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April 22, 2011

Is Bigger Better?

Is bigger better?  In an era of consolidation at all levels of the industry one would think that there is no reason to question if bigger is better.  Consolidation at the distributor level is a movement that will continue as the larger breweries look for ways to simplify their operational model and build a more efficient distributor network.  While the breweries will look for opportunities to consolidate their distributors I do not think their desire is to build a network of mega operations.  I believe the largest breweries do not see the building of a network, like Coca Cola Enterprise, or the formation of large regional wholesalers, like the Wine and Spirits industry, as the answer.

What has been built in the Wine and Spirits industry is peppered with complications.  While having 5 national/regional wholesalers control over 70% of the wine and spirits volume sounds simple, it leads to a much different relationship with the supplier and wholesaler than the relationships enjoyed in the beer business.  The Wine and Spirits relationships can be tenuous at best with both sides flexing their muscles in a battle of heavy weights.  A supplier may have the majority of his national volume with one multi state distributor.  At the same time, the wholesaler is always on the edge, as the Wine and Spirits wholesaler lacks the type of protection granted the beer wholesalers with their agreements. Losing a major supplier could happen in multiple states and lead to having a significant negative financial impact.  The presence of multi state distributors can also lead to significant advantages for the supplier.  Having one place to go to gain distributor alignment is always easier and having your wholesale partner well capitalized, as larger wholesalers are, is comforting.  So, are having mega distributors best for the Wine and Spirits industry?  Depending on who you ask, I am sure you would get mixed opinions.  Those that benefit from the current arrangement will no doubt endorse the mega distributor concept.  Smaller suppliers and wholesalers who feel controlled by the large regional distributors would like to see a relationship where they had a larger voice.

Encouraging growth for the larger distributors may be good for the industry but it has to be done properly.  The concern that distributors have become more logistical providers than brand builders is reinforced by the recent reported comments from several craft brewers.  Comments that have been reported include distributors not earning their margins and a craft brewer looking for alternative distribution methods.  As the larger distributors grow they must maintain their relationships with all suppliers and work with those suppliers to build their portfolio.  Specialization to support the distributor’s entire portfolio is one of necessity. Creating an atmosphere that consolidation does not give the craft brewers the attention they need is not good for anyone. Bigger is fine but you must build an organization that can support a more diverse market with regard to suppliers, customers and employees.  Without a diverse approach to the market I think you could see some suppliers wanting to move away from the more traditional approach of being with the larger distributors.  This could lead to craft brewers expanding distribution to new states with a third distributor, where in the past there were only two distributors.

We have heard plenty of talk during the last three years about consolidation in the beer industry.  This consolidation has been driven by both the suppliers and the distributors.  I believe, consolidation is here to stay and the opportunity for the larger distributors to grow will always be present.  Despite what many may not want to hear, you can expect the bigger to get bigger.   The larger distributors have an operating cost 4-5 percentage points lower than the national average.  They are also able to leverage their financial position while capturing synergies in consolidation giving them an automatic advantage in making richer offers for any contiguous distributor.   Not only does this keep the midsized distributor from growing but it also limits those from outside the industry from entering the business.  Contrary to what some may believe, having the larger distributors grow may not be all that bad.  This growth will no doubt eliminate some of the waste and inefficiencies that exist within the wholesale tier. I have yet to speak with any consolidating distributor who has not found significant efficiencies to capitalize on when making an acquisition.  These are due to either redundant functions, antiquated processes by the seller or larger distributors combining functions within their corporate structure.  This is why I believe you will continue to see the larger distributors grow and why I think it may be good for the industry. Yet I do not believe we will see the mega distributors grow to the size of those in the Wine and Spirits industry.

While the three tier system is one that works and has proven to be the best way to the marketplace for the beer industry,  there remains a certain percentage of the wholesaler tier that have not changed as the industry has changed.  Those who have failed to maintain diversity in their approach to the business through either the management of their portfolios or because they have not been progressive in their approach to the market are exiting the business.  The larger distributors are more sophisticated, well capitalized, and progressive. Thus, they are changing with the market and positioning themselves to grow. The smaller to midsize distributors typically do not have the capital or market structure to invest in the business that will allow them to grow to the next level. This is why I believe the big will get bigger and it will be the best for our industry.

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