The Three-Tier System: From Prohibition to Today

Sovos ShipCompliant’s Alex Koral, regulatory general counsel, invited Tom Wark, executive director of the National Association of Wine Retailers and author of the Fermentation Newsletter, for a conversation about the three-tier system’s role in the modern-day beverage alcohol regulatory landscape.

Tom shares his take on how Prohibition may have initially shaped the approach to regulating the industry, along with how the landscape of what is being regulated has evolved since that time.

Alex Koral: Following Prohibition’s unraveling, John D. Rockefeller commissioned  “Toward Liquor Control” (TLC), a report offering  guidance to policymakers rebuilding alcohol regulation. What were the pre-Prohibition “evils” the authors wanted to prevent and how likely are those evils to arise in the modern day economy?

Tom Wark: “Toward Liquor Control” was published just as Prohibition was ending and served as an influential treatise on how to regulate alcohol sales in a way that would prevent a return to the conditions that resulted in dangerous overconsumption. It’s notable that the problems “Toward Liquor Control” primarily addressed were having their impact at least from 1900 through the beginning of Prohibition in 1918—over 120 years ago.

Preventing a return to “saloon culture” was the primary concern. Prior to Prohibition, saloons were often the center of urban society. Primarily young, immigrant men holding working class jobs used the saloon as a gathering place, as a restaurant, as a social club, as a source of news and as a place of political organizing. In this respect the saloon played a key role as a social center for a growing and important population. However, saloon owners took advantage of their key role in the community to encourage overconsumption. Often, saloon owners were “tied” to specific brewers or distillers and had agreed only to sell these products in exchange for the producer funding their operations. But great demands were placed on the saloons, and they were forced to sell significant amounts of alcohol and often at very low or promotional prices. The results were degrading outcomes that harmed lives, made neighborhoods dangerous and destroyed families. These “tied houses” that saw significant influence over them by producers were what the post-Prohibition regulatory theorists particularly wanted to avoid going forward.

Though it is never mentioned in “Toward Liquor Control”, the solution for many state lawmakers was to adopt the three-tier system, where a wholesaler was placed between producers and retailers (e.g., restaurants, retail outlets and bars). In this way, lawmakers and regulators kept producers, wholesalers and retailers separate and avoided the corruption resulting from tied houses. And it worked.

AK: Modern advocates of the three-tier system claim that they are merely holding up the principles laid out in TLC. How closely does the current alcohol market,and the three-tier system itself, align with those principles?

TW: Present day advocates of the three-tier system need to recognize that today’s society is so radically different from a pre-Prohibition society and support reforms that recognize the socio-economic conditions of the 21st century, rather than pretending we are still combating potential problems that characterized a society that no longer exists. The three-tier system was designed to address a culture where urban working class immigrants and others had very few options for building community other than home and the local gathering place—the saloon.

But in 1900 there were no automobiles. There was no television. There was no Internet, there was no social media. There was no media streaming. There was little sports entertainment. There were no movie theaters. There wasn’t even any radio. There was no intercontinental air travel. Today’s society and culture is nothing like 120 years ago. Yet, current day advocates of the three-tier system pretend we must maintain a nearly 100-year-old system of alcohol regulation to avoid social ills that existed then and could not occur again today. This tells me that the three-tier system serves a much different purpose today than it did in 1935. Today it serves as a gatekeeping mechanism and a prophylactic surrounding the profits of the now unnecessary state-mandated use of wholesalers to bring products to market.

AK: What changes in the alcohol market have we seen since the 1930s? How do those impact the relevance of the three-tier system today?

TW: The three-tier system method of alcohol regulation boils down to two things:

• Prohibiting a licensee of one tier from having any financial or operating interest in another tier.
• Requiring producers to sell products to wholesalers in each state, who in turn are the only entity legally able to sell products to retailers and restaurants.

Everything else is something different from the three-tier system.

