The kings of beer

How two com­pa­nies are run­ning away with the suds mar­ket

The Washington Post Sunday - - FRONT PAGE - BY STEVEN PEARL­STEIN

Ah, yes, Su­per Bowl week­end. Foot­ball on the wide screen. Home­made chili sim­mer­ing on the stove. And, of course, cold beer in the fridge.

Walk into al­most any su­per­mar­ket or liquor store th­ese days and you’ll find an abun­dant as­sort­ment of beer — the big domestic brands, along with im­ports from ev­ery cor­ner of the globe and craft brands that are pro­lif­er­at­ing at the rate of one per day. In terms of qual­ity and choice, this looks to be the golden age of beer drink­ing in Amer­ica.

But be­neath this be­wil­der­ing va­ri­ety lurks a very dif­fer­ent mar­ket re­al­ity. An emerg­ing du­op­oly has come to dom­i­nate the brew­ing, mar­ket­ing and distri­bu­tion of beer no less than Coke and Pepsi have done for soft drinks.

Once threat­ened by up­scale im­ports and up­start craft brews, du­op­o­lists An­heuserBusch InBev and SAB­Miller now seek to turn va­ri­ety to their ad­van­tage. And while they com­pete with Su­per Bowl-like fe­roc­ity to cre­ate prod­ucts with the best taste, the most in­ter­est­ing pack­ag­ing and most al­lur­ing brand im­age, like all suc­cess­ful du­op­o­lists they take care not to com­pete too fiercely on price.

So it is not with­out sig­nif­i­cance that last week, af­ter years of ac­qui­es­cence to the beer in­dus­try’s re­lent­less con­sol­i­da­tion, government an­titrust of­fi­cials de­cided enough was enough. On Thurs­day, the Jus­tice De­part­ment went into fed­eral court to block AB InBev, the world’s and the coun­try’s largest brewer and mar­keter, from buy­ing Mex­ico’s Grupo Modelo, a ri­val that has risen quickly to the No. 3 po­si­tion in the United States on the strength of its Corona brand.

Mea­sured by vol­ume, the com­bined com­pany (Bud­weiser, Beck’s, Stella Ar­tois, Leffe, Bass and Lowen­brau, plus Corona) would con­trol more than 50 per­cent of the U.S. mar­ket. That would be nearly dou­ble the mar­ket share of ri­val SAB­Miller (Miller, Coors, Pil­sner Urquell, Peroni, Grolsch, Fos­ter’s and Mil­wau­kee’s Best) and elim­i­nate any

Then there were two

The ex­treme con­cen­tra­tion in the beer mar­ket is a rel­a­tively re­cent devel­op­ment. In 1980, there were 48 ma­jor U.S. brew­ers, ac­cord­ing to an en­light­en­ing report is­sued last year by the New Amer­ica Foun­da­tion. But all that be­gan to change in the 1990s, as the re­main­ing lo­cal and re­gional brands found they could not com­pete with larger ri­vals that ben­e­fited from the economies of scale and mounted well­funded na­tional ad­ver­tis­ing cam­paigns.

Global con­sol­i­da­tion be­gan qui­etly in 1987 when two of Bel­gium’s top brew­ers formed In­terbrew and spent the next 15 years buy­ing up other na­tional cham­pi­ons. In 1999, In­terbrew joined with two of Brazil’s largest brew­ers to form AmBev.

Mean­while, South African Breweries (SAB) em­barked on a sim­i­lar shop­ping spree, pick­ing up brew­ers in East­ern Europe, Rus­sia, In­dia and China. In 2002, SAB landed on Amer­i­can shores with the pur­chase of No. 2 Miller, fol­lowed a few years later with Coors and Mol­son of Canada. AmBev waited un­til 2008 to launch its U.S. en­try with its $52 bil­lion deal to ac­quire No. 1 An­heuser-Busch. Both trans­ac­tions won easy ap­proval from the Bush ad­min­is­tra­tion, which rarely en­coun­tered a merger it didn’t judge to be pro-com­pet­i­tive.

