Celebrating a Recent Burst of Progress on Direct Shipping

It seems like progress in direct shipping goes in waves. There's a small flurry of movement, in states widely separated in geography and culture, and then a period when nothing much happens.  Then, for whatever reason, progress starts back up.

About six weeks ago I wrote a post State of the Union, Wine Shipping Edition in which I broke down the 51 shipping destinations (50 states plus the District of Columbia) into ten tiers, based on the ease and cost of doing business in each.  I could have written essentially the same article any time in the previous two years without necessitating significant changes (OK, there was one change: Montana became a shipping state in late 2013, but that was it).  Yet the six weeks since I wrote my State of the Union have seen two major developments, with a couple of others seemingly in the works.  Given that there aren't that many states still left that prohibit or severely curtail winery shipping (15, as of late January) that's a measurable blip.  Let's look at them one by one.

Cheers to Massachusetts!
We were thrilled when, late last year, the great state of Massachusetts passed a workable direct-shipping law (thanks, in part, to former New England Patriots quarterback-turned-vintner Drew Bledsoe). Although the law went into effect January 1st, 2015, it took the state a few weeks to process the flood of applications they received. But as of now, we can happily ship to residents of the Bay State, and they can sign up for our wine clubs. And after the winter they’ve had, it sounds like most of them need a drink!

A Bill Passes in South Dakota
South Dakota was until very recently one of the states with the most curious collection of wine shipping laws.  We couldn't ship wine there if we received an order, but only when someone made a purchase in-person at the winery.  And even then, the shipment was subject to the state's individual out-of-state alcohol purchase transport limit of one gallon per instance.  That's five bottles, maximum.  But just two weeks ago, the governor signed into law House Bill 1001, which sets up a straightforward shipper's permit requiring that wineries remit taxes and periodic reports, and verify the legal age of the purchaser. Pretty standard stuff, for wine shipping, and only a moderate burden to wineries.  The law will go into effect January 1st, 2016.

Progress in Indiana
Indiana is another state that throws some interesting roadblocks in between wineries who wish to sell their wares in the state and Hoosier consumers who would like to purchase them.  Right now, the state limits direct shipments to wineries who both take an initial order in-person at the winery, and don't have a relationship with a wholesaler in the state.  The state differs from South Dakota in that only the initial order must be taken in person (not every order) but the wholesaler prohibition means that it's always been a no-go for us.  In late January, the Indiana Senate passed Senate Bill 113, which would remove both the in-person requirement and the distributor prohibition, albeit at the expense of raising the winery shipping permit from $100/year to $500/year, which would make it one of the five most expensive in the country.  Still, this would count as progress.  The bill is now in committee in the Indiana House of Representatives.

Pennsylvania: Glimmers of Hope
With the passage of the direct shipping bill in Massachusetts, Pennsylvania (America's 10th-largest wine market) assumed the mantle of the largest wine market to prohibit winery-direct shipping.  But readers familiar with Pennsylvania will understand why, despite a growing in-state wine industry, there are unusually strong forces that stand in the way. Pennsylvania is one of only two states (Utah is the other) where wine sales are restricted to state-run stores, and with more than 600 stores in the state system, the combination of massive revenue that the stores direct into state coffers and the influence of the state employees' union mitigates against rapid change. Still, the prospects for change seem brighter now than at any time in my memory. The new Governor Tom Wolf went on record in February saying "I'm in favor of direct shipping". The bill, however, that passed the Pennsylvania House of Representatives last week looks to have limited prospects, because it moves faster than the Senate and Governor are comfortable with in privatizing the state stores. In any case, it seems like there is at least the possibility of movement in the Keystone State, although I'm not holding my breath.

Delaware: A Bill in the Works?
Finally, one more small crack of daylight, albeit in one of the smallest states of the union. In November, Delaware House Minority Whip Deborah Hudson made winery direct shipping the focus of her weekly address, pointing out that Delaware was one of just 9 states that prohibit shipping to consumers and inviting her fellow legislators to "objectively weigh the facts and set aside the baseless fears of special interest groups, allowing our residents and Delaware wineries to join the 21st Century". Amen to that!

As always, the best place to find out what's going on in the direct shipping realm, and to learn how you can help, is Free the Grapes.

State of the Union, Wine Shipping Edition

[Editor's Note: We have updated this post as of January 2021. You can find that post at Wine Shipping State of the Union, 2021 Edition.]

The preamble to the United States Constitution is short and sweet:

"We the People of the United States, in Order to form a more perfect Union, establish Justice, insure domestic Tranquility, provide for the common defence, promote the general Welfare, and secure the Blessings of Liberty to ourselves and our Posterity, do ordain and establish this Constitution for the United States of America."

As we look forward to tonight's 226th State of the Union address, I am struck by the "more perfect union" reference in the preamble, as well as the wisdom of the founding fathers and generations of Supreme Court justices in prioritizing the Commerce Clause, which protects the federal government's exclusive role in regulating interstate commerce.  The 21st Amendment, which repealed Prohibition in 1933 and as a side-effect sheltered states from the Commerce Clause's requirement to maintain an open, fair market for all players, provides a glimpse into what a world absent the Commerce Clause might look like. We should all be thankful that most products we might want to buy don't have to face a similar regulatory nightmare.

So, in honor of the State of the Union, here is a summary of what the world of wine shipping looks like, from a winery's perspective, as we enter 2015, with states broken down into tiers based on the cost and ease of doing business there:

Shipping map courtesy of the great free tools at ShipCompliant

Tier I: The no-brainers (AK, DC, MN, MO)

• Right now, there are three states (and one district) that have neither permit fees nor significant  reporting requirements.  Thank goodness for them!  But, 4 of 51 isn't a great percentage.  All of the others make it more difficult or expensive to ship wine to customers who want it.
• Total percentage of US population: 4.05%
• Total number of reports required annually: 1
• Total permit fees: $0

Tier II: Inexpensive and/or fairly easy (CA, CO, FL, IA, IL, MI, ND, NH, NV, VT)

• There are an additional ten states with permit fees of $330/year or less and modest reporting requirements (6-16 times per year).  These states include some big ones like our home state of California, Florida, Illinois, Michigan and Colorado, but even for the smaller ones, the number of orders that a winery would need to fill in order to pay for the annual investment is very reasonable.
• Total percentage of US population: 29.95%
• Total number of reports required annually: 110 (11/state avg.)
• Total permit fees: $1275 ($127.5/state avg)

Tier III: Moderate expense or requirements (GA, KS, MD, ME, MT, NC, NM, NY, OH, OR, TN, WA, WI, WY)

• Once you get to the next tier of fourteen, a small winery would be excused for starting to run cost-benefit analyses before springing for the permits.  Some permits start to get expensive in this tier, like Tennessee's $450/year, Wisconsin's $400/year, or Maryland's $380/year.  Others are less expensive, or even free, but have difficult reporting requirements, like North Carolina (28 reports/year) or Georgia, New Mexico, Oregon, Wyoming and Washington (24 reports/year each).  Still, there are some pretty large-population states in this tier, and most wineries choose to ship to all or nearly all of them.
• Total percentage of US population: 27.79%
• Total number of reports required annually: 267 (19.1/state avg.)
• Total permit fees: $3126 ($223/state avg.)

Tier IV: Difficult/expensive but worth the cost (TX, VA)

• This is a tier with just two states.  Both are expensive (Texas's permit costs $526/year and requires 20 reports annually, while Virginia's permit is only $160/year but requires the submission of 36 reports) but both are also big enough to justify the cost.
• Total percentage of US population: 11.06%
• Total number of reports required annually: 56 (28/state avg.)
• Total permit fees: $686 ($343/state avg.)

Tier V: Difficult/expensive and maybe not worth the cost (HI, ID, NE, SC, WV)

• The main difference between this tier and the one above it is in the potential reward, rather than the expense.  Its five states are all small, and all expensive: as much as $600/year for the permit (South Carolina) and as many as 36 reports per year (West Virginia).  While nearly every winery ships to Texas and Virginia, there are many who don't ship to these five smaller states with often disproportionate costs and reporting requirements.
• Total percentage of the US population: 3.65%
• Total number of reports required annually: 112 (22.4/state avg.)
• Total permit fees: $1766 ($353/state avg.)

