Anatomy of the Costco Initiative

Second in a series on initiatives to liberalize Washington’s alcoholic beverage laws (click here to read the first segment).

A recent article on the Wine Spectator website does an excellent job of detailing the specific elements of Initiative 1100 (which I call The Costco Initiative) and I-1105 (a.k.a. The Distributor Initiative) as they pertain to wine. It is required reading for anyone interested in this issue.

For my part, let me approach the question in a different way: how would the initiatives affect Costco (and other wine retailers), wine distributors, wine consumers and wine makers in Washington state?  This post looks at retailers and distributors. I’ll address consumers and winemakers next time.

Costco’s [Big] Dog in the Fight

Let’s start with Costco, which is appropriate since it is a major backer of I-1100.  How would I-1100 affect Costco? Well, the most important factor is that it would allow Costco and other retailers to sell hard liquor, which is currently a state monopoly in Washington.  Other changes are important, but that’s the big one in terms of economic impact in my view.

What about wine? Not surprisingly, Initiative 1100 would allow Costco to be a much more efficient wine retailer.

First, Costco would be able to purchase wine directly from producers and could take advantage of more efficient central warehousing of alcoholic beverages. Costco would be able to negotiate volume discounts from producers and could benefit from other promotions (wholesalers must maintain uniform prices under the current law and are forbidden from providing retailer incentives). Costco could also negotiate payment schedules — current law requires that retailers pay for wine and beer at the time of purchase.

These changes would make the process of selling wine pretty much the same as other products by removing current restrictions. Costco would also be permitted to sell space on its wine shelves to producers (much as supermarkets routinely sell shelf space for grocery items), although it is unlikely this would actually happen. Costco does not sell space now in states where this is legal. Rather, like Wal-Mart I think, it simply asks for a lower wholesale price.

Taken together these market reforms would lower the cost that Costco pays for wine, savings that would be passed on to consumers. Costco’s normal mark-up on wine is 15% (17% for own-brand Kirkland Signature bottlings), so Costco’s existing absolute price advantage for the wines it carries would likely grow.

Don’t expect Costco to use these advantages to monopolize state wine sales, however. Costco has great wine prices, but it carries a surprisingly small number of wines at any time — about 100-150 different wine SKUs compared to the 1500-2500 that you can find at an upscale supermarket.

So while Costco wine sales will rise, there will be lots of room for other retailers, too. In fact, there is speculation that the market reforms will draw big box wine/beer/liquor retailers Bevmo and Total Wine into the Washington state market.

It is easy to see why retailers are backing I-1100. Their costs will fall and they should be able to sell more wine, which is a high margin item compared to most other supermarket categories.

 

The three-tier distribution system for beer (and wine).

 

The Impact on Distributors

It is also easy to see why distributors oppose I-1100 and why they back I-1105. Initiative 1100 privatizes liquor sales, liberalizes the alcoholic beverages market and allows retailers to cut out middlemen and purchase directly from wine, beer and spirits manufacturers. I-1105 is similar to I-1100 in most respects, but requires that the distribution step in the three-tier process be retained.

Distributors recognize that the ability of large retailers to bypass them and buy directly from producers and to demand discounts and other incentives is a threat to their business and it is understandable that they would oppose this.

Don’t expect distributors to disappear if I-1100 passes, however. Distributors play a vital role in connecting producers and retailers and, although they might lose some “rents” from their previous legal status, I can see where their role will change and might even expand in some specific areas as the overall wine market grows.

Larger distributors, who already have some economic advantages, might get an added edge if they are better able to offer retailers payment terms. Competition in general will increase, so there may be a shake out in this sector if I-1100 passes.

Fundamentally, I-1100 shifts market from distributors to retailers and will redistribute profits within each group, too. What about the people who make wine and those who drink it? Check back in a couple of days for analysis.

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3 responses

  1. I believe that retailers may already purchase WINE directly from producers in Washington and outside of Washington.

    Costco’s lawsuit made that happen.

    Tom…

  2. hope you like those 100-150 wines costco will tell you you should buy because they’re cheap & got a good deal on. because small retailers will be pushed out of business & big ones (bev mo, etc) will come in. so your money will be going to the big boys, and certainly not the small wineries & retailers who currently keep the market flooded with selections. those other, sometimes better ones with small batches, yeah, you’ll pay through the nose for them now. :-) just an alternate viewpoint…

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