Sud­denly, in­stead of 48 ma­jor brew­ers op­er­at­ing in the United States, there were two — al­beit two of­fer­ing con­sumers dozens of com­pet­ing brands. To­gether, they ac­counted for nearly 80 per­cent of U.S. beer sales, as mea­sured by vol­ume. Im­ported Heineken (Am­s­tel, Dos Equis) held a steady 4 per­cent of the mar­ket, while Pabst (which no longer brews its own beer but con­tracts with SAB­Miller to make its Sch­litz, Stroh and Lone Star brands) clings to a 3 per­cent share. la­tent threat to the cur­rent du­op­oly.

An­heuser-Busch InBev (ABI) must now de­cide whether to fight the government in court or walk away from the deal and pay Modelo a hefty $650 mil­lion breakup fee.

And as for those 2,000-plus in­de­pen­dent craft brew­ers, they ac­count for less than 6 per­cent of the mar­ket, with nearly half of that coming from just two brew­ers, Yuengling and Sam Adams.

Which brings us to Modelo, whose Corona and other Mex­i­can im­ports now claim about 6 per­cent of the U.S. mar­ket. In re­cent years, Corona has been in a head-to-head bat­tle with AB InBev’s Bud Light for the af­fec­tions of Amer­i­can con­sumers — in par­tic­u­lar, women and His­pan­ics. ABI re­sponded to the cross-bor­der chal­lenge by in­tro­duc­ing Bud Light Lime, a not-too-sub­tle echo of the lime wedge that bars stuff into the neck of each bot­tle of Corona. Corona fought back with Corona Light. Corona vs. Bud Light

What few peo­ple out­side the in­dus­try re­al­ized was that, back in 1993, An­heuserBusch had bought a non-con­trol­ling 50 per­cent stake in Grupo Modelo and through it a 25 per­cent stake in Crown Im­ports, the ex­clu­sive U.S. im­porter of Corona.

In other words, Bud’s par­ent, ABI, prof­ited ev­ery time a bot­tle of Corona was sold in the United States. For ABI ex­ec­u­tives, how­ever, this proved in­suf­fi­cient so­lace. They were more con­cerned with the way Corona had gained its mar­ket share — by re­fus­ing to fol­low ABI’s lead in rais­ing in­dus­try prices and prof­its.

Since 2008, ABI’s hard-nosed chief ex­ec­u­tive, Car­los Brito, has made no se­cret of his aim to end the price wars that for years de­pressed prof­its in the U.S. beer in­dus­try. Price com­pe­ti­tion was in­evitable as long as there were lots of brew­ers with ex­cess ca­pac­ity com­pet­ing for mar­ket share. But Brito’s strat­egy was that con­sol­i­da­tion would elim­i­nate the ex­cess ca­pac­ity and make it pos­si­ble for the hand­ful of re­main­ing firms to reach a tacit agree­ment not to com­pete on the ba­sis of price.

In­side ABI, the strat­egy was known as its “Con­duct Plan,” which the Jus­tice De­part­ment, in its suit, char­ac­ter­ized as a “how-to man­ual for suc­cess­ful price co­or­di­na­tion.” Each Au­gust, ABI would an­nounce its in­ten­tion to raise prices in Oc­to­ber and then wait to see how ri­vals would re­spond. As Brito had hoped, SAB­Miller an­nounced a sim­i­lar in­crease. A re­cent report by the Amer­i­can An­titrust In­sti­tute found that since 2008, de­spite a re­ces­sion and a mod­est de­crease in the amount of beer it sold, Amer­ica’s beer du­op­o­lists have in­creased prices, op­er­at­ing prof­its and share prices.

Brito’s strat­egy might have worked even bet­ter if Modelo had played along. In­stead, Modelo used the price in­creases to nar­row the gap be­tween its more ex­pen­sive Corona and its domestic com­peti­tors. In Cal­i­for­nia, ABI’s losses in mar­ket share were so great that its vice pres­i­dent for sales wrote in a memo that “Cal­i­for­nia is a burn­ing plat­form,” ac­cord­ing to the Jus­tice De­part­ment’s suit. In Texas and New York City, the loss in sales was so great that ABI was forced to roll back its price in­crease, the government says.