Every winery has a different breaking point.  For us, it comes here.  We've decided that the 35 states above all warrant the expense of the annual permits and the reporting, though it's a close call on some in that last tier.  The 16 states below we either can't ship to, or have found that the requirements to do are unreasonable.  But before I look at those, it's worth doing the math on what shipping to the 35 "shipping" states costs in total: $6853 in permits plus the time and expense of preparing and filing 546 reports each year.  Figure an hour for each report, at $25/hour ($13,650) for a total expense of $20,503.  But for that cost, we can ship to 76.5% of the US population.  Available tools (like ShipCompliant, which we use and recommend highly) provide a savings over the labor of preparing the many individual reports, but still come with a cost.

Why don't states make the cut?  The reasons vary, and you'll notice that some of the "no-ship" states fall into more than one category.  But in most cases, you'll see some effort toward protecting distributors from competition, at the expense of both consumers and wineries.

On-site purchase requirements (AZ, IN, RI, SD, DE)

• There are states that will allow a winery to ship (typically with few or no hurdles) if someone purchases wine at the winery, but won't allow the same customer to order wine by phone or email from home.  The logic written into the laws is typically couched in the guise of ensuring that only of-age buyers can purchase, but given that common carriers routinely check ID's in the 30+ states that allow direct shipping, it doesn't pass critical muster.

Distributor exclusivity (IN, LA)

• There are two states that explicitly say that wineries can ship only if they don't have a relationship with a distributor in that state.  While this does protect distributors from competition from the suppliers they represent, I wonder if it discourages many smaller wineries from signing up with a distributor from those states.  The two states (Indiana and Louisiana) are both just large enough markets (2% and 1.5% of the US population, respectively) and just far enough away from California that we've decided that it's not worth foregoing the wholesale business we do for an uncertain amount of direct business.

Capacity caps (AZ, NJ)

• The capacity cap is the distributor lobby's wedge issue of choice at the moment.  It writes into law that wineries below a certain size may ship direct to consumers, while wineries at or above that size must use the 3-tier system and sell their wine through traditional channels.  Typically, this capacity cap is set just above the size of the state's largest winery, protecting all the local wineries' business models while shielding distributors from as much competition as possible. In the recent case of Massachusetts, the link was made so explicit (it was promoted on the floor of the legislature) that a federal appeals court declared it in violation of the Granholm v. Heald decision that established the primacy of the Commerce Clause in the interstate shipment of wine.  But in other cases it has withstood legal challenge, and with New Jersey's recent capacity cap bill and a push last year to add one in Florida, it seems likely we'll see more in the future.  The capacity caps have been set as low as 25,000 gallons (roughly 10,000 cases) in places like Arizona (which we don't fall under), and as high as 250,000 gallons in New Jersey and Ohio (which we do).

Label registration (CT)

• Connecticut is a shipping state for many wineries, but it's not without its expenses and challenges.  First, it's the third-most-expensive permit, at $595/year, and requires 28 reports to be filed annually.  Second, you must register each label you propose to sell in the state at a cost of $200/label, renewable every 3 years.  At Tablas Creek, we sold 28 different wines direct last year (different wines, not different vintages).  That would require a $5600 investment, adding $1866 to the already-considerable annual $1295 cost of permit and reporting.

Death by 1000 Cuts (NJ)

• New Jersey grudgingly entered the ranks of direct shipping wineries with the passage of a bill in 2012. So far, only a tiny fraction of the nearly 10,000 American wineries have done so. Why would only 237 wineries have received a permit, in the country's fifth-largest wine market? Let us count the ways:
• The permit (a sliding scale, but for us $938) is the country's most expensive and the are 24 reports to submit annually
• There is a significant bond wineries have to post
• There are registration fees of $150 per partner per year, an issue for a winery like ours owned by two families, each with several owners
• Receiving a permit means that we have established a nexus with the state of NJ and are liable for paying an annual corporate income tax of at least $500
• There's a capacity cap to ship that we fall under, but many wineries don't
• And the coup de grace is that anyone who owns at least 10% of the winery must satisfy the same laws that govern the ownership of a liquor store or liquor wholesaler in the state, which precludes foreign residency.

About to join tier II (MA)

• If you're discouraged by the news on New Jersey, enjoy this counter-example: Massachusetts, the country's 14th-largest state and 6th-largest wine market, is about to become a reasonable state to which to ship wine. Thank you, Drew Bledsoe. And thank you, Family Winemakers of California!

Absolute prohibition (AL, AR, KY, MS, OK, PA, UT)

• The good: most of the states that don't allow the shipping of wine in any situation are among the smallest wine markets in the country.  Other than Pennsylvania, the six prohibition states combine to make up just 3.3% of the American wine market.
• The bad: Pennsylvania is the country's 6th-largest state and 10th-largest wine market
• The good: it seems like there is momentum building to finally get Pennsylvania's direct shipping laws changed. Given the challenges now (you can technically ship, but only to a state store, and only if no other vintage of that wine is in the state store system, and the recipient has to come to the state store to pick up and pay all the taxes) welcoming Pennsylvania to the post-Granholm world would be a huge boon for all wineries in 2015.

Weekly Roundup for November 16th, 2014: AVAs, Local Achievements, Veterans Day, Direct Shipping and Uncovering the Obscure

Last week, we debuted the Weekly Roundup, news from around the wine community that we thought worth sharing with you.  It's an admittedly eclectic mix, but we feel each thing that we've chosen warrants few minutes of your time.  It's also a work in progress, so please share in the comments what you like, and what you'd like to see different.  This week's list:

Some Great Press for Paso Robles and our new AVAs

• The Tasting Panel's Anthony Dias Blue visited Paso recently, just before Sunset's Savor the Central Coast in September. His article concludes with an exciting evaluation of our great town: "this sleepy region, once home to a few obscure, under-the-radar wineries, has transformed itself into the most exciting wine region in California".  The article also recommends wines from 15 top Paso Robles wineries, including our 2011 Esprit de Tablas Blanc and 2012 Mourvedre. Read more »
• On of our favorite blogs for the week came from Wine Spectator editor Mitch Frank, whose piece Wine Can Be So Complicated — And That's OK was a notably thoughtful musing set against the background of the recent approval of 11 new AVAs here in Paso Robles.  His conclusion -- that "while wineries, and journalists, need to work hard to make wine inviting for newcomers, that doesn't mean erasing what makes wine like few other beverages—it comes from someplace specific" sums up our thoughts pretty well.  I'm quoted in the article, and submitted a comment with a few more of my thoughts on the subject. Read more »

Something from Tablas Creek

• It was fun on Veterans Day to see the tributes to the many veterans in the wine community flowing through our social media feeds (for the intersection of the #wine and #veteransday hashtags on Twitter, check out this link).  We posted this 1944 Navy photo of Robert Haas, all of 17 years old at the time.  A sincere thank you to him and to all the many veterans and servicemembers, current and past, who have impacted our lives so substantially.

A Glimpse Behind the Scenes into the Business of Wine

• Wine marketer, expert blogger and consumer advocate Tom Wark was interviewed by ReasonTV, and the 3-minute video that resulted is posted on YouTube.  I spend a fair amount of time trying to shine some light on some of the more convoluted and counterintuitive laws that govern how wine is sold around the United States in my Legislation and Regulation series.  Tom's opening salvo: that "the only way to get them to begin to be repealed and reformed is to bring them to light" is absolutely spot on. Watch the interview »

Some Landmarks from our Neighbors

• Congratulations to Alta Colina Winery, who moved their first barrel into their new winery, on their estate which sits about 6 miles toward town from us, down Adelaida Road.
• And we loved this "then and now" photo from Epoch Estate, which has been thoughtfully rehabilitating their property atop York Mountain since they bought it a several years ago.

Paso Robles Beautiful

• We've been posting lots of photos of our fall foliage.  The photo above, which our friends at Cass Winery posted on their Facebook page, is one of the most impressive we've seen.  Too good not to share!

