A long-lost American tradition, the craft-brewed beer industry has enjoyed a comeback in recent years and now is among the fastest growing domestic beverage segments despite national trends of diminishing alcoholic consumption. This industry analysis will explore the economic underpinnings of the craft-brewed beer industry and the reasons for its recent success.
1.0.0 HistoryBefore Prohibition halted "the manufacture, sale, or transportation of intoxicating liquors . . . for beverage purposes" in 1919, over 4,500 independent breweries produced beer for local markets across the country.1 However, prohibition closed the legal beer industry for fourteen years, closing most of the existing breweries and disrupting the tradition of local independent brewers in the United States. Upon the repeal of prohibition in 1933, entrepreneurs entered the beer market and quickly expanded the industry to nearly 900 breweries by 1941. Though larger in size than their pre-prohibition predecessors, these breweries also served local and small regional markets.
The post-WWII years saw immense consolidation in the beer industry. The migration of the American population towards urban centers and the consumer acceptance of metal cans contributed to the emergence of national and super-regional brewers. Economies of scale in production, distribution, marketing, and advertising provided these large players with the ammunition needed to wrest control of the industry from the once dominant local brewers. The results of this concentration is apparent in the oligopolistic market structure of the beer industry today. As of 1995, the four major competitors - Anheuser-Busch, Miller, Coors, and Stroh - accounted for approximately 92% of industry-wide production .
While advantageous for the national and super-regional brewers, the consolidation of the beer industry severely limited consumers' purchasing options. Using low cost ingredients, the major brewers produce a homogenous group of beers that can be mass produced to take advantage of economies of scale, thus limiting consumer choice. The major brewers stopped producing fuller-flavored beers because they do not fit into this mass production model. This left many consumers seeking a fuller-flavored taste.
The unmet demand for full-flavored beer has recently realized itself in an ongoing consumer "taste revolution." Similar to recent consumer shifts to a variety of wines, specialty coffee and bottled waters, consumer demand for full-flavored beers is rapidly increasing. While at one time consumers were satisfied with homogenous products, today, when given a choice, many chose to pay more for higher quality products. Examples include Starbucks coffee and Evian bottled water.
The "taste revolution" prompted the emergence and rapid growth of the craft-brewed beer market.2 While the total domestic beer market has contracted slightly over the past several years, the craft-brewed beer market has grown more than 40% per annum. The emerging shift to more flavorful beers is expected to be permanent and irreversible as market research spanning several industries indicates that once a consumer switches to a more flavorful product, she rarely switches back to the original product, banning drastic changes in price or availability.3 The emergence of the craft-brewed beer market as a response to a specific consumer demand, and not simply as a substitute for existing beer products, has shaped the organizational, marketing, product, and financial variables of firms in the market such that craft-brewers comprise a distinct strategic group within the beer industry. This positioning is what gives craft-brewed beers a competitive advantage in the alcoholic beverage market and makes the group a significant force in the market today.
Although craft-brewed beer products compete with a variety of alcoholic and non-alcoholic beverages, specifically regular beers, the strength of craft-brewers positioning as a strategic group has isolated it from the competitive forces of the overall alcoholic beverage market and has focused its production and pricing decisions on craft-brewed beer competitors. The following descriptions of the craft-brewed beer strategic group, its uses of delivery channels, and the relevant geographic market explain this market definition.
2.1.0 Market Definition - Craft-Brewed Beer Strategic GroupThe craft-brewed beer strategic group of the beer industry has been able to outperform the alcoholic beverage industry in terms of both margin and growth because its unique product characteristics, organizational structure, and marketing focus immunize it from many of the competitive forces that face the alcoholic beverage industry, and beer industry, at large.
2.1.1 Craft-Brewed Beer Strategic Group - Product CharacteristicsThe market definition for craft-brewed beers could arguably contain many alcoholic and non-alcoholic beverages, the most obvious of which are standard industrial beers, because each of these product groups constrains pricing in craft-brewed beer market to some extent. However, craft-brewed beer has horizontally differentiated itself such that few other beverages are close substitutes.
Craft-brewed beers are distinguished from standard industrial beers by their flavor and brewing styles. Brewed according to traditional German or English recipes using high quality ingredients, craft-brewed beers are more full-bodied than mass-produced domestic beers and, as a result, tend to be more flavorful and fresher tasting.