By 2011, price com­pe­ti­tion from Modelo also forced ABI ex­ec­u­tives to cob­ble to­gether a plan for de­vel­op­ing its own “Corona-killing” brands. One idea, ac­cord­ing to in­ter­nal memos, was for ABI to ac­quire the U.S. sales rights to Pres­i­dente, the best­selling beer in Cen­tral Amer­ica. An­other was to ac­quire a small craft brew­ery in Mex­ico or the south­west­ern United States.

Th­ese in­ter­nal de­lib­er­a­tions se­ri­ously un­der­mined ABI’s claim that its pur­chase of the rest of Modelo would in no way hurt com­pe­ti­tion in the U.S. beer mar­ket. If ABI were to gain con­trol over Corona’s sales and mar­ket­ing ef­fort, it is in­con­ceiv­able that Modelo would not shift course and align it­self with ABI’s pric­ing strat­egy. And it surely wouldn’t go to the ex­pense of hav­ing Bud­weiser launch new “Mex­i­can” brands to com­pete with Corona. The fa­cade of com­pe­ti­tion

In­deed, what ABI would have achieved with Modelo is the mar­ket nir­vana that cor­po­rate ex­ec­u­tives have dreamed about for­ever — the ap­pear­ance of com­pe­ti­tion with­out any real com­pe­ti­tion.

ABI and its lawyers nat­u­rally re­ject this char­ac­ter­i­za­tion of the Modelo ac­qui­si­tion. They ar­gue that what really mat­ters for Amer­i­can con­sumers isn’t the com­pe­ti­tion be­tween the brew­ers in the United States, since Modelo doesn’t ac­tu­ally brew any­thing here. Rather, what mat­ters is the com­pe­ti­tion be­tween ABI and Crown Im­ports, which would re­tain the ex­clu­sive right to mar­ket and price Corona in the U.S. mar­ket.

More­over, to en­sure the vi­brancy of that com­pe­ti­tion, ABI had agreed to sell Modelo’s stake in Crown to its part­ner, New York-based Con­stel­la­tion Brands, bet­ter known as one of the coun­try’s lead­ing wine im­porters and dis­trib­u­tors. The the­ory was that an in­de­pen­dent Con­stel­la­tion would have plenty of in­cen­tive to max­i­mize its profit by max­i­miz­ing Corona’s sales and prof­its.

Or maybe not. Af­ter all, with­out its own brew­ery, Con­stel­la­tion would still rely on ABI, its com­peti­tor, for its beer. And how could it be sure it could ob­tain all the beer it needed at a com­pet­i­tive price?

Not to worry, said ABI, point­ing to a lengthy sup­ply agree­ment that, for the next decade, was said to guar­an­tee Con­stel­la­tion a per­cent­age of its brew­ery out­put at a price that will rise only with in­fla­tion. Af­ter that, the con­tract could be re­newed or rene­go­ti­ated to the sat­is­fac­tion of both par­ties, or ABI could buy up Con­stel­la­tion’s in­ter­est for a hefty pre­mium.

Th­ese are the sort of “reme­dies” to anti-com­pet­i­tive merg­ers that cor­po­rate lawyers rou­tinely con­coct to sat­isfy the ob­jec­tions of an­titrust reg­u­la­tors. As a gen­eral rule, you can as­sume that they’ve been care­fully con­structed with clever loop­holes and hid­den trap­doors so that, five years down the road when ev­ery­one is look­ing the other way, the merged com­pany will be able to en­gage in pre­cisely the be­hav­ior th­ese agree­ments are meant to pre­vent.

As it hap­pens, Wil­liam Baer, the new chief of the Jus­tice De­part­ment’s an­titrust di­vi­sion, has long been a skep­tic of such sup­ply agree­ments as an­titrust reme­dies. And in this case, his skep­ti­cism was jus­ti­fied. For what he and his in­ves­ti­ga­tors dis­cov­ered was that there had been a heated de­bate for years be­tween Con­stel­la­tion and Modelo over how to price Corona in the U.S. mar­ket, with Modelo push­ing to in­crease mar­ket share through lower prices and Con­stel­la­tion push­ing to fol­low ABI’s price lead­er­ship.

