Pricing & Competition in the Beer Industry:
A close look at Microbreweries and Industry Giants
Written By:Jamieson Prala
Student, IndianaUniversity
Phone: (812) 332-7668
e-mail:
Written For:Professor Jaffee, IndianaUniversity
Professor Rasmusen, IndianaUniversity
G492
Abstract:The beer industry in the United States is continually changing and therefore companies in this industry must be versatile. Their versatility comes in a variety of forms, from changing their product offering, to changing their strategic goals, and finally, recognizing opportunities and threats. This paper explores many aspects of the industry though the use of Porter’s five forces model. I will analyze the internal rivalry present in the industry, any buyer or supplier power that is present, entry barriers that exist, and any substitutes and threats that face the industry. Furthermore, I will closely analyze the effect that craft brewers and microbreweries have had on the industry. It is my contention that craft brewers have taken market share and sales away from the largest brewers in the industry. I will use two companies to perform this analysis, Boston Beer and Anheuser-Busch. Anheuser-Busch is the largest brewer in the world and Boston Beer is the largest craft brewer in the United States. I have run a regression using sales from both companies and several other factors to test my hypothesis.
Recent History and Terms
The brewing industry in the United States began in 1625 when the first brewery in America was founded. Lager beer as we know it today has changed a lot since then, and so has the industry. In the early nineteenth century the industry was highly fragmented, and competition among different breweries only existed in small geographic circles. It was not until the late nineteenth century that refrigeration and mechanical pasteurization revolutionized the industry. Companies could now transport beer across previous geographical limits.
After prohibition was repealed in 1933, the industry as it is today began to take shape. There was a sharp decline in the number of brewing companies, almost 90% from 1947 to 1995 as illustrated in Table 1. This was mostly due to four major breweries growing rapidly and realizing economies of scale, while the majority of other brewers became bankrupt. By 1980 Anheuser-Busch, Miller Brewing, Pabst, and Stroh’s were the four breweries that constituted nearly 80% of the market. By the mid-nineties three brewers constituted most of the market: Coors, Miller, and Anheuser-Busch.[1]
Although dominated by the three aforementioned brewers, the US industry consists of 1,800 brewers and beer importers, 2,200 beer wholesalers, and 560,000 retail establishments. The industry includes packaging manufacturers, shipping companies, agriculture, and other businesses whose livelihood depends on the brewing. The industry employs approximately 1.66 million Americans, paying them $47 billion in wages and benefits. The industry pays $27 billion in business, personal and consumption taxes, including $5.1 billion in excise taxes.[2]
This paper focuses on Anheuser-Busch, which currently holds 51% of the market share, as chart 1 shows. Anheuser-Buschprovides a good benchmark on which to gauge price variances, competition, and demand. This paper also discusses various types of beer and tiers of beer producers. The different types of beer are: “super-premium”, “premium”, and “economy” beer. Each one describes a different price point for beer, super-premium is the most expensive and economy is the least expensive. There are generally three tiers of beer suppliers in the United States: domestic behemoths like A-B and Miller, importers, and craft brewers. This paper will focus on the 1st and 3rd tiers and all the different types of beers.
Anheuser-Busch
Founded in 1852, Anheuser-Busch has a deep tradition setting the pace in the beer market. From a modest brewery that produced 8,000 barrels a year, Anheuser-Busch has evolved into an enormous conglomerate whose breweries now produce over 100 million barrels a year. Currently the largest brewer in the world, it owns over 50% of the market in the United States. Anheuser-Busch also owns amusement parks around the United States (BuschGardens and Sea World), bottling companies, metal stamping companies, shipping companies, and a variety of packaging companies.
Anheuser-Busch has been a publicly traded company since 1875 and today is still a staple of the New York Stock Exchange. Anheuser-Bush has consistently outperformed the S&P 500, as can be seen in Chart 4. Its return on equity in 2003 was78.7% while the industry and the S&P 500 were 24.2 and 13.7 respectively.3 Anheuser-Busch outperforms the industry and the S&P 500 on many other levels as well. Anheuser-Busch currently enjoys a net income growth rate of 10.5% over the last three years while the industry lags at 7.5%. The S&P 500 experienced a negative growth rate for the last three years. Anheuser-Busch also enjoys larger profit margins than the industry and the S&P 500. Financial information not covered in this portion of this paper is provided by Valueline in the Appendix under table 3.
