Article by Erik Smith. Published on Thursday, July 08, 2010 EST.

It’s Really a Big-Money Fight Over National Control of Alcohol Distribution

By Erik Smith

Staff writer/ Washington State Wire

OLYMPIA, July 7.—If you take a quick look at the two liquor-store initiatives headed for this year’s ballot, you might get the idea they’re all about liquor stores.

            Those are the parts that get people’s attention. Initiatives 1100 and 1105 would both close the Washington-state liquor stores and allow hard liquor sales in supermarkets and other retail outlets. No more booze at twice the price. No more shopping restricted to bankers’ hours. Getting rid of the liquor stores might have been a slam-dunk proposition, if only one of them had submitted enough signatures and there hadn’t been a second initiative to confuse the issue.

            The liquor stores are really the only point they have in common. There’s another monopoly at stake, and it explains why there are two competing initiatives that appear to deal with the same subject. Big retailers, led by Washington-based Costco Wholesale, hope to overturn nearly eight decades of law and tradition that have guaranteed distributors a big cut of the nation’s beer, wine and hard-liquor business – worth $167 billion in 2008, according to federal statistics. The distributors are just as eager to make sure their position is maintained.

            It helps explain why Costco put up nearly $1 million to get I-1100 to the ballot this year. It also explains why two of the nation’s biggest liquor distributors leapt in when it appeared Costco would succeed. At the last possible second they launched a $2 million petition drive, paying unheard-of amounts to signature gatherers, and they turned in enough signatures on the deadline day last week to ensure that I-1105 would appear on the ballot at the same time. Their measure would preserve distributors’ place in the universe.

            What’s at stake is a national distribution system for alcoholic beverages that operates in every state of the union, requiring manufacturers to sell to distributors and requiring retailers, bars and restaurants to buy from them. The battle in this state really is a national watershed – if Costco wins here, the movement could spread. And while the state is distracted by the liquor-store issue, there’s a bigger question involved. Does it make sense to maintain a restrictive system that has reigned since the repeal of Prohibition, or is it time to let the free market rule?

            A Bold Deregulation Measure

            There are really two monopolies that would be dismantled by I-1100. The first is the one all Washington residents know and understand. Since 1934 the state has maintained strict control over the sale of hard liquor, requiring that all hard liquor sales go through the state’s system of liquor stores. Washington is one of 18 such “control states.” The other 32 are “open,” as in California, where gin and whiskey have their own sections in every supermarket and brave souls can purchase Albertson’s-brand vodka if they dare.

            The other monopoly is one that is invisible to anyone who isn’t in the business of selling alcoholic beverages. When Prohibition was repealed, every state adopted some form of what is called the “three-tier system.” It means that distributors provide a buffer between producers and end-sellers, and all sales have to go through them. There are a few exceptions to the rule. Winemakers have been successful in some states in winning permission for mail-order sales; some small brewers are allowed to deal directly with sellers and to sell their own wares in brewpubs. And in control states like Washington, the state controls hard-liquor sales while bulk sales of beer and wine are still funneled through distributors.

            The most striking thing about I-1100 isn’t the liquor-store issue. Closure of Washington’s liquor stores has been debated by lawmakers in this state for years, and the pressure has gotten stronger every time. This year lawmakers sympathetic to the state-employee unions only barely managed to block a privatization bill, and if the initiatives fail, the proposal’s backers say it is sure to come back next year.

            What is most remarkable about the ballot measure is that it would do away with distributor control. Distributors would not be handed the hard-liquor business, as they have been in every other open state. The initiative also would eliminate the rules that force beer and wine sales to go through them. Washington would wind up with the least restrictive set of distribution rules in the country.

            That’s really what the fuss is all about.

            Roots in the Past

            The three-tier system was established because of a set of concerns that really don’t exist anymore, and you have to know a little about the mood at the turn of the last century to understand how it came about. Alcohol use was seen as one of the country’s most pressing problems; temperance crusaders stormed taverns with their hatchets, and a largely rural and religion-based anti-alcohol movement coalesced with urban good-government reformers right about the time women were being granted the vote in one state after another. The result was Prohibition, and history records how well that worked.

            When it was repealed, there were still many who regarded alcohol producers in about the same light as drug pushers are today. The way they saw it, one of the big causes of public drunkenness and alcoholism was marketing. The manufacturers owned bars and taverns; they entered into exclusive marketing arrangements with others. They extended credit, paid for fixtures, and did everything they could to make money.

The three-tier system was designed to stop it. No tier of the business was supposed to have an ownership stake in any other. Congress allowed every state to devise its own alcohol laws, and every one of them adopted some form of the system. There were a few side-benefits, too – by going through distributors, states found it easier to collect taxes, and the tightly regulated system made it easier to keep out organized crime.