In­ter­nal memos also re­vealed that while Modelo’s pri­mary in­ter­est ap­peared to be to grow its U.S. mar­ket share through long-term brand and prod­uct devel­op­ment, Con­stel­la­tion’s fo­cus was on max­i­miz­ing short-term profit. The dis­pute be­came so heated that Modelo filed suit against Con­stel­la­tion for a breach of its fidu­ciary duty. A merger would fi­nally set­tle that dis­pute by leav­ing the more ABI-friendly Con­stel­la­tion in charge. Dis­ci­plin­ing the dis­trib­u­tors

More­over, as a key sup­plier, ABI would have count­less op­por­tu­ni­ties to re­ward Con­stel­la­tion for fol­low­ing ABI’s lead — and pun­ish­ing it when it did not, just as it has done for years in dis­ci­plin­ing its “in­de­pen­dent” dis­trib­u­tors. Un­der state fran­chise laws, it is nearly im­pos­si­ble for a brewer to ter­mi­nate a con­tract giv­ing a dis­trib­u­tor the ex­clu­sive right to sell a beer in a given ge­o­graphic area. But over the years, ABI has be­come very adept at us­ing car­rots and sticks to get dis­trib­u­tors to toe the line.

Ac­cord­ing to in­dus­try ex­ec­u­tives I spoke with, An­heuser-Busch rou­tinely pro­vides its dis­trib­u­tors with sug­gested whole­sale and re­tail prices. Those who fol­low find them­selves with lower prices for their beer and ex­tra mar­ket­ing money with which to sell it. Those who don’t might find them­selves at the re­ceiv­ing end of late ship­ments of smaller al­lot­ments of hot prod­ucts.

ABI also is well-known for dis­cour­ag­ing them from sell­ing any craft brands that com­pete with ABI prod­ucts, which given its wide port­fo­lio of brands cov­ers just about ev­ery seg­ment of the mar­ket.

In Ohio, for ex­am­ple, ABI dis­trib­u­tors who agreed to help Yuengling ex­pand into that state were re­cently crit­i­cized at a na­tional sales meet­ing for be­ing “dis­loyal,” a Yuengling ex­ec­u­tive told me, while oth­ers were treated to re­peated vis­its from ABI in­spec­tion teams who filed long lists of al­leged vi­o­la­tions of the distri­bu­tion agree­ment.

In late 2011, ABI pro­vided its dis­tribu- tors with a glossy four-color “Whole­saler Fam­ily Con­sol­i­da­tion Guide,” in which it de­clared its aim to fur­ther re­duce the num­ber of dis­trib­u­tors through “vol­un­tary” merg­ers. ABI vowed to des­ig­nate a lim­ited num­ber of “an­chor dis­trib­u­tors” that it wanted to do the buy­ing. They would re­ceive fi­nanc­ing and other as­sis­tance from ABI. All the rest were ex­pected to sell out, and ABI warned that it would ex­er­cise its rights un­der the distri­bu­tion con­tract to pre­vent them from sell­ing to any­one other than an “an­chor dis­trib­u­tor,” even if oth­ers were will­ing to pay more.

Among the cri­te­ria for se­lect­ing “an­chor” dis­trib­u­tors: align­ment with ABI’s pric­ing strat­egy, re­fusal to carry com­pet­ing prod­ucts and sup­port of ABI po­si­tions on leg­isla­tive is­sues.

Over the past decade, there had al­ready been sig­nif­i­cant con­sol­i­da­tion among beer dis­trib­u­tors. While this re­flects the com­pet­i­tive push to achieve economies of scale, it has also been driven by the ma­jor brew­ers for more “align­ment” in their distri­bu­tion net­works — hav­ing one dis­trib­u­tor in each ter­ri­tory for all of their brands. As a re­sult, the distri­bu­tion mar­ket has also be­come an ef­fec­tive du­op­oly, with one ABI and one Miller dis­trib­u­tor in each ter­ri­tory, to­gether ac­count­ing for well over 90 per­cent of sales in many mar­kets.

