31
Chapter 3
The Future of the Three-
sell a little wine or stronge water to some natives in theare sickness.”4 Five years later, an ordinance was passed that forbade providing alcoholic beverages to Indians, and permitted anyone finding an Indian in possession of alcohol to confiscate it.5 So began liquor control in America.
From the Colonial period through the institution of national Prohibition with passage of the 18th Amendment, liquor control focused on either an outright ban on liquor sales or laws regulating the conduct of those trafficking in or using bever- age alcohol. Although there was no attempt to force the liquor industry into “tiers,”
first the Colonies and then the States licensed and taxed producers and retail sellers in a variety of ways. There were laws to proscribe the proper times for the sale of alcohol (“It is ordered, that no house of entertainment shall suffer any person to tipple after nine of ye clock at night; except they can give a satisfactory reason to ye constable of magistrate,” March 16566). Other laws prohibited the amount of alcohol that can be sold to particular classes of people (e.g., Indians were limited to a quarter of a pint per day).7
One of the first Sunday sales prohibitions was enacted in 1673, not for reasons of religious conviction, but to keep people from drinking too much on a day that most people did not work. Because most people considered Sunday a holy day and therefore gave their employees and family this day off, they “soe spend it in debaist- ness or tipplinge and unlawful games and wantonness . . .”8
Rather than prohibiting drinking, the colonists sought to license the sale of alcohol. Indeed, drinking establishments were encouraged. For example, in 1654, Rhode Island towns were ordered to license “one or two howses for ye entertainment of strangers, and to encourage such as shall undertake to keepe such howes.”9
Until the early 20th century, state liquor control waxed and waned between outright prohibition and licensing systems, with some states experimenting with local control, as the public grappled with the effects of beverage alcohol on pub- lic health and welfare.10 Before Prohibition, the alcoholic beverage industry was divided essentially into suppliers and retailers. Except for parts of the beer industry, there were no wholesalers.11 The suppliers were able to exercise tremendous influ- ence over those retailers that they did not directly control through ownership by extending credit and other financial incentives. The resulting fierce competition was perceived as forcing drastic increases in consumption, which led to drunken- ness and financial ruin, impoverishing the working man and his family. In an era of debtor’s prisons, when women were unable meaningfully to enter the workforce, the family of a drunkard quickly became a public charge. The supplier/retailer com- bine used its financial strength to corrupt political power to protect itself from building public outrage. The combination of social cost with political corruption was the “tied-house evil” that Prohibition sought to sweep away.
Prohibition did not work; instead, it made the alcohol problem worse. Because it was illegal, liquor took on an aura of glamor. The speakeasy was the place to be. Increased profitability led to more aggressive marketing and murder became a method of competition. Those who liked to drink refused to be told they could
The Future of the Three-Tiered System n 33
not, so many otherwise law-abiding citizens became criminals. The illegal prod- uct was unregulated, untested, and thus frequently dangerous to drink because it became much more potent and adulterated. The sale of beverage alcohol was even more lucrative as an illegal enterprise, so organized crime was strengthened, if not created. Corruption of public officials increased. Government was deprived of tax revenue at the same time that it had to spend more to enforce and cope with the damaging effects of Prohibition.12 Prohibition could not last.
When it became clear that the experiment with national prohibition had failed and the 18th Amendment would be repealed, it was obvious that the responsibil- ity for controlling the sale of alcoholic beverages would fall to the states. John J.
Rockefeller, Jr., a lifelong teetotaler concerned about the consequences of alcohol legalization, commissioned a study by Raymond B. Fosdick, a lawyer, and Albert L. Scott, an engineer, to develop a program of “carefully laid plans of control.”13 Fosdick and Scott concluded that the best method of control was through state management of the distribution and sale of alcoholic beverages. However, they recognized that many states would reject public monopoly of distribution in favor of licensing private enterprise, so they presented both monopoly and licensure as alternative methods.14 Fosdick and Scott postulated that it was central to regula- tion by license that “[t]he ‘tied house,” and every device calculated to place the retail establishment under obligation to a particular distiller or brewer, should be prevented by all available means.”15
Fosdick and Scott’s work was very influential in shaping the states’ efforts to enact liquor control. A minority of states adopted variations of the monopoly model, whereas the states that chose regulation by license created detailed systems to avoid the “evil of the tied house.” As of 2000, eighteen “control” states main- tained some form of monopoly based on alcohol content and market segment: New Hampshire, Pennsylvania, and Utah control wholesale and retail sale of moder- ate and high alcohol content beverages (wine, fortified wine, and spirits); Idaho, Michigan, Montana, North Carolina, Ohio, Oregon, Vermont, and Washington control wholesale and retail sale of high alcohol beverages spirts (fortified wine and spirits); Mississippi and Wyoming control wholesale of moderate and high content beverages; and Alabama, Iowa, Maine, Virginia, and West Virginia control whole- sale of high content beverages (Figure 3.1).16
The states that rejected monopoly selected licensing along the model of Fosdick and Scotts’ “three-tiered system,” interposing a wholesaler level between the supplier and retailer, as the best method of correcting past abuses, establishing an orderly system of distribution and control of alcoholic beverages and preventing the evil of the “tied house.” The wholesaler was intended to be a local, almost exclusively fam- ily-owned business that would spend years and a great deal of capital developing its business marketing brand name alcoholic beverages in its community. With all its capital at risk, the wholesaler has a strong incentive to avoid regulatory sanctions.
