Beer and Wine Cheaper? (WSJ Article)

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Court Ruling Could Cut
Prices For Beer, Wine
By JOSEPH T. HALLINAN
May 11, 2006; Page B1
America's beer and wine tab may be about to shrink.

In a little-noticed ruling last month, a federal court in Seattle struck down key parts of the state's beer and wine distribution laws that the state acknowledged resulted in higher prices to consumers. The laws, which ban volume discounts and the purchase of beer and wine on credit, were challenged by bargain-basement chain Costco Wholesale Corp.

The ruling, which is being appealed, could spill over into the rest of the country because most states have provisions similar to Washington's.

The Costco case follows a decision last year by the U.S. Supreme Court that paved the way for some consumers to buy wine directly from winemakers. Taken together, the two cases could result in lower retail prices for beer and wine. They also could presage a big shift in the complex three-tiered system that has governed the sale of alcoholic beverages in most states since the 1933 repeal of Prohibition.

In Prohibition's wake, legislators erected a complex and costly regulatory architecture to discourage the overconsumption of alcohol. Makers of alcoholic beverages, such as Anheuser-Busch Cos., sell to a distributor, who marks up the price, puts the product on a truck and hauls it to a retailer, traditionally a grocery store, which may mark it up again before selling it to a customer.

In recent years, growing numbers of consumers have been buying their wine and beer at big-box retailers like Costco and Wal-Mart Stores Inc., putting pressure on the old system. "The shift in power ... is just astonishing, and it can't be ignored," says Craig Purser, president of the National Beer Wholesalers Association. In 2005, according to ACNielsen, shoppers took 33.1 million beer-shopping trips to Wal-Mart and other big-box stores, up 64% from 20.2 million in 2001. Beer trips to grocery stores fell 9.2% in the period, to 264.7 million. Over the past few years, Wal-Mart and its sister store, Sam's Club, have become the leading retailer for the nation's second-biggest brewer, Miller Brewing Co., a unit of SABMiller PLC. These retail giants wield enormous clout over suppliers of clothing, food and other products, partly by buying in bulk and eliminating the middleman. So far, though, their attempts to exert influence over beer and wine prices have been stymied by the three-tier regulatory system.

Some states, like Washington, for instance, prohibit volume discounts. All retailers, from the corner store to the giant discount chain, must pay the same price for their beer and wine. The state also bars the central warehousing of beer and wine by retailers. That means Costco must make 24 separate purchases of beer and wine stocks for its 24 stores in Washington, rather than simply make one big purchase and warehouse it at a central location. And many states don't let retailers like Costco buy their wine and beer on credit. Instead, they must pay cash.

Two years ago, Costco, which is based in Issaquah, Wash., sued that state, contending its regulatory restraints were anticompetitive. Costco's chief legal officer, Joel Benoliel, said the state's restraints raise the price of beer and wine not only to Costco, but also to consumers. Last month, U.S. District Court Judge Marsha J. Pechman agreed, deciding that Washington's rules were pre-empted by federal antitrust law and aren't shielded by the 21st Amendment, which repealed Prohibition.

If the Costco ruling is upheld, Costco and similar big-box retailers will benefit in a number of ways, most likely at the expense of middlemen. Not surprisingly, the ruling set off alarms in the beer and wine industries. "It's threatening to distributors," says Carlos Laboy, an analyst for Bear Stearns who follows the beer industry.

Distributorships, many of them family-owned, have profited for generations under the protections afforded by three-tier systems. During the Costco trial, several beer distributors testified that their typical profit margins on beer were about 26%. If Costco prevails, those margins are almost certain to be squeezed.

Beer companies actually might find it simpler to deal directly with the likes of Wal-Mart. But they still need their legions of distributors to move beer to supermarkets and other outlets. So they're treading lightly, at least for now.

Analysts expect Costco's legal victory to embolden the big-box retailers to put pressure on beer and wine distributors to cut prices. "In the long run this pressure will, most likely, be passed on to the brand owners -- Anheuser-Busch, Miller and Coors -- as well as the beer importers," said Dresdner Kleinwort Wasserstein analyst Matthew Jordan in an April 24 note.

Costco already is the nation's largest retailer of fine wine, selling about $330 million last year. Its annual beer sales amount to less than $500 million but are growing. Wal-Mart says it does not break out these figures.

Although the Costco decision pertained only to the distribution of beer and wine, it also could affect the spirits industry, which is regulated in much the same fashion.

If lower prices are in the offing, it'll be awhile before consumers see them. Judge Pechman has suspended her ruling from taking effect and the state of Washington will seek to have her stay extended during the appeal. Meantime, Costco declines to say whether it plans similar challenges in other states. "We haven't even discussed it," said Costco's Mr. Benoliel. A spokesman for Wal-Mart declined to comment.
 
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