The Great Debate: The Three-Tier System Is Fundamentally Broken

G76 Debate - Three Tier System - Illustration by Will Dinski
Illustration by Will Dinski

After Prohibition ended in 1933, states were in need of a better system to regulate the manufacture and distribution of alcohol. They needed a way to discourage large breweries from monopolizing the industry, and to ensure that products were being made and transported safely. In Minnesota, like many others, the result was the establishment of three different tiers of alcohol-related businesses—manufacturers, distributors, and retailers—each with their own set of privileges and responsibilities.

Now, we wonder if this system has outlived its usefulness. The Minnesota Legislature has passed several notable exemptions to these tiers—the Surly Bill being the most famous. Critics argue that the system is not responsive to our modern drinks landscape and mainly empowers distributors at the expense of the other tiers.

But proponents say the system has worked well and will continue to. That it demands accountability from all its players and ensures fair business practices. And that it’s succeeded in preventing an alcohol monopoly—the boom in small breweries is exactly the result that the system is set up to foster and promote.

AGREE

By Jeffrey C. O'Brien

Jeffrey C. O’Brien is an attorney with the Minneapolis-based law firm of Chestnut Cambronne PA. For the past decade, he has worked with numerous breweries, distilleries, wineries and other related organizations on issues of liquor law compliance.

Some years ago, I attended a panel presentation regarding the future of the three-tier system.  One of the panelists was a lawyer and lobbyist for beer wholesalers in another state. When posed asked why wholesalers oppose most, if not all, legal reforms offered by manufacturers, he was brutally honest: “we like the way the current system works because we make a lot of money under it.”  

I have to say, I appreciated his honesty.

The exponential growth in Minnesota’s craft beverage industry during the past decade is largely due to reforms to Minnesota’s liquor laws—allowing off-premise sales directly from the brewery or distillery, brewery self-distribution rights, taprooms and cocktail rooms. This craft beverage boom has increased jobs and tax revenue for the State of Minnesota (in 2018, according to the Brewers Association, Minnesota craft breweries had a $2.12 billion economic impact in the state). 

These reforms are exceptions to the three-tier system which has dictated that manufacturers, wholesalers, and retailers must stay in their own lanes.

The three-tier system was created in hopes of more effectively regulating alcohol sales than the disastrous Prohibition laws that preceded them. The system obligates manufacturers to utilize a licensed wholesaler to distribute their products to retailers, save and except for limited rights of self-distribution granted to small breweries and farm wineries.  

For breweries who engage a distributor, beer franchise laws limit their ability to terminate a wholesaler who is not performing according to the brewery’s satisfaction. Moreover, large national manufacturers have figured out how to game the system by maintaining their own network of wholesalers, which allows them to exert the type of influence that the franchise laws were designed to prevent. Small, local breweries are not able to do so, which puts them at a competitive disadvantage.

Opponents of liquor law reforms aimed at removing restrictions from the manufacturers have cited the need to preserve the three-tier system as a sufficient objection. As if preservation of this system is now the objective in and of itself.  

Preservation of the three-tier system has, in essence, become the battle cry of maintaining the wholesalers’ leverage in the marketplace.  

 

I have no qualms with how the three-tier system works in regards to large producers such as AB InBev. But as it relates to smaller manufacturers in Minnesota, those who benefit from the three-tier system—primarily wholesalers—have succeeded in capping the few exceptions to the general rules of distribution at arbitrarily low levels. 

To fix the current system, I believe that additional exceptions should be created:

  • Increase the production threshold of 20,000 barrels/year, above which breweries are forced to discontinue growler sales. This limit specifically discriminates against the shortlist of breweries that have grown large enough to utilize the services of a wholesaler (and thus support the wholesale distribution network the most.)
  • Provide a “small brewer exemption” to Minnesota’s beer franchise law, similar to what has been enacted in several other states, exempting breweries who represent a small percentage of a wholesaler’s portfolio from the beer franchise laws which severely restrict a brewery’s ability to terminate a relationship with a wholesaler even when the wholesaler is not meeting its obligations.
  • Increase the current allowance of “one 375-milliliter bottle per customer per day” that microdistilleries can sell direct to consumers for off-sale.
  • Increase the production limit for a microdistillery to maintain a cocktail room beyond the current 40,000 annual proof gallon limit (one proof gallon is 6.25 standard 750ml bottles) and allowing microdistilleries to self-distribute a limited quantity of their products.
  • Remove the prohibition against a manufacturer operating a co-located taproom/cocktail room (current law allows a party to hold brewery and distilled spirits plant licenses but they cannot serve both products for on-premise consumption).
  • Allow all wineries and cideries to self-distribute up to 75,000 gallons per year, as farm wineries currently do.

