Struggling with the new realities: The Brewers Association Independence Seal

There’s been so much ado about the new Brewers Association (BA) Independence Craft Brewers Seal released last week. The BA is encouraging it’s member breweries to affix the seal to their labels to distinguish independent brewers, as defined by the BA from breweries that are owned by large brewing conglomerates like AB InBev, MillerCoors and Heineken. The idea is to allow consumers to make an informed choice based on the brewery ownership, as mega-corporations are buying up small breweries to compete in the beer market, as high volume lagers are losing marketshare to more flavorful beer styles brewed by smaller breweries.

Plenty of people like Jeff Alworth, Bryan RothAlan McLeod, and Chris Barnes weighed in on the topic and there’s been plenty of internet chatter over the issue.  I have a somewhat different take on things, so in the spirit of “better late than never”, here are my thoughts.

The concept of identifying independent breweries to differentiate from corporate-owned breweries sounds good, until you start reading the Brewer’s Association somewhat contrived definition of an independent craft brewer.  (That the BA is shifting the semantic debate from craft brewer to independent brewer is telling.)  If you’re wondering why Boston Beer Company, a publicly owned company with a market capitalization of well over a billion dollars pumping out mostly lagers and alco-pops is an independent brewery in the mind of the Brewer’s Association, you’d hardly be alone. Plenty of fine breweries, like Kansas City’s Boulevard, are considered non-dependent due to corporate ownership. And sneer all you want you want at the breweries like 10 Barrel,  Goose Island, Lagunitas, Ballast Point that were recently acquired by mega-corporations as sell outs, they all still brew some mighty fine beer.  So a big problem with the independence seal is that “independent brewer” no longers says a whole lot about the beer, good or bad, inside the package.

The other problem is that consumers of most products really don’t care too much about company ownership, or at least as not as much as beer geeks and brewing industry wonks care about brewery ownership.  Oh sure, people say they love that wonderful locally owned Italian bistro on the corner, but The Olive Garden still does pretty good business. Starbucks has put many an independent coffee shop out of business and most people barely shrug.

Now the BA cites a Neilsen/Brewbound study claiming independence matters most to consumers when making their purchasing decisions.  But as beer writer Bryan Roth has pointed out, Brewbound’s Justin Kendall cautions about taking this finding too far.  “Even though consumers say they understand the terms “independent” and “independently owned,”, Kendall writes, “there remains the question of whether they actually know about ownership changes and if those would actually affect their purchasing decisions.”

So what we’re left with is an Independence Seal for breweries which are deemed independent by the BA for reasons most people wouldn’t understand, and even if they did, might not cause them to purchase differently. The independence seal is basically the old craft vs. crafty argument four and half years later.

I’ve had a few beers these days from independent breweries which may have been brewed with honesty, integrity, and a passion for brewing, but basically sucked. The brewing industry has become too complicated for neat definitions and the BA seems to have little answer to these new realities other than to recycle old arguments which are increasingly less relevant over time. Resorting to a marketing logo to combat some pretty powerful economic and business forces is not very likely to work, and has failed in the past.

Surprisingly, AB InBev felt the need to respond, releasing an odd video in response to the Independent Seal, with six brewers of AB InBev’s High End Craft Beer Portfolio speaking to the camera in talking points, making a bunch of disingenuous arguments against the seal, and calling for breweries to unite together against wine and spirits competition. Needless to say, after hearing the calls for unity from a corporation that’s engaged in all sorts of aggressive, anti-competitive business practices against small breweries for decades.  Watching the video, I  almosted expect one of the brewers to turn to the camera and say “Did you know the word “gullible” isn’t in the dictionary?” .

As laughable as this video is, it highlights a major rift in the brewing industry that doesn’t plague other industries. Plenty of trade organizations in various industries are filled with warring tribes, yet find a way to speak with one voice for the good of the industry without major rifts. In fact, wine and spirits has experienced corporate ownership of small, high end firms for decades and as a result, there’s a lot less business distractions due to these different types of ownerships.  The AB InBev propaganda video contains a nugget of truth and a warning the BA should heed.

 

Bart Watson Talks About the New Realities for Craft Breweries

Bart Watson has one of the coolest jobs in America. He’s the Economist for the Brewers Association and the man behind the widely anticipated numbers documenting the brewing revolution going on in the United States.

