Executive Summary

 

This report will show that the craft brewing industry is a clearly identifiable and potentially profitable niche market within the greater U.S. brewing industry.  It gives an overview of the craft brewing industry, a history of brewing in the U.S, and identifies current industry trends. It will then use Porter’s Five Forces to further examine the industry. 

     Next, it discusses craft brewing industry leader Boston Beer Company (BBC); examines the company’s corporate strategy and financial fundamentals, and uses a SWOT analysis to examine position relative to the industry.  It will then give a recommendation for future competitive strategy for BBC.

     Finally, this report will provide a framework for a firm wishing to enter the craft brewing industry relative to a firm’s ability to generate start-up capital. 

 

U.S. Craft brewing Industry Analysis

Overview

In 2003, the total revenue from beer sold in the US was approximately $78 billion and the craft brewing industry accounted for 3.2% of the total domestic beer market by volume.  80% of the US beer market by volume belonged to only three companies in the total brewing industry - the Anheuser-Busch Brewing (ABB) Company (50%), the Miller Brewing Company (18%), and the Adolph Coors Brewing Company (11%) (1). 

Table I. Total Beer Volume Sales (2)

Sales Type

Volume (millions of barrels)

Percent of Sales (volume)

US domestic (all)

179.4

88.4%

Imported

23.6

11.5%

Total

203

100%

 

 

 

Exported

3.9

1.9%

Craft Beers

6.6

3.25%

 

A craft beer is defined as a beer made from all-malt or nearly all-malt, is considered high quality, and is produced by one of the four types of craft brewers:

·                              A microbrewery is defined as a brewing company that produces less than 15,000 barrels (465,000 gallons) of beer per year. 

·                              A brewpub is essentially a microbrewery that sells all of its product on-site at an adjoining restaurant. 

·                              A regional specialty brewer is defined as a brewery that sells more than 15,000 but less than 2 million barrels per year. 

·                              A regional specialty contract brewer is a regional specialty brewer that uses excess production capacity of other firms to brew its product.

Microbrewing licensing and tax incentive breaks vary from state to state.  For example, in Missouri a microbrewery is defined as producing 10,000 barrels or less, while in Washington a microbrewery is defined as producing less than 60,000 barrels.  Microbreweries and brewpubs are taxed at a much lower rate per barrel than both national and the larger regional breweries.  Breweries producing less than 60,000 barrels enjoy an $11 rebate on the $18 government surcharge per barrel.

The remaining 17% of the U.S. beer market is divided among the smaller national and regional brewers (Pabst Brewing, D.G. Yuengling & Son) and import companies like Heinekein, Corona, and Diageo-Guiness USA.

Figure 1. U.S. Brewer Market Share by Volume

 

History of the Brewing Industry in the US

During the late 19th and early 20th century, there were approximately 2000 independent breweries operating in the United States.  Immigrants from around the world brought their favorite flavors and brewing techniques with them.  US Prohibition during the 1920s and early ‘30s shuttered many of these small businesses. When prohibition was repealed by the 21st Amendment, roughly 500 breweries returned to (legal) business operations. 

Over the next several decades, economic pressures related to prohibition-related laws still on the books as well as consumer demand forced many brewers out of the business or into consolidations/takeovers.  Meanwhile, mass-marketing and public tastes encouraged the rise of what has become known as “American Standard” beer.  American standard emerged during the Great Depression as a brewing response to deal with low funding and high costs by augmenting the traditional ingredients (malted barley) with cheaper grains (rice, corn, and sugar).  It is best represented by Budweiser.

By the end of the 1970s, the beer industry had consolidated into only 44 brewing companies. Industry experts predicted that soon there would only be 5 brewing companies in the United States (3).

However, on October 14, 1978, President Carter signed House Resolution 1337 and Senate Amendment 3534 to legalize home brewing.  This law is credited as being the stimulus to the new US craft brewing industry.  Over the next several years, the states enacted favorable laws allowing and enabling small-scale breweries, home brewers, and brewpubs. 

In the years that followed, a number of regional specialty breweries, microbreweries, and brewpubs/restaurants opened.  At the beginning of the 21st century there were nearly 1400 breweries operating within the United States. 

