends, gross profit multiples, etc." But he's not a fan of carve outs as their "basic premise…provides special treatment for a select group," which "doesn't work for me." What's "not fair" in his view is "to potentially penalize the suppliers whose brands are paying for the basic distributor infrastructure." Furthermore, state legislators don't understand "complexities" of beer biz and add to litigiousness, rather than relieve it as recently claimed by BA, he argued.

Mike didn't have toughest critique of BA. That came from Lagunitas founder Tony Magee: "I don't understand why the BA pursues the crazy stuff that it seems to feel is so important," he remarked. "The notion of fooling around with something so fundamental to the structure of the landscape is just reckless and it's dangerous," he continued. He finds 3-tier system as fundamental to beer industry as oxygen to life. And while humans might be happier, work harder if atmosphere enriched by 3%, "the thing that you didn't foresee is that forest fires would burn a thousand degrees hotter."

Tony's comments built on suggestion of possible "interesting, unintended consequence," according to Mike. Mazzoni's found it "particularly interesting" that "AB and MC have been silent on this issue." He wondered if AB could expand branches, "leaving only one conventional distributor option for smaller suppliers." Even Steve Crandall noted his "concern" about "the unintended consequences of doing carve outs…. Right now I know what the playing field is," he said, "and I'm not sure what it's going to be like once that occurs." Regardless of future, "partners you ain't," Mike concluded, insisting that brewers and distributors may be "allies," but are certainly not "partners," in his perspective or experience.

Partners They Are, Craft Panelists Insist, Singing Distributor Praises; Transitions Possible, If "Contentious" Mike's discarding of word "partner" was later wholly discarded by small brewer panelists and moderator Bump Williams. Most of them regularly use the word to describe their wholesalers and used it on stage. They all also had plenty of kind words for distributors, including their "fabulous" work, having "successful relationships" and being "genuinely engaged" with the category, to throw out a smattering. Both Jim Koch and Bill Hackett offered similar sentiments earlier and Tony Magee insisted he has, and other small brewers should have, nothing but "gratitude" for wholesalers, which he's "always seen…as our customers." Tho Lagunitas has "had terrible distributor situations in places where there was no way out," the co has "always found ways either around, through or out." And the co "never spent hundreds of thousands of dollars, or spent years litigating with a distributor…and it wasn't because we were brilliant in our early choices. We made plenty of problematic choices…but you gotta chew your own food here." Ninkasi has dealt with "a few" transitions "that were pretty contentious" too, Nikos said, but "in every case so far, it's led to immediate and dramatic improvements that have been sustained." That stood in direct contrast to Mike Mazzoni's claim that such improvement occurs only "rarely."

Who's Got the Onus: "Outing," "Policing," and the Way Forward So what happens now? Wynne finds it "disingenuous to not acknowledge that there's disproportionate power between some larger wholesalers and some smaller brewers." She also doesn't "quite understand...why the second tier isn't calling out their own members." Further, she believes "it would benefit the entire second tier and the legitimacy of the argument to acknowledge that there are certain players who are causing the problem and the vast majority of wholesalers are playing a very even-handed honest game. I don't really understand why it's sort of circling the wagons, suggesting the problem doesn't exist."

Mazzoni similarly pointed to "a minority of jugheads who have magnified the problem," earlier. That in turn was echoed by Bump who claimed "there are very very few offenders that take [small brewers'] brands for granted," perhaps 1 or 2%. He agrees with Wynne on a "self-policing" model, in his words, wherein wholesalers may be "outed" by other wholesalers, in her words. Bump hammered the issue hard, asking if BA folks talk about the issue "behind closed doors" or would "publicly print naughty distributors," wondering what if the NBWA "policed their own group," and what the effect on the industry would be "if there were carve out laws in every state." Even though Wynne supports wholesalers pointing to other wholesalers, "I think that would be a bad business for [the BA] to get into," adding "I don't think we should be publicly painting the tar" and "that witch-hunt kind of thing unnerves me." Rob, the only member of the BA board on stage, reminded that "I think our counsel would probably encourage very strongly that we stay out of that."

"Obviously it would be nicer if there were…more amicable dialogue," Rob Tod said. He pointed to the "New York compromise" as a possible model: "I don't see what's so wrong with New York." "There just needs to be dialogue," he insisted, largely between state brewer and wholesaler associations. "I would hope that the door would be open to that dialogue," he continued "because if the door closes quickly, I think the next natural venue for the brewers is kind of the more public debate." His encouragement for dialogue follows same sentiment expressed by Mike, quoting apt language of BA prexy Charlie Papazian: "there's beer at the table, why aren't we both sitting around that table?"  

