Three Cheers, Three Tiers: Why Alcohol Production, Distribution, and Sales are Legally Separate

For the most part, when Prohibition ended in 1933, liquor laws just reverted to whatever they were before the 18th Amendment went into effect. People were too busy dealing with the Great Depression to try to reinvent the wheel here. There are, however, two big exceptions to this general rule. The first is that authority over alcohol law shifted to states, thanks to the second section of the new 21st Amendment.[i] The result of that shift, of course, is the patchwork of laws that we enjoy today.

The second change was the introduction of laws against vertical integration for alcohol producers. For the unfamiliar, vertical integration is that classic scheme in which a business buys up all the other steps in the process of making their product. The Robber Barons/Captains of Industry of the late 19th century—your Carnegies and Rockefellers—were great at this. Do you make steel? Well, if you buy the iron mine, the smelting plant, and the shipping company that hauls it to and fro, all the profit that used to go to them will come to you, and there will be cost savings aplenty by uniting it all under one management structure. For alcohol producers, especially big brewers like Anheuser-Busch, that meant buying up hop and barley farms, distribution companies, and even bars.

It might seem hard to imagine given the cornucopia of offerings at your average pub these days, but through much of American history bars served only one beer. The name of that beer was plastered all over the place, and in many cases, the brewery that made it had a stake in the establishment.[ii] Even if they didn’t own it outright, in many cases they would provide a new bar owner with chairs, tables, glassware—everything you needed to open, provided you served only their brew. These bars were known as “tied houses,” and their number grew rapidly in the age of industrialization. Since brands were paying them for how much product they sold, they quickly developed a reputation for overserving. Their rise corresponded, not coincidentally, with a rise in the fervor of the teetotalers.[iii]

The close relationship between distilleries/breweries and saloons was a particular source of ire for prohibitionists. Source: National Prohibition Museum

When Prohibition ended, state lawmakers could apparently discern few concrete lessons from our flawed pre-Prohibition regulatory system, but they grabbed on to this idea that manufacturer involvement in bar and retail sales was destructive. Of course, it helped that during Prohibition, the role of producer/distributor was played by gangsters.[iv] Across the country states inaugurated what became known as the three-tier system: production, distribution, and retail, always separate. A company like Pabst or Miller could no longer ship their own product to a store, or own a stake in that store.

Splitting the industry up into tiers served alcohol control interests in several ways. For one, it made the end product more expensive, which reduced consumption. For another, it made it harder to open a bar, since brewers couldn’t front the capital. It also made it easier for states to control and tax the industry, extracting dollars from each stage along the way. Some states actually took over a tier or two, distributing and even retailing the alcohol themselves. These are the ABC states, or Alcoholic Beverage Control, the subject of an earlier article. In non-ABC states “distribution” was essentially a whole new sector, since most large breweries had previously distributed their own product. That sector is reliant on this legally mandated system, giving it incentive to oppose relaxation of a lot of laws.[v]

More obviously, the laws restricted the power of the large breweries, taking away one major avenue for market control. Ironically, however, this system helped those same breweries dominate the industry for the rest of the century, because they made it nearly impossible to start a new, small brewery. A brewpub, where the beer is produced and consumed at the same place, was flat illegal in most states. Small production-only breweries were forced to negotiate prices with giant distributors who were loath to anger their larger clients. If they did take a small brewery’s beer, the markups along the way made it just about unsellable by the time it reached the consumer.[vi] For the craft revolution to occur, exceptions to the law had to be made. Small brewers have been fighting for those changes for forty years—and quite successfully so. At this point, every state now allows some form of brewpub, taproom, and/or self-distribution for small producers.

Present Day

For a while, this model—a blanket law separating the tiers, with exceptions for the micro crowd—has worked pretty well. The laws are easier to enforce when the industry is essentially three smaller industries, and the system prevents what was perceived as the inherent negative incentives of the big brewery-bar relationship.

But the balance might not last much longer. More and more micros are being bought up by giants like AB InBev and MillerCoors, themselves products of consolidation. The law may have made vertical integration illegal,[vii] but the lateral kind is alive and well. Big breweries take advantage of the micro exceptions to operate places like the Blue Moon Brewery restaurant in Denver (Blue Moon is a Coors product), or the gooseshitload of Goose Island brewpubs around the country (Goose Island belongs to AB InBev). As the inevitable Great Beer Agglomeration picks up the pace, the whole point of the three tier system—keeping breweries out of the bar business—could fall by the wayside.

Some states are already worried about this, and the result has been some pretty detailed pieces of legislation, like this one in Texas, or this one in neighboring Oklahoma. These lawmakers are aiming to keep the good bits of the micro exceptions without losing the spirit of the three tier system. Opponents argue that these laws discourage companies from growing beyond the point at which they can no longer take advantage of the exceptions.

Regardless of how you feel about this system, it is worth noting that the arguments surrounding it are quite different from the post-Prohibition days. In 1933, it was a question of moral and social health, with advocates striving to limit alcohol’s deleterious effects. In 2018, it is more a question of economic power, with different branches of the booze industry lobbying for their own narrow financial interest. I expect most politicians will stick with small tweaks to the existing system, and avoid upsetting the proverbial apple cart.

[i] Section 2: “The transportation or importation into any State, Territory, or possession of the United States for delivery or use therein of intoxicating liquors, in violation of the laws thereof, is hereby prohibited.”

[ii] Knowing this makes period piece movies’ heretofore laughable trope of the protagonist asking for “a beer” actually seem well-researched and un-anachronistic. The character would have known what beer they were getting. The branded-bar idea is still common in Europe, though less so as consumers demand a broader selection.

[iii] As always, Ken Burns’ Prohibition covers this well

[iv], esp. footnote 10

[v] For example:

[vi] For more on this, I recommend the NPR show How I Built This’s interview with Jim Koch, founder of Boston Beer Co. (Sam Adams).

[vii] Well, mostly illegal. You can still own farms and control the hop supply.

4 thoughts on “Three Cheers, Three Tiers: Why Alcohol Production, Distribution, and Sales are Legally Separate

  1. Pingback: The Whiskey Trust

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