Does the three-tier system in the US still have legs?

The US’s three-tier distribution system for alcoholic beverages will be 90 years old next year, and some are questioning whether it may have outlived its usefulness, reports Roger Morris.

Opponents of America’s three-step system of alcohol sales – producer to distributor to retailer to consumer – argue that the process throttles innovation, competition and consumer choice and should to be dumped. The system’s defenders, on the other hand, fear its historic role as market regulator is being eroded by direct-to-consumer sales.

In truth, there is not just one three-tier system, but approximately 51 distribution systems for selling alcoholic beverages – one for each state and Washington, DC – all somewhat similar and each intended to provide order in a critical, highly contentious industry by dividing it into three parts – the people who produce wine, beer and spirits or import them, the ones who distribute them and the ones who sell them retail to customers.

The system has been constantly under attack – and vigorously defended – since it was first put in place following the repeal of Prohibition in December 1933. In some ways, it’s a bit like the weather – everyone talks about it but no one has done anything about it.

Now there are fresh attempts to mount an attack and, with it, a defense.

The Wine & Spirits Wholesalers of America (WSWA), which represents the middle part, or “filling,” of the three-tier sandwich is upset that the trickle of direct-to-consumer (DTC) shipments by wineries became a flood during the Covid pandemic. It claims this is a violation of the system and poses an increasing hardship on states who must spend millions of dollars to enforce it. The National Association of Wine Retailers (NAWR) says the WSWA is metaphorically blowing smoke.

Earlier this year, The Federal Trade Commission (FTC) opened an investigation into practices of the WSWA’s largest member, Southern Glazer’s Wine and Spirits, one of two distributors who together control the bulk of the business, for anti-competitive practices.

Finally, perhaps the most-vocal critic of the three-tier system has launched what he says is an independent, one-man attack upon it and by extension the WSWA, admitting that his is perhaps a David vs. Goliath or Quixotic exercise – choose your metaphor.

Prohibition, America’s naive but deadly exercise in temperance which lasted from 1920 to 1933, made most sales of alcoholic beverages illegal and thus fostered the rise of gangs and mobsters who fought a bloody war over who would control the flow of alcohol into each neighbourhood, city and state.

So, once Prohibition was over, the government sought to prevent the rise of monopolies while allowing citizens to have relatively easy access to their booze.

This gave birth to the three-tier system in those states that reintroduced liquor sales, though not all did immediately. As with most rules, there are many exceptions, especially from state to state, and especially in the fine print about practices allowed or forbidden for each tier.

And it should be recognised first off that the current debate is not purely a philosophical one, that it goes beyond giving consumers more choices and protecting the public good. There are millions – billions, actually – of dollars at stake for both defenders and attackers.

Contrasting Views: Defenders of the Faith

The WSWA – the wholesalers – have build a case around the premise that while the system isn’t perfect, it works well and that any attempt to dismantle it will result in disaster.

Their basic stated arguments are

• Distributors are the people who ensure that only customers of legal age are buying only genuine, unadulterated products.
• The system engenders a “competitive, consumer-focused wine and spirits market where craft labels can thrive and innovation breeds success.”
• The tree-tier system works to maintain responsible sale and consumption of alcoholic beverages.
• The system is self-funding by employing a predictable flow of taxation at all levels to fund its operations.

“Alcohol regulation is rooted in the belief that states are the primary regulators of the product,” says Michael Bilello, SVP for communications and marketing for WSWA. “The 21^st Amendment [which ended Prohibition] grants them broad authority to regulate alcohol.  WSWA wholeheartedly supports this state-based system, which recognizes that different states have different beliefs on how alcohol should be regulated.”

This is why, Bilello says, WSWA sees interstate DTC alcohol sales and proposasl for uniform national standards as being corrosive to the system in place. New DTC rules and laws have in recent years permitted American wineries in particular to side-step distributors or wholesalers completely in most states. This began in volume when states began encouraging growth of craft winemaking, brewing and distilling by allowing tasting room and brewpub sales.

Many states subsequently allowed DTC shipments within their borders, but in 2005, the U.S. Supreme Court ruled in Granholm v. Heald that if a state allows such intrastate shipping, it is competitively illegal to prevent interstate shipping. Hence, the flood of wineries building thriving businesses by shipping bottles to their customers to customers in almost all states. A few states, however, still forbid all DTC shipping of alcohol within its borders, regardless of source.

