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Is There a Future for the Three-Tier Alcohol Beverage Distribution System?

The repeal of Prohibition in 1933 by the 21st Amendment of the United States Constitution not only reinstated the legality of alcohol beverage consumption, but also introduced a new system for alcohol beverage distribution: the three-tier system. The three-tier system creates a platform between alcohol beverage producers, distributors, and retailers. The underlying purpose of this system is to divide the legal responsibilities of the three tiers on the basis of state (and, in some cases, federal) regulation. Specifically, the three-tier system allows only producers to sell to distributors and only distributors to sell to retailers (who can then sell to consumers). Under this system, there are no direct sales between the producers and retailers (or the producers and consumers).

Not all states within the United States embrace the three-tier system of distribution. In fact, several states are called alcohol beverage control states and their state governments maintain a legal monopoly over the distribution tier. Several more states even monopolize both the distribution and retail tiers. These alternative systems are still, essentially, a three-tier system and the difference is simple: a state-operated distributor as opposed to one that is privately operated.

Notwithstanding the above, the majority of states within the United States outlaw the direct sale of alcohol beverages from the producer directly to the retailer (or even the consumer). Wine producers must sell directly to wholesalers who, in turn, sell to restaurants. The results of this system for consumers can be dismaying: higher prices and a limited selection.

Irrespective of the system’s ramifications on restaurant patrons and retail customers, wineries often face an even greater chilling effect: competition. The three-tier system creates and especially competitive environment to those wine producers seeking to sell their products to large-scale wholesalers and distributors; large distributors are prone to larger producers with broader inventories because it is cheaper (and hence more profitable) and more practical for said distributors to market large volume wines than to promote a collection of smaller quantities. In addition, many distributors are faced with external pressures by restaurants, who prefer to purchase wines from distributors with more expansive selections. Essentially, this current model damages the small-scale wine producer, as well as heightens prices for the customer.

Recently, alternatives to the three-tier system of alcohol beverage distribution have been suggested. Some support opening the market to allow wine and other alcohol beverage producers to sell directly to retailers, thus inflicting a free movement of wine, while still allowing wholesalers to capitalize on bulk wine sales from large-scale producers. This proposal would not only lower the cost to consumers, but also expand the variety of wines available in retail sale. Wineries would also be able to market to out-of-state consumers, allowing an expansion of not only market territory but also consumer tastes in wines. (Currently most wines, with some exceptions of course, produced in a state are marketed to the state in which they are produced; the only way in which an individual of one state can experience wine produced in another state is to visit said state.)

However, advocating such change does not come without legal examinations; if the three-tier system is to become antiquated, new federal and state regulations must be imposed. The regulation of wine sales across state lines from producers to retailers or consumers must be considered. More so, the regulation of international sales must also be contemplated.

Recently, the United States House of Representative introduced H.R. 5034 (the Comprehensive Alcohol Regulatory Effectiveness Act (“CARE”)), relative to the regulation of the three-tier alcohol beverage distribution system and reflective of the Supreme Court decision Granholm v. Heald, 544 U.S. 460 (2005). This bill, along with its (currently) precedent case, will be discussed at a later date at On Reserve.

(Source: A Perspective on Wine Regulation: Patrick Duffeler)

DISCLAIMER: This blog post is not intended as legal advice, and no attorney-client relationship results. Please consult your own attorney for legal advice.

lazahn 9 Is There a Future for the Three Tier Alcohol Beverage Distribution System?

About 

Lindsey is the founder and author of On Reserve: A Wine Law Blog. She is an alcohol beverage and food attorney and is admitted to the New York State Bar.

{ 5 comments… add one }

  • Tony Jelke July 28, 2010, 6:21 PM

    The topic of the three tier system is one that has been discussed for decades within the alcohol industry, but never the less is one that is still captivating. As a student of the Wine Business Program at Sonoma State University and current employment in the Sonoma County wine industry, I am well attuned to the subject. Like many aspects of our political system, there are positive and negatives. The level of distribution serves many purposes such as providing wineries a means of communication and logistics with retailers and the end customer. On the other side, the more middlemen are involved the more the end cost will be. There seems to be a plethora of solutions, suggestions, alternatives and innovations but the first real big step into improving the system is to implement standardization and uniformity. I argue that before we decide whether or not to uphold or negate the current system of alcohol sale and distribution, the alcohol industry needs to work harder to create a more uniform system. The first step is to standardize the laws and regulations governing the sale and distribution of alcohol across all states. Each state has their own set of laws, taxes and with that comes excessive red tape and excessive costs. By implementing a more current and innovative business solutions mentality all parties from the winery to the consumer will benefit overall.

  • Vic Motto July 30, 2010, 1:30 PM

    The 3 tier system, despite it’s shortcomings and challenges is an important link between producers and the trade. Consumer-direct and direct-to-trade sales (DTT) are also important.

    The U.S. wine market is highly fragmented with over 10,000 domestic and foreign producers trying to sell over 100,000 SKU’s to 750,000 trade licensees spread over millions of square miles. That fragmentation requires the use of local distributors to reach the broad market and handle the logistics inherent in this complex environment. DTT will eventually work for larger sales to larger accounts and chains. It will also eventually work for allocated wines sold to high-end on premise accounts. Consumers can get special wines directly from consumers. But, until tens of thousands of broad market retail accounts go out of business, the industry will need distributors.

    The U.S. wine industry is going through a major transformation over many decades, from a generic agricultural commodity industry to an increasingly fragmented branded premium wine market. This transformation is stimulating massive changes in the distribution model, revolutionizing U.S. wine distribution. Distributors are changing, but will always be needed. New routes to market are also being created and are also badly needed. These are dramatic changes, but all for the better.

  • Tom Wark August 2, 2010, 5:56 PM

    Vic:

    The issue has never been whether the marketplace will need distributors. In fact, I know of no one who has ever suggested that distributors need or should or could be removed from the chain of commerce in alcoholic beverages.

    The real question, however, is if there remains today, 75 years after the three-tier distribution system was implemented and in a market that does not resemble in any way that of the 1930s, any good reason to stifle competition, stifle free trade and give distributors such enormous power that results form MANDATING the use of a distributor.

  • Vic Motto August 3, 2010, 4:12 PM

    Tom, of course the mandate or requirement to use distributors was the issue for many years, but post-Granholm (2005), the issue has shifted to legalizing alternative routes to market, like consumer-direct and trade direct. Creating and developing these alternatives is a more productive and more readily acheivable approach, in addition to evolving the effectiveness of the three-tier system, which is slowly ongoing. Ending the mandate sounds good in principle, but unless the system is changed to actually work, it would be a pyrrhic victory.

  • Lindsey A. Zahn August 4, 2010, 10:13 PM

    Just to reaffirm what Vic said, there has been much discussion on the limitations of the three-tier distribution system with respect to wineries directly shipping to out-of-state consumers. In many states, it is against state laws for out-of-state wineries (/producers) to ship directly to consumers within said state; for consumers to receive wine in such a manner can constitute a felony. To legally obtain wine from an out-of-state producer, a consumer in states with such regulations must go through the middleman distributor (and hence face markups).
    Like Vic stated, much contemporary discussion post-Granholm ponders as to whether there could be an alternative structure for out-of-state consumers to receive wine directly from wineries. But again, a newly imposed system would have to be effective on all ends.

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