The Three Tier System is Living a Lie

This is Part 2 of a series on Texas’s Three Tier System of beer regulation. Part 1 is here. 

Proponents of restrictive beer laws (inability to sell beer direct to consumers, mandatory use of distributors) often justify their argument by saying such laws are necessary to protect the Three-Tier System (3T System). This then begs the question of why protecting the 3T System is important. This is seldom asked by lawmakers, who have been paid big money to protect it. But, just in case anyone is curious, the 3T System’s protectors offer a host of explanations, many of which are completely incredulous (covered in part 1).

In reality, an institution should exist for a sound reason, and from that it follows that we might wish to curtail our own rights. For example, first we determine that Lake Houston is worth protecting, and from that it follows that I shouldn’t have the right to dump toxic waste into Lake Houston. However, in the case of Texas beer laws, it appears that the goal itself is to curtail our rights, and the 3T System is then enlisted to serve this purpose¹. You should be highly suspicious when you see a tail wagging its dog.

To satisfy this suspicion, we now take a deep dive into the 3T System’s foundation. Why was it actually created? What purpose is it supposed to serve? How well is it serving that purpose? And, is that purpose still relevant today?

It Was All About Temperance

If you watch a classic 3T System propaganda video, you might miss the part where they discuss that the 3T System was devised to ensure temperance. It was not devised to ensure “competition” or “fairness”², help craft brewers, employ hard-working men and women as distributors, or prevent black-market liquor from reaching the public. While 90% of said propaganda piece entailed a trustworthy voice reciting the go-to spurious 3T System justifications, it did accurately (although quickly) portray the origin of the 3T System. Nevertheless, we’ll tell it in our own words and with a bit more detail here.

By the early 1900’s, intoxication was seen as a social problem. Distillers and brewers controlled networks of saloons that intoxicated the public and maintained a grip on state and local governments. States had each tried several regulatory regimes (including prohibition, in many cases), but by 1919 the public had had it, and enacted Prohibition to replace a patchwork of failed regulations with one simple and bold rule. It did not go well. Ordinary citizens became criminals, leading to widespread disregard for the law in general. The evils of the saloon were replaced by the evils of the speakeasy – the same thing, but run by organized crime. By 1933, it was clear that the experiment of Prohibition had failed, leading to the passage of the 21^st Amendment, which repealed federal prohibition, thus returning alcohol regulation to the states.

With repeal looming, statesmen were faced with the obvious question of how to regulate alcohol effectively. One Senator Capper remarked, “We may repeal prohibition, but we cannot repeal the Liquor Problem.” To fill this void, John D. Rockefeller, Jr, a former prohibition advocate, commissioned a study and report called Toward Liquor Control to provide guidance to states on how to regulate alcohol to restore the rule of law and successfully promote temperance. It is this report that introduced the 3T System.

Toward Liquor Control

I must admit, I had preconceived notions about this report. The founders of the Three Tier System, I assumed, were a couple of brazen social scientists overconfident in their ability to solve a problem with their sheer intellect, and this report would promise the “perfect” regulatory antidote to this decades-old problem without hesitation or disclaimers. Instead, I found the report to be a fascinating meditation on human nature and the challenges of using law as a tool to regulate it. It impressed me in its thoughtfulness, comprehensiveness, and humility. The report’s authors candidly concede that their aim is ambitious, explaining how error-prone such regulatory measures may be, and they point out how critical it is that our laws remain relevant to the demands of society, particularly in the localities to which they’re applied.

Toward Liquor Control’s authors conducted hundreds of interviews of a cross-section of 1930’s American society – across professions and localities. They also investigated liquor laws in various other developed countries. Their stated goal was to achieve temperance: to avoid, on one hand, a prohibition imposed against the will of the governed and, on the other, a drunkenness that couldn’t be stemmed merely by self-control. One of the conclusions (a premise, really) of the study is that a key culprit of pre-prohibition excesses was the “saloon”, which they used to introduce the concept of the “tied house”:

The saloon, as it existed in pre-prohibition days, was a menace to society and must never be allowed to return. Behind its blinds degradation and crime were fostered, and under its principle of stimulated sales poverty and drunkenness, big profits and political graft, found a square foothold.