Craft-brewed beers are also distinguished from standard industrial beers by their ties to local geographic markets. Many craft-brewed beers are recognized by their geographic affiliation (i.e. Samuel Adams ( Boston) and base their marketing campaigns on the images that this affiliation creates.
Craft-brewed beers are horizontally differentiated from "regular" industrial beers, placing them in separate competitive markets. Craft-brewed beer's unique taste places it at a distinct point on the horizontal differentiation axis, indicating that its product features increase economic benefit (B) to a group of consumers unique from those who chose other products (regular beer), and vice versa. Evidence that a specific group of consumers derives economic benefit at the craft-brewed beer horizontal position is the beer "taste revolution" described above.
The distinct horizontal differentiation between regular and craft-brewed beers theoretically reduces the cross-price elasticity of demand between the two products by raising the price and quality points at which consumers will switch between the two products and increasing the ability of sellers in the craft-brewed market to extract profits from the economic benefit (B) delivered to consumers. The fact that craft-brewed beers compete at price points above those of regular beers provides evidence that craft-brewers are able to demand a higher price for the benefit they provide. Although some of this pricing difference is attributable to higher production costs, craft-brewed brewers enjoy higher margins even after these costs are considered.
The craft-brewed beer industry's horizontal differentiation position has been successful for two reasons. First, as discussed above, consumers are willing to pay a price premium for the enhanced economic benefit that they derive from craft-brewed beers. Second, the product is an experience, rather than a search, good. The particular flavors and brand images that craft-brewed beers provide are very difficult to define and imitate, evidenced by the major national brewers futility in producing their own craft-brewed beers, which protects the craft-brewers horizontal differentiation position.
A second dimension of the craft-brewed beer strategic group is its organization. Craft-brewers compete via a differentiation, not cost, positioning strategy. This reduces the impact of economies of scale and scope and extensive price competition on the competitive position of the group. The primary mobility barriers that prevent larger brewers from capitalizing on the organizational positioning advantage are (1) their orientation towards scale production (2) their inability to duplicate the craft-brewed flavor and quality and (3) their inability to promote the craft-brewed market image.
2.1.3 Craft-Brewed Beer Strategic Group - Marketing FocusThis differentiation-driven organizational structure directs the group's marketing focus. The craft-brewers' emphasis on product differentiation allows them to compete at higher price points than do the regular beer producers and to promote an image of high product quality and innovation. These attributes offer benefits to a consumer segment distinct from that of the regular beer segment, reducing the effects that price and image competition in the regular beer industry have on the craft-brewed market. The large brewers' inability to compete via differentiation positioning is a mobility barrier to its use of these pricing and marketing strategies.
2.2.0 Market Definition - Distribution Channels The craft-brewed beer industry is often divided into four industry segments - microbreweries, regional specialty breweries, contract brewing companies, and brewpubs - which are differentiated by volume of production and distribution channels. The subgroups are defined as follows:
The craft-brewed beer industry is separated into two classes of competitors - large national and small local brewers. The three largest craft-brewers - The Boston Beer Company, Pete's Brewing Company, and Redhook Ale Brewery - and several other large brewers distribute their products nationally and compete both with each other on a national basis and with various smaller craft-brewers on a local basis. These craft-brewers are also increasingly engaged in competition with large national brewers, such as Anheuser-Busch and Miller, as a result of targeted advertising and marketing campaigns by the nationals.
Smaller craft-brewers generally focus their marketing and distribution efforts on their local markets. In some markets, the local brewer is the only provider of craft-brewed products while in more mature markets, such as San Francisco and Portland, OR, a multitude of craft-brewers compete head-to-head for local market share. Small craft-brewers are increasing responding to consumer demand for variety by using beer wholesalers to distribute their products over wider geographic areas.
Although this industry structure makes it appear that there is one national and many local geographic markets for craft-brewed beers, several facts indicate that the market is best viewed as a single national market. Considering that a product's geographic market consists of the area within which buyers and sellers react to price changes by competitors, two factors make the craft-brewed beer market a national market:
Both the N-firm concentration ratio and Herfindahl index indicate that the craft-brewed beer market is unconcentrated. In 1995, the national market had an eight firm concentration ratio of 53.4%. When considering that Boston Beer Company holds a market share of 25.1%, this ratio indicates very low concentration. The market's Herfindahl index was .08 for the same time period (See Exhibit 4 for index analysis).
