Thoughts on fears of a "Beer Bubble" and why we probably won’t see one

People still kick around the idea the craft beer might hit a bubble.When I say “bubble”, it’s about a concern that somehow, all these new and growing breweries might somehow fail. During the dot-com bubble fifteen years ago, we saw so many Internet based firms proliferate and spectacularly flame out. With the housing bubble, we saw housing prices increase and housing construction reach a crescendo, only to screech to a halt as the easy credit fueling the market became unsustainable. So it’s not too unreasonable to look at the exceptional growth of breweries in American, couple that with our experience of previous bubbles, and conclude something similar could easily happen in the brewing industry as well.  On this, I have a couple thoughts to add.

There is psychological side to these beer bubble concerns. For such a long time in the United States, there was only a handful of breweries. We’re just not used to seeing so many breweries in operation which can cause us to think something can’t be right and all these breweries simply cannot be sustainable. I used to think this way myself. Those thoughts ended for good last fall when I visited some friends in Bend, OR, a town of only about 85,000 easily supporting more than ten breweries.  Yet, when I went to the local grocery store, I noticed plenty of people rolling through the check out line with stuff like Bud or Coors’s Light in their carts. Given all the crowded brewpubs all over Bend while there were still plenty of people who could still convert to craft beer consumers, in no way did the craft beer market in Bend seem saturated.

The more you think about it, the more it makes sense.  Breweries like A-B InBev sell beer by the millions of barrels. That’s a little less than the annual output of Sierra Nevada.  Ten brewpubs, each selling just a few thousand barrels of beer a year is still pretty small fraction of total beer sales in city of 85,000. The market can easily absorb that many small breweries and certainly a few more.

The second thought has more to deal with mathematics. If there will be a bubble, it will depend a lot on how fast the growth of craft beer’s market share declines. Right now, craft beer is growing at a rate of 15-20% per year. Given that craft beer is only about 11% of the overall market in terms of volume, these torrid growth rates are actually sustainable for a number years.  But of course, they cannot last forever.

How will all this growth end? Will it be a gradual decline as the adoption of craft beer slowly reaches equilibrium or will things just hit a wall when everyone is converted to craft who can be and the rest of the market stubbornly sticks to their macrobrews?  This matters because a lot of future growth is built into the beer industries. I don’t need to tell you hundreds of breweries are coming online each year. But more importantly, lots of established breweries are investing in major expansions. As more money is being invested to produce more beer, if the market demand suddenly stopped increasing, it could no longer absorb all the beer produced by this expansion. People who paid a lot of money based on future expectations could find themselves in a lot of trouble if they could sell enough beer to pay off their loans. That’s how bubbles happen, folks.

My take is when craft beer’s growth rate inevitably slows, it will do so at a rate that breweries can adjust to.  Suppose in 2016, the growth rate is 15%, and then in 2017, it’s 12%, with 2018, 2019 and 2020 respectively being 10%, 8%, and 6%. Breweries will have time to reign back in their investments and adjust to changing market realities. On the other had, if the growth rate in 2016 is 15% and then it drops to 3% in 2017, there will likely be a whole bunch of extra unused capacity with costs and lost opportunity that could cause some breweries to fail.

My guess is that we’ll see the former scenario rather than the latter. Habits like beer drinking tend to change over years, not overnight. Craft beer isn’t some new fad, it’s been around arguably for fifty years, and started becoming firmly established 20 to 30 years ago. As such, craft beer isn’t going anywhere. While breweries will likely see more a more difficult business climate moving forward than the current go-go times and breweries will fail as any businesses do, the idea of a devastating craft beer bubble seems less and less likely. I certainly hope to be right.

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.

The Session #80: More Like a Correction

For this month’s SessionDerek Harrison of “It’s Not Just the Alcohol Talking” asks us weigh in our opinions on the prospect of a craft beer bubble.  It’s a subject I looked at in detail in a previous post, where I came to a somewhat troubling conclusion that in not too distant future, much tougher times were clearly on the way for the craft brewing industry and my best guess was that a few hundred breweries were going to fail or otherwise cease operations.  Rather than just repost it, let me summarize the major points

1) Bubbles occur when there’s too much supply and not enough demand for all the supply to be sold profitably.
A bubble is a pretty loose term for large scale market failure.  I’ve experience bubbles professionally in both fiber optics and solar panels, and in the United States, we all witnessed the “dot.com” bubble and the housing bubble.  Lots of people describe bubbles using a bunch of big words and technical jargon that sound deep and insightful, but bubbles really aren’t that complicated.   Bubbles occur when too much supply is created in a market where there’s not enough demand for all that supply to be sold profitably by most of the firms in the market.  While craft beer is growing fast, many breweries are involved in major expansions and over a thousand new breweries are in the planning stages.  Brewing requires large investments in equipment and material, so most breweries take out large loans to pay for start-up and expansion costs.  If all these breweries have trouble finding distribution channels in an increasingly crowded market to sell their beer, or have to highly discount prices leaving them with little or no profit, they could find themselves unable to pay off the loans and may go out of business. 