Food for Thought (Beverage for Thought?)

• We'll conclude this week with an article by Lettie Teague in the Wall Street Journal, entitled Dark Horse Wines: Great Finds in Odd Places.  As a winery who chose what was, at the time, an odd place (Paso Robles) to make odd wines (southern Rhone-style blends), we find comfort in her conclusion that because gatekeepers will naturally tend toward the conservative, "wine drinkers themselves must ultimately be the ones to pursue the unexpected, to eschew the tried-and-true".  She also suggests 5 wines, including one (a Pinot Noir from South Africa) imported by Vineyard Brands.  Read more »

Are direct-to-consumer sales really failing to lift the wine industry?

Last month I was surprised to read a headline on the industry portal Wine Industry Network titled Direct to Consumer Sales Fails to Lift the Wine Industry.  As a winery whose business model works only because of direct sales, I was curious to learn more about what the author Brian Rosen, consultant and former proprietor of Sam's Wine & Spirits, meant by the headline.  I posted my thoughts on Twitter:

After which, he and I shot a few tweets back and forth, elaborating our positions:

Brian's article was particularly interesting to me because it plays against the dominant narrative right now, that direct sales are on an inexorable rise, and that wineries should do everything that they can to make sure they're well positioned in this channel. What's more, that dominant narrative certainly jibes with our own experience here at Tablas Creek.  When we started, we believed that we would sell all our production through the wholesale channel.  Between the reputation of Beaucastel and the marketing muscle of Vineyard Brands, we thought that we could focus on grapegrowing and winemaking and the rest would take care of itself.

Five years of experience taught us that our initial expectations were unrealistic, and we made the decision in 2002 to take a much more active role in our marketing and sales.  We opened our tasting room, started our wine club, began participating in a wider array of events, worked harder and more closely with our distributor partners, and started participating more consistently in the promotional efforts of the regional and varietal organizations to which we belonged.  Little by little, we clawed our way out of what was a dangerous period when we were bleeding cash each year and became profitable.

In the steepest period of this climb, where we went from selling just under 4000 cases of wine in 2001 (all in wholesale) to nearly 20,000 cases of wine in 2007 (split between wholesale and direct) we saw significant growth in all our channels.  Our wholesale sales increased more than 250% over that period, to some 11,000 cases.  Our direct sales grew from nothing to some 9,000 cases.  But each year, as we looked at our financial reports, it became clear that our growing wholesale sales, far from driving our profitability, were only about a 50/50 bet to cover the cost of selling our wine in this channel.  As a company, all the profit that hit our bottom line came from the direct sales.

The greater profitability of direct sales should be intuitive, but it's likely even more important to wineries than you think.  Most wineries aim to achieve the same price out in the wholesale market and in their direct sales.  For product destined for the wholesale market, wineries back out the expected wholesaler and retailer markups, leading to a wholesale sell price half of full retail price.  Given that the cost of producing a wine is likely half or more of the wholesale sell price, the profit of selling a case direct isn't double that of selling it in the wholesale market; it is several times greater.  It is this disparity that means that a winery can offer good discounts to its wine club members and still come out far ahead. 

Further increasing the relative attractiveness of direct sales is that most wineries find, as we have, that the mix they sell direct skews toward their higher-end wines, while the mix that sells in wholesale skews toward wines that are less expensive, both because the wholesale market is naturally more price-competitive and because of the practical limit on wholesale price for wines that restaurants can pour by the glass.  When we did the math we realized that 75% of our revenue was coming from the 45% of our wine we sold direct, while just 25% of our revenue came from the 55% of the wine sold through the wholesale channel.  In simpler terms, we sold our average direct case for three and a half times what we sold our average wholesale case for.

OK, that was a lot of background.  But it gives you what you need to understand why I took objection when I read in Brian's piece, "I can tell you with 100% certainty that the DTC movement is not what you think it is and will not provide the added revenue that wineries around the globe are seeking."

The crucial question, and one that Brian himself addresses later in the article, is which wineries will benefit from direct-to-consumer sales, and which won't.  A winery's direct sales is limited naturally by its cachet, its tasting room traffic, and its perception of scarcity.  Even with high traffic, high cachet, and the perception of scarcity, there are only a handful of wineries selling more than 25,000 cases direct.  And most wineries' direct customers are far fewer than that; even established wineries I speak to around Paso Robles typically count a few thousand wine club members.  So,  imagine the challenge that faces a winery making a million cases a year, trying to have direct sales matter on the bottom line.  Even if they are able to build up to 25,000 direct cases per year (likely difficult given the challenge of creating the perception of scarcity) and able to sell those direct cases for 3.5 times what they sold their wholesale cases for, the direct sales channel would account for just 8.2% of the company's revenue.

Yet direct-to-consumer wine sales have grown to a $1.58 billion dollar industry: nearly the size of the total of wine sales to restaurants (some $1.8 billion last year).  It's still dwarfed by the $7.34 billion in retail wine sales, but it's growing.  So, is DTC important to wineries, or not?  It depends on your size.  Most wineries are small; by the Wine institute's estimate, 90% of wineries produce fewer than 50,000 cases, with three-quarters producing fewer than 5,000 cases.  Every one of those wineries should be looking to consumer-direct sales to make their business viable.  But most of the wine produced in America is produced by large wineries; estimates are that the three largest wine conglomerates produce half the wine sold in America each year.  And the twenty largest firms account for 90% of the market. For them, as the math showed above, direct sales are not going to make a significant difference in profitability.

If you're the average bottle of American wine, produced by one of the big companies in lots of tens or hundreds of thousands of cases, you're not likely looking at a future that involves transport via UPS or FedEx.  But if you're an average winery, producing a few thousand cases of wine a year, you should be focusing on selling a high percentage of however many bottles you produce directly.

Three final notes.  First, why, if they'll never notice it on their bottom lines, do the big wine companies still have tasting rooms and wine clubs?  I think (and based on the effort put into their direct sales by many of these large wineries, they agree) that it's valuable marketing: each direct relationship that a winery maintains is going to have a positive ripple effect as that customer communicates his or her enthusiasm to friends, and will support the work of distribution in a way similar to -- yet more profitable than -- advertising.

Second, you may be wondering why a relatively small winery like us bothers with wholesale sales at all.  Like a large winery with its direct sales, we think of it as powerful marketing, for which we get some revenue to offset the costs.  Having wine in great restaurants and wine shops means that customers don't have to come to us to discover us, and we have literally thousands of wine-savvy professionals around the country telling our story.  If we can get all this at something close to break-even, it's a big asset.

And third, if 90%+ of wineries rely on consumer-direct sales for their livelihood, why did Brian say that it won't provide the revenue wineries are seeking?  I think that there are two reasons.  First, Brian comes from a retail perspective.  The regulatory environment still makes it much more difficult for retailers to ship around the country than it does wineries.  And retailers are all competing to sell wines their competitors can buy at more or less the same price they can.  This level playing field, the regulatory patchwork, and the high cost of expedited shipping on a perishable, heavy item like a bottle of wine all combine to shield smaller local retailers from competition.  Will this equilibrium last forever?  Probably not. Given that Amazon is on their third foray into trying to sell wine, the e-commerce giants must see some potential here.  And here is an important area that I agree with Brian: whether you're a retailer or a supplier, Amazon and its ilk are likely to be neither savior nor apocalypse in the near term.

But all that's beside the point to a small or medium-size winery.  If that's who you are, you likely already know that direct-to-consumer sales isn't just your future.  It's your present, too.

