Austin craft brewery booming, but threatened by distributor rule

By Erin Clark

Live Oak Brewing Company is a success story 20 years in the making, but a battle over distribution rights could hamper the Austin microbrewery and hundreds like it.

Chip McElroy is on the cusp of making it big, small-business style. The owner of Live Oak is celebrating his company’s one-year anniversary in a big new facility after years of making due without one.

“We started about 20 years ago on a shoestring budget, and we have bootstrapped our way along for about 18 years,” McElroy told Watchdog.

“Finally we were able to show our credit-worthiness to a bank and get a loan large enough to build a nice beautiful brewery like the one we just moved into a year ago today.”

In order to keep making it, however, small breweries like McElroy’s need the state to fail in its appeal of an August court ruling invalidating portions of the Texas Alcoholic Beverage Code. The ruling was favorable to Live Oak Brewing, Peticolas Brewing and Revolver Brewing, which joined together to sue the Texas Alcoholic Beverage Commission over SB 639.

Among other provisions, SB 639 made it illegal for alcohol manufacturers — who are limited to using only one distribution company at a time — to sell or trade their distribution rights to a distributor. Instead, it required them to give the rights away for free. Distributors, however, have no restrictions and can sell or trade regional rights with other distribution companies.

According to McElroy, the double standard is a doozy.

“What did it do? It took our assets and awarded it to beer distributors with no rational basis for the state to do so,” he said.

“An asset like that has a value that can be used in various ways. It can be used to get money, [and] it can be used in a trade to get other things of value with distributors. Beer distributors are our suppliers and partners, and there is always a push and pull as to who’s going to pay for what.”

If the state enriching one business at the expense of another sounds unconstitutional, it’s because it is. In the ruling in August, Travis County District Court Judge Karin Crump ruled that SB 639 violated both the due process and takings clauses of the Texas Constitution.

According to Institute for Justice attorney Matt Miller, who is representing the brewers, the state “exceeded its police powers because there’s no connection between this and public safety and welfare.” He added that the law has disproportionately affected small businesses because larger breweries sold their rights a long time ago.

“Once sold, [rights] are essentially gone forever; distributors have them and sell among themselves,” Miller said.

“Big beer companies don’t care because they have no more rights left to transfer. The only people impacted are craft breweries and those still growing. It’s one of the weird vestiges of the three-tier system that once you transfer rights you can almost never get it back.”

The three-tier system Miller referred to is the mandated separation between links in the beer supply chain. No single company is allowed to produce, distribute and sell alcoholic beverages, or do even two of the three. The regulation has softened slightly since its inception following Prohibition.

The Texas Alcoholic Beverage Code makes some concessions to smaller companies, however. For example, an individual company can self-distribute up to 125,000 barrels per year. To grow beyond that, a company would need to enter into a contract with a distributor to expand its market.

“If our distribution rights have value, we should be able to negotiate at the table for them,” Miller said. “It would be worth $250,000 just for Live Oak’s Houston distribution rights — that’s just one particular market. You can can imagine what it’s worth statewide, what that capital means to expand business.”

McElroy says SB 639 took power away from consumers.

“From just a beer consumer’s perspective, it took away choice from them by keeping us more and more under the thumb of large businesses. … It’s not good for small business,” he said.

Small business, big prospects

Craft breweries typically are small, but they’ve had an outsized impact on the Texas economy. According to the Colorado-based Brewers Association, which tracks the craft beer industry, Texas has the most breweries per capita of any state — 189 craft breweries in 2015. The craft beer industry added $3.77 billion to the Texas economy in 2015.

Paul Gatza, director of the Brewers Association, says Texas is a good state for beer entrepreneurs.

“Before 2013, Texas was one of, if not the hardest place to do business. That’s not the case anymore,” Gatza told Watchdog. That was the year brewpubs won the right to sell their products into distribution and to manufacture brews for on-site drinking.

“The only thing that rubbed brewers the wrong way was the inability to sell distribution rights,” he added.

“It’s easy to open a brewery, [but] it’s hard to make it successful. You need the beer drinker behind you to make that happen, and you also need a great distribution relationship. But most importantly, if the beer drinker’s not on board, you’re not going anywhere.”

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