Wholesalers protect their interest by being good corporate citizens and becoming politically active. In addition, the states are able to collect taxes at the wholesaler
level, which provides the states with an efficient, reliable, and cost-effective revenue source that is easy to police. But the three-tiered system means more than just a division of distribution functions among supplier, wholesaler, and retailer. Other restrictions were thought necessary to restrain the natural capitalist drive toward increased profit and growth. The license states frequently adopted other regulatory measures to promote temperance by keeping the retail segment fragmented and weak, such as restrictions on “inducements,” the number of off-premise consump- tion outlets that can be owned or controlled, and even price controls. Nonetheless, protecting each tier of the industry from domination by the other is vital to main- taining the three-tiered system.17
The 21st century presents a far different economic environment from that in which the states crafted their methods of alcohol control based on the Fosdick and Scott method. The combination of social, economic, and technologic changes typified by deregulation, economic consolidation, and mass communication are discussed in detail elsewhere in this work. For the purpose of this chapter, it is suf- ficient to note that 1) public attitudes toward consuming alcoholic beverages have been shaped by sophisticated advertising; 2) deregulation of business is the norm if not the goal of today’s political system; 3) systems for ordering, transporting, and delivering all products are much more efficient; and 4) perhaps most significantly, there is an inexorable trend toward consolidation at every level of the industry that
NoneRetail and Wholesale of High Alcohol Beverages
Retail and Wholesale of Moderate & High Alcohol Beverages Wholesale Only of High Alcohol Beverages
Wholesale Only of Moderate & High Alcohol Beverages
Figure 3.1 Alcohol content and the states’ control over market segment.
The Future of the Three-Tiered System n 35
mocks the goal of fragmented, weak players that will be unable to wield political and marketing power.
A prime example of consolidation at the supplier level, now dominated by gigan- tic multinational corporations, occurred in 1998. Bacardi purchased the Dewars and Bombay brands from Diageo plc. The Federal Trade Commission had ordered Diageo to divest those brands because, as a result of its creation by consolidation, Diageo was so enormous that it would be a violation of federal antitrust laws to retain them.18 Indeed, as shown in Figure 3.2, in 1999, five of the top 100 suppli- ers accounted for 41.8 percent of the sales volume, with $22.92 billion in sales of distilled spirits, and just ten of the top 100 spirits marketers account for more than 50 percent of total sales volume, with more than $32.25 billion in sales.19
In another example, the array of brands that had been controlled by the Joseph Seagram Companies was transferred to other suppliers, including Diageo and Per- nod Ricard. The disappearance of Seagram altered the arrangement of the world’s top five distilled spirits marketers giving the top five companies a 43 percent world market share (Figure 3.3).20
Most recently, Pernod Ricard has bought the wine and spirits business of Allied Domecq, exponentially concentrating the supplier tier.
Occasionally, the top management of suppliers will reveal an agenda that is contrary to the purpose of the three-tiered system. For example, in a 1999 inter- view, UDV’s chief executive Jack Keenen made a statement calculated to keep wholesalers on edge.
Q: Are you satisfied with current arrangements at the U.S. wholesale tier, or might there be future change?
A: We haven’t finished our value chain work. There’s clearly opportu- nity for distributors and brand owners to do things more effectively and determine more clearly who does what. Chuck Phillips will be looking at key states and determining the right moves for UDV and our dis- tributors. ...21
More recently, the chief executive of Kendall-Jackson Wine Estates was less subtle in announcing his company’s agenda with respect to the “value chain.”
Q: Speaking of the value chain, have you taken a look at the issues regarding distribution in this market?