And so the system continued to the present day, even as other social ills moved to center stage – drugs, gangs, racism, sexism, melting polar ice caps. America’s unique alcohol-distribution system became a quiet fact of life. Pieces of the system have come under challenge as the Internet has made every other aspect of business more efficient, allowing customers to deal directly with producers. That’s a particular issue in wine sales, where small wineries often complain they have trouble getting distributors to carry their products.

But what’s happening in Washington is a full-bore frontal assault. And it forces the distributors, now a firmly established segment of the alcohol business, to defend their protected status.

            Holding the Line in Washington

Initiative 1105 is being backed by two major liquor distributors – Young’s Market Company of Los Angeles and The Odom Corporation, a Bellevue-based beverage distributor that operates in partnership with Southern Wine and Spirits, the nation’s largest liquor distributor. Neither returned a call for this story.

But one of the most articulate defenders of the current system is Craig Wolf, president of the Wine and Spirits Wholesalers of America in Washington, D.C. Wolf is watching the situation in Washington closely.

“Because of the power of Costco, it is a trend that could be of nationwide scope,” he said. “If they’re successful there, they will take it elsewhere, and it could spread across the country.”

Privatization of the state’s liquor stores is really a “subsidiary issue,” he said. The distribution is the real prize.

The system that has evolved over the last seven decades has done the job that was originally intended, Wolf said. It prevented manufacturer control of the business. But over time, other advantages emerged. Distributors make the market more efficient, he said. They give merchants more choices, he said, and give producers access to a national market. In states like Washington, where volume discounts are prohibited, all merchants pay the same price and no one has an advantage.

Perhaps the biggest difference between the situation at the turn of the last century and today is that a few discount chains now are more powerful than the manufacturers, he said. If big-box retailers like Costco and Wal-Mart are allowed to go to manufacturers directly and negotiate their own prices, they’ll force the price down on the few lines that they carry, and smaller merchants will pay higher prices as a result.

Yes, the middlemen add a markup. But the experience of other countries shows what happens when market forces are unrestrained, he said. In England, alcoholic beverages are sold as a loss-leader by some discount chains, and the result has been a spike in alcohol consumption.

“Nobody I’m aware of in the alcohol industry other than Wal-Mart and Costco thinks it’s a good idea to have alcohol sold cheaper than water,” he said. “You don’t want to have the same market rules for alcohol as every other product. It’s not jeans, it’s not chain saws, it’s not books. We saw what happened in 1918 when the market was unregulated, and it could happen again.”

            Why Not Free Trade?

The way Costco and other big retailers see it, the alcohol laws are something like the long-discarded fair-trade laws that once prohibited stores from discounting – a government-imposed restraint of trade that boosts one segment of business over another. Washington has become the battleground because Costco is based in Issaquah, and because this state’s rules are among the most restrictive in the country. The warehouse chain maintains that the distribution rules are archaic and anti-competitive, and that alcoholic beverages ought to be sold like any other commodity, in line with modern business practices. Among other things, that means retailers ought to be able to deal directly with manufacturers, they ought to be able to negotiate volume discounts and credit terms, and they ought to be able to manage their own warehousing and distribution. All are prohibited under Washington law.

Costco has been trying to overturn the rules for years. It sued the state in 2004 and ultimately lost the battle four years later in the 9^th Circuit Court of Appeals. It turned to the Legislature in 2009, but amid heavy lobbying from distributors and small retailers it won only modest changes to distribution rules. By going directly to voters, Costco has its best shot at getting something done. As for getting rid of the state liquor stores – the most visible element of the initiative and perhaps the most appealing element for voters – that’s a new issue this year.

Joel Benoliel, chief legal officer for the warehouse chain, said Costco didn’t start the fight. The chain got involved when it was widely rumored that the distributors would run a liquor-store privatization initiative that protected the middlemen. So it put its money and its muscle behind an initiative already filed by a third party, a group calling itself Modernize Washington. “We’re not doing this because of its national significance,” he said. “But other states might think it is a model to follow. One by one, every one of them is going to look at how they maintain state monopolies on alcohol products. The question is how long is the public going to put up with it?”

The conflict is all about breaking the monopoly power of the distributors, he said. Nothing in 1100 prevents them from operating, and if the market demands their services, they’ll survive. And there’s something a little funny about the distributors calling the big retailers bullies, he said. They’re the ones who have the power now. He notes that even though Washington wineries have the ability under state law to deal directly with in-state retailers, none of them have been willing to do it. Producers are scared to death that distributors will drop them in other states, he said.

“The best defense is to point your finger and accuse your opponent of doing exactly what you’re doing,” he said. “We’re not the bullies here.”

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