If you’re with me so far, having suffered through the first 2 droning lectures on the Three Tier System of alcohol regulation in Texas (and many other states), you’re hopefully convinced that it doesn’t serve the public interest. Its original purpose – promoting temperance by prohibiting tied houses – is not actually being served. I say this not because society is insufficiently temperate for my taste, but because removing the 3T System would not negatively impact temperance. (This argument was fleshed out in Part 2.)
Proponents of the 3T System rarely, if ever, debate this claim – you’ll be hard-pressed to hear the distributors say that we need the 3T System to promote temperance. Instead, they choose to fabricate other purposes that the 3T System serves: It prevents monopolies, it helps craft breweries, it employs hardworking people, it protects your safety, it institutes “market order”, etc. These purposes are usually bundled together, in the hope that several flawed arguments can be combined to form one reasonable argument. The particular flaws have been addressed in the previous posts, but the most important flaw is that the system itself predates all of these supposed reasons for its existence. This alone should be a source of extreme skepticism, which is sadly lacking among those with the responsibility to consider such matters.
The original motivation for this series was that the 3T System is often invoked as a sacred institution vital to the fabric of our society. Distributors tell us, essentially, that we must have the 3T System because we must have the 3T System. I wanted to examine this argument closely and prove that, in fact, the 3T System is not a vital pillar of our republic but rather an unnecessary institution. Thus, if the 3T System stands in the way of the public interest (say, if it prevents Texans from buying craft beer from a brewery), then the public interest should prevail, rather than the 3T System. This argument is derived from examining the 3T System’s origins and applying common sense.
Having shown that the 3T System is unnecessary, I’d like to go one step further and explain how it’s harmful. Harmful not just to brewers, but also to every beer drinker and tax-payer who isn’t a member of one of the wealthy families who own Texas’s few massive distributors.
Why the 3T System is Harmful
The 3T System mandates that, with a few exceptions, a distributor must be paid to sell a brewer’s products to retailers. For example, when a brewer sells a case of beer to a distributor, that distributor typically marks up the price by 25-30% to sell it onto a store. The distributor provides a valuable service, but how valuable? In some cases, it’s less than the price that the store (and thus the consumer) pays1. We’re getting ripped off.
Not only that, but the three tiers must be completely independent, thus, the law in Texas makes all of the following potentially valuable ideas illegal:
- Consumer purchases beer to-go from brewery
- Brewery makes a beer for exclusive release at a restaurant
- Brewery opens a restaurant at a separate location
- Landlord owns one property leased to a brewery and another to a restaurant
- A bartender from a restaurant works part-time at a brewery
- A brewery sells another brewery’s products in their tap room
- Three small breweries form a small distributorship cooperative
- Bank lends money to a brewery and also to a bar
- A brewery services a bar’s draught system for a fee
- A bar purchases a brewery’s beer in advance
- A brewery sells beer to a store on credit terms
- A restaurant adds a micro-distillery or micro-winery to its premises
- A brewery and a brewpub make a collaboration beer and market it jointly
- A bar owner participates in a brewery’s crowdfunding campaign
- One bar sells a keg of beer to another bar
It’s important to remember that every one of these illegal arrangements is not an ad hoc law but a direct extension of the 3T System. Once we accept that upholding the 3T System is not important, there’s no rationale for any of these things to be illegal.
Why It’s Worse Than You Think (Franchise Laws)
Of course, the key mandate of the 3T System – that [almost] every drop of beer produced and consumed must have a middle-man to distribute it – adds a cost often borne by the consumer via fewer options, higher price, and staler beer. But, shouldn’t the threat of competition keep this cost in check? In other words, couldn’t someone open up a distributor that would do a better job and charge a more competitive price, thereby minimizing the burden of this unnecessary law? If 30% is too high a markup, shouldn’t someone be able to find a cheaper way to do it and charge, say, 20%? If it’s taking too long for my products to reach the shelves, couldn’t I find another distributor that would guarantee my products’ freshness?
In the 1970’s and ‘80’s, many states, including Texas, enacted franchise laws, which govern the relationship between brewers and distributors. The law in Texas is called the Beer Industry Fair Dealing Law (TABC 102.71-82), which, as you might guess, does the opposite of what its name suggests. It mandates that nobody can terminate, cancel, or fail to renew a distribution agreement without “good cause” and without giving the other party a 90 day notice / remedy opportunity. Essentially, you are bound for life, regardless of the agreement you think you made.
There’s an extraordinary asymmetry here. While both the brewer and the distributor are subject to this lifelong bond, the distributor is not really bound, because he can simply stop selling the beer at any time, and the brewer’s recourse is to provide notice and give 90 days for remedy. During that 90 days, the brewer can’t sell any beer (because the distributor has exclusive rights). After 90 days of lost sales and the litigation cost (to prove good cause), the brewer is (maybe) free of the contract’s obligations, whereas the distributor was never bound to begin with.
This law is further strengthened by exclusive territorial limits (TABC 102.51(b)), enacted in 1995. This law states that a brewer can only have one exclusive distributor for each territory – giving every distributor monopoly rights over the products they sell. There is no competitive pressure on a distributor’s performance or the fees they charge. And, thanks to franchise laws, there never will be. If you want to start a competitive distributor, good luck – you cannot outcompete another distributor for business; instead, you have to buy it from them2.
Thanks to these laws, you can think of a distribution agreement as a distributor having a loaded gun pointed at the brewer at all times. The distributor can inflict pain (or worse) at will on the defenseless brewer by refusing to sell his product, potentially putting the brewer out of business. Given this relationship, it’s no wonder that you will rarely hear a distributed brewery (most larger craft breweries) talk openly about their disdain for our beer laws. Since we self-distribute, this perpetual gag order doesn’t affect us.