Table I. US Brewer Breakdown by type (3)

Type

US Number Operating

Regional Specialty & Contract Breweries

55

Microbreweries

371

Brewpubs

936

Total Craft Breweries

1,362

Major Breweries

20

Regional Breweries

14

Total Breweries

1396

 

 

Craft brewing Distribution Chains

 

Regional specialty and contract specialty breweries sell through a three-tier system: brewer to wholesaler to retailer to consumer.  Microbreweries sell through either the three-tier system, a two-tier system in which the brewer also operates as the wholesaler, and/or directly to the consumer through on-site sales and taprooms.  Brewpubs sell their beers on-site; they may sell bottled product through the same system as the microbreweries if they have also obtained the relevant licensing.

 

Industry Trends

 

The craft brewing industry saw rapid expansion between 1992 and 1996, increasing volume sales between 25 and 70 percent per year, and became highly fragmented.  The industry underwent a moderate amount of downsizing in the late 1990s as the craft beer market matured.  However, volume sales have increased each year since 1980, and have grown a steady 1-3% since 2001 (3).  In 2002, 57 breweries in the United States sold more than 15,000 barrels of beer, and in 2003 all craft brewers sold 6.6 million barrels of beer.

Table II. Craft Beer Volume Sales (2)

Type

Barrels sold (2003)

Barrels sold (2002)

Contract

943,077

1,053,314

Regional Specialty

4,405,437

3,972,326

Microbrewery

690,075

752,975

Brewpub

614,872

654,132

Total sold

6,653,461

6,432,747

 

     In 2004, 22 brewpubs, 13 microbreweries, and 1 regional brewery opened for business, while 24 brewpubs and 5 microbreweries closed.  In 2003, the rate of growth of craft brewer volume sales outpaced imported beers for the first time since 1996 (3).  U.S. per capita consumption of beer is just about 85 liters per person (3). 

     The craft beer market has higher price points than American standard products.  Craft brewers compete through a differentiation strategy rather than cost positioning and are horizontally differentiated from American standard beers, allowing them to promote high quality products and innovation.   Succesful craft brewers enjoy higher profit margins even when their higher production costs are taken into account.

     Craft brewers typically engage in contracts with packaging suppliers rather than expend resources on horizontal integration. 

     The craft beer market structure is considered monopolistic competition as there are many buyers and sellers, differentiated products, prices are known, and there are low entry costs.  However, the dominance of several of the major regional specialty and contract regional specialty brewers and their influence over national pricing structure among craft beers indicates a slight tendencey towards oligopolistic competition.

In 2004, Budweiser raised prices on its flagship brands, enabling even higher price points across the entire industry.

Consumer Trends

 

The recent popularity of low-carb diets has had a negative impact upon the image of the beer market as a whole.  In addition, “baby boomers typically cut back on beer-drinking as they age, and young consumers are increasingly finding more beverage satisfaction in spirits.” (5)   The entire beer market is projected to grow less than 1 percent in 2004 (5).  Additionally, there has been significant reduction in college age drinking patterns – roughly 30% less alcohol consumption than in 1982 (6).

However, the image of craft beers has gained a strong foothold as a sophisticated alcholic beverage suitable for moderation-tempered enjoyment with dinner, and has been unfazed by the larger market trends.  According to Paul Gatza, director of the Association of Brewers, “craft-beer volume should grow between 4 percent and 6 percent this year (2004).” (7)  And Generation Y, those born after 1980, are considered fertile ground for the sophisticated appeal of craft beers. 

 


Porters Five Forces Analysis of the Craft Beer Industry

 

     While brewpubs are members of the craft brewing industry, they are also members of the restaurant industry.   For reasons of scope, this section does not perform an in-depth analysis of brewpubs within the context of the restaurant industry.

Barriers to Entry

 

The barriers to entry are fairly low to enter the craft brewing industry.  Startup equipment can be purchased for approximately $25,000 and the material costs for hops, barley, and water are low.  While there are significant economies of scale and scope in the larger beer industry, they are much less significant within the craft brewing industry. 