The basis for alcohol regulation in Minnesota is to regulate alcohol manufacture and sale as a public safety issue. Thus, when looking at proposed reforms, the key question should not be “how would the new law affect the three-tier system?”, but rather “does this new law create a public safety issue,” with the understanding that causing manufacturers to make more money (and wholesalers to make less) is not a public safety issue. As Prince once famously said, “the baker should enjoy the bread.”

Correction: The original argument stated that one proof gallon is 631 standard bottles; one proof gallon is 6.25 standard 750ml bottles.

DISAGREE

By Brandt Erwin

Brandt Erwin is Vice President of the Minnesota Beer Wholesalers Association

In Minnesota, alcohol is regulated through a three-tier system of alcohol distribution where each tier of the system—suppliers, distributors, and retailers—are restricted to their own service function. Suppliers, such as brewers, make the product. Distributors store, sell, and deliver the product to retailers. And retailers sell the product, either on-sale or off-sale, to consumers.  

This separation among the tiers provides a level playing field for small businesses in our state, enabling them to compete against global behemoths and create jobs. Among other things, the three-tier system is designed to prevent any industry member, particularly large suppliers, from monopolizing distribution and retail sales. This system benefits consumers by providing unprecedented choice and variety and benefits new market entrants by lowering the barrier to entry.

The three-tier system also has brought us strong consumer safeguards and helped the beer market grow and thrive like never before. This system keeps consumers safe from the dangerous sale of contaminated alcohol, which is a major public health risk in other countries. For example, the strict record-keeping requirements that distributors are obligated to retain allow for a recall to occur expeditiously should a contaminated product be discovered. Independent beer distributors are licensed by the state and federal governments and source high-quality beer only from federally-registered brewers and sell it only to state-licensed retailers.

These safeguards also protect against potentially dangerous business practices while ensuring the safety of products for consumers. For example, these laws prohibit a supplier from terminating a distributor, the majority of which are local, family-owned businesses, because a distributor refuses to violate federal or state alcohol laws – such as selling to unlicensed retailers or engaging in deceptive or irresponsible business practices, designed to favor only certain suppliers to the exclusion and detriment of other suppliers. Such conduct, which was commonplace before Prohibition, has a negative impact on each member of the industry, as well as consumers.

Prior to Prohibition, the over-eagerness of some brewers to dominate the market led to a situation where they would bankroll retail locations, usually saloons, and contractually require the staff to serve only products of their particular brewery. This was a major barrier for access to the marketplace for competitors and restricted the variety available to consumers.

Following Prohibition, each state, through thoughtful deliberation, adopted its own regulatory framework that has led to a system that prevents monopolies by alcohol companies, holds bad actors accountable and guarantees competition among suppliers, distributors, and retailers. This system facilitates a competitive marketplace open to all brands—big and small. 

It is this three-tier system that has contributed to the successful boom in craft beer. Brewers can partner with distributors and access new markets through local relationships without being blocked by larger beer companies. 

 

It’s this very structure that supports a competitive marketplace that generates unprecedented choice and variety for consumers. These laws allow distributors to function as an independent business not beholden to one manufacturer. Because of this system, consumers have access to a vast selection of beer brands, and independent beer distributors can invest in new brands without fear of retribution from existing brands they represent.

Furthermore, under this system, independent beer distributors give suppliers, large and small, unparalleled access to an array of markets. This also allows distributors to respond to local consumer trends occurring in specific markets without undue influence from any one brand. Whereas brewing beer requires a significant amount of capital investment, so too does distributing products—including warehouses, cold storage, trucks, and personnel. Because of the three-tier system, suppliers can leverage their distribution network, and the significant capital investments made by those distributors, to expand their reach and create a market for that supplier’s products within their territory. 

Critics of the three-tier system often seek to dismantle its structure through new exemptions that would provide advantages to the manufacturers over distributors and retailers. Yet, the irony is that manufacturers have been able to succeed as a direct result of the regulatory structure in place, which provides a level playing field to all manufacturers.

It is evident that Minnesota’s current alcohol regulations have given us a thriving industry for small businesses in all tiers that can offer competitive prices and a wealth of choice for consumers. The recent craft beer boom is a testament to the success of these fair and balanced regulations. Why change a good thing?