Our crazy state alcohol laws: a farce in nine acts

You probably don't need me to tell you our alcohol laws are often crazy. But, well, our alcohol laws are crazy, particularly if you look at the state and local level.  The national level, for what little it has to do with alcohol, tends to be positive, like the Granholm v. Heald decision that helped reduce protectionism and create a more level playing field for American wineries.  State alcohol laws shelter behind the 21st Amendment's protection -- written in the aftermath of prohibition -- that gives them broad leeway to write laws to suit their local mores about alcohol.  Of course, that protection, which was intended to allow states or counties to remain alcohol-free, has allowed powerful constituencies to write protections for themselves into their state's alcohol legislation. The results can be frustrating, infuriating, unexpected and even funny.  Here are a few favorites:

• Minimum markup laws.  In Ohio, retailers and wholesalers are required by law to mark up wine a minimum amount: 33% at the wholesale level, and either 40% (on cases) or 50% (on individual bottles) at retail.  Written into the law is a remarkable justification: "to prevent abuses caused by the disorderly and unregulated sale of wine ... prevent aggressive sales practices that improperly stimulate purchase and consumption ... discourage intemperate consumption of alcoholic beverages ... eliminate discriminatory sales practices that threaten the survival of wholesale distributors and retail permit holders". The admission at the end is breathtakingly honest: that "the survival of wholesale distributors and retail permit holders" is a goal of the legislation.  Typically, price competition -- the foundation of the capitalist system -- is protected, not labeled a "discriminatory sales practice".
• Price posting. Many states require that wine wholesalers post the price at which they're offering their products, and then enforce with varying degrees of rigor that no customer is given preferential treatment. In New York, for example, you are required to post the price that any licensee will pay for your wines.  You are allowed (expected) to offer a better price if someone buys 2 or 3 or 5 cases than if they buy just one. In Oregon, wholesalers are required to post prices per bottle, and are not allowed to offer discounts on quantity (or to charge extra to deliver purchases of just a few bottles).  On the other hand, they're also not allowed to extend credit, so they receive payment at the time of delivery.  That helps with the cash flow problems created by all the tiny deliveries!
• Franchise laws.  In some twenty states (AR, CT, DE, GA, ID, KS, MA, ME, MI, MO, MT, NC, NM, NJ, NV, OH, TN, VA, VT, and WI) once you've chosen a distributor to represent you, you cannot leave that distributor and move to another even if they perform badly, lose their key personnel, or are purchased by another firm. There are in some cases exceptions to these franchise laws -- or review boards to which you can appeal with cause -- but in every case, it tilts the balance of the playing field even further toward the state-licensed distributor.  I wrote about this at length last year in the article the costs of state alcohol franchise laws.
• The Johnstown Flood Tax.  In Pennsylvania, which sells all its wine and liquor through state-run stores, all alcohol sales are assessed an 18% tax earmarked to pay for repairs from the Johnstown Flood.  Which happened in 1936.
• Wet, dry and damp counties.  In Texas, like much of the south and midwest, there are counties that are "wet", where alcohol may be sold.  There are counties that are "dry", where it may not be sold.  But there are also quite a few counties where wine may only be sold if it is 14% alcohol or less.  I remember doing a presentation to our sales team there and having many of the reps making notes on which of our wines they could sell, and which they couldn't because those wines were on the wrong side of the 14% law.
• State control.  In Wyoming, you are not allowed to sell a wine without being with a state-licensed broker.  And by sell, I mean talk about.  You aren't really selling the wine anyway; the state of Wyoming is the only licensed wholesaler.  But their job pretty much stops at warehousing and delivery.  If you want to help convince the local retailers and restaurants that they should ask the state of Wyoming to deliver your wine, you'd better be with someone with a license.  Same thing in a few other states.  Want to pour wine at a festival in Maine?  You'd better get the state license.
• Direct shipping protectionism.  The arcane barriers to direct shipping, nearly all erected to protect wholesalers but couched in language about encouraging responsible alcohol consumption or ensuring the collection of tax revenue, could fill a post by themselves.  There are still roughly a dozen states that effectively prohibit all wine being shipped in, but (like with dry counties) that's a choice. The ones that get me are the inexplicable ones, like Maine not allowing us to ship half-bottles there (minimum size: 750ml). Or states like Rhode Island, South Dakota, Arizona and Delaware that allow us to ship wine if the customer makes an in-person purchase here, but not if they pick up their phone and call us, or want to order online.  Or those with bizarre or minimal limits per month or year, like South Dakota's limit of 5 bottles per shipment, Texas's limit of 46 bottles per individual per calendar month, or Wyoming's limit of 2 cases per household per year.  Or (and this starts to go from ridiculous to serious) those with capacity caps, the distributor lobby's wedge issue of choice at the moment. Arizona decided that wineries that produce fewer than 20,000 gallons per year -- conveniently, just above the size of Arizona's largest winery -- can ship to consumers, while larger wineries like us can't. These encroachments and others like them will get increasingly onerous unless people stand up. Free the Grapes is a great place to start.
• Sampling restrictions.  In Vermont, you are not allowed to sample multiple accounts on a single bottle of wine.  In fact, you are not allowed to bring a sample of wine into a licensed establishment.  If you, as a winery or distributor representative, want to show a wine to an account, you have to convince the account to buy the wine from the warehouse, then you have to buy it from the establishment, open it and taste it with the proprietor, and then repeat the same process at each stop in your work day.  You can imagine how well this works.
• Massachusetts.  Finally, we'll devote a paragraph to the Commonwealth of Massachusetts, which passed a direct shipping law so obviously anticompetitive -- the sponsors explained in the legislature, during the debate about the law that the law's limits were set so as to allow all the in-state wineries to ship to consumers while prohibiting as many out-of-state wineries as possible -- that a federal court declared it unconstitutional. Of course, this declaration was moot, because the law also contained a clause making the common carrier (think UPS or FedEx) liable if they delivered a shipment to a consumer in excess of the 26 cases/household/year aggregate limit.  Think about this.  The carrier is supposed to know whether or not this customer has bought more than the aggregate limit already that year, that could have been delivered by another carrier.  Even before the law was invalidated, both UPS and FedEx announced that they wouldn't accept any shipment bound for the state, and now, four years later, nothing has changed, though there's a glimmer of hope, as the Massachusetts House of Representatives passed a budget that includes reasonable wine shipping provisions.  It's now awaiting action at the state Senate.  If you live there, or know any wine lovers who do, there's a template at Free the Grapes that will help you ask them to move it forward.

Perhaps the most surprising thing from my perspective is the degree to which the restaurants, retailers and consumers in these different states accept the status quo.  Nearly all of these laws enrich some entrenched interest at the expense of the consumer.  Wineries, restaurants and retailers are often collateral damage.  As much fun as this craziness can be, I, for one, would like to order a little sanity.  But I'm not holding my breath.

Zombie legislation: HR 5034 lurches back to life as HR 1161

Last year, beer and wine wholesalers' associations spearheaded the introduction of HR 5034 into the US House of Representatives.  Although the legislation was never passed (it never even made it out of committee) by the end of the legislative year it had amassed 153 co-sponsors, or more than one-third of the House's total membership.  The bill would have effectively rolled back the status of alcohol law to where it was before the Granholm v. Heald decision required states to treat in-state and out-of-state wineries equally.  This is potentially significant to wineries like us because the voices of in-state wineries (and the local jobs that they represent) proved decisive in several state legislatures who were forced either to open up direct shipping to all wineries or cut off their own wineries from the bulk of their customers.  We can now ship to 32 states, with Maryland expected to be the next that will come on line later this year.

Beyond wineries, the principal beneficiaries of liberalized wine shipping laws are consumers, who receive greater choice and lower prices thanks to increased competition.

Although HR 5034 did not make it into law, on March 17th an updated piece of legislation was introduced into the 2011 Congress.  Perhaps the sponsors thought that last year's "Comprehensive Alcohol Regulatory Effectiveness (CARE)" title wasn't sufficiently caring; this year's bill is slightly renamed to the "Community Alcohol Regulatory Effectiveness (CARE)" Act.  It states its purpose "to recognize and reaffirm that alcohol is different from other consumer products and that it should continue to be regulated by the States".  More specifically, the legislation clarifies that "Silence on the part of Congress shall not be construed to impose any barrier under clause 3 of section 8 of article I of the Constitution (commonly referred to as the ‘Commerce Clause’) to the regulation by a State or territory of alcoholic beverages."  Interested readers can read the complete text of HR 1161.