However, limited access to distribution channels does present a barrier to entry. “The wholesale beer market is highly concentrated, with most geographic markets having only three or four beer wholesalers.”  (8)  These wholesalers generally demand a reasonable variety of beers.  Thus, existing market participants that can expand their product lines have an advantage over new entrants.  There is also a proprietary learning curve to the brewing process, creating another barrier.  

The government plays a large role in the craft brewing industry and does present a barrier.  All craft brewers must comply extensive laws relating to state and federal licensing requirements, marketing and advertising practices, and distributor relationships.

     Brewpubs would additionally face all the capital and marketing requirements of a mid- to upscale restaurant.

Supplier Power

 

     There is little supplier power within the craft brewing industry.  “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.” (8)  There are also a large number of suppliers in the market, and there is little threat of supplier-initiated forward integration.

Buyer Power

 

Buyer power is high within the industry.  The craft beer industry participants have relatively little power relative to the three or four area wholesale distributors.  In addition, many of the distributors have agreements with the larger national brands, making it difficult for craft brewers to obtain distribution.  Retailers are also hesitant to stock craft brands without a proven sales record.

While craft beers have higher profit margins, volume sales are lower, making retailers very slow sell products.  They stay with more established regional craft beers like Sam Adams Boston Lager of the BBC.  Consumers of craft beers also tend to have low brand loyalty and switch products regularly for experience and change.

Threat of Substitutes

 

Products that have similar product performance uses and occasions for uses that may affect the demand for craft beers include American standard beers, imported beers, and other alcholic beverages like wine, malternatives (flavored malt drinks), and spirits.  The two products most similar to craft beers are high quality imported beers and beers produced by the U.S. industry leaders and heavily marketed as a specialty beer.  As reported earlier, imported beers had 11% of the market share in 2003. 

Additionally, Anheuser-Busch now owns stakes in several regional specialty or microbreweries, as do Coors and Miller.  These partially owned regional brewers gain access to the resources of the must larger parents. The parent firms, which leverage vast economies of scope and scale, are able to heavily market both the regionally owned and their own specialty brands. These are the biggest threat to the cross-price elasticity of demand for craft beers.

Brewpubs face the additional challenges of extreme threat of substitutes from all manner of restaurants.

Rivalry

While there are a number of competitors within this industry, they are for the most part small, privately owned, highly fragmented, and geographically marketed.  BBC and Sierra Nevada Brewing Co. together hold 27% of the craft brewing market share but it quickly fragments thereafter.  There are limits to price competition among craft brewers due to the monopolistic nature of the market. 

There are low switching costs among wholesalers, retailers, and consumers.  Brewers attempt to mitigate this by producing seasonal varieties of their products. 

Excess capacity intensifies internal rivalry by creating incentives for brewers to use the capacity and drop price. BBC utilizes this strategy and is able to maintain a lower price point than most other craft beers.

There is an incredible amount of diversity and segmentation in the craft brewing industry, allowing craft brewers to pursue niche differentiation focus strategies.  In addition, while the craft beer market segment is mature, it has continued to grow steadily, further reducing internal rivalry.

Porter’s Five Forces Summary

     The potential for profit for a typical firm within the craft brewing industry is moderate.  Barriers to entry and supplier power are relatively low, the threat of substitutes is moderate to high, buyer power is high, and rivalry within the industry is moderate to moderate-high.  As indicated by the earlier discussion of the number of brewpub closings and openings in 2003, brewpubs have the lowest profit potential within the craft brewing industry.  For reasons of economic scale, regional specialty breweries have the highest barriers to entry.

 

 The Boston Beer Company

 

The clear leader of the craft brewing industry is the publicly traded BBC, and it presents a compelling case for considering entry into the market.  The company currently ranks as the fifth largest brewer in the United States and is considered a regional specialty contract brewery.  It is headquarted and owns one brewery in Boston.  It owns another brewery in Cincinatti.  The BBC brews approximately 50% of its beers at these two facilities and contracts out the rest to brewers in Oregon, North Carolina, and Wisconsin.  Product is packaged and distributed from these points to the associated geographic areas.

In 2002, the BBC held 0.62% of the US domestic beer market - 18% of the craft beer market.  The company sold 1.2 million barrels of beer in 2003, had net revenue of $208 million and net income of $10.6 million. 

