September 2008 issue

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PAGES (49-53) September 2008

Navigating the Three-Tier Distribution System Robert Bath, MS

As we near the 100th anniversary of Prohibition—the 18th Amendment to the Constitution, passed in 1919—it’s a good time to look at the consumption habits of the American public and how alcohol, specifically wine, gets into the hands of the people who drink it.

Americans’ consumption of wine topped 300 million gallons in 2007. As one of the few countries that have shown a consistent increase in annual per capita wine usage in recent years, the United States is now poised to pass France as the largest consumer of wine in the world. The percentage of Americans drinking wine has risen by nearly 15% in the last seven years; more than half of the population now drinks wine on a regular basis. Wine is a bigger part of Americans’ day-to-day lifestyle than it was a century ago, and certainly more than it was 25 years ago.

HOW THE SYSTEM WORKS

The 21st Amendment, which repealed Prohibition in 1933, established state control over alcohol sales and thus created the three-tier distribution system we know today. Essentially, in each of the 50 states, every alcoholic beverage must flow from a supplier/importer to a distributor/wholesaler and finally to a retailer. The price set by the supplier is marked up by both the distributor and the retail shop or restaurant before the wine reaches the consumer.

Regulations vary dramatically from state to state. Some, such as Pennsylvania and Utah, have injected themselves into the system, creating yet another tier and another level of profit. Consumers who complain about wine costs in these states may not realize that their higher prices are not a result of overzealous markups at the trade level, but rather of state governments that reap profits on all alcohol sales.

In reality, the 50 states are like 50 different countries. “When I started in the business, there was an additional 14% tax levied on wine and alcohol purchases in the state I worked in,” says David O’Day, director of wine for Del Frisco’s Double Eagle Steak Houses and Sullivan’s, which have restaurants in 15 different states. “After opening many new locations, I saw how different states and even counties use the system. I understand the system is to regulate, control, and collect taxes, but I have always felt that in some states, the laws are outdated and unreasonable.”

Because of the 21st Amendment, then, it is much easier to source wines and charge reasonable prices in some states than in others. Jeff Porter has been a fine-dining restaurant buyer and is currently the wine buyer for Andronico’s Markets, a high-end, multi-unit retailer in the San Francisco Bay area. “As a regional buyer in northern California, I have the ability to work directly with wineries, suppliers (who act as their own distributors), and distributors themselves,” he says. “The direct interaction with wineries and suppliers affords me the ability to negotiate with the source and get better pricing, and allows me to have a better understanding of what the winery or supplier is trying to achieve with their products—story, type of product, or philosophy.” Working in a wine-producing state with more liberal liquor laws gives Porter more options and thus the freedom to create a wine program with more choices for the consumer, usually at better prices.

Globalization and the exponential growth of suppliers, distributors, and wineries worldwide are now motivating American sommeliers and wine buyers to find new ways to access wine. The three-tier system faces fundamental challenges in today’s marketplace. Would wine sales be growing even faster without it? Is the wholesale tier an outdated mechanism protected by state governments, artificially raising prices for consumers? How do sommeliers and wine buyers work within the three-tier system to source the best wines for their customers?

A DIFFICULT ENVIRONMENT

Regardless of your position, it’s a sensitive topic. Peter Granoff, MS, of Ferry Plaza Wine Merchants in San Francisco and Oxbow Wine Merchants in Napa, Calif., puts it this way: “We live in a business culture that holds up free markets as the ideal, and yet, when it comes to the distribution and sale of alcohol beverages, we tolerate a fragmented, arcane, arbitrary, inefficient, and sometimes blatantly protectionist system. Defenders of the status quo who benefit, both commercial and bureaucratic, usually point to the fact that alcohol is a socially sensitive product that must be sold in a regulated marketplace.”

Dale Sparks has worked both sides of the street. He’s a co-founder of Quench Fine Wines, an Arizona distributor, but was formerly the wine buyer for Anthony’s, an award-winning restaurant in Tucson, Ariz. Sparks feels strongly about the need for the distribution tier. “Distributors provide restaurants and retailers with tens of thousands of line items available at their fingertips,” he says, “and I do not know of a single independent retailer or restaurant that can afford the personnel, storage space, and capital it would take to duplicate that. Ultimately, the consumers benefit from choice and competition.” Sparks believes the trade tier has its own set of challenges: “There are some really sharp, excellent buyers in my state who talk the talk, but then make deals for wines they are repulsed by to appease short-term gains to the bottom line that in the long term hurt the consumer.”