Unfortunately, the latest figures don’t look so good. Given the rather modest 6% growth figures released by the Brewers Association last week after years of strong growth in the 10-20% range, it seemed reasonable to wonder if the craft beer industry, at least the industry defined as small and independent by the Brewers Association, is entering a market correction.  Signs this has already happened include the business failures of San Francisco’s Speakeasy Ales & Lagers and Metalcraft Fabrication, a Portland supplier of brewing equipment based in Portland. In a brief interview, Bart Watson delivered rapid fire responses to my questions about the state of craft beer.

Q: In 2014, small and independent brewers grew 18% by volume.  In 2015, that number was 12%.  Now in 2016, that number has dropped to 6%.  Is the party over?

Bart Watson: We’re certainly entering a new and more competitive phase.  There’s just a lot more breweries and larger breweries have gotten more aggressive.  It’s also becoming less instructive to look at the national as a whole and instead look at certain regions.  In some areas of the country where craft does well, when you combine craft market share plus imports, you’re looking at 60-70% market share.  It’s tough for a craft brewery to grow a lot in a place like that. A key to brewery growth will be how to adapt and enter regions where craft beer has a lot less penetration.

Q: Speakeasy has gone into receivership due to a failed expansion launched in 2015.  Metalcraft Fabrication is going out of business for the same reason.  These were two solid craft beer companies who expanded in more optimistic times.  Are we going to see more stories like this?

Bart Watson: I think we will more see more of this, that’s part of business in competitive times.  The last five years in craft beer were not normal.  Everyone could succeed. Now we’re seeing a new competitive industry, and companies will need to be more cautious.  Companies that were overly optimistic will run into trouble and I think we’ll see some more failures.

Q: Some of the beer with biggest growth in 2016 include Goose Island IPA (81.7%), Lagunitas IPA and Little Sumpin’ (20.3% and 45.2%), and Firestone Walker 805 Blonde Ale (74.4%)….none of these were from small independent breweries.  Considering small independent brewers grew at only 6%, do these numbers validate a lot of people’s concerns about brewery acquisitions by large corporations.

Bart Watson: We’ll see.  If you look at these things more holistically, it’s a mixed bag.  Shock Top and BlueMoon didn’t have good years.  Craft beer plus big business doesn’t automatically translate to big success.  Some of these growth figures for the beers you point out are already slowing down.  We’ll see how it plays out in the long term.

Certainly, when you put big money and distribution behind a craft brand, that can be powerful combination.  Large breweries are trying to replicate what succeeded for local breweries….tasting rooms, festivals…trying to be like smaller brands.  We’ll see what consumers think about this.

 

Having survived a couple market corrections in the fiber optics and solar panel industries in my professional life, I know all too well what happens to smart, seemingly careful people who get trapped in expansion plans that are no longer sustainable when the market suddenly slows. It’s easy to get caught up with the latest news, figures and speculation on market corrections, forgetting that lots of people’s jobs, dreams and livelihoods are suddenly on the line like never before. Best of luck to everyone in the industry dealing with beer’s new realities.

(Bart Watson photo from the Brewers Association)

 

 

Contemplating Last Week’s Tepid Statistics from the Brewers Association

The craft beer party might be over. The Brewers Association (BA) released their annual growth statistics for small and independent craft brewers in 2016, calculating a 6% volume growth with a corresponding growth of 10% by retail dollar for the year. While those numbers are good for most industries and suggest the brewing climate remains healthy, they’re way down from 2014, when the industry grew 18% by volume, 22% by retail dollar and 2015, where the numbers were 13% by volume, 16% by retail dollar.

2016_ba_growth-infographic_abridged_square

The Brewers Association conceded the brakes had been applied to all the go-go growth of the past few years as BA economist Bart Watson intoned “Small and independent brewers are operating in a new brewing reality still filled with opportunity, but within a much more competitive landscape.” It should be pointed out these numbers reflect “craft breweries”, as defined by the Brewers Association, which depending on your opinion, may or may not actually reflect the health of craft brewing. The BA craft brewery definition excludes breweries with large corporate investment or ownership, so breweries own by large corporations or investment groups like Boulevard Brewing, Goose Island, St. Archer, Lagunitas, or Ballast Point no longer qualify.  These and other breweries with similar corporate ownership are pulled out of the BA’s analysis.

The numbers back up what we’re all starting to see: The business climate for independent breweries is definitely getting tougher. Just this month, San Francisco’s Speakeasy, ceased operations for about a week before going into receivership due to failed expansion plans launched in 2015.  Portland’s Metalcraft Fabrication, once a successful supplier of innovative brewing equipment sold to craft breweries has also shut down, with Metalcraft co-founder Charlie Frye citing greatest factor their demise due to “...several unforeseen challenges associated with our expansion.”  There will always be failures in any industry, even in good times, but Speakeasy and Metalcraft were two rocks in craft beer, yet both  embarked on failed expansions during craft beer’s heady growth that weren’t sustainable. Given that Speakeasy and Metalcraft were hardly the only two established craft beer businesses engaging in major expansions during those optimistic times, there’s a good chance more failures will follow.