Amidst "the age of hops," as Tony called it, there's only a finite amount of land dedicated to hops farms currently (about 37-38,000 acres in Willamette Valley, noted Jim Boyd of Roy Farms from the seats). "So if you run the numbers…you could find that the world runs out of all of the acres up there just to supply craft in about 5 yrs." So, "there's kind of a train wreck coming over hops." Recall, "AB's been out of the Valley" for some time, and they're "gonna come back shopping," tho "the varieties they're looking for may not be available," Tony added. And growing overseas craft markets are gonna continue to source American hops: hop farm Yakima Chief Inc. shipped "half-a-million pounds of Simcoe hops to Europe," in 2012, and "this year, 1 million pounds."

Then too, "for us hops are just not a commodity," they're "mission critical, value added input," Tony remarked. He referred to current way craft shops for hops (and barley) as "an old store front," originally created "for the biggest brewers in the country, for whom the whole supply chain oriented itself." So Lagunitas lookin' to "de-commodify" these "value added inputs." "We spend a lot of time up there to try and understand what their needs are so we can show the farmers what craft could mean for them down the road." With co's barley supplier in Canada "we sign 3-year rolling contracts…before they even put it in the ground," said Tony. "We ensure their bet." Tho likely a bit easier to commit that far down the road when you're growing at such a rapid rate. To add weight to importance of hops, Tony credited one person in particular, Jason Perrault of Perrault Farms, as "probably the most important person in craft brewing right now." He credits Jason for basically inventing a handful of new hop varieties including Simcoe, Mosaic, and Citra, to name a few. Some of the more sessionable IPAs likely "couldn't have been made…without Citra and some of its cousins," Tony added.  

Blue Moon, Shock Top, Guinness, Negra Modelo: all brands that Tony Magee believes "are all about the same consumer motivation as drinking a craft beer," he said. "There's no pure this or pure that, it's consumer motivation," in his view. "Those people could be drinking Shock Top or drinking my beer and feeling the same thing." But Tony sees "all the Blue Moon and Shock Top in the world as spackling in the cracks of craft's inability to supply the actual demand." He believes craft breweries are pretty much "all operating at capacity," and "the likelihood that the capacity of built craft breweries exactly matches the demand" isn't very high. Years ago "people drank the beers they could get until they could get all they wanted, and then all of a sudden they began to drink the beers they desired…. That sorting process will go on again when craft brewers are finally able to put the beer out there and fill every gap, so I see very little risk in building forward."  

High-flying Lagunitas could finish the year somewhere north of 650K bbls, founder Tony Magee told conference attendees. (Note this article appeared in Insights Express earlier in the week.) That would mean growth of 250,000+ bbls in 2014 alone and 550,000 bbls in last 4 yrs. Its Petaluma plant is currently running at 650K-bbl per yr pace, "completely maxed out," said Tony. Recently-opened Chicago plant (ribbon-cutting with Mayor, Governor soon) working on "back-filling all the inventory" left open by capacity-constrained Petaluma. So "650 might well be the number" for 2014, and it "might be a little bit north of that if we're really able to make Chicago play." In another couple months, the Chicago brewery will already be up to about 500K bbls of capacity with the addition of 12 new tanks. Lagunitas has been trying "to put the reins forward on the horse, just relax the bit and see what it would do on its own without kicking it at all," Tony said. But "every time we do that a little bit we end up having to pull back pretty hard because certain markets will grow kinda quickly...and soak up...whatever capacity we just put online." Lagunitas has added a handful of new mkts in 2014 and plans to fill out the rest "as soon as we build out the rest of Chicago." In Chicago alone, Lagunitas expects to do 800K cases this yr.

Looking further forward, Tony also revealed that his Lagunitas Development Company has far broader ambitions. It is already scouting out a 3d possible site that would likely be needed in next 2 yrs. And further down the line? "We should have 5 breweries," Tony thinks, "inside of the next six to ten years." But "they don't have to operate at full capacity" to help Lagunitas "make deeper affinities with different parts of the country" or be profitable. Lagunitas builds breweries more inexpensively and runs them more efficiently than many of its craft brethren, Tony sez, which means that his breweries can find profitability at much lower capacity utilization than traditionally considered. And if Tony not able to make all those breweries work down the line? "If I'm not winning, somebody else is, and I'm sure that I can sell it."  