A: Yes. My position is this: Distributors will continue to be very impor- tant to us, but they’re not the only way that wine will reach the con- sumer. We need to understand that, and so do our distributors.22
It is not surprising then that similar consolidation has been occurring at the wholesale level. In 1975, there were some twenty-five major alcoholic beverages wholesalers of wines and spirits in Massachusetts. In 2004, there were three, which operate regionally in New England and elsewhere. Nationally, the top twenty wine
Share of Top 100 Company # of Brands Sales Volume
Cases × 106 Retail Value
$ × 106 Sales
Volume Retail Value UDV (Diageo)23
The Seagram Co. Ltd.
Allied Domecq VAO Sojuzplo-doimpor Bacardi Ltd.
Total Top 5 Pernod Ricard Suntory Ltd.
Brown-Forman Moet-Hennessy (LVMH) V&S Vin & Spirit AB24 Total Top 10 Jinro Ltd.
William Grant & Sons Remy Cointreau SA Polmos/
Agros Trading Takara Shuzo Co. Ltd.
Total Top 15 Other companies Total Top 10025
13 8 8 3 3 3 6 7 4 1 2 55
2 2 2 2 2 65 35 100
55.5 20.3 22.2 105.6 24.0 227.5 16.2 12.6 11.8 2.8 7.8 278.7 47.2 4.6 2.5 8.8 14.0 355.9 188.5 544.3
$8,785 4,130 3,775 3,545 2,690 22,920 2,180 2,035 1,985 1,670 1,495 32,285 1,450 1,190 1,050 865 840 37,680 11,305
$48,985
10.2%
3.7 4.1 19.4 4.4 41.8 3.0 2.3 2.2 0.5 1.4 51.2 8.7 0.9 0.5 1.6 2.6 65.4 34.6
100.0% 100.0%
17.9%
8.4 7.7 7.2 5.5 46.8 4.5 4.2 4.1 3.4 3.1 65.9 3.0 2.4 2.1 1.8 1.7 76.9 23.1
Figure 3.2 100 Top distilled spirit brands worldwide at retail by marketer through 1999.
The Future of the Three-Tiered System n 37
and spirits wholesalers controlled 67.9 percent of the entire U.S. market. The top wine and spirits wholesaler, doing business in more than twelve states, had a 17.2 percent market share.30 Now that wholesaler has bought an interest in one of the three New England regional wholesalers, increasing its overall market share and geographic reach.
Off-premises retailers and chain retailers are challenging state restrictions on entering the market.31 To the concern of wholesalers, Costco has brought suit in federal court in Washington to force the state to allow it to bypass the three-tiered system and deal directly with suppliers.32
As social, economic, and technologic changes have evolved to undermine the three-tiered system, changes in constitutional doctrine have undermined its legal foundation, which depends on giving the states virtual carte blanche to fashion liquor control.
The three-tiered system was intended to suppress the natural drive of business to increase profits by increasing consumption. But, as the industry has evolved after Repeal, the federal Constitution has been the instrument by which the most aggressive actors in the alcoholic beverages industry have overcome the tight regu- lation required to maintain the logic of the three-tiered system. State price controls that required suppliers to sell in state at the best price offered anywhere in the county were stricken as violative of the Commerce Clause.33 State mechanisms for controlling wholesale prices through private price posting arrangements have also fallen.34
Governmental attempts to dampen demand by restricting advertising have fared no better. The First Amendment has been found to protect commercial speech con- cerning alcoholic beverages in spite of federal regulation.35 And notwithstanding the 21st Amendment, the states’ power to regulate advertising has similarly been Figure 3.3 World’s top five distilled spirits marketers29 (before and after the Sea- gram sale). Source: Impact Newsletter, January 1, 2001, p. 15 (M. Shanken Com- munications, Inc. New York, NY).
Millions of Nine-Liter Case Depletions
Rank 1 2 3 4 5
BEFORE Company UDV (Diageo) Allied Domecq Seagram Co.27 Bacardi Ltd.
Pernod Ricard
Volume 98.8 43.6 41.9 34.2 27.8
AFTER Company26 UDV (Diageo) Allied Domecq Seagram Co.
Bacardi Ltd.
Fortune Brands
Total Top 5 246.3 Total Top 5
Top 5 Companies’
World Market Share28
Top 5 Companies’
World Market Share 41%
Volume 112.8 43.6 41.6 34.2 23.2
255.4 43%
Rank 1 2
4 5 3
curtailed.36 Indeed, the states have not been able to implement an effective ban on billboard advertising.37
The conflict between the economic forces at work in the alcoholic beverage industry and the three-tiered system as envisioned by Fosdick and Scott will be resolved politically either through legislation or litigation. The leading edge of that resolution is the Supreme Court’s decision of the direct shipping cases, which pres- ent the forces working against the traditional three-tiered system in microcosm.