Were their any craft beer success stories in 2016? Depending on your view of craft, yes there were.  Goose Island’s IPA recorded an astonishing 81.7% growth in 2016. Lagunitas IPA and Little Sumpin’ Ale sales grew 20.5% and 45.2% respectively. Firestone Walker’s 805 Blonde Ale took off by 74.4%. What do all these beers have in common? They were all from breweries with corporate ownership, not included in the Brewers Associate figures, with the extensive distribution networks to drive that growth, which many small independent breweries lack.

While there were certainly some small independent success stories and corporate craft flops, the concerns many small and independent breweries raised about recent corporate acquisitions seem validated.  Corporate breweries are clearly putting the squeeze on the independents, and their distribution networks seems to be the key.  The smaller independents will continue to do well, as long as their ambitions are modest. But if you’re a independent brewery who took considerable financial risks to ride the once fast growing wave of craft beer, watch out! Those aggressive plans may lead to very tough times ahead in the current market.

 

 

Bubble Bursting Numbers from the Brewer’s Association

Everyone seems to have an opinion as to whether the craft brewing industry will experience a bubble. Most of this speculation is fueled by the shear growth of so many new breweries.  I’ve weighed in on the subject myself and I’ll spare you the details of pouring through my number heavy analysis if you don’t want read through it and just give you the conclusion.   I estimated that given so much new brewing capacity coming on line that the craft brewing industry would have to continue to grow sales volume at an annual rate of 15% for all that beer to be sold.  If the craft brewing industry slowed to a 5% or even 10% percent growth rate over the next couple years, there would be so much excessive capacity coming online the many breweries would have a hard time selling enough beer to meet their financial obligations.   Most have taken on debt to fund their expansions, so if they can’t sell enough beer to pay off the debt and operating expenses, they’re in a lot of trouble.  Over time, a lot of breweries could end up going out of business and I made a semi-wild guess that two or three hundred breweries could exit the industry in the next couple years, higher than the current 1-2% failure rate of craft breweries.

The good news is that the astonishing recent growth of craft beer sales hasn’t slowed, but has inexplicably increased.  A recent press release by the Brewer’s Association reports an 18% volume growth and a 20% revenue growth in 2013.  These are just amazing numbers.  Rarely does growth in any industry, let alone a fairly mature one like beer, reach these anything close to these growth levels.  Most businesses are elated whenever they achieve 10% sales increase and seldom does this happen year after year after year.

Bottom line:  As overheated as the craft brewing industry seems right now with so many new breweries and brewery expansions, this industry-wide capacity growth seems sustainable in the near term given the 20% increase in revenue growth in 2013.  With craft beer still occupying only 7.8% of the beer market, it’s hardly to the point of saturation.  So a 20% growth rate is still plausible for at least the next two or three years. Maybe the growth will slow, but there’s really no compelling reason why.  If the industry ever experiences a shake out with many breweries going out of business, that day of reckoning, if it ever comes, seems further off in the future.

Are we headed towards a craft beer bubble? Back of the envelope calculations are troubling

New Brewing Equipment Entering Hanger 24 Brewery as part of their
expansion earlier this year.    (Photo from Hanger 24 press release)

A bubble brought me to California.   It was the year 2000 and fiber optic networks were all the rage.  I moved from Detroit to take a job selling optical test equipment to companies making fiber optic components to build up all those high speed fiber optic networks.  Problem was, the world was pretty much drowning in a glut high bandwidth communications.   There were too many companies selling optical components for the few fiber optic networks being built.  Lots of high flying companies run by really smart people failed.  I survived a couple layoffs while my company transitioned to other markets.  Less than ten years later, I witnessed a similar bubble in the solar panel industry, where once again, demand for a product was growing but way too many firms entered the solar panel market and most were not be profitable.

Usually when bubbles occur, a bunch of smart people say complex things using big words, sounding very deep and philosophical.  But in reality, the nature of industrial bubbles are pretty simple.  Way too much supply come online and there’s not enough demand for most of the suppliers to be profitable.  The key thing to remember about bubbles is this:

Bubbles often occur even as demand rises dramatically.  Many firms jump into the market to cash in  on this rapid growth, and even though the market is growing, it simply can’t support all the new entrants.  Plenty of companies full of smart, talented and hardworking people with great products still fail spectacularly.

