Alcoholic oriented beverage sales are a highly regulated system that is in all 50 states. These systems are known as both a Three-Tier System and the Control System Model that in employed in 18 Control States/jurisdictions.  Basically, the Three-Tier System is (very simply): Manufacturers provide alcoholic products to Wholesalers/Distributors who then distribute these products to Retailers, and finally the Consumer gets into the mix.

Why must government make a relatively simple distribution issue so complicated?  We are talking about alcoholic beverages and wine in particular. When there are few options the consumer generally loses. Every industry has some form of subterfuge or idiosyncrasies that consumers do not understand, especially when there is no added value to a morass of regulations.   For wine lovers (and all alcohol beverage consumers) the reference is to the complex system of getting wine to consumers.  The logic is somewhat confusing if not totally contradictory. The Three-Tier Distribution System is a government mandated system that must be followed to get alcoholic beverages to the consumer, while protecting fragile consumers from themselves.  Unfortunately, the system is not uniform from state to state relative to laws regulating wine, spirits and beer and has become a veritable moving target for consumers to debate and understand.

This classification of state laws was mandated by the Federal government in 1933 and the system was left to the states to implement and manage.  Basically, the Three-Tier Distribution System mandates the system by which alcoholic wine, spirits and beer producers must employ to get their products to the consumer.  Not surprising, there are a plethora of exceptions to the Three-Tier System and the exceptions are based upon individual state regulations.  Nonetheless, specific to wines, the system mandates (albeit with exceptions to the rule) that producers can sell their wines only to wholesale distributors who then sell to retailers, and only retailers may sell to consumers.  One glaring exception is consumer direct wine sales at the wineries or on-premise winery sales.  Obviously, at every level in the distribution process, there is a mark-up added to the products costs.  This politically mandated control system adds approximately 30% and more to the product cost.

If you are a consumer from Utah reading this, you are a criminal if you bring back a case of your favorite wine from California; two bottles is your limit!  Technically, the Three-Tier System is not about tax collection entirely, those mechanisms are already in place that ensure  governments (state and federal) get their taxes on the alcoholic products produced and sold.

In general, 32 states allow private companies to be distributors and 18 states employ some or all of the “Control Distribution Model” in which the state owns the distribution for retail sales.  Washington and Pennsylvania are two such states.

Generally, state governments allow or give approval for a private company to be the only distributor in a state or region within a state.  Even in those states with multiple distributors, those distributors’ territories are protected by state laws which are ordained by state governments.  To illustrate the detrimental effect such a system can have, imagine if states could authorize/endorse only one gasoline distributor to sell within their state.  Wouldn’t that be a monopoly?

The question that begs asking is: How did we get into this convoluted system of getting wine (beer and spirits also) to the consumer?   The Three-Tier System is not about getting taxes to state and federal government.  Collecting that tax was decided long ago. The history of any tax on alcohol goes back to 1791 when Alexander Hamilton proposed an excise tax to help fund a federal government.  The common man felt this “tax” targeted the citizen excessively.  Alcoholic drink was considered a staple of life, part of the social fabric, and was akin to taxing the air they breathed.  Thus eventually the Whiskey Rebellion came into being in Pennsylvania. But, the excise tax remains to this day.

It was the passage of the 21st Amendment, repeal of the 18th Amendment, which gave the individual states the right to control most aspects of alcohol beverage (beer, wine, and spirits) distribution.  Depending on one’s predilection, two of the stated objectives of the Three Tier System were: states were interested in keeping citizens from excess consumption and yet they wanted to encourage sales for the tax revenues.  It might have even been a way to reward a few companies with franchises.   In any event, this evolved into the Three-Tier Distribution System in 1933.

The NABCA represents the Control States Systems (similar to the Three-Tier System but a state owned distribution system) and promote the benefits of a Three-Tier System/Control State System:

  • Regulatory-Each Tier in the System is responsible for ensuring laws are executed; self regulation.
  • Economic Benefits-“Impacts society with tax dollars” which support government programs.
  • Public Health Benefits-Can protect public from tainted alcohol.
  • Commercial Benefits-Manufacturers have equal access to the marketplace, thus more consumer choices.