Scott Clime, wine and beverage director for Passion Food Hospitality, operators of DC Coast, TenPenh, Ceiba, and Acadiana in Washington, D.C., finds the business environment in the nation’s capital to be a true free-market system. “I am constantly looking for the best deal and pitting supplier against supplier and wholesaler vs. wholesaler, and the winner gets my account,” he reports. “Sometimes you get so caught up in this game, you lose sight of what you are trying to do, which is to build the best wine and beverage program you can at the best price for the guest.”

The balancing act between restaurant profits and the quality of the wine program will always inspire debate. But the real question is whether the wines sommeliers want to serve are available in their markets and, if not, how they can access these wines under current state laws.

WORKING THE SYSTEM

Consolidation has had an increasing impact on all three tiers. In the wholesale segment, consolidation has created mega-distributors with huge portfolios that could actually make sommeliers’ jobs easier. But Doug Frost, MS, MW, a wine writer and consultant based in Kansas City, Mo., feels that “the consolidation in the retail, restaurant, and supply sectors poses the greatest danger to wholesalers. Why? Though most people complain about consolidation in the wholesale side of the three-tier system, powerful and vast supplier groups, as well as well-organized customer chains, can dictate price and limit availability far more than wholesalers.”

Despite Frost’s warnings, some of these mega-wholesalers have taken an aggressive stance toward wine producers. A smaller supplier or winery may be held responsible for visiting the market, calling on accounts, and creating sales; only then will the distributor order the wine and, ultimately, deliver it to the accounts. Is this distributor hiding behind the three-tier system, or merely admitting that it doesn’t have enough sales resources to effectively present all its products in the marketplace? Or is this distributor actually trying to make more wines available to its accounts?

Regardless of who is presenting the wine, today’s sommeliers need a thorough understanding of how the three-tier system can work for them. Many of the mega-distributors are staffed with young, inexperienced sales representatives who are forced to push major wine brands, sometimes as part of the deal to get the liquor brands they represent. Throw in the allocation system for wines used by distributors as leverage to sell other wines, and the challenge to stay honest to a restaurant’s wine program seems to be constantly increasing.

To protect their position in the market and to access new products, many of today’s successful sommeliers and wine buyers not only have contacts with the distributors who make the most sense for their program, but also with their suppliers or importers—even the wineries themselves—just to stay one step ahead of their competitors.

THE FUTURE OF THE TIERS

The growing sophistication of wine buyers and sommeliers in the United States may be the ultimate challenge to the three-tier system. New wines are traditionally presented by suppliers to distributors, who decide whether to add them to their portfolio and market them to the trade. Nowadays, however, many hot wines are discovered at the trade level. Although such a wine must still flow through a distributor, who still takes a markup, the wholesaler essentially functions as a delivery service for the wine.

Granoff has made many of these wine discoveries throughout his career. “It’s not that I have a problem with the three-tier system,” he explains; “it’s just the fact that it is mandatory. There are many industries that don’t mandate intermediaries between producer and consumer where there are also thriving wholesale firms. Given the explosion of small producers and the geographic dispersal of buyers, I can’t imagine a business landscape functioning without dynamic, successful distribution companies.”

Porter calls for more far-reaching modifications. “My first change would be to federalize alcohol laws in general,” he says. “The most imposing challenge to distribution is not the distributors, suppliers, or wineries, but the 50 state laws that regulate the sales and transportation of alcoholic products.”

Would it be possible to establish an optional three-tier system, in which the trade could bypass the distributor tier and go directly to the supplier? If this option allowed wine buyers to provide better wine at better prices to their customers, wouldn’t that inspire greater consumption and sales? Should a small winery or supplier be required to have a distributor or even an importer?

At present, the power of the big distributors, the 21st Amendment, and the 50 state legislatures seems too strong to permit such a system. Their control over the nation’s alcohol sales is weakening, however, according to Frost. “Distributors have hung on with steely determination to the state laws that enforce their control of wine distribution,” he says. “Despite their best efforts, and thanks to Granholm v. Heald and its ramifications, wholesalers control fewer wine sales than a few years ago.” That Granholm v. Heald Supreme Court decision, in 2005, opened up more avenues for direct shipping of wine to consumers, so that more wine sales than ever before now bypass the three- tier system.

Less than two decades ago, South African wines were banned in this country, Austrian wines were thought to be tainted, Portugal was known only for rosé, Argentina wasn’t considered a serious producer, and New Zealand wines were a brand new thing. Now, we have wines available from Ecuador, Mexico, Switzerland, even India—and more high-quality wines available from everywhere. And isn’t that what the customer deserves?

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