For im­porters and craft brew­ers, the only choice is to hitch a ride on one of the two trucks or sign up with one of a dwin­dling num­ber of in­de­pen­dents who have no ac­cess to con­ve­nience stores or chain re­tail­ers. Most in­de­pen­dents also don’t have the sales­men or trucks to call on the full range of restau­rants, bars and liquor stores. Go­ing with an in­de­pen­dent dis­trib­u­tor ef­fec­tively en­sures that a small brewer will re­main small for­ever. It’s all about shelf space

It’s some­thing of a mys­tery why the Jus­tice De­part­ment has al­lowed such a pow­er­ful du­op­oly to de­velop both among brew­ers and dis­trib­u­tors. But its an­ti­com­pet­i­tive ef­fect is mag­ni­fied by the fact that big re­tail­ers are now con­tract­ing with one dis­trib­u­tor to serve as “cat­e­gory cap­tains,” with the re­spon­si­bil­ity to man­age their shelves, se­lect point-of-sale mar­ket­ing and, in some cases, even set re­tail prices. Un­der th­ese ar­range­ments, a lucky dis­trib­u­tor is re­spon­si­ble not only for man­ag­ing the sale of its own beer in each store but also the beer of its com­peti­tors.

“When I walk into a store, I can tell within 30 sec­onds whether the cat­e­gory cap­tain is Bud or Miller,” one craft brewer told me. The cap­tains put their own prod­ucts in the prime po­si­tions at eye level at the ends of the aisles, many with point-of­sale dis­plays. Typ­i­cally, craft brews mar­keted by other dis­trib­u­tors are rel­e­gated to top and bot­tom shelves in the back aisles.

How much does place­ment mat­ter? Be­cause beer is an im­pulse pur­chase, brew­ers say shelf place­ment can swing the sales vol­ume in any store by up to 50 per­cent.

All of which ex­plains why craft brew­ers, in par­tic­u­lar, have qui­etly op­posed ABI’s ac­qui­si­tion of Corona. They fear that giv­ing ABI any more mar­ket clout will only strengthen its hold on dis­trib­u­tors and put com­pet­i­tive pres­sure on SAB to do the same. The re­sult they fear is that all but the strong­est craft brands will be marginal­ized or thrown off the de­liv­ery trucks.

“You’re damned right I feel threat­ened right now” by ABI, said Jim Lutz, pres­i­dent of Delaware-based Old Do­min­ion Brew­ing. “And I can as­sure you I’m not alone.”

It’s also not lost on the craft brew­ers that, through the pur­chase of key whole­salers in 17 states, ABI it­self is al­ready the coun­try’s largest dis­trib­u­tor, han­dling at least 10 per­cent of its na­tion­wide sales. ABI’s goal is to raise that to 50 per­cent.

The real ques­tion raised by ABI’s ac­qui­si­tion of Corona isn’t so much whether the deal would re­duce com­pe­ti­tion in the U.S. beer mar­ket — it’s how such con­cen­tra­tion was al­lowed to de­velop in the first place.

With the help of cat­e­gory cap­tains, that du­op­oly now ex­tends from the brew­ers right down to liquor store shelves and bar­room taps. And if it is al­lowed to strengthen, it will not only dampen any se­ri­ous price com­pe­ti­tion but grad­u­ally chip away at what Barry Lynn of the New Amer­ica Foun­da­tion calls the “ri­otous jun­gle” of craft beers now on of­fer to ur­ban con­sumers.

For the Amer­i­can beer in­dus­try, it seems, ev­ery week­end is Su­per Bowl week­end — it’s just that it’s al­ways the same two teams on the field.

JOHN JAY CABUAY FOR THE WASHINGTON POST

MARVIN JOSEPH/THE WASHINGTON POST

D.C.’s Churchkey bar and Birch & Bar­ley restau­rant of­fer craft beers. The na­tion’s 2,000-plus in­de­pen­dent craft brew­ers ac­count for less than 6 per­cent of the mar­ket, with nearly half of that coming from Yuengling and Sam Adams.

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