What is the Three-Tier System and Why Does it Exist?

If you’re around the alcoholic beverage industry for even a minute you will hear about the three-tier system. There are a lot of questions about it. Where did it come from? Why does it exist? Do we still need it? We thought this week we would take a look at the three-tier system’s origin, history, and potential future. There is much debate about the validity of the system, but we are here to state the facts, so you can be fully informed and make the best decision for you and your business.

History of the Three-Tier System

To best understand the three-tier system we must begin more than 100 years ago in 1906 with the creation of the Anti-Saloon League (ASL), which began lobbying for the prohibition. It wasn’t until 1917 that the ASL was able to push for a vote on the 18th Amendment to the United States Constitution creating the Prohibition of "intoxicating liquors." As many will remember from their high school government classes, this began the process of state ratification for the creation of an amendment to the US Constitution. Mississippi became the first state to ratify the amendment on January 7th, 1918 and was followed by numerous others until January 16, 1919, when Nebraska became the 36th state to ratify the amendment. As stated in the passage of the amendment, the law would take effect no sooner than one year after the ratification of the amendment. On October 28, 1919, the US Senate passed the Volstead Act which enacted the enforcement of the 18th amendment. At the time, President Woodrow Wilson worked to stop its progression by vetoing the bill. This veto was quickly overturned by the US House the same afternoon and followed by the Senate the next day. The earliest date allowed for the Prohibition was used and the Prohibition came into force at midnight on January 17, 1920.

Over the next 13 years, alcohol was banned within the United States and would lead to the major profession at the time known as bootlegging. By the end of the 1920s, The Great Depression took a major toll on the country and with it, support for the Prohibition began to fall apart. By the fall of 1932, then candidate, Franklin D. Roosevelt started including a central plank calling for the repeal of the Prohibition. With his election on November 8th, 1932 the end of Prohibition was almost inevitable. On February 20, 1933, the Congress officially proposed and passed the 21st amendment presenting it for consideration by the states. Michigan became the first state to ratify the amendment on April 10, 1933, and other states quickly followed. On December 15th, 1933, the United States officially ended the prohibition.

With the passage of the 21st amendment and end of the Prohibition, states were left to self-regulate the laws for alcohol within their state. States moved quickly to find ways to regulate the alcohol industry and levy taxes on alcohol producers. To ensure the accuracy of the information and reporting  states created unique tiers for each point of alcohol distribution. Because the states were left to control their laws with the ratification of the 21st amendment, every state has their specific regulations. Despite that,  most states stuck to the idea of the three-tier system separating producer, distributor and retailer.

What exactly is the Three-Tier Beverage System and what are the three tiers?

The most straightforward explanation of the three-tier system is the separation of producer, distributor and retailer in the alcohol distribution space.

Tier 1 - The Producer

There are many names for the producer. They can be called the manufacturer, the supplier, or the maker, but most simply the producer is the creator of the product. The producer can be a large beverage company, such as MillerCoors or Anheuser Busch, or a much smaller craft brewery such as Lakewood Brewing Company or (512) Brewing Co.

Tier 2 - The Distributor

The distributor is the middleman who moves the alcohol from the producer to the retailer. Depending on where you are located in the country you can find distributors of all sizes. Some can be as small as a one or two-person operation using the back of a pickup truck to move product from a single warehouse, while others can be a multi-state operation with thousands of employees moving millions of cases of product per year.

Tier 3 - The Retailer - On-Premise and Off-Premise Consumption

The retailer is where the general public will buy alcohol. There are two sides to the retailer level of the three-tier system. They categorize retailers by the way in which customers will consume the purchased alcohol: on-premise and off-premise. On-premise retailers are like your local bar or even a football stadium where you would buy and consume the alcohol - on-premise. The other option is an off-premise retailer like your local grocery, convenience or liquor store where you would purchase alcohol to consume it later - off-premise.

The Good, The Bad and The Ugly

Without taking sides, it is easy to say that there are a lot of varying opinions of the three-tier system today. One of the most significant critiques of the 3 tier system tends to be large retailers themselves as they are used to dealing directly with producers in other categories. Other large critics of the three-tier system tend to be smaller startups trying to get into the space where larger distributors have already staked their claims. Because these larger manufacturers have had long established relationships with distributors, they work to aggressively protect their territory.

One party that has found the three-tier system to be advantageous is smaller craft breweries. While it can be difficult for them to gain traction and get shelf placement, these small breweries have benefited by not having to invest in additional warehousing or field level employees that are already in place with distributors across the US. Small breweries have also benefited by many state laws that have helped to promote business for micro brewpubs. These brewpub laws allow for the manufacturing and retail sale of their product in a single location. Depending on the state, some limit the sale to on-premise sales only, while other states allow for off-premise sales. It’s best to look into your state level Alcoholic Beverage Commission to fully understand your current laws. Remember, because the 21st amendment put the responsibility on the states each and every state is different.

The Changing Landscape

As everything, with time comes change. Many states are continuing to make changes to their laws and evolving the way the three-tier system works. In the last ten years, Washington State passed initiative 1183 dismantling their state-operated retail system for alcohol sales. This change has led to more free-flowing sales to the consumer. It should be noted that while the state has gotten out of the 3rd tier of the 3 tier system, they have levied a hefty $35 per gallon liquor tax. This liquor tax is 50% higher than the next closest state tax in Oregon.

Oklahoma is another state to push changes through their four-tier system. As of October 1st, 2018, Oklahoma will be merging their middle two tiers. This will effectively eliminate the broker tier by combining it with the distributor tier. The hope is that this will simplify the requirements for all levels and allow the state to be more business-friendly when it comes to the three-tier system.

The Politics

As we initially stated, we don’t have a political stance on what is right or wrong with the three-tier system. If you are a distributor, there is a lot on the line if the three-tier system were to be dismantled. At the same time, if you are a producer, there may be more profits to be earned by handling your own distribution. There could also be a significant number of expenses that challenge your business. Many companies today such as Red BullCoca-Cola and Pepsi use a network of distributors because it is more efficient for them to handle their core functions.

The three-tier system is the one we have and the one we will most likely have for some time. Are the opponents right to hate it? Possibly. Are the proponents right to defend it all the time? Possibly. Every side has their argument but remember:

No matter how thin you make a pancake, it still has two sides.

- Dr. Phil

Learn about the role of the three-tier system in asset tracking for the beverage industry by downloading our free guide, The Complete Guide to Asset Management.