Speaking of which, these laws make it 0.0001% likely (only because never say never) that our brewery will ever use a distributor. That’s because the only possible arrangement on the table is bound-for-life-exclusive-territory sales at a prohibitive cost. So, let’s add a few more illegal arrangements to the list we started above:
- A distributor agrees to distribute a specified quantity of a brewery’s beer for a finite period of time
- A brewery uses multiple distributors in the same territory
- A startup distributor gains traction by purchasing small quantities of beer for resale
Because of the 3T System
Franchise laws like these were passed in several states under the justification that they were needed to (you guessed it) protect the integrity of the 3T System! During that time, brewers had consolidated in number – there were only 89 operating breweries in the U.S. in 1978 – and distributors were small, local, and numerous. Thus, big bad brewers wielded significant market power over distributors, who complained that franchise laws were needed to level the playing field so that they could maintain their independence and thus uphold the 3T System. Of course, this proved to be a heavy-handed law in retrospect: From 1979 to 2010, as the number of breweries grew 20-fold, the number of operating wholesalers was cut in half3. These small family-owned distributors have consolidated into large family-owned distributors, owned by a few wealthy and powerful families.
And, if you ask distributors why we need franchise laws, they’ll tell you that nothing has changed since 1979. Repeal them and our beloved independent distributors will succumb to the influence of Big Beer (they already do), and then our 3T System won’t do what it’s supposed to do (it already doesn’t).
These laws combine to eliminate all competition for big distributors. They face no competition from brewers (who usually can’t distribute their own products), consumers (who can’t show up to a brewery to buy products), or other distributors (exclusive territories for life). Life is good if you’re one of these wealthy families, and, much like the Office Space penny-stealing scheme, it works by skimming a little bit of value from everyone, hopefully without them noticing. You pay a little more for your beer, have a little less optionality, and it’s, on average, a little bit more out-of-date. Breweries are less likely to open, grow, improve property values, and hire people4.
It’s hard to quantify how much this costs, but consider that Texas distributors collectively make political contributions on the order of millions of dollars per year to protect the 3T System, so we can infer that it’s costing Texans at least that much.
But What Can We Do About It?
I’ve enjoyed writing this Outrage Trilogy. It’s served as a platform for engagement with some concerned and interested folks. However, one criticism I’ve heard is that I’m merely preaching to the converted and that this writing will not change anything.
And I agree. I don’t consider these essays an attempt at activism. They’re a way for me to organize my thoughts and engage with the industry and our community of beer drinkers. In that respect, I thank you for reading and I welcome your engagement.
As for what to do, that could be an entire blog series by itself and perhaps I’ll elaborate on this question in the future. For now, I’ll be brief.
Since the 3T System enables distributors to extract value from all beer drinkers and taxpayers (and not just craft brewers), their benefit from this protectionism far exceeds what craft brewers would be able to pay (in lobbying dollars) to unwind it. Thus, the solution must include not just craft brewers but also beer drinkers and the general public. CraftPAC is one way to do this – pooling money from brewers, beer drinkers, and others to combat distributors – and they’ve had a lot of success this year (I encourage you to help them by going to craftpac.org and follow them on social media).
Beyond this, we must impose some transparency on the politics at work. Where does each legislator stand today? How likely are they to vote for a bill to allow To-Go Sales (the current hot-button issue)? Would they be willing to sponsor or carry the bill? If not, why not? Given the number of breweries in Texas, why don’t we have a craft beer caucus in the house and senate (as we do in the U.S. House)? I think this need for transparency is critical, and I hope the Texas Craft Brewers Guild will pursue it before we head into the legislative session early next year.
In the meantime, to those in Texas who are interested, please start a dialog with your state legislators. I’m not talking about Ted Cruz vs. Beto. I’m talking about someone whose office is probably a few miles from your house and who has more influence over your life (in beer and elsewhere) than whoever is being talked about on CNN right now. You can easily find this information using your home address on this form. Give your state representative and senator a call and talk to their staffers. Tell them you’re concerned about beer laws and you’d like to see them changed next year. Engage them (respectfully) on social media.
Wrap it up Already
I don’t expect distributors and their lobbyists to stop characterizing the 3T System as a valuable institution that must be preserved at all cost.
However, for the rest of us dealing in facts rather than propaganda, I’d like to see a more honest treatment of the 3T System. It is not a necessary evil that exists for our protection. It is a menace that exists only to serve a special interest, and every bad beer law can be traced directly back to it. Reforming those beer laws is an uphill battle, but it will be easier once we all recognize the 3T System for the fraud that it is.
1Logic dictates that if these arrangements weren’t mandated by law, some of them would not exist, in favor of cheaper options.
2By law, distributors may sell their rights to another distributor (TABC 102.76(a)), and the brewer must not unreasonably withhold approval. On the other hand, it’s illegal for a brewer to get paid for its distribution rights when it signs a [lifelong!] dist. agreement (TABC 102.75(a)(7)).
3Brewing Up a New Century of Beer, David Scott, p. 432. https://wfulawpolicyjournaldotcom.files.wordpress.com/2016/05/7_scott.pdf
4Ironically, large brewers and distributors like to tout their employment numbers as a proxy for their contribution to a community. However, compared to small brewers, these guys are much more efficient and thus employ far fewer people per barrel produced. Thus, if you really care about employment, replacing large brewers and their distribution networks with small self-distributed breweries would employ a hell of a lot more people.