By Yo W. Shiina

 

The United States Treasury Department has answered President Biden’s call for increased antitrust enforcement with a comprehensive report (the “Report”) on competition in alcohol markets that strongly recommends increased antitrust scrutiny of those markets by the Department of Justice (“DOJ”) and Federal Trade Commission (“FTC”).

 

The Treasury Department issued the Report on February 14, 2022, in response to President Biden’s Executive Order  on Promoting Competition in the American Economy, which he issued on July 9, 2021.

 

The Treasury Department’s 63-page Report identifies two major areas of competitive concern in alcohol markets: (1) rigid and fragmented distribution system based on obsolete state regulations created at the end of Prohibition, and (2) concentration of market power in both the producer/supplier tier (especially in the beer industry) and the distributor tier.  According to the Report, anticompetitive regulations of the alcohol industry could be causing consumer to pay an extra $147-478 million.

 

Many of the competitive concerns identified by the Report can be traced back to the immediate aftermath of the Prohibition era.  The 21st Amendment to the U.S. Constitution, which ended Prohibition in 1933, recognizes states’ authority to regulate “transportation or importation . . . for delivery or use therein of intoxicating liquors.”  This provision has been interpreted to give states broad powers to control trade of alcoholic beverages, even to the preemption of federal regulatory power under the Commerce Clause of the U.S. Constitution. (State Board of Equalization v Young, 299 US 59 (1936)).  As a result, state laws and regulations played a significant role in shaping today’s alcohol markets.

 

Because many of these state laws that still govern the fundamental structure of the alcohol markets were enacted at the end of Prohibition era, they are designed to keep the pricing at the supra-competitive level to “foster temperance.”  Such regulations also make it difficult for small-scale craft producers to compete with large-scale producers.

 

Many states require alcohol beverages to be sold through a “three-tier” system for producer/supplier, distributor/wholesaler, and retailer, originally designed to prevent monopolistic control through vertical integration.  The distributor tier is subject to varying state regulations, categorized as “open,” “franchise,” and “control” schemes.

 

In open states, suppliers are free to terminate their relationships with existing distributors and switch to different distributor (subject to contractual obligations). But in franchise states, a supplier is typically required to show “good cause” in a legal proceeding. This practically locks in the supplier-distributor relationship once it’s formed and places burden especially on craft producers.  In addition, many states require producers to assign exclusive distributor territories, thereby prohibiting producers from contracting with multiple distributors.  The resulting lack of competition can be problematic especially when a large, national-level supplier such as Anheuser-Busch has a vertical relationship with the distributor.

 

In control states, a state-run monopoly carries out distribution. Suppliers in control states sell directly to the state.  States typically use different regulatory schemes for beer, wine, and spirits.  For example, Virginia is a franchise state for beer and wine, but a control state for spirits.

 

Another relic of the temperance movement’s interest in keeping alcohol prices high are state restrictions that preempt price competition among distributors.  For example, many states impose “post-and-hold” restrictions, requiring alcohol distributors to “post” their prices with state authorities and “hold” the posted price for a period of time, e.g., 30 days.  Some of these laws also contain “meet-but-not-beat” provisions, providing distributors a brief period to match, but not undercut, a competitor’s lowest price.  As the Report points out, the ability of competitors to monitor each other’s prices and follow the price leader’s pricing inhibits price competition.  Some states even require distributors to offer uniform prices for a given product.

 

Consolidation is problematic at both the producer level (especially for beer, where the two largest brewers, Anheuser-Busch and Molson Coors Beverage Company, control an estimated 65% of the market on the revenue basis) and the distributor level.  The concentration at the distributor level is conspicuous in states that allow “two-tier” system, allowing producers to own distributors. The Report notes that the “efficiency” argument proffered in support of consolidations has not been borne out in practice.  For example, while efficiencies from the Miller and Molson Coors joint venture were contemplated, beer prices increased following its creation.  Consolidation also makes it easy for large players to engage in tacit coordination with respect to pricing and barriers to entry.

 

Another notable area the Report covers is the Treasury Department’s authority to regulate competition under the Federal Alcohol Administration (FAA) Act.  The FAA Act contains six categories of “unfair competition and unlawful practices,” four of which are directed at the vertical relationships (between producer, distributor, and retailer) and two at advertising and labeling.  The four categories barred by the FAA Act are: (1) the “exclusive outlet,” requiring a retailer to buy from producer or distributor “to the exclusion of alcohol sold by others”; (2) the “tied house” arrangement where a producer or distributor “induces” a retailer to purchase alcohol “to the exclusion of others” through means such as partial ownership of the underlying property, offering credit, or repayment of loans; (2)“commercial bribery”; and (4) the “consignment sale.”

 

Acts of “exclusion” can be shown by evidence of certain “red light” practices.  The “red light” practices include, for example, the “slotting fees,” a.k.a. “pay to play” schemes, in which producers/distributors pay fees to retailers for stocking and displaying fee-paying producer/distributor’s products.  Another example is the “category management” scheme, in which producers/distributors seek to influence purchasing, stocking, and display decisions.

 

The Report makes several recommendations to address such competitive concerns.  On the federal level, the Department encourages continued antitrust scrutiny by both DOJ and the FTC.  Specifically, the Report urges that: (1) DOJ and the FTC examine their approach to horizontal consolidation; (2) DOJ and the FTC apply particular skepticism to claims of efficiencies, with particular attention to concerns of tacit coordination (e.g., secondary player following the price leader’s move); (3) DOJ conduct a retrospective on the pricing, innovation, and distribution impacts from craft acquisition by major breweries; and (4) DOJ and the FTC consider guidance as to already-highly-concentrated markets.

 

The Report also recommends that states explore changes in their franchise laws and revisit “post-and-hold” regulations, as well as evaluate the direct-to-consumer distribution model enabled by e-commerce.  The Treasury Department also encourages DOJ and the FTC to engage with state actors on those state laws, including by submitting letters in response to state legislative requests for technical assistance.

 

As demonstrated by the above, President Biden’s antitrust initiatives are focusing on competitive concerns that may not be making headlines—yet still harm consumers.  Whether the Report’s findings lead to any improvement of consumer welfare is yet to be seen.

 

Written by Yo W. Shiina

 

Edited by Gary J. Malone

Read Treasury Department’s Report Recommends an Antitrust Cocktail to Revive Competition in Alcohol Markets at constantinecannon.com