     The flagship beer is Sam Adams Boston Lager, and there are nine year-round varieties and six seasonal varieties.  The beer is heavily marketed for a regional specialty, with $3.5 million budgeted in 2004.  BBC also produces three varieties of alcohol tea drinks aptly named Twisted Tea, the Hardcore Cider brand drink, and frequently culls unfavorable beverage brands for new ones.  The company exports a small amount of product to several overseas countries and was the first American beer to be brewed and sold in Germany.

     BBC went public in 1995, and founder Jim Koch owns 34% of the shares.  Koch founded the company in 1983 with his former secretary Rhonda Kallman and $400,000 raised from family and friends.  The company currently owns $53 million in assets and has $43 million in cash or cash equivalents with no debt. It is financially healthy with a 3.32 current ratio.

     Sam Adams is positioned as a premium lager and sells at a price point 20-30% higher over American standard brands like Anheuser-Busch’s Budweiser.

     According to Porter’s Generic Strategies, within the craft brewing industtry BBC is currently pursuing a cost leadership strategy.  They have the largest market capitalization and are able to leverage significant economies of scale and scope.  While the Sam Adams brand is priced at a premium compared to the American standards, it sells at a discount when compared with most other craft beers.  BBC is therefore better equipped to compete on price.

BBC’s core competency is the ability to produce a high quality, premium-positioned lager in high volume and at low cost.  It enjoys a sustainable competitive advantage, having been one of the first movers in the craft brewing market.  The strategy of contracting out a significant portion of production to existing brewers with excess capacity has kept overhead expenses lower than if the company owned all its production equipment. This has enabled the BBC to engage in more aggressive marketing than the rest of the craft brewing industry.  This further solidifies its premium craft position in the mind of consumers.

The company has also successfully maintained the Sam Adams brand position as a premium craft beer while weathering various backlash from the craft brewing industry due to its contracting nature. Purists within the craft brewing industry are disdainful of contract brewing because of the loss of process control.

If we consider the entire brewing industry, BBC pursues a focused differentiation strategy targeting the premium craft beer market segment, as do all craft brewers within the framework of the larger market.

The most direct competitor of the BBC in size, scope, and target market is the Sierra Nevada Brewing Company, which is a privately owned craft brewery and based in California.  Sierra Nevada was the ninth largest volume producer within the entire brewing industry in 2002 with 566,000 barrels of premium craft beer, just about half of the amount of BBC. 

BBC also faces competition from premium imports as well as the premium positioned brands and partially-owned craft brands of the U.S. brewery industry leaders.  Miller owns the J. Leinenkugel Brewing Company, which was 13th in volume sales in 2002, while Anheuser-Busch owns 34% of the Redhook Ale Brewery, which was 17th in 2002. (10)  With regards to market share within the craft brewing industry, Sierra Nevada is second, Leinenkugel fourth, and Redhook eigth.

Below is a brief SWOT analysis of the BBC.

Table III.  Boston Beer Company SWOT Analysis

Strengths

- Economies of scope and scale

- Strong brand awareness & national market access

- Cost leadership position within craft brewing industry; Premium differentiated niche position within entire industry

- Healthy financial position

Weaknesses

- Tarnished reputation as a contracting regional specialty brewery

- Lack of control at contracting facilities

 

Opportunities

- Craft beer market continues to grow

- overseas market possibilities (China per capita consumption on the rise)

- Generation Y

Threats

- Copycat (analyzers) entering or growing

- Premium imports

- Baby boomer spending thrift

- Low consumer brand loyalty

- Loss of regional brewer identity

 


Boston Beer Company Strategy

     As the industry leader in a mature market, the BBC has proven its corporate strategy successful.  The company’s stated strategy is to “…maximize total family growth, through continued investment behind our brands on the media that is most effective for the messaging.” (11)  It has no long term debt outstanding. 

BBC uses a combination of radio, TV, and newspaper ads to stimulate brand awarenesss and loyalty.  It has well-established distribution channels and the flagship brand, Sam Adams Boston Lager, is sold in all 50 states and several foreign countries.  The company trademark figure is the brand namesake, Sam Adams.