Why would anyone want the US Congress to differentiate alcohol from other consumer products?  Because of the money at stake.  As a quick review (I wrote about this more extensively last year, to which I refer anyone wanting more background) the 21st Amendment to the Constitution, which repealed Prohibition, grants states the rights to regulate alcohol within their borders.  State legislatures have traditionally taken an expansive view of what this permits, at times bringing them into conflict with the Commerce Clause of the Constitution that gives the US Congress sole authority to regulate interstate commerce.  The end result has been the near-universal adoption of the three-tier system, where producers or suppliers of alcohol (the first tier) must sell to state-licensed wholesalers (the second tier) who must sell to retailers and restaurants (the third tier).  Only this third tier, in the classic three-tier system, can sell to consumers.  Each tier has its profits built into the system, which means that the typical price that a winery like Tablas Creek sells to a wholesaler is about half the end sale price to a consumer.

With the increasing ease of Internet and mail-order commerce -- and the move of small wineries and wine tourism into the American wine consuming mainstream -- cracks have appeared in the foundation of the government-protected wholesale tier.  Exceptions to the three-tier system are now the norm for wineries, and the Granholm decision made explicit the Court's opinion that states cannot discriminate against out-of-state wineries but must establish a level playing field.  Wholesalers see the logic used by the Supreme Court in Granholm as a threat.  What if, they worry, courts permit out-of-state wholesalers to make deliveries to in-state restaurant and retail accounts?  What if chain retailers can purchase from whichever wholesaler, in whatever state, will give them the best price, and then supply their in-state stores out of a central warehouse?  Or, scariest of all, what if retailers cut out the middleman wholesaler in one of the states that allows them to do so (like California) and then begin self-distributing to their locations around the country?  It's fairly clear to me that wholesalers view stores like Costco as their biggest threats, not small wineries like us.

Of course, all these steps that alcohol wholesalers fear have already happened in nearly every other consumer product.  Consumers have the option of buying direct from the manufacturer, or from stores in other states, or in person.  The result has been a dramatic lowering of prices and a proliferation of innovative producers, who can leverage the power of Internet long-tail marketing to reach customers whose concentration in any one area may be low, but whose cumulative buying power is significant.  Wholesalers have not disappeared in other consumer products, but their power has been limited as their customers have more options and demand better service and more competitive prices.  But understanding why alcohol wholesalers are worried doesn't mean that one should feel sympathetic to their efforts.  The casual disregard the bill's wholesale advocates show for the harm that this bill would cause their suppliers (wineries, breweries, distilleries and importers) their customers (restaurants and retailers) and consumers around the country can be breathtaking.

Despite the claims of proponents of the legislation that wineries wouldn't be harmed -- and the phrasing of the bill does include some safeguards for nondiscrimination in winery direct shipping that were absent from HR 5034 -- the proposed legislation would still be bad for both wineries and consumers, and terrible for retailers.  Although a clause states that states "may not intentionally or facially discriminate against out-of-State or out-of-territory producers" there are many non-facial discriminations that can be put into place that have similar effects.  Some states have put into place capacity caps, where only wineries under a certain size can ship to in-state consumers.  Of course, the cap is carefully set just above the size of the largest in-state producer.  Other states require that wine be purchased in-person, which of course is much easier at an in-state winery than an out-of-state one.  And retailers, who should by any logic I can understand also be subject to the same legal principals espoused in Granholm, would not be covered by the language protecting "producers".  This omission is particularly important because retailers were recently rebuffed without comment by the Supreme Court in their effort to apply the logic of Granholm to their businesses and are still unable to access most out-of-state markets.

The proponents of the legislation take pains to refer to the bill's supporters as "bipartisan", and I imagine it's no coincidence that the bill's eight co-sponsors include four Democrats and four Republicans.  I think it's more accurate to say that the bill is nonpartisan than that it is bipartisan; there is really no overriding constitutional principle here except for a very narrowly-defined emphasis on states' rights (if you consider it a state right to put into place discriminatory laws regulating commerce).  But what is at play, like last year, is money.  The Wine Spectator found last year that beer and liquor wholesalers had made over $11 million in campaign donations over four years to House and Senate campaigns, a total that rose dramatically after the Granholm decision.  In total, the organizations that supported HR 5034 outspent those that opposed it by a total of more than four to one.

The risks of this year's bill are real.  Last year, Nancy Pelosi (whose district contains dozens of wineries) was an important opponent of the legislation.  With the change in leadership in the House, Pelosi's influence is diminished while new Speaker John Boehner's position on the bill is unknown.  I urge wineries and wine lovers not to be complacent about the act's prospects.  With the money at stake, wholesalers' organizations are committed to protecting their interests over the long haul, and are willing to continue to pour money at legislators to ensure that their opinions are heard.

Join Free the Grapes to get involved

There are two important actions we can all encourage.  First, we in the wine industry need to continue to spread the word that this bill is a threat not just to the livelihoods of family wineries but also an anticompetitive piece of legislation that will raise prices and dramatically reduce availability of wines for consumers around the country.  And the second is to make sure that our congressional representatives know that we're watching.  As usual, the Web site Free the Grapes has great tools to make this easier, principal of which is a form with a customizable letter that will be sent automatically to your congressional representatives.  I have already reached out to Representative Kevin McCarthy (whose insight and behind-the-scenes work last year was welcome) and will let readers know what I hear back.

An update on HR 5034: a good meeting with Kevin McCarthy and a positive note from Diane Feinstein... but the co-sponsors list grows to 106

About a month ago, prompted by an email exchange I had with Representative Kevin McCarthy, I wrote about HR 5034, a bill introduced into the U.S. House of Representatives by the beer and wine wholesalers associations that would, among other impacts, likely restrict or eliminate out-of-state winery direct shipping. 

In the month since I posted, the political process continues to move.  On the positive side, I joined a group of local wine community delegates for a reassuring meeting with McCarthy, and he provided his clearest statement yet of opposition to the measure.  I also received a positive note from Senator Diane Feinstein, and many of the country's major newspapers have come out against this bill.

But the bill remains a threat.  Proponents of the bill continue to sign up co-sponsors, and are up to 106: almost exactly one-quarter of the 435 members of the House.  And from what we've learned from our elected representatives and from the reporting that the media has done, this is a long-term effort by the wholesalers and we're only seeing the first salvo.

A good meeting with Kevin McCarthy
Perhaps the most positive development over the last month came in the form of a reassuring meeting with Kevin McCarthy.  Within a week of my last post, he had reached out to set up a meeting with a delegation of vintners from his district (which includes the Paso Robles and Edna Valley wine regions).  By the time of the meeting, he had clearly made the effort to learn what was behind the bill and was well-informed as to the potential consequences to wineries should it pass.  He reported that the beer and wine wholesalers associations were making a major push behind the bill, and that he'd been visited by lobbyists for both groups to try to recruit him as a co-sponsor (he declined).

He also made it clear that he felt that wine was a fundamentally different business than beer and liquor, as the experience of visiting a winery, and the necessary requirement that wineries be able to ship their products to these new customers, drove a different business model.  I don't see it that way; I believe that any producer of alcohol -- whether they be a craft brewer, a distiller or a winery -- should be able to sell their product to any interested customer of legal age.  And I believe that the type of alcohol is irrelevant to the logic that the Supreme Court used to overturn discriminatory wine shipping laws.  But it does hint at a way that he can try to split the difference between explaining that he's not against the three-tier system while still protecting an important local constituency.

I found most interesting his analysis that winery shipping is not the principal focus of the wholesalers' efforts.  Sure, most of them don't like wineries shipping direct and cutting out the wholesaler tier.  But they recognize that due to economies of scale, consumer-direct shipping of wine is never going to be sufficiently widespread to make a serious dent in their profits.  What they're more worried about is the threat from larger retailers who can use the Supreme Court's logic to argue that they should be able to buy direct from producers, or from wholesalers in other states.  Consider Costco's 2004 lawsuit in Washington State, where the nation's largest wine retailer attempted to become, in effect, its own distributor (it lost in the 9th Circuit Court of Appeals).