Note: On June 25th, a class action lawsuit was filed against AB InBev for fraudulently advertising their Beck’s Beer as being a German beer.  It was noted that no distributor participated in the lawsuit to “protect” the consumer which is purported to be a guiding principle of the Three-Tier System.

The threats to the Three Tier System/Control State System’s come in the form of de-regulation, which is gaining a consumer voice and advocacy.  In most instances the large manufacturer industry leaders want to keep the Three-Tier System for some obvious reasons.  Remember in the late 1970’s the airline industry was deregulated and predictions that America’s airline industry would crumble.  It did not.

Outside of the Three-Tier System, other industry distributor networks exist by voluntary/free choice participation of their customers. These are distributors who provide a service for a competitive fee.  The Three-Tier System is based solely upon government mandates at the state level.  In fairness, this industry generally promotes stated values of: Encouraging moderation, Generate tax revenues for governments, Avoiding/monitoring aggressive marketing by producers and sales practices, and Facilitate state and local control of alcoholic beverages.

From a consumer viewpoint there might be problems with the system that was put in place 83 years ago:

  • There is an added 30%, or more, cost added to the product (wine). It would be up to the consumer, and the producer, to ascertain the financial value of these added costs to the product.
  • It tends to promote monopoly practices in states. Producers have no choice relative to negotiating with a third party relative to getting their products distributed; even at what added costs.  Without true competition what leverage do producers control? For sure, small producers can’t compete with big guys when trying to work with a distributor.
  • Today the Three-Tier System is a conglomeration of distribution companies.
  • Producers (small wineries) cannot compete on shelf space at the retailer level because the distributor promotes brands based upon revenues they receive from product sales.
  • Increased costs are disproportionately high on small producers that produce limited wines (varietals).
  • Large distributors can dictate distribution term to smaller producers.
  • In a macro market sense, the Three Tier Distribution System may not be competitive for U.S. producers; one size does not fit all.
  • In some instances a Three Tier Distribution System will not afford a small wine producer access to markets (local or national). A fact of any channel of distribution, sometime it is not financially viable for a distributor to warehouse, sell, deliver and shelf manage wines that are in small production.  Even introducing a wine that is new, with limited marketing budget, it can be cost prohibitive.

Note: Beer is one of the alcoholic beverages that have very few exceptions to the rule.  With some exceptions, retail sales are through distributors only.  However most notably is the “brew pub” which is defined as an establishment that brews and sells its own beer on their own premises.

To avoid getting into a quagmire in discussing distribution of each type of alcohol products let’s stick with wine.  Wine distribution, for many reasons, has a lot of deviations from Three Tier System distribution’s general rules and they vary by state.  The options for wine distribution are as follows-with significant variations by state:

  • Direct to Consumer shipments (DtC)
  • Self Distribution
  • On Premise sales (at the winery)

As simple as wine sales concepts are, there are many law firms that help wineries navigate the plethora of complex regulations specific to sales in each state and even cities and counties within a state.

With changes and even expansions of other channels, the Three Tier System gets tweaked a little bit year after year as markets emerge and the industry changes.  Still, the Three-Tier System is larger than all the other channels combined.  The wine industry (in the U.S. and California in particular) has changed greatly as more wineries are started and vineyards/wineries have become tourist destinations. For example, in the very late 1960’s Robert Mondavi had the vision and imagination to make Northern California Wine Country an attraction unto itself.  This one event helped expand the on-premise winery channel of distribution through winery tasting room sales and wine clubs.

The craft beer business has also come into being with vengeance and the public has responded.  We now have brew pubs and venues with 100’s of beer on tap at a single location and consumers can buy take-out containers of their favorite brews (called growlers-64oz.)

Direct to Consumer – Wine

This is a growing segment of the wine industry and probably has come about from four sources-consumer visits to wineries, organized wine tasting events, recommendations from friends, and restaurant experiences.

If you find an out of state wine you like, it still doesn’t mean you can go on-line, join a winery wine club or call the winery and ask them to ship you a case.  The availability still must be determined by such things as state laws, how much wine the winery produces, licenses the wineries with the receiving state and even common carrier agreements.