     Majority owner and founder Jim Koch remains actively involved in the promotion of the product brands.  Koch has been the driving force behind the success of the company, stumping for distribution and performing in many radio spots.  The strategy of contracting out all production in the early years allowed him to focus on the marketing side, and while this earned him the scorn of other craft brewers, it allowed Koch to turn the company into the industry leader.

     The company’s IPO took place in 1995.  This enabled BBC to increase total market presence, nationwide marketing, and distribution channel access while retaining control independent from the major brewing companies, which were seeking equity stakes in craft brewers at the time.

     The BBC is cash rich and has been buying back stock since 2001 (11), consolidating its ownership pool in order to increase the concentration of wealth on existing shareholders.  In 2003, volume sales were down slightly from 2002 while profitabilty was up slightly.  The company expanded the marketing budget by approximately $1.5 million in 2004.

BBC Strategy Recommendation

     The recommendation for BBC is to continue to invest significantly in marketing while maintaining and increasing relationships with distributors.  The feasability of forward integration into the distribution chain in low penetration U.S. markets should be examined.  The BBC should continue to increase the percentage of beer that is brewed by company owned assets in order to offset contracing criticism and increase process control to maintain standards of quality.  This production mark is currently at 50% and should reach 75% by 2010. 

The company should strongly consider using debt to fund any further large scale growth.  The entire brewing industry debt to equity ratio average is 1.86 and ROE average is 54.6%, indicating a higher degree of financial leverage is acceptable within.  For comparison, BBC’s debt to equity was 0.0 and ROE was 17% in 2003.

BBC should continue to innovate new formulas and leverage its flagship brand Sam Adams for continued craft beer market domination.  It should also consider acquiring equity stakes in smaller niche microbreweries that have established regional reputations.  In this fashion BBC would gain an additional degree of regional market penetration and could compete in deeper niches where its products are not currently positioned.

 

New Firm Entry into the Craft brewing Industry

     The craft brewing industry is in the early stages of maturity according to the product life cycle.  However, the market continues to support a high degree of innovation and the likliehood of a market decline downstream is very low as indicated by the steady earnings growth of the total brewing industry.  Rivalry is moderate and barriers to entry are low.  The present should therefore be considered a reasonable time to enter the market.

     With regard to product type: There are several varieties of malt-based lagers that a firm could choose to specialize in.  Secondary choices involve bottling size, keg availability, and packaging design. The general trend of smaller microbrewers is to produce at least two to three with one or two additional seasonal brews.  The larger microbrewers and regional specialty brewers have the ability to produce and market a fuller line of beers – for example, BBC produces at least 15 different types each year and most are available in bottles and kegs. 

     In order to have a reasonable chance to establish a successful presence in the market, a firm would need to define their strategic and financial objectives prior to entering.  Reasonable strategic objectives for a microbrewery could be to achieve distribution rights in twenty regional city grocery stores and three local pubs within one year.  Financial objectives could be to achieve sales volume of 1,500 barrels (roughly $250,000) within three years, or profitability within five years.

The firm would also need to have access to the following at a minimum:

·                  $30,000 for immediate investment in capital equipment, supplies, and leases

·                  $50,000 per year for continuing operations, distribution, and supplies

·                  $50,000 per year salary for a certified brewmaster

·                  The ability to withstand negative earnings for 3 to 5 years

·                  A detailed business plan, strategic and financial objectives, and mission and vision statement.

I do not recommend that a firm enter with a brewpub unless they have experience in the restaurant industry due to the higher barriers, turnover and additional competition.

An existing firm with access to deeper resources could make the large scale purchases necessary to achieve regional specialty brewery status; however, the bottom up nature of the craft brewing industry in hand with the challenges associated with achieving product distribution make this a sub-optimal plan.  Such a firm would be better off starting small and engaging in a pull-strategy marketing campaign at the consumer level to encourage distributors and retailers to carry the product. 

By focusing on the consumer, this strategy would undercut to an extent the distributors’ reluctance to carry unknown products.  David Edgar, director of the Institute for Brewing Studies in Boulder, Colo, reports that "the bottleneck for craft brewers is definitely at the distribution level." (12) This sort of firm could then engage in push-pull marketing to help achieve its strategic and financial goals.