Direct shipping of alcoholic beverages from suppliers to consumers, and its cousin, direct dealing of suppliers with retailers, anathema to the three-tiered system, is the result of inexorable social, economic, and technologic forces. The consumer culture spawned by advertising and facilitated by mass retailing and Internet commerce is based on choice and price, neither of which is a friend of strict control under a rigid three-tiered system. Within the recent past, states, responding to economic forces and perceived popular will, or effective lobbying, have passed laws liberal- izing parts of their alcohol regulatory schemes by bypassing the three-tiered system.
In particular, states have allowed in-state wineries to sell or ship wine directly to consumers in their state, while prohibiting out-of-state wineries from doing the same. Out-of-state wineries protested these laws as discriminatory in violation of the Commerce Clause of the U.S. Constitution. The states responded that it was within their power under the 21st Amendment. As a result, federal courts across the country have had to resolve the tension between the “dormant” aspect of the Commerce Clause and the 21st Amendment, but the proponents of direct shipping make their case by presenting the tension as existing between modern, dynamic, innovative free enterprise and anachronistic concerns with the long-banished “evils of the tied house.”
Section 2 of the 21st Amendment prohibits “[t]he transportation or importa- tion into any State, Territory or possession of the United States for delivery or use therein of intoxicating liquors, in violation of the laws thereof...” Although Section 2 directly authorizes state control over imports, “dormant” Commerce Clause juris- prudence concludes that the grant of power to Congress to regulate interstate com- merce implies a limitation on state authority over the same subject. Initially, the Supreme Court afforded the states nearly limitless power to regulate alcohol under the new amendment.38 However, as early as the 1960s, the Supreme Court signaled a break with this line of reasoning. In Hostetter v. Idlewild Bon Voyage Liquor Cor- poration,39 a case involving the prohibition of liquor sales to departing international airline travelers, the Court observed:
To draw a conclusion from this line of decisions [Ziffrin, Young’s Mar- ket, etc.] that the Twenty-first Amendment has somehow operated to
“repeal” the Commerce Clause whenever regulation of intoxicating liquors is concerned would, however, be an absurd oversimplification.
If the Commerce Clause has been pro tanto “repealed,” then Congress
The Future of the Three-Tiered System n 39
would be left with no regulatory power of interstate or foreign com- merce in intoxicating liquor. Such a conclusion would be patently bizarre and is demonstrably incorrect. …Both the Twenty-first Amend- ment and the Commerce Clause are parts of the same Constitution.
Like other provisions of the Constitution, each must be considered in the light of the other, and in the context of the issues and interests at stake in any concrete case.40
In Capital Cities Cable v. Crisp,41 although not a liquor importation or Com- merce Clause case, the Supreme Court found that a state ban on alcohol adver- tising conflicted with regulations of the Federal Communications Commission.
The Supreme Court applied a balancing test to determine “whether the interests implicated by a state regulation are so closely related to the powers reserved by the [Twenty-first] Amendment that the regulation may prevail, notwithstanding that its requirements directly conflict with express federal policies.”42 The Supreme Court concluded that the federal interest must prevail because the state’s banning of alcohol advertising did not directly relate to the core concerns of the 21st Amend- ment (i.e., to exercise “control over whether to permit importation or sale of liquor and how to structure the liquor distribution system”).43
Shortly after Capital Cities was decided, the Supreme Court issued Bacchus Imports v. Dias,44 in which out-of-state wholesalers challenged a Hawaii excise tax exemption for certain locally produced alcoholic beverages. The state argued that the statute advanced legitimate state interests, that it imposed no patent discrim- ination against interstate trade, and that the effect on interstate commerce was minimal.45 The Supreme Court rejected these defenses, finding that “the legislation constitutes ‘economic protectionism’ in every sense of the phrase,”46 and noting that “one thing is certain: The central purpose of the [Twenty-first Amendment]
was not to empower States to favor local liquor industries by erecting barriers to competition.”47 Instead, the Supreme Court considered “whether the principles underlying the [Twenty-first] Amendment are sufficiently implicated by the [tax exemption] to outweigh the Commerce Clause principles that would otherwise be offended.”48 In Bacchus, the state did not contest that the law’s purpose was “to promote a local industry,” so the Supreme Court did not have to engage in the nor- mal Commerce Clause analysis of whether the law was sufficiently closely related to the promotion of lawful interests to vitiate its discriminatory effect. Instead, the Supreme Court held that the law discriminated against interstate commerce in violation of the Commerce Clause and was therefore unconstitutional.
Thus, although the Supreme Court has observed that “the State has ‘virtually complete control’ over the importation and sale of liquor and the structure of the liquor distribution system,” and that “the States have the power to control shipments of liquor during their passage through their territory and to take appropriate steps to prevent the unlawful diversion of liquor into their regulated intrastate markets,”49 it