2) Everyone focuses on the new breweries but established breweries are about to bring at least an extra 4 million barrels of annual capacity online by 2015.
All the new breweries being formed draw most of the attention when a craft beer bubble is considered, but no one seems to pay too much the large expansions taking place within the industry.   Simply counting from press releases and making reasonable and conservative estimates, I find at least  an additional 4 million barrels of annual capacity is about to come on line.  This includes Lagunitas, Anchor Brewing, Sierra Nevada, and New Belgium building second breweries and major expansions from breweries like Deschutes, Boulevard Brewing, Dogfish Head and Bell’s.  There are numerous monthly press releases from various smaller breweries breathlessly announcing expansion plans and major distribution deals. 

So what?  Well, according to the Brewer’s Association, craft beer sales for the first half of 2013 were 7.3 million barrels. If we simply double that number, that means at least 14.3 million barrels of craft beer will be sold this year.   If we compound that number for 2014 and 2015 at craft beer’s currently astonishing growth rate at 15%, that means there will be an additional 4,700,000 million barrels sound in 2015 over 2013. 

That means the current 1,605 breweries the Brewer’s Association says are in the planning stages will be fighting over the sales of the remaining 700,000 barrels of beer, which works out to 436 barrels per brewery, or a little less than the size that a small brewpub.  Which suggests if you plan to open a small brewpub, there will probably be a place for you.  However, any brewery with ambitions of becoming a regional brewery pumping even smallish 1,000-3,000 barrels of beer each year is facing some very long odds.

It’s also important to add I haven’t included so-called crafty brewers like Goose Island or the Craft Brewers Alliance in this analysis, since they are not included in the statistics of the Brewer’s Association.  Needless to say, they make the situation for any aspiring craft brewer worse since Goose Island is in the midst of a nationwide rollout as Anheuser-Busch transitions their Budweiser facilities to produce more Goose Island.  The Craft Brewer’s Alliance recently announced a brewery expansion of nearly 150,000 barrels annually as well.

Can this astonishing growth of breweries continue? 


3) If the Growth of Craft Beer Slows to 5% or even 10%, a lot of breweries are going to fail despite this high level of growth.

I have seen and heard numerous comments assuring everyone that craft beer won’t experience a bubble because it will continue grow.  While it certainly true that craft beer is growing and is currently humming along at a 15% a year pace, it’s an open question if this high growth rate is sustainable for the next 2-3 years at least.  Because if this 15% growth rate is not maintained, a lot of breweries are going to find themselves is seriously difficult position.

To understand this, consider various rates of growth of the craft beer industry from 5-15% over the next two years and how that will affect the demand over the next two years, assuming 14.6 million barrels of craft beer sold in 2013.

Growth rate in      2014                        2015                      Difference between 2013 and 2015  Sales
                                15%                        15%                       4,700,000
                                15%                        10%                       3,900,000
                                15%                          5%                       3,000,000
                                10%                         10%                      3,100,000
                                10%                           5%                      2,300,000
                                  5%                           5%                      1,500,000


Based on at least 4,000,000 barrels of annual capacity coming online during this period from currently existing breweries, we see that only under 15%-15% scenario will this demand exceed what is already coming online by existing breweries.  Under any other growth scenario, it becomes clear that way too many breweries will be producing too much craft beer that can be sold.  Some breweries will muddle through this, others with strained fiances, questionable business strategies, or simply mediocre products will face tough times and likely fail.  In addition, many new breweries are founded by smart, ambitious 20 and 30 somethings that may find eking out a living with a small brewery struggling in a saturated market is not what they signed up for and fold up their operations for greener pastures.

Yes, it is certainly possible that craft beer industry could grow by 20%.  That would be an unprecedented growth rate for a mature product like craft beer, which has been around for decades, and craft beer has never experienced anything close to 20% growth in any year.  It’s just not likely to happen.


4) So what do I think will happen?

I see the craft brewing industry going through a similar pattern to bubbles past, with many new entrants and over expansion in a rapidly growing market to the point where it becomes over saturated and only the strongest firms can survive.  But unlike the dot.com, fiber optic, or solar panel bubble I’m familiar with,  I don’t expect the majority of the businesses to fail.  Established breweries like Stone Brewing, Sierra Nevada, or New Belgium should do fine.  The current rate of failures in the craft brewing industry is currently absurdly low,  around 40 a year, or 1-2%.

Talk to people in the craft brewing industry, and you’ll find them conceding a shake-out or consolidation is on the horizon. In fact, what I’ve basically done is express in numbers the gut feeling many in the industry have.  So it’s pretty realistic to expect a few hundred breweries failing as the market reaches equilibrium.  There is little doubt in my mind we are headed towards a market correction of this magnitude.

 

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.