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October 3, 2018 • Volume 26


Is this the last call for the three-tier alcohol distribution system?

I’m preparing to speak at a wine industry event in Napa, California. It’s a tough job, but someone’s gotta do it. Despite the drudgery of having to spend a couple of days in one of the more beautiful places on earth, [hopefully] sampling its prize crop, I’ve been able to find solace in digging more deeply into Rakuten Intelligence’s data on online sales of wine.

Let’s begin with a few fun facts about online wine:

  • Taking the merchants that Rakuten Intelligence measures [composed of the bigger national retailers of wine, excluding the direct sales of most wineries], online wine is big business, exceeding $500 million in sales in the past 12 months [between September 2017 and August 2018].

  • Wine is the dominant form of alcoholic beverage sold online, accounting for 79 percent of alcohol sales (dollars) online.

  • Sales of wine online have grown at a compound annual sales growth rate of 44 percent, powered largely by growth in buyers. Average spending per person has been flat-ish [by online standards].

Naked Wines was the leading US retailer of wine in the most recent 12 months, by a long stretch. For those unfamiliar with Naked Wines, check it out. It’s sort of an Amazon Prime for wine, with an “indie” financing model built in. For $40 per month, members can buy wine at wholesale prices – generally around 50 percent of the stated retail price [I can’t vouch for the validity of the ‘retail’ prices, of course]. Membership fees are used to seed [pun intended] independent winemakers’ production.

For those of you unfamiliar, in the US we have developed what has become a state legislated three-tier alcohol distribution system. Producers of wine, beer and spirits can only produce. In the middle of the producer and the retailer sits the wholesaler, whose presence is mandated by state law. Producers can’t sell, except in the small scale cases where they have exemptions [think wineries and brewpubs] that allow them to sell directly to consumers. Retailers can sell alcohol at any price they’d like, as long as that price is at or above the minimum price set by the state, in many states. 

Because retailers need to be competitive with one another, states essentially set prices. The only real price competition is between retailers close to state borders, where consumers can drive over the border to buy booze in states with lower tax rates. This explains why Dad hits the last liquor store in New Hampshire on the way home from vacation.

Shaken or stirred -- What’s in store for the future of alcohol distribution?

In an effort to smarten up, I talked with a few wine industry veterans, who all told me that the three-tier distribution system is here to stay, despite the fact that it is essentially a sharp stick  in the eye to free market economics.

As an interloper in the alcoholic beverage industry with 20 years of experience watching seemingly entrenched categories [music, books, TV, taxis, hotels, etc…] being disrupted by the combination of technology, entrepreneurship, and venture capital dollars, I’m going to take the broader view that no set of norms is sacred in today’s retail economy.

It seems that the lobbying organizations of the big alcohol wholesalers [the middle tier in the three-tier distribution system] have pulled off a remarkable coup for more than 80 years. Despite changing political climates, no political party has dared challenge this system, which effectively [at least] doubles the price that consumers pay for alcohol. Some argue, in fact, that the higher prices generated by the three tier system are a good thing, compelling us to control our instincts to drink too much.  I’m not sure that I’d want to be known as the the politician willing to build his brand on cheaper booze. 

Despite this, I see three reasons that this regulatory system could be undone much quicker than the alcoholic beverage industry thinks.

States are getting contentious
While each state gets just two Senators, bigger states have the ability to exert influence beyond their borders. California is the best example, mandating more fuel efficient cars than federal standards, and getting away with it because it has so much spending power. Liberal states, frustrated by the election of Donald Trump, have considered joining the Paris Climate Agreement, and have refused to support enforcement of harder-line immigration tactics. Ballot initiatives have legalized marijuana despite hostility from the federal government. The idea of a state, or two, or three going rogue is actually underway, with Washington State [sort of] doing away with the three-tier distribution system.

Risk-loving entrepreneurs
Entrepreneurs aren’t like normal people in their capacity for business risk. And there is a subset of entrepreneurs that make regular entrepreneurs look like IBM lifers by comparison. Let’s take Airbnb for instance. Back in 2008 when the founders of Airbnb started renting their inflatable mattresses out to strangers, I’m fairly confident that it didn’t occur to them to check with the landlord or the city to make sure that it was cool. They just did it, and they scaled it until it popped on the radar of cities around the world.

Each significant growth stage for Airbnb was created by a ‘beg for forgiveness, don’t ask for permission’ ethos, I’m guessing. The support of their passionate customers gave them all of the leverage they needed when they ultimately had to negotiate with regulators, making reasonable concessions that left them with a model that never would’ve been approved if permission had been sought on day one.  

The marijuana precedent
Finally, we’ve got legal marijuana in a growing number of states. And guess what?  None of those states have [yet] chosen a three-tier distribution system. The state regulates the growers and the retailers, and hasn’t felt a particular need for the unnecessary markups that wholesalers would bring. Of course, wholesalers from the alcohol and tobacco industries [oh yeah, a similar system is in place in the tobacco industry] are trying to change that by arguing that there is a need for a wholesale distribution layer in the legal marijuana industry. If this two-tier distribution system holds up in the marijuana industry, it could set a promising precedent for consumers of alcohol.

However, the counter to my argument is a strong one and I want to acknowledge so here.  

First, booze isn’t like music.  Selling alcohol illegally is a felony [while I’m pretty sure that allowing a stranger to sleep on your couch isn’t] - something that even the boldest of entrepreneurs (Julian Assange aside) are going to be wary of.  Second, there are significant constitutional issues wrapped up in this issue; namely a conflict between the Interstate Commerce Act and the 21st Amendment that needs to be resolved at the Supreme Court level. And finally, and most importantly, there are those that argue that the three tier system actually works well if you put the pricing issue aside, and that if we did away with the requirement for a wholesale tier something else would evolve that plays the same role.

Will the three-tier alcohol distribution system collapse? Factors are lining up that seem to endanger it like never before. At the end of the day, though, it is going to be up to the consumer to force change. Will wine drinkers mobilize, or will they decide that they’ve got bigger political causes to champion and choke down their delicious, but overpriced wines? But we all need to understand that industries resistant to change are being forced to change at a rate we’ve never seen before.  

Put another way, the status quo ain’t what it used to be.

About Ken

Ken Cassar is vice president, principal analyst at Rakuten Intelligence, where he looks at trends in the e-commerce industry armed with Rakuten Intelligence's robust set of online sales data.

Ken brings a rich online retail background to Rakuten Intelligence. Most recently, Ken was SVP, Media Analytic Solutions at Nielsen, where he developed several innovative digital commerce measurement and advertising effectiveness solutions. Prior to Nielsen, Ken was an analyst at Jupiter Research, where he was an early thought leader, trusted adviser, and media source on e-commerce. His prescient outlook on fledgling e-commerce industry was a key contributor to Jupiter’s dominance as a digital media zeitgeist at the dawn of the Internet.

Ken has an MBA and Bachelors Degree in Political Science from the University of Connecticut. Ken aspires to stay technologically ahead of his teenage children, as evidenced by his ‘Gadget Geek’ Rakuten Intelligence's profile. He also has the appropriate jacket for every occasion.