“Tied houses”, that is, establishments under contract to sell exclusively the product of one manufacturer, were, in many cases, responsible for the bad name of the saloon. The “tied house” system had all the vices of absentee ownership. The manufacturer knew nothing and cared nothing about the community. All he wanted was increased sales. He saw none of the abuses, and as a non-resident he was beyond local social influence.

Aside: It’s interesting to note here that the tap room of a brewery does not have the vices of absentee ownership that concerned the study’s authors.

The report proposes two regulatory regimes for states to consider:

1. Control system: The state establishes a controlled monopoly who buys alcohol from manufacturers and sells to individuals. This promotes temperance by ensuring a completely independent retail tier – one that could not be (legally) influenced by manufacturers to stimulate demand for alcohol. The state monopoly would serve only to meet “the unstimulated demand within conditions established solely in the interests of society”.
2. License system: The state issues licenses for the manufacture, distribution, and sale of alcohol. The state licensing board should use all available means to prevent tied houses.

Between the two systems, the authors urge states to pursue the control system, warning that the license system “contains a fundamental flaw in that it retains the private profit motive which makes inevitable the stimulation of sales”. However, the authors concede that many states will adopt it anyway, and they were right. Most states adopted a license system, and all of those states insisted on three separate tiers in order to prevent tied houses³. Hence, the license system became known as the Three Tier System, designed to promote temperance by prohibiting tied houses.

Does it really do that?

But how likely is it, really, that this system of alcohol regulation is promoting temperance? Put differently, were the 3T System to disappear tomorrow, how long would it take for our society to drift back into the drunken excesses of pre-prohibition? Or, would we even drift at all? This question appears difficult to answer. Some argue that the pre-prohibition nightmare is revisionist history – that The Liquor Problem was overblown by a group of intolerant puritans with an agenda to impose Prohibition. Others, especially 3T System proponents, use a form of Pascal’s wager: Even if it’s unlikely that removing the 3T System would bring about a drunken mess, why take the chance? Why mess with the 3T System after it has proven its ability to maintain temperance for so long, by prohibiting tied houses? After all, we can plainly see that tied houses do not exist. Or do they?

Enter, Pseudo Tied House

There’s a bar, not far from my house, whose beer selection is almost entirely AB-InBev products. Bud, Bud Light, Mich Ultra, Karbach, Shock Top, Goose Island, Stella. There are a few token non-AB taps: Corona, Saint Arnold, Sierra Nevada – but these come from the same distributor. That distributor (the largest AB distributor in the U.S.) installed the bar’s draft system and services it. They provided glassware, coasters, decorations, t-shirts, tap handles, ice buckets, and bar mats to the bar – essentially providing capital to the bar just as an owner would. While the bar carries some non-AB products, the AB products are what the bar advertises. A mural outside the bar shows the fierce “Hopadillo” mascot, and inside there are posters informing you that said IPA is available at a bargain price. Signs in the bathrooms urge you to refill your bladder with a cheap bucket of Bud Light. The bar’s entrance is adorned with flags that say “Dilly Dilly”, as if their allegiance to the crown were otherwise in doubt.

However, even if the retailer is not purely independent, an independent distributor would ensure a buffer between the brewer and retailer — hence the three tiers. It’s true that the distributor, Silver Eagle, is not owned by AB-InBev, but how independent are they? That giant Bud Light building on I-10, west of town, is not a Bud Light building, but the Silver Eagle headquarters. Silver Eagle’s Twitter handle is @BudLightHtown. The Bud Light trucks are driven by Silver Eagle. Ask a Silver Eagle employee who he works for, and you might hear him tell you, casually, “Bud” (I have). Using its market power and financial resources, AB is able to influence its distributors as if it owned them⁴, and, in turn, that influence extends to retail establishments. There is no buffer.

Recall the definition of “tied house” above (reprinted here for convenience):

“Tied houses”, that is, establishments under contract to sell exclusively the product of one manufacturer, were, in many cases, responsible for the bad name of the saloon. The “tied house” system had all the vices of absentee ownership. The manufacturer knew nothing and cared nothing about the community. All he wanted was increased sales. He saw none of the abuses, and as a non-resident he was beyond local social influence.”