Finally, such a firm could copy the strategy made so successful by the BBC and pursue contract specialty brewing.  This would free the firm from making large capital investments and it could then focus on creating demand for their product through a combination of push-pull marketing and extensive person-to-person sales (relative to its financial ability).  Koch, the founder of BBC, spent most of the late ‘80s and early ‘90s on the road visiting pubs and restaurants across the nation with a suitcase full of beer (11).  The drawback to this type of strategy would be the potential quality problems resulting from the lack of direct process control. 

In conclusion, while successfully entering and becoming profitable within this niche market would be challenging, the revenue and consumer base are there for the taking.


References Cited

1. Beer Marketer’s Insights Online. <http://www.beerinsights.com/> 29 Nov 2004.

 

2. Association of Brewers.  2003 Craft Brewing Industry Statistics. <http://www.beertown.org/craft brewing/statistics.html> 10 Nov 2004.

 

3. Association of Brewers. History of Craft Brewing. <http://www.beertown.org/craft brewing/history.html> 4 Dec 2004.

 

4. Ackman, Dan. “US Losing its Beer Identity.” Forbes Magazine. <http://www.forbes.com/business/publicpolicy/2004/07/23/cx_da_0723topnews.html> 23 July 2004.

 

5. CSNews Online. “Big Beer Brewers Struggling.”

<http://www.csnews.com/csnews/headlines/article_display.jsp?vnu_content_id=1000694209> 29 Oct 2004.

 

6. Conibear, Helena. The University of Alabama at Birmingham. World Consumption Trends. Helena Conibear. 

<http://www.aim-digest.com/gateway/pages/trends/articles/trends_new.htm> 24 Nov 2003.

 

7. Cancelada, Gregory.  “Regional brewers use craft beers to boost sales among younger drinkers.” Knight-Ridder Tribune Business News. 26 November 2004.

 

8.  S. Berghoff, et al. “Tapping into the Craft-Beer Industry.” <http://www.stumptown.com/brews/articles/mgmtbeer.html>  20 Dec 1996.

 

9. Editor.“Drinking better: high-end beer holds up the profitability of the overall malt beverage market.” Beverage Aisle. Volume 13 (5): 26. 15 May 2004.

 

10. Modern Brewery Age. “Industry Statistics.” <http://www.breweryage.com/industry/sales.html> 20 Nov 2004.

 

11. Boston Beer Company website. <http://www.bostonbeer.com> 05 Dec 2004.

 

12. Jaquis, Nigel.  “Microblues: How Bud is mashing local breweries.” Willamette Week. <http://www.wweek.com/html/cover040898.html> 8 April 1998.

 

 

 


Additional References

 

BeerAdvocate.com. <http://www.beeradvocate.com> 17 Nov 2004.

 

Ivry, Sara.  “Craft beers are challenging the status quo.” Lexus dot MSN Luxury Living. <http://www.lexus.msn.com/id/2074206/sid/2097342/> 05 Oct 2004.

 

Hauserman, Julie.  “Law allows beer of many sizes.” St. Petersburg Times Online.

<http://www.sptimes.com/News/053101/State/Law_allows_beers_of_m.shtml> 31 May 2001.

 

Hoovers Online Database. <http://www.hoovers.com> 05 Dec 2004.

 

Kiley, David.  “Big Brewers Have a Hangover.” BusinessWeek Online. <http://www.businessweek.com/bwdaily/dnflash/oct2004/nf20041029_4339_db035.htm>  29 Oct 2004.

 

Missouri Revised Statutes. Chapter 311, Liquor Control Law: Section 311.195

<http://www.moga.state.mo.us/statutes/C300-399/3110000195.HTM>  04 Dec 2004.

 

Smith, Gregg. “A Short History of Beer in America.” Brewers Association of America. <http://www.brewersadvocate.org/publications/brochures/history.shtml> 19 Nov 2004.

 

Standard and Poor’s NetAdvantage. <http://www.netadvantage.standardpoor.com> 05 Dec 2004.

 

Young, Gordon.  “Attack of the microbreweries.” Metroactive online. <http://www.metroactive.com/features/breweries.html> 01 Jun 1996.