Tho some observers have deemed craft beer a "bubble," with implication that it could/will burst, outgoing Beer Inst economist Lester Jones begged to differ on panel with BA economist Bart Watson. High number of permitted and active brewers have inspired bubble talk, said Lester, but he views craft as a "gold rush." Why? According to TTB, 2811 brewers made beer in US last yr. But over 70% of those brewers made less than 1000 bbls, another 20% less than 7500 bbls. That's "not so much a bubble as people rushing in to fill niche markets." Very few brewers actually making over 60K bbls, he reminded. Bart agreed "completely." He had interesting slide that compared craft volume produced in 2013 by brewers in biz before 2010 and huge influx of newbies since then. While newbies made up over half of all craft brewers in 2013, again inspiring "bubble talk," they produced only 5% of the beer last yr. This "represents a change in what a brewery is," Bart suggested. "Now it's your neighborhood brewpub, restaurant, micro taproom." So thinking about these primarily retail outlets in same vein as regional breweries "doesn't make sense. The bubble talk becomes silly, because how many restaurants can we have in this country, how many bars that make quality beer? There can be a lot. I don't think there's a number of breweries that we should be talking about."

Tho Dollars Trump Volume, and Beer Trumps Cider, Even Craft Brewers Moving to "More Occasions," Volume Perspective, Sez Bart Bart not only warned against paying too much attention to brewery count, but he believes there's too much emphasis on volume, rather than dollar sales. He pointed out the "old business model" in US beer of making fewer dollars on volume has "shifted toward a high end model" that's not just about craft, but for "the big guys too." "Volume used to be a good metric because it also said something about profit," Bart said. That's not as true now, as AB and MC collectively pocketed additional $3 bil since 2008 while each shed about 10% of its volume. No longer simply about selling cases, in Bart's view: "now it's about making those dollars, making that margin on your case." We should ease off on cider talk too, Bart also suggested. Sure, individual companies like Boston gotta talk about hot cider brands, but overall cider biz still tiny and "really not moving the needle." He had fun slide that showed cider dollar sales to date this yr slightly higher than Bud Ice, slightly lower Natural Ice, which don't get a fraction of the attention that cider has. But "people like to talk about 80% growth numbers." Bart's warning about over-focus on volume notwithstanding, he also mentioned that he sees a "turning point" in what craft brewers are brewing. Noting trend toward sessionable beers, plus variety packs outpacing seasonals, "it strikes me that craft is moving to the 'more occasions' business, taking on a more volume perspective than in the past."

Bart's 20/20 Vision Recall, craft had just below 8 share in 2013, without addition of handful of "new" craft brewers, especially Yuengling, who will join the club (and BA's "craft" numbers) in 2014. Bart explained his current take on BA's stated goal of 20 share for craft in 2020 to us after the conference as the question got cut for time. "Assuming an additional 1.5 share points in 2013" from those brewers, Bart later told us, "craft will need to average 11.5% volume growth to achieve 20% volume market share by 2020. With a more realistic growth figure of 18% for 2014 (based on scan data and the 2013 trend), the necessary growth drops to 10.5% for the remaining six years. Given continued strong demand trends, and that craft has averaged 10.9% volume growth over the past decade this seems quite possible. In addition, with the continuing challenges to overall beer volume and the resulting likelihood of a reduced base, the probability of 20% market share increases." Bart acknowledges that double-digit gains get harder to sustain as base expands, plus "a slowdown in new tap handles will be a challenge, though hopefully offset by scale retailers increasingly embracing craft…with shelf space a new challenge in a few years." At same time, brand new breweries will add incremental volume. Finally, "in the medium term I think the micros will be the deciding factor. The regionals will have solid steady growth. But if the micros can keep growing and finding new distribution channels like last year, we may look back at 20 as conservative." We'll see.

Is Craft Under-Spaced or Over-Spaced at Retail? Lester Sez Mktplace Will Decide; Bump Agrees and Adds Hot running topic in beer biz has been question whether craft deserves space it's been grabbing at retail. Top supplier execs suggest no, given much higher velocity (sales per pt of distribution) mainstream beers offer. Craft execs suggest otherwise, given much higher margins their brands provide. When we asked this question at our Spring Conference this week, BI economist Lester Jones said flatly that "the marketplace will decide this." Within 3-tier system, "flow of information" across brewers, wholesalers and retailers "will determine what happens." The more data available to retailers, the "better informed" their decisions will be, he added. One day, "we'll wake up and we'll know…. Consumers will let us know whether they are thoroughly confused, or things are not moving and they want something else." We asked consultant Bump Williams same question and he gave similar answer. "The consumer should ultimately decide how much of the shelf space" specific brands/segments get. "Craft could have 40% of the pack out but if consumers don't want/buy them, then they're over-spaced." Up to retailer to find "right balance" of volume and profitability/margin. Third piece to space challenge, in Bump's mind: distrib and brewer "collaboration on execution" (keeping right pkgs in stock, targeting drinkers with right brands) and brand innovation, while continuing to "educate the retailer and consumer on uses of beer and pairings."  

craft segment front-and-center at Beer Insights Spring Conference in Chicago earlier this week. In addition to loads of numbers and biz insights from brewers, consultants and economists alike, recent comments from BA about franchise law reform popped in several presentations. See below for specifics and other craft issues discussed during the day.  

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