The three-tier system: how is it doing? - wine distribution

There has been increasing and sometimes angry debate over the past few years regarding the fate of the three-tier system, that traditional method by which wines get from the producer to the consumer in the United States. Some contend that wines could get to market better without the three-tier network, others believe it is essential to an efficient marketing operation.

John Hinman, a California attorney and one of the leading voices behind the Coalition for Free Trade in Licensed Beverages, views the three-tier system as complementary to a system of direct shipment which is now evolving.

According to Hinman, the three-tier system must evolve to survive. He says the worst case scenario is for the entire three-tier system to be invalidated by the courts, which would lead to chaos. Hinman believes that is a real possibility. The Coalition for Free Trade (CFT) is working to encourage the adoption of legislative safety-valves that allow for market access by direct shippers in every state of the U.S., starting with California. The CFT will work to defeat state efforts at enforcement of what Hinman termed unconstitutional and restrictive state laws until all concerned agree on mutually-acceptable direct-shipping mechanisms.

"The three-tier system will always exist, as long as they provide the necessary service for the big chains. It's the most efficient mechanism for getting wine out in that kind of volume," Hinman said.

"What I see happening is the development of a system where very small lots of wine from small producers or retailers can move directly to the consumer. What might actually happen, as these smaller producers build their market and grow in size, they will outgrow the direct system and step into the three-tier system. That's why the two systems are complementary."

Hinman said the basic laws of supply and demand are behind the movement for direct shipment of licensed beverages to consumers. He contends that direct shipment demand is not driven by price, but by the consistent growth of consumer demand for publicized products not easily available through traditional sources. The current trend in many states toward decreasing the number of licensed off-sale retail outlets makes direct delivery demand even more urgent, according to Hinman.

He cites the explosion in the number of wineries - as well as micro-brewers and micro-distillers, in the face of a shrinking wholesale industry. According to Hinman, the number of wholesalers has declined from 5,000 in 1950 to around 600 today.

"The survival of producers depends upon having access to broader markets through non-traditional channels, such as direct marketing via telephone, mail, wine clubs, internet and customer clubs," he said.

Hinman said that it is impossible for the existing three-tier system to be used by smaller producers since large chain retailers are forcing wholesalers to cut margins and pass on the lower costs to the retailer, squeezing the shrinking number of wholesalers. "Handling small brands makes little sense for most wholesalers because the cost of serving the brands is excessive, giving the profits."

Hinman added that most wholesalers now are focusing on serving chain and large market retail accounts with fewer and more profitable volume brands. Hinman contends that direct shipment does not mean price competition between wholesalers and local retailers and direct shippers. "Direct shipment prices will usually be higher, because transportation costs will always be significantly more than consolidated traditional shipment costs," he said.

The CFT believes that the 21st Amendment of the U.S. Constitution, which apparently gives the states broad power to regulate the sale of licensed beverages, gives them the clear power only to go dry, or to give political subdivisions of the state the power to go dry. The CFT contends that the power of the states under the 21st Amendment is usually curtailed when it conflicts with other provisions in the Constitution. Courts have increasingly struck down state laws based on the 21st Amendment that restrict advertising, or the rights of residents of one state to be a beverage licensee in another state, or price posting or "fair pricing" laws that restrict free competition in trade.

Hinman points to a U.S. Supreme Court decision in 44 Liquormart v. Rhode Island, that held there is no legal way for state regulators to prevent or restrict consumer access to informational marketing publications, websites and other modern communication tools. He believes the stage is set for a dramatic court case that could end with the Supreme Court review of the national three-tier system. "This could happen in Kentucky if it attempts to enforce its felony-sale-of-licensed beverages law."

Hinman believes that the situation will become even more critical as we move away from the present supply-demand situation to a situation of over supply, which he says may be only two to three years away, based on new plantings.

"I think we are looking at an ocean of wine about three years out. That will drop prices and further tighten distribution. The people with shelf space will continue to do well, while the smaller producer will be squeezed even harder," he said.

"What will happen is that direct marketing - either by a winery mailing list, website, catalogs or whatever - will become even more critical. It will be a matter of simple survival to be able to go direct. They will have to go to a nationwide customer base."

What the CFT proposes is legislative actions that tailor statues to fit with individual local and state access. The CFT has proposed a model Interstate Shipping Registration Act which provides, in part:

* Shippers already licensed as producers or retailers in any state, would be eligible to register as an out-of-state shipping licensee.

* Shipper candidates would sign a Shipping Agreement with the state and pay a licensing fee to the state. The agreement would call for all containers to be labeled "Signature of a person over the age of 21 required; a semi-annual tax reporting of total gallonage of alcoholic beverages by type shipped into the state and remission of state excise taxes. The state would send out tax returns to every registered shipper. Shipping records could be audited and the states would identify dry areas by zip code. The shipper would certify that no shipments would be sent to those areas. The registration law would require that the product be purchased only for personal use, not for resale.

The CFT says this model legislation permits state-by-state direct shipper registration in acceptable form with all state interests satisfied, including satisfying citizen demand for access to legal beverage products, preventing sales to minors and collection of excise taxes. The CFT believes that in-state retailers would always be more competitive than direct shippers on the great majority of licensed beverage brands because direct shippers will be required to pay licensee fees and taxes as well as bear the transpiration costs. Direct shipping will free wholesalers to focus on the more popular, profitable and faster moving national brands.

Hinman believes there is a possibility that such direct shipment legislation could be in place in most states within 24 to 36 months, as the individual states realize that the tide is running against them.

For example, in Florida, the attorney general is planning to propose legislation opening up the state to direct shipment, with the only condition being registration and payment of state excise and sales taxes. Hinman said that position is almost identical to proposals made by CFT.

If the new legislation passes, both the Florida federal and state court lawsuits would be dismissed. Hinman says the state's action implies recognition that the current Florida laws will not stand up to the challenges being brought by CFT and sends a strong message to other states to take a hard look at their laws involving direct shipments.

Hinman warned, however that the Florida legislative session, which runs through early May, will be strongly lobbied by opposing forces, anxious to maintain the status quo.

Hinman repeated that the CFT has no desire to dismantle the three-tier system, but to work in tandem with the existing network.

Resources:

Coalition for Free Trade in Licensed Beverages, 244 California Street, Suite 300, San Francisco, Calif. 94111; tel: (415) 362-1215; fax: (415) 362-1494.

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