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What Beer Can Teach Us About the Unintended Consequences of the Small-Business Exemption

· February 13, 2020

There is growing appetite to regulate the tech industry in Congress. These proposed regulations are trying to balance promoting competition with new obligations meant to promote other interests, like privacy and security. These obligations cost resources, which are easier to bear by large companies. This creates new competition problems.

One of the favored solutions to this problem is to simply exempt smaller companies from any new obligations. At least, until they reach a certain size. This seems like an easy solution on paper, but it’s rife with many unintended consequences. Putting aside arguments that if privacy and security matter to consumers they should matter everywhere, exemptions themselves can be anticompetitive. 

One industry that clearly exemplifies this problem is the beer industry. The beer industry is interesting in that its regulatory structure is heavily influenced by the Temperance Movement and Prohibition. Tied houses, or drinking establishments required to buy at least some of their beer from a particular brewery, bore much of the blame for a perceived over-consumption of alcohol in the late 19th and early 20th centuries. After the repeal of prohibition, alcohol regulation was left up to the states and almost all of the states decided to prohibit virtually any form of vertical integration. This established a three-tiered system made up of brewer, distributor, and consumer sales. This system, in theory, allows for greater competition because individual distributors are free to champion the sales of smaller, but profitable, craft beers. Indeed, distributors have been known to fight for these small businesses.

However, during the 2016 settlement of the Anheuser Busch Inbev (ABI)/SABMiller merger, and related investigation, a lot of attention was placed on the Wholesaler Equity Agreement. This agreement is designed “to encourage ABI-Affiliated Wholesalers to sell and promote ABI’s beer brands instead of the beer brands of ABI’s competitors.” ABI also accomplished this through a related Voluntary Anheuser-Busch Incentive for Performance (VAIP) program, that would reward distributors who had 90% of their sales or more attributable to an ABI brand. These programs made it hard for competitors to gain traction through ABI-affiliated distributors, but the programs exempted local craft breweries of a certain size from counting towards non-affiliated sales. Some states also exempt smaller brewers from having to participate in the three-tiered system at all, and allow for direct sales.

These exemptions can be very helpful in supporting small breweries while they are starting out. But what happens when a craft brewery nears the cap? If the brewery is operating under a state exemption then it suddenly needs to start looking for a distributor, and many good options are operating under an affiliation agreement. This presents difficulties. If the brewery is using a distributor subject to a VAIP or similar program, then suddenly their sales will be applied against the distributors’ alignment percentage and they could cause the distributor to lose big incentive payments.

These craft brewers have three options: 1) they can pass the cap and deal with potentially finding a non-aligned distributor; 2) they can slow their own growth to stay below the cap; or 3) they can sell the brewery to a bigger company. Dealing with the cap can be painful for small companies. One craft brewer described the problem by stating “the state of North Carolina is effectively holding our hands behind our backs while Anheuser-Busch is beating us up.”

It would be great if all small brewers could choose option 1, but it is not easy for craft brewers to find non-aligned distributors to place their products. Oregon-based Ninkasi Brewing Company submitted comments to the DOJ regarding the 2016 settlement explaining that when they were forced to move their business it was difficult for them to find a new distributor, and they lost sales and overall momentum as a result. Even Yuengling, by no means a small brewer, uses ABI-affiliated distributors for about half of its 180 wholesalers. Yuengling also submitted comments in 2016, describing the significant problems they deal with in their distribution as a result. For some brewers slowing down or being acquired might be their only options, and we know that ABI does actively acquire new craft brands (increased notification requirements of craft brewer acquisitions is one of the terms of the settlement).

In many ways, the beer industry presents unique issues based on the history of Prohibition. However, the problems with small-business exemptions are a universal concept. Most small businesses want to be successful and become big businesses; that means they will have to pass the cap and take on new obligations. If these companies cannot handle the new obligations, then they will need to slow their growth or sell to a company that has the capacity to comply with the obligations. Either way, this chills competition.

When drafting tech regulations, policy makers should learn from the beer market that exemptions can cause unintended harms. This is obviously not an easy problem to solve, but exemptions should be used sparingly and only in ways that don’t discourage growth. Good regulations should be scalable and match the size of the business.

Competition

Some, if not all of society’s most useful innovations are the byproduct of competition. In fact, although it may sound counterintuitive, innovation often flourishes when an incumbent is threatened by a new entrant because the threat of losing users to the competition drives product improvement. The Internet and the products and companies it has enabled are no exception; companies need to constantly stay on their toes, as the next startup is ready to knock them down with a better product.