So with lots of new craft breweries forming and with existing breweries expanding capacity, there’s been plenty of speculation about whether the craft brewing industry is headed for a bubble.  If it is, plenty of great breweries making good beer with good business plans will go bust.  Such is the unfortunate nature of bubbles.

I’ve read a number of interesting speculations on a craft beer bubble which has inspired me to take a closer measure of the issue.  If you bare with me, I’m going to use a little math the investigate the whole bubble question.  Don’t worry, it’ll be just some simple addition, subtraction and multiplication that hopefully I’ll make clear enough along the way.

To get right to the punch line, some straight forward “back of the envelope” calculations suggests tough going ahead for craft breweries even under fairly optimistic conditions.  We appear to be coming to a point where too many breweries are producing far more beer than the marketplace can absorb.    While there will still be room for small breweries and brewpubs producing less than 1,000 barrels a year, there will be increasing pressure for larger breweries to remain profitable with so much excess capacity coming online that can’t all be sold in the marketplace.

This matters because breweries can’t sell enough beer, or need to heavily discount their pricing due to the excessive supply, they will struggle to pay off the loans most of them have on their books.  Breweries require large capital equipment costs, and most new breweries operate under some form of financing.   Of course, they also need to pay for operating expenses like payroll, materials, and rent.

Let’s delve into the numbers that cause me to reach for this conclusion, starting with the demand side of things.

Demand

Everyone knows the recent growth of craft beer is nothing short of remarkable.  The latest release by the Brewer’s Association cited an estimate of 7.3 million barrels of craft beer sold in the first half of 2013, a growth of 15% over the previous year.  Recent growth rates of 10-15% in the craft beer industry recently are pretty common.  And the good news is that since craft beer is only about 10% of the beer currently produced, the 15% growth level can compound for quite some time before the beer industry output by volume is produced by a majority of craft breweries..  

Whether or not this 15% growth is sustainable for the next few years is an open question based on other factors such as market penetration, changing customer preferences, distribution systems and current demographics.  Of course, if this growth rate settles down to a more modest 10%, the compounded demand will slow considerably.  Just take that 7.3 million barrel figure for the first half of 2013, or 14.6 million sold annually.  If the current rate of growth stays at 15%, that means 16.8 million barrels will be sold in 2014, or 2.2 million additional barrels.  But if the growth rate slows instead to 10%, then instead only 16.1 million barrels will be sold, or 0.7 million barrels less than with 15% growth.    I’m going to use the current 15% growth rate in my analysis, even though it may be optimistic to expect the craft beer industry to continue this torrid rate of growth with a mature product.

Year           Additional Barrels over 2013, 10% Growth     Additional Barrels over 2013, 15% Growth
2014           1,500,000                                                          2,200,000
2015           3,100,000                                                          4,700,000

The Supply Question

In addition to numerous new breweries in the works, plenty of existing breweries have announced expansion plans or in some cases have announced building second breweries.  So to look at the Supply side of the craft beer bubble question, let’s look at both expansion plans of craft breweries couple with reasonable expectations of the output of all these new breweries.

Supply Due to Increased Capacity of Existing Breweries

Through a simple search of press releases online, I count approximately 2,800,000 barrels of brewing capacity available to come online between 2013-2015 by some of the largest craft brewers listed below.

Brewery                                     Estimated Increased Output in barrels
Sierra Nevada                            300,000 (2nd brewery to be operational early 2014)
New Belgium                            400,000  (2nd brewery to operational late 2014/early 2105)
Deschutes                                  115,000  (Expandable to another 100,000)
Lagunitas                                   600,000  (2nd brewery operation in late 2013)
Bell’s Brewing                           300,000  (Additional capacity for expansion completed in 2012)
Boulevard Brewing                   400,000   (Additional capacity from 2006 expansion)
Dogfish Head                            100,000   (Estimated growth in two years from 2013 expansion)
Anchor Brewing                        500,000   (2nd brewery to begin construction 2014)

It should be also noted the Craft Beer Alliance, technically not a “Craft Brewery” due to a substantial ownership by Anheuser-Busch added 140,00 barrels of capacity in the last year.  Furthermore, another one of those pesky “crafty” breweries, Goose Island has transferred much of their production to larger Anheuser-Busch facilities as part of a nationwide roll-out so we should expect at least a few extra hundred thousand barrels of capacity a year as part of that development.  Of course, Blue Moon is still out there, selling more beer than the entire craft brewing industry.  Since I’m using Brewer’s Association data, I can’t really include these breweries defined as non-craft in the analysis, but needless to say, these breweries are also capitalizing on changes in the beer market and certainly aren’t making it any easier for a new enterprising craft brewery.