These ratios indicate the presence of a large number of small brewers in the market. As discussed below, although a less concentrated industry structure often indicates intense the internal rivalry, the horizontally differentiated nature of the craft-brewed beer product significantly reduces competition.
The structure of the craft-brewed beer industry is defined as monopolistic competition, However, oligopolistic competition may be evident in the near future as several major players have come to dominate the national market. As mentioned above, these players - Boston Beer Company, Pete's Brewing Company, and Redhook Ale Brewery - have a significant influence on the national pricing structure of craft-brewed beers. As these players' market shares continue to grow, this oligopolistic market structure will be enforced.
2.5.1 Market Structure - Monopolistic CompetitionFirms in this market are horizontally differentiated by taste and image such that no one of the multiple industry competitors can take action that will materially affect other competitors' price or production. Brewers do not compete on price but instead compete on consumer benefit. Thus, consumers usually switch between horizontally differentiated products because the benefits of one product match their specific preferences better than the benefits of a competing product match those preferences.
The lack of price competition among craft-brewed beers is evidence of this market structure. While the national industrial brewers compete on vertically differentiated, commoditized beer products which are distinguished by price, craft-brewed beers more commonly compete at the same price points with new flavors or images, such as the release of seasonal brews or a "hand-made" or "home town-made" brand image, and avoid price competition.
The craft-brewed beer market is moving towards an oligopolistic market structure as:
Economies of scale and scope play a significant role in the overall beer industry. Achieving economies in production, distribution, advertising, and marketing are key success factors for all competitors in this market. However, because craft-brewed beers are distinguished from other beers and alcoholic beverage products by horizontal differentiation, economies of scale and scope are less significant to achieving profitability. While cost-advantages obviously affect the profitability of craft-brewers, taste and reputation are more critical success factors.
The following discusses the impact that various of economies of scale and scope have on the craft-brewed beer industry.
ECONOMIES OF SCALE
Production - Spreading the cost of fixed assets over multiple units provides obvious economies of scale to both major national and craft-brewers. However, the scale necessary to compete on cost is generally too large for craft-brewers to achieve. In addition, large batch size often hinders the major brewers' success in the craft brewed market because the production of small batches, necessary to produce the product variety and freshness demanded by craft-beer drinkers, does not fit profitably into scale production operations.
Purchasing - The cost of variable inputs goes down with purchase volume. The major industrial brewers enjoy tremendous economies of scale in this area. However, craft-brewers small batch sizes and use of many specialty inputs are not conducive to economies of purchasing. In fact, like economies of production, these economies prevent the variety that is critical to craft-brewers' success.
Distribution - The ability to ship in large quantities and control distribution channels provides economies of scale and scope. This is the area where craft-brewed beers suffer the greatest disadvantage and where competition is expected to erode industry profitability.
ECONOMIES OF SCOPE
Advertising and Marketing - The major national brewers achieve significant economies of scope in advertising and marketing through bulk media purchases and umbrella brand marketing. Local-craft brewers spend more than twice that spent by large brewers on marketing and advertising per barrel. While this has not stopped the growth of smaller craft-brewed brands to date, as the market matures and brand awareness becomes and increasingly important success factor, advertising and marketing economies will have added importance.
Craft-brewers enjoy one cost advantage that their larger competitors do not - accumulated experience on the learning curve. Large industrial brewers have invested significant resources to produce a competitive craft-brewed product. However, not being able to produce a suitable product, they have recently resorted to buying craft-brewers, and their accumulated brewing experience, for significant premiums. The premiums that the craft-brewing skill has demanded represents the value of their learning curve advantages. Despite not being able to achieve the economies of scale and scope that their larger counterparts have for regular beer, they have been able to achieve lower production costs per unit of craft-brewed beer through learning economies.
Michael Porter's 'Five Forces' framework is a necessary tool in order to thoroughly understand how this industry functions. The remainder of this paper will focus on how this framework can be applied to the craft-beer industry. In addition to the elements which comprise the five forces framework, an understanding of the role of government is critical to this analysis. Consequently, we will deal with the effect of government on the industry as a 'sixth' force.
4.1.0 Internal RivalryInternal rivalry in the craft-brewed beer industry is moderate for several reasons, including the nature of the craft beer product, the nature of industry sales transactions, and high consumer demand.
Factors leading to increased internal rivalry include low market concentration, excess capacity in the industry and low switching costs for consumers.