McCarthy also gave us his opinion that the bill, despite its relatively large number of co-sponsors, didn't seem to have a lot of momentum in the House.  First, he said that the Democratic leadership, including Nancy Pelosi, was squarely against it, and he didn't think it would make it out of committee.  Second, he thought that the House had so much other business (we all interpreted this, correctly I think, as "other more important business") on the docket that it seemed a long shot to make it to the floor this session.

When we left the meeting, all of us felt better, although we didn't get a declarative statement from McCarthy on his position.  We've been following up with his office for the last months to receive one, and are told it's in the works.  So, it was very nice to read last week that he told the Wine Spectator's Rob Taylor "There are over 200 wineries in the 22nd Congressional district, and I am always concerned about legislation and regulation that would negatively impact such an important part of our local economy.  I met with a diverse group of wineries about H.R. 5034 recently, and smaller wineries, especially, told me this legislation would negatively impact their ability to sell to their customers directly, and I will continue to support their right to do so."

A nice note from Diane Feinstein
When I used the great email generator that Free the Grapes built using CapWiz (http://www.capwiz.com/freegrapes/issues/alert/?alertid=14948676) to send an email to Kevin McCarthy, I decided that it couldn't hurt to also send messages to our senators Barbara Boxer and Diane Feinstein.  I haven't heard from Senator Boxer yet, but received a nice note from Senator Feinstein last week.  After giving a little background on the circumstances in which she feels the federal government should supersede state laws, she continues:

I have long supported the ability of wineries to ship directly to consumers. Direct shipping enhances consumer choice and can be an important market for small, niche wineries - many of which are located in California.

On April 15, 2010, Representative Bill Delahunt (D-MA) introduced H.R. 5034, the "Comprehensive Alcohol Regulatory Effectiveness Act." This legislation would declare that it is the policy of Congress that each State or territory shall have the primary authority to regulate alcoholic beverages and that state alcohol regulations shall be accorded a strong presumption of validity when they are challenged in court. I understand your concern that this bill could allow states to discriminate against or otherwise limit direct-to-consumer shipments from local wineries in California to out-of-state customers.

H.R. 5034 has been referred to the House Committee on the Judiciary, and companion legislation has not been introduced in the Senate. Please be assured that I will keep your concerns in mind should this bill or related legislation be considered by the Senate

It seems clear that she would fight a bill similar to HR 5034 were one to be introduced into the Senate.

Recent developments
Perhaps the most important development in the last month has been the engagement of the wine press. A number of major media outlets (including the New York Times, San Francisco Chronicle, Washington Post and Wine Spectator) have written articles on HR 5034, all of them critical of the bill.  A Web site (http://www.stophr5034.org/) and a Facebook campaign have been created.

Both brewers and distillers have come out strongly against the bill, in large part because it is written so broadly as to permit states to impose different state-based product labeling laws.

For all that, I still don't think that either the general public or the winery community is sufficiently engaged on the issue.  The Facebook campaign has gathered 13,000 adherents in a month, which is only a tiny fraction of the wine drinking population in the country (or, for that matter, a tiny percentage of the wine club membership population in the country).  Most wineries I speak to have not yet sent out alerts to their mailing lists and wine club membership, and don't have anything posted on their Web sites.  Most consumers I speak to are at best only vaguely aware of the bill.  While wineries and consumers remain unengaged, the wholesalers' lobbyists keep working, and the nearly $15 million that the wholesalers' associations have donated to national campaigns in the last decade guarantees they have access.  The number of co-sponsors has doubled in the last month, and more are signing on each day.

Conclusions
I guess it's nice to know that the wholesalers' associations didn't specifically target the small winery community with this bill.  Still, it's clear wholesalers would be fine with a law that would put a significant number of wineries out of business as long as they maintained their cut of the sales to big box stores.  And make no mistake, the risk is real.  We calculated that at Tablas Creek 21% of our revenue last year came from wine we shipped to consumers outside of California.  I am sure that for many small wineries losing 20% of their revenue would mean financial ruin.

I urge wineries to continue to spread the word to their customers, and consumers to suggest to the wineries who they patronize to do so.  And everyone should be speaking to their elected representatives.  As always, Free the Grapes is a great place to start and has the tools to make this all easy.

An exchange with Representative Kevin McCarthy on HR 5034 and direct shipping

On April 15th, H.R. 5034 was introduced into the US House of Representatives.  This bill, written by the Beer Wholesalers of America and titled the "Comprehensive Alcohol Regulatory Effectiveness Act of 2010" [Get it? The "CARE Act"] would write into law the primacy of the 21st Amendment, which repealed prohibition, over the Commerce Clause of the US Constitution, which gives the federal government exclusive power to regulate interstate commerce.  The net impact would be to allow states to write laws which allow their own in-state wineries (and breweries) to ship direct to consumers but prohibit out-of-state wineries (and breweries) from doing the same.  Read the full text here.

Of course, local wineries, and the in-state jobs that they represent, have been one rallying point for the advocates of direct shipping.  And direct shipping has been largely victorious in the nearly five years since Supreme Court ruled in Granholm v. Heald that states were not allowed to discriminate in favor of in-state interests in their alcohol regulations.  At that time, we could ship to 13 states.  Later this month, we will add Maine as our 31st legal shipping state.  The end result of the deregulation has been more choices for and lower prices to consumers, and more tax revenue to states, who have nearly all written shipping laws that require out-of-state wineries to remit state and local taxes on the wines they ship into the state.

Of course, one tier has been left out of the celebration: the wholesale tier, who in the era before direct sales collected a state-mandated markup on every bottle of beer, wine and liquor sold in every state.  These wholesalers are licensed by each state, and are often the single largest contributors to state political campaigns.  And although direct shipping of beer and wine is a tiny proportion of all sales and largely covers products that are not available through distribution, wholesalers have mobilized in force against direct shipping.  It's really amazing that so many direct shipping laws have been written in the last five years given the money and political muscle that have been lined up against each one.

With state ploys for legal discrimination being eliminated one by one in the courts (the most recent, a Massachusetts capacity cap under which all in-state wineries fell, was reaffirmed as unconstitutional by the First Circuit Court of Appeals in January) wholesalers have evidently turned to the federal government for help.  Hence H.R. 5034.

Although the bill has yet to be brought to the floor of the House for a vote, I did not want to be complacent about its prospects.  So, I wrote our local congressman, Representative Kevin McCarthy of California's 22nd District, to urge him to oppose the bill.  I assumed, given that his territory includes both Paso Robles and Bakersfield (wine producing regions) that he would be opposed to the bill.  His response suggested to me that he had not yet considered the bill's impacts on his district, and that he was taking the legislation's sponsors at their word when they said that this was an issue of states' rights.

I thought it would be interesting to post our exchange.  I have a few concluding thoughts (as well as how to contact your own representative) below the emails.  First, from last Thursday:

Dear Representative McCarthy,

We met a few years ago at an event organized by the Paso Robles Wine Country Alliance about immigration issues.  This is much more pressing to us, and to every small wine producer in the Paso Robles region.  I hope you will oppose HR 5034, a bill sponsored by beer wholesalers that would overturn winery-to-consumer shipping around the United States.

The legislation is couched as addressing public safety and states' rights, but is better described as an effort by wholesalers to protect their monopoly and choke off a potential source of competition.  If it passes, it will eliminate consumer access to thousands of small wineries and tens of thousands of wines, nearly all of them with such small productions as to be irrelevant to distributors.

HR 5034 has been condemned by winery associations including the Paso Robles Wine Country Alliance.  It would choke off the lifeblood of most small wineries in our area and around the country.

Please let me know how you intend to vote on this important issue.

Sincerely,
Jason Haas

I received a response this morning:

Dear Jason:

Thank you for contacting me in opposition to H.R. 5034. 

According to the bill's sponsors, H.R. 5034 is intended to reiterate the three-tier system of alcohol regulation in the U.S., and to ensure that states retain their traditional regulatory authority over alcohol distribution, which are areas that I support. However, I appreciate your concerns that the legislation could negatively impact wineries, especially small ones, in California. Given these concerns, I will closely monitor this legislation before making a final decision on this bill should it come to the House floor for a vote.