The primary and key differences today from the early 1900s are three-fold:

• There has been an explosion of producers of beer, wine, spirits and other alcohol products that lawmakers of the 1930s could never have contemplated. At the same time, there is a continued consolidation of the wholesaler tier to the point that in most states no more than a few  wholesalers dominate the distribution of alcohol.
• Producers are no longer primarily regional operations. Today, a brewery or winery might sell the majority of their inventory locally, but it is just as likely that any given marketplace is filled with products from producers that hail from across the country and across the globe.
• Logistics technology today has shrunk the country. A person in New York can order a case of wine from a Washington winery and have it the next day. This is revolutionary compared to pre-Prohibition America. All these changes make the three-tier system a relic that offers no substantial benefit except to those in the middle tier whose use is largely still mandated.

AK: What parts of the three-tier system do you think would still be utilized, even if they weren’t required by law? 

TW: If we are going to continue to pretend that the dreaded saloon of 1900 will make a reappearance in 2022, then keeping producers, wholesalers and retailers separately licensed will surely prevent any tied houses. However, there remains no value today to legally mandating that producers sell through wholesalers. This is not to say that if the wholesaler mandate disappeared so would wholesalers. In fact, most alcohol would still be moved through them. However, we would also see the utility that comes with producers, particularly small- and medium-sized producers, selling directly to restaurants and retailers.

AK: Are there parts of the three-tier system that you find are harmful, that are contrary to the principles set out in TLC?

TW: Consumers are certainly harmed by the continued wholesaler mandates. They have access to far fewer products than they would under a self-distribution option. Moreover, opponents of direct shipping by brewers, wineries, distillers and retailers (primarily wholesalers but also a very large number of retailers) believe they are upholding the three-tier system by opposing this obviously successful distribution channel.

It should also be said that producers and retailers are both harmed by a lack of producer self-distribution privileges. Numerous producers would easily self distribute their products locally if it were legal. They would also be able to distribute to farther flung markets while producing greater revenue than they do by selling through a wholesaler in those markets. Retailers, particularly independent fine wine retailers, benefit from being able to offer products to their customers that are not procured through wholesalers. By being able to purchase products directly from in-state and out-of-state producers and importers, retailers can distinguish themselves by offering a greater diversity of products. This also helps alleviate lower pricing as a means of addressing the competition. The benefits of removing the state mandated use of a wholesaler and allowing direct shipping by producers, retailers and importers are substantial.

AK: The current alcohol market in the U.S. is vastly safer and healthier than it was pre-Prohibition. Why do you think there is not more attention paid to the apparent success we’ve had, and how much should we attribute that success to the three-tier system and alcohol regulations generally, as opposed to more social forces?

TW: The three-tier system played a key role in preventing a return to what was essentially an unregulated system of alcohol sales prior to Prohibition. But that system outlived its usefulness more than two decades ago. Surely the various anti-abuse efforts by folks like Mothers Against Drunk Driving (MADD) had an impact. However, the three-tier system exists today to prop up a collection of, largely, huge wholesalers with tremendous market and political power.

The other day I asked the head of a trade association why they don’t advocate more for self-distribution rights and direct shipping rights. I was told, “My members are afraid if they did undertake that kind of political advocacy there would be repercussions from wholesalers.” This tells me two things. First, an entire group of alcohol market participants are avoiding pursuit of their own interests. Second, the sizable upside of self-distribution and direct shipping is negated by the threat of real repercussions by wholesalers.

AK: Three-tier advocates often claim that the system  is needed to prevent the sale of “dangerous” and counterfeit alcoholic products, to prevent sales to minors, and to ensure tax payments are made to states. Why do you think that the three-tier system is not necessary to prevent those “harms” and how can they be managed outside of the three-tier system?

TW: No one believes the three-tier system does anything to prevent counterfeit products or dangerous products from entering the marketplace. It’s a pretext for maintaining the three-tier system and the profits it funnels to wholesalers. The assumption here is that bars and restaurants would be buying counterfeit and dangerous products to pass off to their customers for profit. But wholesalers are just as likely to do the very same thing.

As for the notion that the three-tier system plays a role in keeping wine out of the hands of minors, there simply is nothing to support this. First, every study and survey conducted on this issue shows that minors primarily get alcohol from inside their home or from older friends and family. Whether a producer sells alcohol to a wholesaler who then sells it to a retailer has nothing to do with this dynamic. More to the point, with online ID verification and shippers obtaining adult signatures at the time of delivery, direct shipment (presumably a distribution channel that falls outside the three-tier lines) can be seen as the least likely way by which minors obtain alcohol.