As described in Section 2.11, the craft-brewed beer product is highly horizontally differentiated, indicating that the characteristics of the product produce a different level of perceived benefits for various consumers. This differentiation creates monopolistic competition in the craft-brewed beer market. This competitive structure limits price competition among craft-brewers and restricts the ability of major brewers, whose products are vertically differentiated, from intensifying internal rivalry.
4.1.2 Internal Rivalry - Sales TransactionsThe terms of sales transactions between brewers, wholesale distributors and retail consumers are easily observable in the craft-brewed beer industry. Brewers can access information relating to competitors sales and cost levels and budget and price accordingly. Furthermore, sales orders are moderate in size and are received relatively frequently according to seasonal requirements. These factors reduce price competition and, consequently, internal rivalry within an industry.
4.1.3 Internal Rivalry - DemandFinally, the level and direction of consumer demand reduce internal rivalry in the craft-brewed beer industry. Although the craft-brewing industry did not reach the 1 million barrel annual sales milestone until 1992, the industry increased sales by 1 million barrels in 1995 alone, a 50% increase for the second year in a row, and increased its share of the overall domestic beer market from 1.3% to 2.0%.5 This rapid growth has permitted the entry of many new competitors without significantly increasing internal rivalry (See Exhibit 5).
4.1.4 Internal Rivalry - Market ConcentrationAs discussed in Section 2.4, the craft-brewed beer industry is unconcentrated. Although an unconcentrated market structure generally creates intense price competition within an industry, the horizontal differentiation of the craft-brewed beer product, and resulting monopolistic competition in the craft-brewed beer industry, mitigates this pricing trend.
4.1.5 Internal Rivalry - Excess Brewing CapacityExcess industry brewing capacity intensifies internal rivalry by incenting competitors to increase production and lower prices to the point where price equals average variable costs, thus reducing economic profit. At present, a number of craft-brewers, including Boston Beer Company and Pete's Brewing Company, are taking advantage of this excess capacity by contracting out the majority of their brewing operations.
The use of contract breweries by some of the larger craft-brewers is the basis of negative advertising campaigns being waged by in-house brewers. These campaigns imply a correlation between contracting out brewing and a reduction in quality of the product. Although this correlation has not, to our knowledge, been properly established and has been adamantly refuted by major contract brewers such as the Boston Beer Company, it is still to be seen if the sales of contract-brewed beer will suffer as a result of these campaigns.
Low consumer costs of switching between craft-brewed beers increase internal rivalry. John Hall, owner of Goose Island Brewing Co., identified the lack of customer loyalty as a major obstacle for brewers to overcome in this industry. He stated to us that consumers tend to try the latest "hot new craft-brew", similar to trends in wine consumption, and tend not to show brand loyalty to a particular beer. This trend is made possible by the increased availability of a variety of craft-brewed beers.
The combination of low switching costs and the fact that consumers often switch make craft brewers extremely conscious of the quality of inputs to and outputs from their breweries. The lower the switching costs in an industry, the higher the internal rivalry tends to be in that industry. In order to keep consumers buying his brand, Hall stated that Goose Island introduces different seasonal brews periodically in order to offer variety to customers. An example of this is their Christmas Ale offered during the holiday season.
The combination of influences referred to above create moderate internal rivalry in the craft-beer industry. This rivalry will increase, however, as even the optimistic craft-brewers predict that the rapid growth in demand for craft-beer will soon taper. The industry's profitability will be adversely affected by increasing market concentration and large number of market entrants (including the majors) under circumstances of more moderate rates of growth.
4.2.0 EntryA lack of substantial entry barriers is a key characteristic of the craft-brewed beer industry. "Modern Brewers Age" asserts that "ample capital is available today so brand-new breweries start operations with state of the art equipment and skilled brewers."6 Evidence of the ease of entry is the fact that during 1994 the total number of craft brewers, including regional specialty, microbreweries and brewpubs, increased by a growth rate of 41%, well above the 29% growth enjoyed during 1993.7 Factors which facilitate entry are availability of basic physical resources and insignificant economies of scale and scope. However, access to distribution channels is increasingly becoming a barrier to entry.
4.2.1 Entry - Physical ResourcesThe physical resources that are essential to the success of a craft brewery are easily obtained by entrants. Basic brewing equipment can be purchased for approximately $25,000, inputs are commodities (hops, barley, and water) and there are few issues pertaining to rights to certain products or processes, such as patents, that need to be overcome by entrants.