Thanks again for contacting me on issues of importance to you. If you would like additional information on services my office can provide you, my votes and positions on issues facing our nation, and to subscribe to receive periodic "e-newsletters," please visit my website at http://kevinmccarthy.house.gov/.

Sincerely,

Kevin McCarthy
Member of Congress

I responded to him just a few minutes ago:

Dear Representative McCarthy,

Thank you for your response to my earlier note regarding HR 5034.  In your response, you write:

"According to the bill's sponsors, H.R. 5034 is intended to reiterate the three-tier system of alcohol regulation in the U.S., and to ensure that states retain their traditional regulatory authority over alcohol distribution, which are areas that I support."

Please, in your deliberations, recognize that nothing currently prevents states from regulating alcohol in any way they choose.  Some states force all wine to go through the three-tier system and prohibit wine shipments entirely.  Others only allow it only for wineries of a certain size.  Others allow shipment into some areas and not others.  Others allow wineries and retailers to ship.  The only prohibition is that states not discriminate in favor of in-state wineries.  The major beneficiaries of the free trade that has resulted from the Supreme Court prohibition of discrimination have been the small wineries of California, over 200 of which are in your district.

While the sponsors of the bill would have you believe that this issue is one of states' rights, it is instead an issue of legislated monopolies (the liquor distributors) trying to eliminate their competition (your small wineries).  If you support free trade, you should oppose this bill. 

The passage of HR 5034 would likely result in dozens of local wineries having to close, the elimination of hundreds of good local jobs, and blunt the most powerful engine of the vibrant Paso Robles economy.

I hope that you will oppose this dangerous bill.

All the best,
-Jason

I find it hard to believe that a California representative, and a member of the Congressional Wine Caucus, would take a bill like this at face value.  If a representative who has a territory with such a vested interest in expanded access to direct shipping can be so willing to accept the justifications of the wholesalers' lobby, what can the prospects be in the rest of the country?

If we expect the members of Congress to see this bill for what it is -- an anticompetitive money grab by big businesses with legislated monopoly power -- we need to make our voices heard.  Please speak up!  As usual, the Web site Free the Grapes is a great resource.  Or, you can also go straight to a page where you can customize and have notes sent to your senators and representatives.  And please continue to spread the word.  There is a Facebook group dedicated to stopping HR 5034, and a quick blog search on HR 5034 turns up nearly 4000 articles, led, appropriately, by Tom Wark's full-throated repudiation of the wholesalers' claims.

Wine markups at the wholesale, restaurant and retail level

I try not to rant about the wholesale market for wine in the United States.  Really I do.  I know that distributors and retailers play an important role both in marketing and in delivering wine to the millions of American wine consumers, and I am grateful for the work of the dedicated wholesalers, restaurateurs and retailers who support Tablas Creek wines every year.

But there are times when the entire wholesale channel can be discouraging, when I eye jealously the producers around here who sell most or all their production direct.

The economic challenges of a recession hit both ends of the distribution chain.  Restaurants have so far taken the largest hit, with several notable top spots already closed and others, particularly those who rely on businesspeople with expense accounts or tourists, down as much as 30%.  Retailers as well have seen the effects of consumers tightening their belts, and though they continue to sell plenty of wine, most of what is selling now is on the less-expensive (and less profitable) end of the price spectrum.  Similarly, smaller, higher-end wineries are impacted by having to convince several people along the distribution path that they should have enough confidence to sell their wines.  As I wrote a few weeks back in my post Succeeding in a poor economy:

"for a wine to sell in the wholesale market, the distributor manager has to believe in the product enough to maintain a healthy inventory, the distributor rep has to believe he or she can sell the wine enough to pull a sample and show it to his or her accounts, and the buyers at the accounts have to have enough confidence to buy the wine in a crowded marketplace full of people offering them hitherto-unimaginable deals.  That's a lot of people whose confidence you have to win or keep before the consumer even gets the opportunity to buy your wine."

While both restaurant/retailers and wineries struggle, the system is set up such that wholesalers are guaranteed to make healthy money off of wine.  For example: a typical wine that retails for $25/bottle ($300/case) a retailer would expect to buy for $200/case.  The distributor who sells it for $200/case would expect to buy it for $150/case.  An agent who sells to distributors for $150/case would expect to buy it for somewhere around $120/case.  So, a winery starts off with $10 of the eventual price of $25, and bears most the real costs of the wine (including, but not limited to, land, winery building, farming, harvest labor, winery labor, barrels, bottles, corks, and marketing).  Nearly every wholesaler and many retailers pay their sales force on commission, so if they sell less, they're paid less.  It's a great way to make sure that whatever sales are, the business ends up in the black.

The world of restaurants has even more dramatic markups on wine (which go to subsidize food and labor costs).  That same wine which the retailer sold for $25/bottle would normally sell on a restaurant list for triple the restaurant's cost, or $50.  If the restaurant were to pour it by the glass, the typical markup is to charge bottle cost for each glass of wine.  So, a glass of the wine would be $16.  I wonder if most people realize what a small percentage of the price that they are paying for wine at the retail shop or restaurant goes back to the producer. 

It's worth mentioning that I am not particularly complaining about restaurant markups, at least not wine list markups.  Restaurants typically use the margins they make on wine to help subsidize the rest of the astronomical costs of building out and running their operations, and given that 60% of restaurants close or change ownership in the first three years, most restaurateurs are not in the business getting rich.  I do think, though, that the standard 400% by-the-glass markup and the resulting $12 bottle cost limit for by-the-glass wines, is often self-defeating for restaurants, as most restaurants therefore can't offer great wines for their by-the-glass selections.

Why did this system evolve in a way that protects the profitability of wholesalers at the expense of restaurants and producers?  In my opinion, it's a combination of legislation that protects the distribution tier (the famous three-tier system) and natural economies of scale.  For a distributor to be effective, they must be relatively large, and sell many dozens (probably many hundreds) of wineries' wines.  This means that the success of any individual small winery or any individual restaurant or retailer means relatively little to them financially.

In addition to these natural economies of scale, wholesalers are protected by the laws that license them to make deliveries of alcohol to restaurant and retail customers. (A few states do permit wineries to do this, but it's usually only practical in the winery's own home region.)  Many states give even more explicit protection from competition to the wholesalers, including roughly 20 states with franchise laws that expressly prohibit wineries who are dissatisfied from choosing to move their custom elsewhere.  This has always seemed to me a clear violation of antitrust laws, and on a more pragmatic level allows distributors in franchise states to routinely work on higher markups.  With distributors' large size comes political clout and efforts to protect their privileges through favorable state legislation, as advocacy groups like the Specialty Wine Retailers Association point out.

It's worth noting that there are exceptions to every generalization.  We have several wholesalers in key states around the country who are terrific, who share the costs of offering better deals to our customers, and who are out on the streets regularly advocating for our wines.  But those distributors who provide advocacy and education in addition to their warehousing and delivery tend to be our smaller, wine-focused distributors rather than larger we-sell-everything-from-Jack Daniels-to-boutique-wine wholesalers, and mostly (though not entirely) come from states without franchise laws.  It doesn't take a rocket scientist to guess in which sort of wholesaler Tablas Creek does best.

How does a small to medium-sized winery who makes their livelihood in the wholesale market survive?  I have no idea (thank goodness for our tasting room and our mailing list, through which channels we can offer customers good discounts on wines and still make a much better margin than on what we sell wholesale).  My dad and I have come to the conclusion that for a winery to be successful focusing solely on the wholesale market they need to make somewhere above 50,000 cases.  I wouldn't know about that.  But I do know that at Tablas Creek, we've been forced to think of our money-losing efforts in the wholesale market as a portion of our marketing budget.  It's about the only way that we can avoid throwing the mouse at the computer when we get a request from a wholesaler that we lower our price on a bottle of wine that we sell for $9 (out of which come all the concrete costs of making the wine) so that the distributor can make their $4 for delivering a bottle of wine from their warehouse to a restaurant and the restaurant can make $58 on that bottle when pouring it by the glass.

