The term ‘three tier system’ is used to describe how the alcoholic beverage market works in most states. The term is tossed around rather liberally, particularly in articles regarding the ongoing battle of shipping wine to adults across state lines. This has been a hot button issue for at least the last quarter century, and we are sure a lot of consumers wonder what all of the fuss is about. We thought it might be a good time to touch on this issue. It’s complicated, and we should definitely recuse ourselves as we have a definite bias. But here goes anyway.
So what is the three tier system? The explanation is simple enough. It is a system in which each segment of the market is focused on a specific aspect of that market. At the origination level, either wineries (distilleries too for that matter) are producing wines which they then sell to wholesalers or importers are bringing in wines (or sprirts or beer for that matter) which they in turn sell to wholesalers. The wholesalers in turn sell the products to retailers and restaurants who, in turn, sell to the public. The flow chart is simple
Producers/Importers sell to>Distributors who sell to>Retailers/Restaurants
Couldn’t be simpler on paper. But in this ‘eliminate the middleman’ world we live in, there will be someone who will ask the obvious question ‘why do they need a wholesaler?’ Why not just sell direct to those retailers and restaurants? Wouldn’t the price be better without the extra markup? Pretty logical, right? Well, not really and, of course, it’s all about the money.
As you may know, some wineries do sell direct. Usually though they are limited volume brands that have a very tight control on where their wines go and don’t have to spend a lot of money on sales. Their brands are popular enough that buyers seek them out or consumers demand that the outlets carry them. In those cases it is often the case that the cost savings is minimal because the winery would just as soon pocket both ‘cuts’ of the distribution system. Also, out of state, wineries need to have a distributor either for the sake of functionality, or (often) by law.
Because they need to leave a little space to allow the wholesaler in the other states to make a profit, the winery will fix the ‘export’ price at one level (FOB) and then charge the ‘wholesale’ price here in state and keep that portion themselves, effectively selling it to everyone nation-wide at the same price. This provides what the wineries love to call the ‘level playing field’ for one and all. We could go off on quite the rant about how ‘level playing fields’ are like unicorns and leprechauns in that they are an interesting myth (and we still might do that someday). But today we are more on about the ‘why?’.
So why do wineries need distributors at all? Don’t they make more money if they sell it in the way described in the last paragraph? Yes, they do. But only a tiny portion of the winery roster has that kind of clout in terms of demand and can afford to put their own small sales force out in the market for business development and maintenance. Others that don’t necessarily have the situation to support their own sales force will offer their wines through a brokerage, paying a small commission to the seller.
So there still isn’t a reason to go with a distributor, you say. Why not minimize that middle tier cost? Like we said, it’s about the money. Usually brokers can’t sell enough of one winery’s produce to make a living. So they will assemble and represent a group of wineries, giving them more wines to offer clients. On the flip side, there is less time to focus on each of those individual wineries because there are still the same amount of hours in a day (except today of course) and they must attempt to sell everything. So the winery’s ‘sales force’ is marginalized as the representatives must spread their attention among the group. And at the end of the day, the winery themselves are responsible for collecting the money for the wines that the brokers have sold. That is easier said than done.
There are a lot of good operators out in the retail/restaurant marketplace, but also a lot of flakes. It doesn’t take long for a few slow-pays or bad-apples to run up some serious arrears that amount to thousands of dollars. Such sums can be crippling to a lot of wineries. As we have stated before in other pieces, the winery rep has to work very hard just to even get a placement in most restaurants, and then if they have to go back and try and collect that money, even if they are successful, it takes time away from selling.
The distributor model takes away all of that financial risk by buying the wine and reselling it, But they will need to be compensated not only for their investment, but their expenses of maintaining a sales force. And the distributor doesn’t necessarily want to operate as a de facto collection agency. They want the ‘good apples’, to. So typically the arrangement is all or nothing. The winery geets a smaller cut, but their money worries are greatly reduced. The distributor’s existence, the maintenance of an infrastructure, sales force, and as a collection arm, has to all be financed by that extra margin. Wineries love restaurants over retail 90% of the time, but restaurants are still one of the highest failure rate businesses, making money problems part of the territory. It’s not rocket science. Physics is much more predictable.
There is also the delivery system, and the maintenance of other services that the winery would otherwise have to arrange themselves. This model, as we said, largely eliminates financial risks (we say largely because sometimes distributors go under, too, though rarely). It also affords the winery to concentrate on production, broad market planning, going to lunch (see ‘broad market planning’), or whatever they feel they need to do.
Are we saying we embrace the distributor model and feel it is important to maintain the ‘three tier system’? Sort of. We are saying that the model exists for good ‘market’ reasons. In a lot of states, the arcane laws give the distributors almost ‘gangland-like’ fiefdoms, but that’s just the way it is (money, politics, etc.). The bottom line is there is a need for some manifestation of this service in virtually every market.
A winery could sell all of their wine to a big-box store or national chain. That would eliminate the need for a distributor. But they also wouldn’t end up with any other customers and pretty much be at that store’s mercy in time. Distributors ideally mediate that by spreading the product far and wide. It’s just like ‘diversifying your portfolio’ by establishing a broad and varied customer base.
So as to our take on the three tier system is, ‘we don’t have a better idea’. It works well enough and stabilizes the market enough that we can spend time looking for the seams and cracks and pockets where the ‘deals’ reside. The ‘system’ provides options for us to get the things that we want. The middle tier does serve a purpose because the market needs those services and they also absorb some risks. This is from guys (us) who are less in need of those services than most.
What we aren’t keen on is how some of the ‘modern’ distributors are playing fast and loose with the system, and how some of the wineries and importers are playing fast and loose with the distributors. Something’s got to give, but we’ll get into that another time.