4.2.2 Entry - Economies of Scale and ScopeAs discussed in Section 3.0.0, although economies of scale and scope influence the overall beer industry, they are not a considerable entry barrier in the craft-brewed beer market. Technological advances in brewing equipment have reduced the costs of brewing small batches by creating some economies of scale at lower levels of production. Further, fixed brewing equipment costs are not 'sunk' if the entrant decides to exit the market because, as a result of the growth of this industry and the large numbers of new entrants, there is a large market for used brewing equipment. As a result, economies of scale and scope are not significant barriers to entry in the craft-brewed beer industry.
4.2.3 Entry - Distribution ChannelsLimited access to distribution networks is increasingly becoming a barrier to entry (and is also relevant to buyer power - see our discussion below). This is because craft-brewed beer, like many other forms of alcoholic beverages, is distributed through a 'three tier' distribution system (i.e. producer to wholesale distributor to retailer).
The wholesale beer market is highly concentrated, with most geographic markets having only three or four beer wholesalers. There are a dwindling number of independent wholesale distributors that handle the craft brands, and because of the overwhelming growth rate of the industry, it is becoming increasingly difficult to be noticed by them.
This difficulty is increased for new entrants as these distributors generally require that a reasonable variety of products be provided before they are willing to distribute the product. Consequently, current market participants with established distribution channels have an advantage over new entrants. This advantage will become increasingly significant as either the number of new entrants increases or the amount of demand tapers and shelf space become increasingly sparse.
The profits being obtained by the current market participants have attracted not only other small entrants, but also entry by some of the major brewers. With the 1% market share and the consistent double digit growth of the craft-brewing industry, "Brewers Resource Directory" reported that "'specialty' beer was the buzzword among large brewers" in 1994.8
However, the majors have not been able to compete on the same basis as in the regular beer market. Competition in the regular beer market is vertically differentiated, and as a result, significantly different key success factors are involved - economies of scale and large scale marketing capabilities are less important to the craft beer segment than to the regular beer market. Also, product quality is more important in the craft beer segment - and arguably the fact that the 'majors' have been successful in the mass-market regular beer segment leads to a negative quality image in the craft brewery segment. Bob Weinberg, President of the beerindustry analysis firm R.S. Weinberg & Associates, comments that, "I don't know of any large brewer that isn't working frantically to capture this market. It will be an organizational challenge for them, however. They have the resources, and they have the technology, but they don't have the organization. That's the thing to watch".9
The issues canvassed above are perhaps the rationale behind Anheuser-Busch Inc. ('Anheuser') and Miller Brewing Co. ('Miller') starting to focus on purchasing successful and growing craft breweries, as opposed to brewing craft beers themselves. Miller purchased a majority share in Celis Brewery in March 1995 and then bought 50% of the high-growth Shipyard Brewery in November 1995. Anheuser teamed with Redhook Brewing Co. in 1994 and Adolph Coors Co. announced in November 1994 that it was 'looking for partners.' (See Exhibit 7).
Entry barriers in the craft-brewed beer industry are currently low to moderate. Evidence of this is the recent imbalance between high new entrance rates and low exit rates. Only one in six new entrants failed in 1995 while the number of new entrants continued to grow exponentially.10 The factor that may explain this imbalance is the considerable growth in demand in the craft-brewed beer industry that has kept exit rates lower than would otherwise be expected (See Exhibit 6). We conclude, therefore, that entry barriers are low to moderate.
4.3.0 SubstitutesSubstitutes to craft-beer are those products that affect the craft-beer industry cross-price elasticity of demand because they possess similar product performance characteristics, occasions for use and geographic markets (such as regular beer, 'specialty' beer, imported beer, some types of wine and spirits and other mid-level luxury consumables).
The market for craft beer has developed as a result of an increasing desire on the part of some consumers to obtain full flavored, high quality beer. These consumers are taste and quality sensitive, and tend to purchase the product at bars, restaurants and supermarkets in their local area.
Consequently, we consider the closest substitute to craft beer to be high quality imported beer. In 1995, imported beer had an overall US beer market share of 5.7% (up from 5.3% in 1994). The imported beer segment is reasonably concentrated.
Craft-brewers believe that at the top end of the market, product quality is a key success factor. They further believe that they generally have a quality advantage over imported beers as a result of the freshness they can achieve in the craft-beer product.
Craft-breweries are much closer to their market and may therefore engage in different production systems (such as non-pasteurizing methods of preservation). Craft-brewers such as Hall from Goose Island argue that these systems increase the price consumers are willing to pay for the product and therefore product quality.
