This IEI Insight is provided by Luke Buffington, a Gail Werner-Robertson Fellow and author of forthcoming papers on Nebraska liquor regulations and public choice challenges in education policy.
Following the end of prohibition in 1933 every state instituted some form of what has come to be known as the three-tier system for alcohol distribution. The system requires that all alcohol must go through a state-licensed, independent, third party distributor between the producer and the retail location. This has been combined with franchise laws, which give distributors in many states — including Nebraska — exclusive local contracts with producers that are very difficult to terminate. This legal regime certainly has some benefits, but it also has economic costs.
The addition of a mandatory middleman with exclusive contracts means that most of the competition that occurs is at the initial contract stage, after which a distributor has an effective monopoly on the distribution of a producer in a given area. This adds additional cost that must be shouldered by either producers or consumers. This drives up the price of the retail product and drives down the margin for the producer, which can be a particular challenge for local craft producers, who have lower margins and higher prices to begin with.
Further, the difficulty of terminating contracts is likely to make distributors more cautious about signing a contract with an unproven new brewery or distillery, creating an additional barrier to growth in an industry already fraught with regulation. Nebraska is one of only thirteen states that do not have some sort of self-distribution exception for small breweries, which compounds this issue. These are two examples of the economic cost of this regulation.
On the other hand, modern proponents of these laws (mostly the distributors themselves) usually promote four goals of the three-tier system:
(1) To avoid the overly aggressive marketing and sales practices of the pre- prohibition era,
(2) To generate tax revenues that can be collected efficiently from the beer distribution industry,
(3) To facilitate state and local control of alcoholic beverages, and
(4) To encourage moderate consumption.
While these goals do sound compelling, it is not clear that all of them are relevant in the modern era, or could not be accomplished in a more open system that encouraged greater competition and choice. The overly aggressive practices of the pre-Prohibition era mentioned in the first point, are what are often called “tied houses,” which occurred when brewers had ownership stakes in bars and retailers. The first and fourth goal are connected, because the theory is that these practices gave barkeeps incentive to promote immoderate consumption. It is not immediately clear why the three-tier system changes that, considering members of all three tiers still make the lion’s share of the their income on the sale of alcohol. The second and third likely made much more sense in an era prior to the Internet, widespread telephones, and other low-cost transportation and communication technology. In the modern world the government effectively collects taxes from thousands of businesses of all sizes, and regulates many types of goods without the need for consolidated distribution. Why this is different for alcohol in unclear.
It is not the case that independent distributors add no value in the process of bringing these products to market. They clearly provide a valuable service by allowing producers to focus on what they do best. They help by managing producer-retailer relationships, assisting in marketing of products, and educating retailers on proper serving techniques among other things. They could provide all of this value, and more, in an environment that allowed for more competition from self-distribution, non-specialized distributors, and one another. If the service that distributors provide is a high-value service, which it clearly is, they will continue to exist and thrive, but consumers will benefit from lower prices and producers from more choice and better services.