Michigan’s Government-Mandated Beer Contracts: Harder to Escape Than Marriage?

Amongst the decade-plus wreckage that has been the Michigan economy, there is an industry of 80 small businesses that have quietly carved out a success story. A February MLive profile tallied up $70 million in business expansions and job creation currently being invested in this state by these quiet capitalists. They didn’t do it with help and special deals from government economic planning czars trying to pick winners and losers, and they’re individually too small to credibly cry for taxpayer bailouts when the bottom line goes bad. Indeed, in a tale all too typical of Michigan businesses that decide to pack up and leave for friendlier locations, these stout sons and daughters of the Great Lakes State are winning in the marketplace in spite of Michigan government imposing strict regulations on their industry.

They make beer: some of the very best beer in America and the world.

But a little guy beating the giant mega-brewers by making a tastier product is just the start of the challenges facing a Michigan craft-brewer. Getting that product to thirsty customers presents another obstacle. And it’s one where state government has put up hurdles rather than helped. Unlike most other Michigan businesses, high-end craft beer makers are severely limited regarding how they sell their product and who delivers it to customers and retailers.

Consider, for example, the HoneyBaked Ham Company, another Michigan company that produces a high-end consumer grocery item. They have more than 400 stores nationwide to directly distribute their product, and they make their own choices about how to deliver those hams to those stores. They can buy their own refrigerated trucks and hire drivers to do the job, call up somebody else to do it, and change their mind as often as they need to about this basic business decision, depending upon the best price and service model for what they need to accomplish.

While these seem like freedoms that should be available to just about any business in America, this isn’t the case for Michigan’s craft beer makers, due to a state regulation called the three-tier distribution system. Poorly understood and virtually unknown to the general public, the three-tier system for the most part requires strict legal separation between those who produce beer or wine (the first tier), the restaurants and stores that sell it (third tier) and the wholesale distributors that move it between the two (second tier). With only minor exceptions, the Michigan Liquor Control Commission will not allow any business active in one tier to be involved in either of the other two.

The practical effect is the creation of a government-mandated middleman in the second tier: the wholesalers or distributors. Beer makers can't sell their product directly to large discount stores such as Costco, or even to tiny mom & pop grocery stores. They must go through a state-approved beer wholesaler.

Brett VanderKamp, president of the New Holland Brewing Company, explains that a craft brewery such as his must be very careful which wholesaler moves its first truckload of beer to retail stores or restaurants for them. Michigan’s distribution law means that this first shipping decision effectively locks the brewery into at least years or decades of a business partnership with that distributor. If disputes over service or price develop between these government-enforced “partners,” then unlike the ham company, a small brewery cannot just ring up a new distributor and arrange to have the beer delivered another way.

Jennifer Dixon of the Detroit Free Press authored an extensive 2005 investigation of the three-tier system. Her conclusion is similar, saying Michigan’s law “makes it nearly impossible for a brewer or a winery to fire a wholesaler unless the wholesaler commits fraud in its dealings with a supplier, fails to comply with its agreement with its supplier, sells outside designated territories or loses its state license.”

She then quotes a director of enforcement for the state Liquor Control Commission, who said no wholesaler had lost a license during his then-27 years with the agency.

The competitive marketplace is distorted in two ways: Brewers are stuck with only one viable way to move their product, and there’s a barrier to new businesses moving into the distribution tier because there are so few new suppliers available to sign contracts: Most existing breweries are already locked up by these restrictive distributor contracts. For these reasons, and with only modest exaggeration, VanderKamp says that it is easier to get out of a marriage contract in Michigan than it is for small breweries to get out of a beer distribution contract.

As the MLive profile made clear, Michigan is one of 20 states that will not even allow a modest “self-distribution” policy, thus creating the perverse result that a small brewery in a small town wishing to sell a locally made product to local restaurants and stores cannot simply take it there: They must ring up their one and only government-approved distributor, whose trucks and warehouses may be nowhere near the town where the brewery and restaurant exist.

This legalized quasi-monopoly over beer distribution has created substantial financial benefits for a small number of large wholesalers in the state with the lion’s share of the distribution contracts. They are ostensibly private businesses, but their profits are protected by the special government three-tier barrier that freezes out competitors and locks in beer makers.

The distributor’s trade industry group, the Michigan Beer and Wine Wholesalers Association, is quite aware of the unique perk enjoyed by their members in comparison to other states.

The 2005 Detroit Free Press investigation into the three-tier system quotes the former chairman of the MBWWA giving a speech to the group in 2004. He boasts of the good deal that his members have achieved relative to wholesalers in other states as a result of the MBWWA’s ability to keep laws that are favorable to their quasi-monopoly.

“I am sure everybody in this room has experienced what I and other leaders of this group do when we travel to out-of-state meetings and conventions with the wholesalers from around the country,” he said. “We are constantly being congratulated or harassed in some cases, about how good we have it here and how people wish they could be wholesalers in Michigan.”

Meanwhile, only four other states have as many small craft breweries as does Michigan, according to the MLive report, and each of the others are well west of the Mississippi River: California, Oregon, Washington and Colorado. In many of those states, the market penetration of craft brewed beer is much greater, according to VanderKamp.

The Michigan Brewers Guild estimates that its 80 members produce $24 million in wages annually and $133 million in economic impact each year. The MLive story quotes market research showing that sales of Michigan craft beers at Michigan supermarkets has doubled since 2007, from just over $11 million to $22 million in 2010. This represents more than one-third of the $30 million total increase in all beer sales over that period of time.

VanderKamp believes the strong growth of Michigan brewers and lightening of the restrictions imposed upon them could do a lot toward making one of the state’s brightest economic success stories shine even brighter.

“If you look around, we are really starting to become an economic force,” he said. “We [Michigan’s craft breweries] are in the heart of downtowns, a main street business, and we’re touching a lot of aspects of communities. I see people moving away from the mass industrial beers; I see a change in the market; I see consolidation among the large brewers; and I think this offers an incredible opportunity for the small brewers. I can’t say it any better than that: We should be creating laws that are business-friendly.”

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