Other products such as regular beer, wine and spirits are less close substitutes. However there is little doubt that consumers would substitute these products for craft-beer if craft-beer prices increased by a sufficient margin. As a result of our research, it is our assessment that the level of substitutes is low.
As previously mentioned, the wholesale distribution market is highly concentrated, with most geographic markets having only three or four beer wholesaler distributors. The craft beer industry is not concentrated, and the industry participants have comparatively little power relative to the wholesale distributors.
In the words of Paul Shipman, President of Redhook Brewing Co., "Distributor relationships are key. . . retail consumer are still looking for products, but distribution is a choke point because of consolidation and the weakness of middle tier brands, which is forcing even more distributors into mergers."11 It is, therefore, reasonably difficult to obtain favorable distribution agreements as a result of the buyer power of the wholesale distributors.
In addition, many of the large wholesalers have agreements with the majors that jeopardize the ability of craft brewers to obtain distribution through them. According to Jerome Chicvara, Marketing Director and Co-Founder of Full Sale Brewing Co., "Big brewers are telling distributors that the craft guys have enough. They want in on the action, and have decided that if the specialty/craft segment is going to grow, they want the brand to be theirs, not ours."12 This means that craft-brewers must generally rely on a dwindling number of independent distributors, who usually have distribution agreements with a number of craft breweries and must allocate their efforts accordingly.
A novel solution to the distribution problem was achieved by Goose Island Beer Company, which relies on a wine distributor to circulate its products. This enables Goose Island to avoid the problem of dealing with distributors which are linked to other breweries, be they majors or other craft breweries. It also places Goose Island in a position to enter into exclusive agreements with the wine distributor. Therefore, they have obtained the services of a distributor with a good distribution network that is able to focus on the Goose Island product in the craft-brewed beer market without compromising it's other client's product in the wine market.
An additional distribution problem expressed by small craft-brewers is the competition for shelf space. Retail outlets are hesitant to stock craft-brewed beers without proven sales records. They said that the increasing number of craft-brewed beers in the market makes it difficult to get shelf space in the large retail outlets. Generally these outlets stick with the large craft-brews like Samuel Adams and Pete's Wicked Ale. Although retailers are able to command a higher profit margin on the craft-brews as compared to regular beers, they are reluctant to carry them because of the lack of volume sales. However, Jim Koch, President of Boston Beer Co., optimistically believes that retailer are "excited about what craft beer-brings to the beer category - profit and growth. We're now important to them. We make a noticeable contribution to their bottom line."13
We believe that buyer power is moderate to high in this industry, and has the potential to increase further as a result of consolidation of wholesale distributors and the influence of the majors.
There is very little supplier power in the craft-beer industry. This is due to the nature of the supplies required and the low level of concentration of the supplying industries. The physical components required in the production and packaging of craft beer which include hops, bottles, packaging products and water, are homogenous in nature and may be considered commodity products. Prices for these ingredients are relatively stable and are set as a result of significant competition or government regulation. Many craft-breweries purchase their ingredients up to a year in advance. There are also a large number of physical ingredient suppliers in the market, and craft-breweries make few if any specific investments based on their relationships with those suppliers. This reduces the likelihood that craft-brewers will have to worry about hold-up expenses.
4.6.0 GovernmentThe role of federal, state and local government is an important consideration in the examination of this industry structure. Craft-brewers must comply with extensive laws and regulations relating to state and regulatory approval and licensing requirements, trade and pricing practices, permitted and required labeling, advertising and marketing practices and relationships with distributors.
Although these governmental regulations have arguably constrained the development of the craft-beer industry, others have stimulated it's development. The most important of these is the relaxation of excise tax on the craft brewing industry which has been fundamental to the establishment and growth of the industry in the United States.
At present, the United States government imposes an excise tax of US$18 per barrel of beer produced for domestic consumption. A small brewers excise tax credit in the amount of US$11 per barrel on the first 60,000 barrels produced per year is granted to brewers with production under 2,000,000 barrels per year. As all craft-brewers produce significantly less than 2,000,000 barrels per year (and in fact the vast majority produce below 60,000 barrels per year) this tax credit equates to a significant cost saving for craft brewers.
The very large role of government in the industry has potential future consequences. Changes in government policy have the potential of significantly effecting the structure of and average firm profitability within the industry. However, recent government policy has been favorable to the craft-brewed beer industry.