Given the steady drumbeat of press releases announcing brewery expansions and new distribution deals, it seems pretty plausible the 1,300 remaining micro and regional breweries  as defined by the Brewers Association, each add an average of 920 extra barrels each of brewing capacity meaning another additional 1,200,000 barrels of capacity is coming online.    I’m excluding the brewpubs from the equation as we don’t normally expect them to expand their operations much.  (Of course, some brewpubs do make the leap into retail sales often requiring expanded operations, but I’ll set these expansions aside to simplify things.)

Supply Due to New Breweries

According to Brewers Association, another 1,605 breweries are in the planning stages.  If existing breweries will bring an estimated 4,000,000 barrels of beer online in the next two years, how much room is left in the marketplace for these new breweries?  If the growth of craft beer declines to 10% growth, it’s looking a bit grim for all these new breweries, since existing craft breweries have enough extra capacity to supply 900,000 more barrels of beer that will be demanded in 2015 at 10% compounded growth. 

Suppose for the next two years, it’s full steam ahead and growth continues at 15%.  By the end of 2015, all 1,605 of these new breweries will fight over the remaining 700,000, a mere 436 barrels per brewery.  That’s the yearly output of a small brewpub.  Since roughly half of the current number of craft breweries are defined as brewpubs that should be fine for many of them.  For the other half aspiring to be a successful microbrewery or regional brewery, their 436 barrel per year share is likely to be way too low to be profitable.   The craft brewing industry makes about $850 in revenue per barrel of beer, so 436 barrels translates to $370,000, ost likely insufficient to support a stand alone brewery.  A brewery this size could exist through contract brewing.

Yes, it’s possible that the growth of craft beer could further accelerate to 20% growth but that would be highly unprecedented.  Call me a pessimist, but 10% growth next year seems much more realistic than 20% growth.  Don’t forget, the assumptions above are all based on what I think is a reasonably conservative 4,000,000 barrels of capacity coming online by existing breweries and recent expansions by the Craft Brew Alliance and Goose Island have been left out of the analysis.  Even under the rosiest scenario, we see that a lot of breweries are clearly going to be under considerable pressure to stay in business and a number of them will probably fail.

Final Thoughts

How many breweries will fail?  There’s not enough precision in the numbers to make that sort of prediction.  However, lots of people make bold predictions all the time while totally ignorant of the relevant data, so why should that stop me?

I predict starting next year, life starts getting pretty difficult when Sierra Nevada’s and Lagunitas’s new breweries come online, Boulevard Brewing and Dogfish Head continues their expansions,  and Goose Island’s national roll out is in full swing.  The current failure rate of craft breweries is 1-2%.  It’s reasonable to expect this number to grow to 5-10% starting in 2014, which means 100-200 breweries will close per year.  Given the chumminess of the industry, I expect smaller breweries to join forces in the face of tough business climate and some brewery consolidation to occur.   In addition, I expect some breweries founded with aspirations of becoming 50,000+ barrel operations will find themselves stuck struggling to barely keep afloat selling 2,000-3,000 barrels each year and fold up their tents for greener pastures.  Things could turn into a blood bath, with failure rates as high as 25%, but more likely, the industry will go through a difficult 2-3 year correction as the weaker players are weeded out, and then things stabilize.  That’s my best guess.

On a personal level, I have friends and acquaintances who work for, or in some cases founded craft breweries in the past couple years.   They are all smart, hard working experienced professionals who are passionate about making great beer.  It gives me no joy to realize they will have an increasingly tough time staying profitable, may fall well short of their ambitions, and run an increasing risk of complete failure.  I also sense the normally cheerful craft brewing community is in a bit of denial over what many perceives as coming.

To end things on a more optimistic note, for decades craft beer has been about home brewers turned businessmen launching carefully aimed rocks at brewing Goliaths.  Those days have ended.  While I anticipate a difficult period ahead, what will likely emerge is a varied mosaic of breweries across the United States, with large national and multinational firms competing against stronger regional and microbreweries. Plenty of unique brewpubs will be found sprinkled throughout the landscape.  There will always be room for another brewery doing innovative and creative things, as long as they are willing to keep things small.  The brewing industry will emerge as colorful and vibrant as ever.