By Laurie Wachter
Has the time come for small and medium wineries to move beyond the 3-tier distribution system? Should they build direct-to-retailer (DTR) networks across states just as they have developed direct-to-consumer businesses? That’s what attorney John Hinman of Hinman & Carmichael, LLP., an expert in beverage law, believes the recent Supreme Court ruling portends.
In 2016, the state of Tennessee denied retail liquor licenses to Total Wine & More and a mom-and-pop liquor store in part because they didn’t meet a minimum two-year residency requirement. The two companies sued the state and won. Tennessee, however, wasn’t done. They believed that Section 2 of the 21st Amendment gave states the right to pass laws regulating the transportation and use of alcohol in their legal jurisdictions. Tennessee drew on the original purpose of the 21st Amendment to repeal Prohibition, claiming that their residency restriction advances temperance and an orderly market. Their appeal ultimately reached the U.S. Supreme Court, which last summer affirmed the lower court’s ruling. The Court’s decision referenced the Constitution’s Commerce Clause to assert that Tennessee’s two-year residency requirement “blatantly favors the state’s residents and has little relationship to public health and safety” and is therefore unconstitutional.
Hinman calls this a “landmark decision that could change the landscape” of alcohol’s three-tier distribution system for all three beverage types—wine, beer and spirits. “The Tennessee decision is the crack that opens that door,” he says. ”Look at what happened with the 2005 decision on Granholm v. Heald—it opened the door to direct-to-consumer (DTC) shipping.” That Court’s decision also centered on the issue of discrimination against interstate commerce in violation of the Commerce Clause. As Hinman points out, “The Tennessee case affirms the Granholm principle that the state has to have substantial reasons for discrimination.”
In 2005, Michigan and New York laws were preventing out-of-state wineries from shipping their wines, while allowing in-state wineries to do so. The ruling enabled wineries to interact directly with their consumers across the country. As a result, DTC has been a key growth driver over the past decade and now accounts for 60% of a typical winery’s sales.
Industry consolidation was another major factor driving the transition to DTC. “When you have big wholesalers working with big wineries,” Hinman points out, “you’re squeezing the small guy because it’s all about margin.” With DTC profit margins higher than those through the wholesalers, most small and medium wineries can’t afford the margin cut to get into Costco, Walmart and large grocery chains.
“The challenge,” he says, “is that they have to change their route to market by making dynamic changes in how they build their customer base.” He recommends that winery owners, “Step back and look at the landscape holistically.”
Consolidation is happening on three tiers of distribution.
- Mergers and acquisitions among alcohol producers have led to giants like Diageo, Pernod Ricard, AB InBev, Constellation and Gallo.
- S. distributors have consolidated to the point that two distributors—Southern Glazer’s Wine & Spirits and Republic National Distributing Company (RNDC)/Young’s Market—control over half of the industry. RNDC became the second-largest distributor after the FDC rejected their bid for Breakthru Beverage Group, citing market overlap, and they bought Young’s Market instead.
- Retailers have also consolidated their footprint across the U.S. marketplace, creating grocery store chains with more bargaining power, like Kroger, Albertsons, Trader Joes, Aldis and Whole Foods.
In the face of this continued consolidation, Hinman says, if a winery stops to consider what market it wants to serve, the logical solution is often to build a healthy DTR business across states. Yet today, 37 states ban out-of-state retailer shipping. The Tennessee ruling cracks that wall, creating the potential for out-of-state shipping by retailers, just as Granholm v. Heald did for wineries in 2005. It took 10-15 years for DTC to reach maturity, with all but seven states now permitting DTC shipping. Hinman anticipates that it will go faster for DTR.
He also points out another recent legal case that impacts the future of how wineries and other alcoholic beverage producers advertise their brands. The Missouri Broadcasters case lifted state bans on retail advertising on First Amendment grounds. The decision means suppliers and distributors can provide in-store advertising support to retailers, and retailers can offer coupons and price discounts on beer and wine (spirits were already allowed) inside and outside their stores.
Hinman draws on many other notable legal cases that point to a trend in loosening state restrictions in preventing wineries, brewers and spirit producers from marketing and selling their brands out of state. Often, these legal cases are decided against the states because their regulations are contradictory and not applied uniformly and lack the essential evidence to justify their restrict of a constitutional right.
Listening to him explain the legal rulings that are empowering small and medium wineries to go to market in new ways is a fascinating dive into the legal path to broader rights for wineries. He’s convinced that the way a winery can build a stronger brand is to build relationships with and ship directly to retailers—and, looking more broadly, wholesalers—in multiple states.
John Hinman will further examine The Future of Direct to Trade; The Evolution of Routes to Market in the wake of the Supreme Court ruling and what opportunities it will present to producers looking to leverage the direct to trade channel the at the 3 Tier Wine Symposium.