So, where does this leave us?  Get involved in your state legislatures' discussions on wine-related matters.  Oppose franchise laws, exclusivity for wholesalers and other laws that protect the middle tier from competition.  Support direct shipping legislation.  Free market capitalism stops working when the markets aren't free, and the wholesale wine market, at least outside California, isn't very free.  And both producers and consumers suffer the consequences.

An Independence Day look at progress in direct shipping since Granholm v Heald

On the day that Granholm v. Heald was announced in 2005, there were impromptu celebrations around the country, stories in the national media about how the Supreme Court had sided with wine lovers and struck down restrictions on interstate wine shipment, and general euphoria among small and medium-sized wineries who rely on direct shipping.  A closer reading of the decision in the ensuing days produced a more nuanced view, that the Supreme Court overturned a certain type of state protectionism and that the real-world consequences of this decision were likely to be on balance positive to wineries and consumers wishing to order wine from these wineries.  Readers might be interested in a detailed analysis of the Granholm v Heald decision I wrote for a newsletter back in 2005, which I later expanded on this blog.

Slightly more than three years later, the results are complex.  The net effects have been to allow more people in more places to receive wines direct from wineries, but the impacts have been far from uniformly positive for wineries and their customers.

When the Granholm decision was announced, we could ship to the thirteen states with reciprocal shipping laws.  These states (Alaska, California, Colorado, Idaho, Illinois, Iowa, Minnesota, Missouri, New Mexico, Oregon, Washington, West Virginia and Wisconsin) allowed wines from the other twelve reciprocal states, with the stipulation that those states also allowed their wines.  Geographically, they were clustered around the West Coast and the upper Midwest.  None (with the exception of West Virginia) was near the East Coast or the South.  The total population of the reciprocal states comprised just under 30% of the US population.  The benefits of this system were that, as long as you were shipping to someone in one of these states, you needed to do very little compliance work and (outside of California) did not need to charge for or remit taxes.

Now, three years post-Granholm, we can ship to 26 states (Alaska, California, Colorado, Florida, Idaho, Illinois, Iowa, Michigan, Minnesota, Missouri, Nebraska, Nevada, New Hampshire, New Mexico, New York, North Carolina, Ohio, Oregon, South Carolina, Texas, Vermont, Virginia, Washington, West Virginia, Wisconsin and Wyoming).  We expect to receive approval to ship to Georgia within the next month. These 27 states comprise nearly 70% of the US population, and most of the rest border on at least one state to which we can ship wine.  Our only "landlocked" states (where no bordering state allows direct shipment) are Mississippi and Rhode Island -- two of the smallest wine markets in the country. 

Note that if you look at a shipping map such as the one published by the Wine Institute (in conjunction with ShipCompliant, which we'll hear more about later), you'll see 36 states listed as legal shipping states.  The discrepancy between their number and ours comes because of the varying levels of restriction and cost that states impose on wineries wishing to ship.  Some (like Arizona and Massachusetts) restrict us from shipping because we're too large.  Some (like Louisiana and Indiana) prohibit wineries from shipping if they also have a relationship with a distributor in the state.  Some (like Kansas and Rhode Island) allow you to ship orders placed while the customer was on-site only.  Others (like Hawaii and Connecticut) have such onerous reporting requirements that the business we could do does not justify the expense.  Finally, the District of Columbia has such a low monthly limit (one quart per month) that shipping there is not practical.

This variability by state is a large part of the downside of the proliferation of state direct shipping laws post-Granholm.  By and large, states have taken advantage of the portion of the Supreme Court decision that allows them to recoup the taxes they would otherwise have collected from an in-state sale of the same wine.  Some states (like Texas) have made this relatively simple by applying a uniform state-wide tax rate and then distributing the revenue internally.  Others (like New York) require that we collect the precise tax that would be charged at the point of delivery.  So, in addition to any state taxes, we need also collect county and city taxes, and remit these to the appropriate agencies at the schedule they dictate. As you'd expect, this can be a nightmare.  Different jurisdictions require reporting -- which can range in complexity from relatively simple to exceptionally detailed -- monthly, others quarterly, others annually.  At Tablas Creek, we have one person in our office who specializes in compliance.  She spends about one third of her time on this, and we receive additional contributions from our Controller.  The overall cost of the time they spent (in salaries and benefits) probably approached $20,000 last year. 

The main cost to consumers is that (with the exception of the three remaining reciprocal states) we are now required to collect and remit taxes on the wines that we sell.  The 21st Amendment that repealed prohibition gives special authority to states to treat alcohol differently from other products.  However, the Supreme Court has held that the Commerce Clause prohibits states from collecting taxes on most out-of-state sales.  For example, you don't pay taxes on a book you order from Amazon.com unless you live in Amazon's home state of Washington.  The Supreme Court last weighed in on the collection of taxes in interstate commerce in the 1992 decision Quill Corp. v. North Dakota, and affirmed the earlier rule that required a company to remit state taxes only if it has a "nexus" in that state.  The decision looked specifically at a mail-order business, but it has been held to apply equally to Internet commerce.

Yet, the new direct shipping laws nearly all require that wineries collect and remit taxes on their sales.  I think it's interesting that I can't distinguish how this conflict between the 21st Amendment and the Commerce Clause differs materially from the one ruled on in Granholm.  Yet, when the states' Attorneys General argued in Granholm that they had a "legitimate local purpose" in collecting taxes on the sales of wine within their borders (as a justification for prohibiting untaxed out-of-state sales) Justice Kennedy specifically rebuts their concerns by suggesting that wineries remit taxes.  From the court's opinion:

Licensees could be required to submit regular sales reports and to remit taxes. Indeed, various States use this approach for taxing direct interstate wine shipments, e.g., N. H. Rev. Stat. Ann. §178.27 (Lexis Supp. 2004), and report no problems with tax collection.

This imposition of formerly-uncollected taxes amounts to a surcharge of between 6% and 10%, depending on the location where the wine is delivered.  On the volume of sales even of a relatively small winery like us, this adds up.

You might well ask how a really small winery, with little or no staff, can hope to navigate this labyrinth.  It is a real challenge.  Some small wineries have simply abandoned shipping to the non-reciprocal states, and therefore seen their market shrink rather than grow in the last three years.  However, a handful of companies specializing in compliance have moved in to fill the void. We use what is probably the market leader, ShipCompliant, and it has made the process much easier.  For a fee of a few hundred dollars per month, we filter our sales through their software and have state and local compliance documents generated automatically.  Of course, there have been other costs in setting up and integrating this system with both our Web front-end and our accounting back-end systems.

Another hidden cost to consumers has been the erosion of rights to receive out-of-state shipments from wine retailers.  The Granholm decision specifically addresses wineries, and many states have taken the (in my mind, constitutionally indefensible) position that it was not intended to apply to other sellers of wine.  The Wine & Spirits Wholesalers of America has been tireless in the face of public ridicule and judicial rebuke in opposing any expansions of direct shipping privileges, and the newly formed Specialty Wine Retailers Association has only recently begun mobilizing to protect retailers' shipping rights.  Meanwhile, several states, most notably Illinois, have stripped their consumers of the rights to order wine from out-of-state retailers.

Finally, as a conclusion, it's worth noting that my initial idea in writing this article was to find relevant sections of the Declaration of Independence, and its spirit of rule by and for the people governed, as a way of exploring the various impacts. Looking at the Declaration's text, I decided that idea was overblown. Yes, I'd love to be able to ship a bottle of Mourvedre to Maryland, but I don't think that the fact that we cannot should encourage us to dissolve our system of government.  The US Constitution (which, after all, specified the mechanism of government rather than the justification for it) seems a better guide.  The most relevant?  The wisdom of the founding fathers, who in the Commerce Clause (Article I, § 8, cl. 3) reserved for Congress the power to "regulate Commerce with foreign Nations, and among the several States".  It's clear that states, given a sliver of opportunity, find justifications for imposing and collecting taxes and for favoring businesses licensed by and in that state.  One can only imagine how fragile the federation of states would be, and how discouraging it would be for business in general, if every product had to navigate the same patchwork of regulatory challenges that producers of wine face.