Ship Compliant and Wines and Vines Analytics reports that DtC (Direct to Consumer) wine shipments increased 15.5% in 2014.  That translates to 3.95 million cases of wine.  To add some perspective, Gallo produced over 80 million cases for U.S. consumption.  The average price of a bottle of wine shipped directly to the consumer was $38.40; a relatively expensive wine.

In 2014, 60% of all Direct to Consumer (DtC) wine shipments were to five states; California, Texas, New York, Florida and Illinois.  It also appears that newly enacted changes in state laws in 2014 simplifying DtC shipments were a welcomed change for consumers.  In Montana such changes resulted in a 245% increase in DtC sales and in North Dakota there was a corresponding 61% increase.

In summary, 43 states allow shipment of wine to the state and 7 do not.  The states not allowing DtC shipments are: Alabama, Delaware, Kentucky, Mississippi, Oklahoma, Pennsylvania, South Dakota (until 2016), and Utah.

As noted earlier, all states either use a Three-Tier Distribution System or a Control System (these are systems that operate like the Three Tier System but are owned and operated by the individual states).  Bottom-line, every state controls wine sales to consumers in some form.  The exception to these rules is that DtC shipment states allows consumers to buy wine direct from the producer.  However, the great equalizer is shipping costs passed along to the consumer which, depending on the volume of the purchase, can be significant.  It’s kind of a–pay the distributor or pay the shipper on DtC shipments.

Even in California, held up as being the poster child of DtC shipping, requires a Three-Tier Distributor to bring wine into California from out-of-state wineries.

As reported by Wine Folly, there are only 17% of U.S. wineries that have national distribution.  There are various reasons: some wineries are too small to be economically viable for a distributor to carry the brand, the winery may not produce enough labels to make it attractive for a distributor, price point of the wine is too low and/or not enough corresponding volume sales, or a distributor wants to much of a discount to be profitable for a winery.  In all of these instances a Direct to Consumer model is a great alternative.

Self-Distribution

Self-Distribution refers to the ability of a winery to act as their own wholesaler by selling directly to retail and restaurant companies.

Fourteen states allow wineries to Self-Distribute, but it is not an easy process; with an avalanche of bonds to post, licenses, applications, reports and paying excise taxes; all of which are different in each state.  Interestingly, California does allow for self distribution for the in-state wineries.  Many wineries in California have sales staffs that sell their wines to restaurants and retailers.

Just like the Three-Tier System, Self-Distribution is defined by different rules established by each of the states that allow wineries to Self-Distribute.  To illustrate this point with 2 examples: Arizona allows Self-Distribution for wineries producing 20,000 gallons or less of wine.  In Illinois an out-of-state winery who produces less than 25,000 gallons annually may Self-Distribute.  However, the Self-Distribute exemption allows for the sale of not more than 5,000 gallons of wine to a retailer annually.  This just illustrates the complexity of distribution options in various states.

Bottom-line there are approximately 10 states that do not allow any shipments to consumers.  In fact, if you’re a resident of Utah and you buy a case of wine during a winery visit in Sonoma, CA, you could be committing a felony offense if you bring that wine back to your home in Utah.  In some other states wineries must purchase a yearly permit from the state just to ship to you.

On-Premise

This approach does not require much explanation.  But, buying a few bottles of wine and going to your hotel, asking the concierge to ship it for you using your FedEx number…don’t count on it getting delivered unless the hotel has an alcohol shipping license.  Solution is to keep the wine with you.

If people are interested in following the events of getting laws changed relative to the Three-Tier System and other related issues, I have been impressed with– Fermentation: The Daily Wine Blog http://www.fermentationwineblog.com put out daily by Wark Communications.  There are others but this blog is one that lobby’s politicians on behalf of the wine consumer and the blog is written with an eye towards the consumer.

A casual wine consumer is probably not interested in the politics of wine.  Frankly, consumers should be concerned when there may be little added-value for the imposed distribution costs of wine.  DtC may be an emerging alternative but the laws are not uniform across states.  If you go to a wine mart or even Costco, depending on states, you are probably paying a 30% plus added cost for a Three-Tier System distributor; simply because of an 83 year old law.

Consumers will pay for value received but give the producer or consumer the option of choosing.  They will state their preferences at the cash register.

Cheers!