The first part of the definition is well-known: Tied houses are “establishments under contract to sell exclusively the product of one manufacturer.” However, the second part of the definition is critically important context, explaining why the tied house threatens temperance: “It has all the vices of absentee ownership. The manufacturer, a non-resident of the community, was beyond social influence and cared only about increased sales.”

The bar mentioned above (the archetype of many bars we’ve all seen), with its devotion to one manufacturer and the promotion of its products, behaves the same way. It may not be under exclusive contract, but it’s heavily under the influence of a manufacturer, pushing that manufacturer’s products with the objective of increasing its sales, and that manufacturer is a foreign multinational – the most absentee-ish owner imaginable. The bar itself may even be part of a chain with its owners outside its community. These bars (and restaurants, and airports, and sports stadiums) are not tied houses, per se, but they behave the same way. They are pseudo tied houses, and they’re everywhere.

The Monopoly Argument

The crux of the most credible 3T System defense is that it exists to prevent tied houses (which is true). However, proponents of this argument rarely elaborate on why the tied house must be prevented. When they do, they use a fabricated reason: They tell us that tied houses must be prevented to prohibit a monopoly by a single producer⁵. Tom Spilman of the Wholesale Beer Distributors of Texas tells us the system requires separate tiers “to avoid the vertical monopolies and market abuses that limit brands available”. However, this concern is nowhere to be found between the binds of Toward Liquor Control, whose authors cared zero for the number of brands in the marketplace. This foundational text⁶ makes it clear that the objective is not “market order” (whatever that is) or competition, but temperance, and temperance alone. And a pseudo tied house poses the same threat to temperance as an actual tied house.

Time to Stop Pretending

I have no problem with these pseudo tied houses. However, the fact that they’ve been allowed to proliferate is sufficient evidence that the 3T System is not serving its intended purpose, which, to beat the horse some more, is to promote temperance. To get back to the question posed above: Imagine we dissolved the 3T System today. AB-InBev would be free to outright buy that pseudo tied house and make it into a proper tied house. All other impacts aside, would it impact our society’s temperance? Most would say, “No”. Take, as evidence, that distributors and other 3T System proponents rarely invoke temperance as a reason to maintain the system. They know that we know that the 3T System does not promote temperance.

So, let’s stop pretending that at the core of the 3T System is a very important purpose, and instead recognize that that core is hollow. What remains is a scaffolding of various ex-post explanations that have been layered on. These explanations continue to evolve in their substance and importance, the most minimized of these explanations being the system’s founding principle of temperance. 

Thus, at the heart of Distributors’ justification for arcane beer laws is the 3T System, and at the heart of the 3T System is a purpose that is no longer served. But, make no mistake, it does serve a purpose, which is to enrich a few wealthy distributors. They are the parasites, and the brewers, beer drinkers, and tax-payers are the hosts. This extortion, vast in its mechanisms and consequences, is deserving of its own blog post, which is coming up next in this series.

 

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¹This is evident from the multiplicity of 3T System justifications, many of which could not have existed before the law. For example, the assertion that the 3T System “generates vast choice for consumers” could not have been made until 50 years after its implementation.

²When someone tells you that a certain law is required to achieve “free-market competitive fairness”, it’s probably a law that does the opposite.

³Andrew D’Aversa, Brewing Better Law, p. 1475

⁴The means in which they do this occasionally make news. In 2016, when AB proposed to buy Miller Coors, news surfaced of an incentive program AB offered to its distributors, which provided cash payments based on the percentage of the distributor’s sales occupied by AB. The Department of Justice demanded AB discontinue this program as a condition of the merger. AB complied, but assured its investors that, “It is important to note that while [that program] will no longer exist, we can continue to incentivize our wholesalers in the US in other ways.”

⁵Beer Alliance of Texas: http://www.beeralliance.com/legislation.php

⁶Jim Petro, et al, Intro to Fosdick & Scott, p.1