“When out-of-state shipments are allowed, a state’s regulators are faced with an ever-growing number of entities to regulate,” Bilello argues. “This overwhelms the regulator’s ability to regulate alcohol in their state [and] it opens the door to unpaid taxes and products being delivered when and where they shouldn’t.”

Further, WSWA fears that allowing retailers, the bottom tier in the system, to ship directly to consumers is potentially even a larger problem. “Interstate retailer shipping has all the same problems as producer shipping with the added layer that it is often difficult to discern where the retailer obtained the product,” Bilello says. “Retailer shipping opens the door to bad actors who want to capitalize on the scarcity of certain products by selling potentially dangerous counterfeits.”

Contrasting Views: Proponents of Change

It would probably be fair to say that attackers of three-tier agree that some of its elements make economic sense in the marketplace, but they lead to abuses if protected by regulatory law.

Dave Parker is one of the largest online wine retailers, his Benchmark Wine Group specializing in the resale of rare and fine spirits. He is also board president of NAWR, but he notes his comments represent his personal thoughts as a retailer.

“I think the three-tier system provides value in many situations, especially the movement of high-volume product,” Parker says. “Each of the tiers – producing, distributing and retailing – has certain responsibilities and requirements to fulfill, and so separate licensing for each is appropriate.”

But he sees a system out of balance, with wholesalers dictating to the other two tiers while being dominated by two prominent distributers – Southern Glazer’s and Republic National Distributing Company (RNDC) – what Parker calls a “duopoly.”

“Overly restrictive systems include regulations that give undue control over one tier by another, such as sole rights to a producer’s product given to one distributor, or prohibiting a producer from severing such a relationship easily,” Parker says. “Overly restrictive systems also arise when a state discriminates against allowing resellers outside the state from doing business with customers within a state while allowing businesses within the state to transact that same business,” in other words, what Granholm v. Heald allows producers to do.

Each year, there are a flurry of legislative hearings in states to consider tweaking the three tiers, some in ways that would benefit distributors and some that would benefit retailers.

Tom Wark is executive director of NAWR, and in some ways he plays bad cop to Parker’s good cop. Recently, Wark took off his NAWR badge and launched his own advocacy website called “Fermenting Change” (www.three-tiersystem.com) to “eliminate this archaic system harms the alcohol industry and prevents consumers from accessing the products they want.” Wark also has a book, Fermenting Change, that further makes his argument.

“The wholesale side of the alcohol industry has been gaslighting alcohol regulators, lawmakers, members of the alcohol trade and consumers for decades,” Wark contends, “with their false assertions that the three-tier system is necessary to prevent minors access to alcohol, promotes competition, keeps counterfeit products out the marketplace, and prevents monopolies.”

Wark’s proposed alternative system would essentially eliminate wholesalers and retailers as a required step for producers to use, but it would allow retailers most of the same freedoms as producers to ship to consumers anywhere. Using wholesalers would be any economic option for producers to employ. States would regulate how all this would be done.

Enter the Feds

While states may decide how the three-tier system works within its borders, the federal government is in charge of deciding whether laws and regulations are being properly followed at the national level. And while federal regulators do not like to show their hand before taking action, they are not averse to tipping it.

So, in late March of this year, Politico reported, “The Federal Trade Commission has opened an investigation into the largest U.S. alcohol distributor, Southern Glazer’s Wine and Spirits, over practices related to how wine and liquor are priced and sold around the country, according to three people with knowledge of the probe.”

The agency, the article said, was investigating “whether the company has engaged in a wide array of conduct including any unfair, deceptive or anti-competitive business practices, according to [sources]. While Southern Glazer is the only known target of the probe, the agency is seeking wide-ranging information on wine and alcohol sales by distributors and retailers around the U.S., according to the people.”

In response, Bilello comments that, “The President’s Executive Order on Competition directed Treasury to look at the alcohol marketplace.

WSWA submitted comments during that process that highlighted how the alcohol market is more dynamic and competitive than ever with low barriers to entry from a regulatory perspective.”

Parker welcomes the prospect of federal intervention. Whether it’s NAWR and its allies trying to change or abolish the system or WSWA and its allies trying to preserve it, their fighting on an issue-by-issue level on a state-by-state basis is a taxing and expensive endeavour.

“Unless the federal government does step in, it will be a long and gruelling process,” Parker says.