The alcohol industry is highly regulated and complex, partially due to the legacy of Prohibition. One of the most curious aspects of this legacy is the three-tier system which governs how alcohol is distributed. In this post, we take a look at what the three-tier system is exactly and how it impacts alcohol producers, distributors, and retailers.
What Is the Three-Tier System?
The three-tier system is an alcohol distribution framework that regulates the taxation and distribution of alcohol. Put into place shortly after the Prohibition era ended in 1933, it was intended to remedy several of the issues that had led to the ban on the production and consumption of alcohol in the US.
This system is an attempt to balance the interests of those selling and consuming beer, wine, and other alcoholic beverages and the governmental agencies that collect the tax revenue. This system of checks and balances divides the industry into three distinct tiers: producers, distributors, and retailers. No entity is allowed to occupy more than one tier, preventing anyone from exerting significant influence over how alcohol is sold and consumed.
Tier 1: Producers
Breweries, distilleries, wineries and other manufacturers of alcohol all fall into tier 1 of the three-tier system of the alcohol industry regulation. The federal government directly regulates and licenses these businesses, collecting federal excise taxes.
Tier 2: Distributors, Importers, and State Control Boards
The middle tier is occupied by the entities responsible for purchasing (or importing) alcoholic beverages from manufacturers and transporting them to retail establishments. For states that still have alcohol control boards (ABC stores), the boards serve in the roles of both distributor and retail establishment. State alcohol control boards are the only exception to the rule that no one entity can operate in more than one-tier. These entities are also licensed and regulated by the federal government.
Tier 3: Retailers
Bars and liquor stores occupy the bottom tier of the three-tier system. These retail establishments purchase products from distributors and dispense them to the public. Unlike manufacturers and distributors, retailers are licensed and regulated by the state they’re located in.
Why Does the Three-Tier System Exist?
The three-tier system seeks to remedy several of the abuses that precipitated the push for Prohibition, ensure compliance with government regulations, and secure the orderly collection of taxes.
Here’s an example of a pre-Prohibition problem that the three-tier system corrects. Before Prohibition, alcohol producers would often own their own retail establishments, requiring those establishments to exclusively stock their own brands. This arrangement worked out spectacularly well for the manufacturer, but significantly reduced the brand choices available to consumers. Called a tied-house, some of these producer-run bars did little to prevent over-consumption, sometimes even encouraging it.
Pros and Cons of the Three-Tier System
No system is perfect, and the three-tier system is no exception. This time-tested method of ensuring safe movement of alcoholic beverages from manufacturers and importers to consumers comes with both benefits and trade-offs.
Streamlined Regulatory Compliance
Alcohol distribution laws are complex. The three-tier system creates an easy-to-regulate hierarchy where each tier is licensed and regulated by a dedicated government entity. Prior to the introduction of this system, not all alcohol production was properly regulated, resulting in potentially poor-quality alcohol finding its way into the glasses of consumers.
More Efficient Tax Collection
Additionally, without the built-in monitoring components found in the three-tier system, not all alcohol produced and sold was taxed, resulting in lost revenue for the government. Today, tax revenue from the production and sale of alcohol in the US represents a significant sum. Without it, funding for important social priorities like education, highway maintenance, and food assistance programs would likely suffer.
National distributors help level the playing field for smaller producers, making it possible to extend the reach of their brand beyond the local market. Without access to distributors, craft brewers, small wineries, and local distillers would struggle to penetrate larger markets dominated by the big-name producers. This arrangement also directly benefits consumers interested in trying out new breweries, wineries, and distillers.
Public Health Benefits
Prior to the implementation of the three-tier system, large alcohol producers used aggressive marketing tactics to increase sales. Their methods included aggressive sales practices and the encouragement of consumer overconsumption.
The three-tier system also prevents the type of monopoly seen prior to Prohibition where large alcohol producers owned everything from the production facilities all the way down to the bars that served their products to consumers. Under the three-tier system, this type of monopoly is impossible.
The three-tier system includes a substantial amount of regulations. Some industry leaders have called for deregulation in order to reduce the burdens of regulatory compliance. However, fears that large-scale deregulation of the alcohol industry could lead to reduced competition and lapses in quality control have made this option less palatable to lawmakers at the federal and state levels.
Large Brewers Effectively Work Around the Three-Tier System
Another criticism of the three-tier system is that larger alcohol producers now actively maintain their own network of distributors, allowing them to exert the type of marketing pressure the system was originally intended to prevent. This allows big brands to place smaller breweries and other alcohol producers at a competitive disadvantage.
The Future of the Three-Tier System
Although it’s not perfect by any means, the future of the three-tier system looks bright. By effectively regulating alcohol production, distribution, and retail sales, the three-tier system ensures compliance with government regulations and taxation obligations. Despite its weaknesses, the implementation of this regulatory framework has created a safe and diverse supply of alcoholic beverages for consumers. Now that’s something worth raising a glass to!
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