The 'Five Forces' analysis indicates that the profit potential of the average firm in the market is relatively strong. Internal rivalry in the industry is moderate, entry is low to moderate (but the effect of entry on internal rivalry is reduced as a result of the rapid growth of the industry), the threat of substitutes is presently low, buyer power is moderate to high, and supplier power is low.
5.0.0 Future Issues Relating to the Craft-Beer IndustryThere are a number of important issues that we believe will affect the future structure and profitability of the craft-beer industry, including market growth, entry by major brewers, government regulation, and general economic trends.
5.1.0 GrowthThe craft-brewed beer industry has achieved tremendous growth over the past 5 years, particularly during the last 2 years, and even the more pessimistic industry experts believe that the market will continue to grow by 30-40% for the next five to ten years. This growth will probably, in the short term, be sufficient to limit internal rivalry such that the industry will remain profitable for the average craft brewer. It is arguable, however, that if the market continues to grow at a rapid rate and new, large entrants are attracted by industry profits, it may reach a threshold where greater economies of scale will become a key success factor in the industry. Such a change in the market structure would have a severe negative impact on the profitability of all but the largest craft-brewers, which will be the only ones capable of achieving sufficient throughput to obtain these economies.
However, if the craft-brewed beer market does not grow to sufficient size, economies of scale will not be a primary determinant of industry profitability. The Institute for Brewing Studies estimates that the industry will capture between 6 and 7 percent of the United States beer market by the year 2000. Although this is a significant share of the entire beer market, the fact that the craft-beer market is very segmented may mean that economies of scale will not become a key success factor in the foreseeable future, making growth a primary factor determining industry profitability going forward.
The greatest threat to the profitability of craft-brewers is the increasing level of entry by the major brewers. The majors have not failed to notice the considerable growth of the craft segment of the beer industry and general contraction of the regular beer segment. Tom McCormick, principal of McCormick Distribution & Marketing, asserts that, "Here we are just scratching 2% of the market and already the big brewers have gotten involved. Why? Two percent of the market may be a sliver, but it's a $50 billion pie, so 2% is sizable".14
This entry by the majors may affect future industry structure in two ways. Firstly, it increases the potential competition in the craft beer industry and decreases average firm profits by increasing the number of competitors in the market. The increasing number of competitors is not, in itself, a major problem for the average craft brewer, as the growth of demand for the product is increasing (and, therefore, there is a bigger 'pie' to go around). As mentioned earlier, most of the majors are following a policy of purchasing existing craft-breweries, as opposed to entering the market with their own craft-beers.
The second, and more significant problem for the average craft-brewer is the influence of the majors on the availability of wholesale distribution to craft-brewers. Although at present there is sufficient excess capacity in the wholesale distribution industry for the influence of the majors to be overcome by enterprising craft brewers, the growth of the craft beer industry is progressively diminishing this excess capacity.
A related problem is the increasing buyer power arising from the tendency for distributors to consolidate, and therefore increase the level of concentration in the wholesale distribution market. This consolidation and increased concentration may enable wholesale distributors to negotiate prices that extract profits from the average craft-brewer.
As stated earlier, government policy influences craft brewers in numerous ways. A change in particular government policies could have a considerable effect (favorable or non-favorable) on the craft beer industry. For example, tax increases or the loss of the small brewers excise tax differential would have a significant impact on the industry structure. Increases in government related expenses would have the potential of either decreasing profit margins (if market price remained steady) and therefore average profitability, or increasing market price and the threat of substitutions (such as imports and spirits).
5.4.0 Economic TrendsFinally, it is worth mentioning the threat of a general downturn in the economy. Such a downturn would potentially have a great impact on the growth of the craft beer industry. Consumers may turn to cheaper substitutes such as regular beer, reducing demand for craft-beer and driving down quantities sold. This may significantly increase internal rivalry among the non concentrated market participants and negatively affect the average craft brewer.
6.0.0 ConclusionWe have neither information to suggest a change in government policy which negatively effects the craft beer industry nor any indication that a sudden downturn in the economy is likely over the next 5 years. Consequently, for the reasons detailed above, we believe that the craft beer industry is likely to be profitable over the next 5 years. We believe that the profitability of the industry over a 10-15 year period is more difficult to determine, however, as a result of the natural growth ceiling of the industry and the threat of new entrants (especially the majors).