Anheuser-Busch obviously outperforms the industry and the S&P 500 in most facets of the market place. Its sales, currently above $16 billion, are unmatched in the industry. It has continued to be innovative in all the businesses they own, which is made apparent later in this paper. This has allowed them to grow faster than competitors and stay ahead of the pack by large margins. Anheuser-Buschis the benchmark around which this paper is built.[3]
Porter’s Five Forces Model and Market Structure
This paper focuses heavily on Porter’s five forces model for evaluating the beer industry. The Porter model consists of five variables that are used to analyze an industry: internal competition, entry barriers, supplier power, buyer power, and substitutes and compliments. The model was developed by Michael Porter, a HarvardBusinessSchoolprofessor. As stated before, this paper will use Anheuser-Busch as a benchmark to analyze the industry.
Entry and Internal Competition in the Brewing Market
When analyzing any industry, the ease at which newcomers can enter the market is of great importance. If there are high entry barriers, due to economies of scale, government intervention, hostile takeovers, or high concentration, inefficiency exists and the company on top can realize monopolistic gains. However, if there are no entry barriers, companies will not be able to raise prices and realize profits.
As with any five forces analysis, there is a need to define the market. For the purpose of this paper, the focus is on domestic brewers. I will mention international influences but my analysis, except the concentration analysis, will not include any markets outside of the United States.
Economies of Scale
The brewing industry is rather different from many industries because it is not governed by patent law or exclusive grants. The inputs required to brew beer are not controlled by a majority firm and the supply of brewing materials is quite fragmented. There are, however, large costs associated with entering this industry. The task of establishing a supplier network to efficiently distribute the product is extremely difficult. Furthermore, it has been estimated that the construction of a four to five million barrel a year plant would cost around $250 million.1 This is simply the fixed cost of building and maintaining the brewery. There is even greater cost in the marketing activities needed to distribute the beer. Any entrant would have to invest heavily to establish a strong reputation and brand awareness. It will be made clear later the exact importance marketing plays in the brewing industry.
There is a reason why it costs so much to build and maintain a brewery in the United States. Table 2 illustrates this point very well; observe that there has been a significant decrease in breweries below the four million barrel mark. On the other hand, breweries that produce above four million barrels have increased 1000%. A reason for this is the economies of scale that exist in the industry. However, to realize these economies, a brewer would have to produce at minimum two to three million barrels a year. Chart 2 illustrates this point further.
Microbreweries / Craft Beer& the Regression Model
Table 2 does show an increase in breweries that produce between 1,000 and 10,000 barrels. This is mainly due to the presence of microbreweries and brewpubs. From 1986 to 1998 the amount of microbreweries in the United States has more than tripled.1 This is an oddity in the brewing industry because de novoentry, or new entry, into the industry since World War II has been limited.
During the late 1980’s early 1990’s the craft brewing industry or the microbrewing industry experienced double digit leaps in volume and sales growth. While this number has decreased sizably in the last couple of years, there is still growth to be realized in this brewing segment. In 2003 the malt beverage market was down for the first time in many years by .9%. The craft brewing segment, however, saw an increase in volume of 1.7%. “While there is some level of competition among brewers, most realize that they’re all in this together.”, states Beverage World columnist Jeff Cioletti. Mr. Cioletti speaks of the millions of small craft breweries in America and their objective to carve out market share in the beer market. Collectively the craft beer segment has a 3% share of the domestic beer market, however; according to John Bryant, a craft brewer, “Our (the craft brewing industry) goal is to take craft beer from 3 percent of the beer consumption in the US up to 10.” Chart 9 demonstrates that this may be possible if the industry can keep the 11% growth it has experienced over the last six years.[4]
It may seem that the proliferation of craft brewers and microbrews in the United States may have brewers like Anheuser-Busch concerned. As it turns out, the opposite is true. Greg Hipp, General Manager of an Anheuser-Busch wholesaler in Toledo, Ohio, states that Anheuser-Busch has embraced the new wave of microbreweries. He stated that microbreweries and craft beers have brought about a new awareness of beer and that helps the whole industry. There are many indicators that this statement is true. Chart 3 is a graph of the sale of malt beverages over the last thirty-four years. The upward trend indicates that as an industry, brewers are doing well. Anheuser-Busch enjoys the same success as chart 5and chart 6 suggests. Note in table 7 that the market share for Anheuser-Busch has increased over the last decade to an estimated value of 51%. It seems microbreweries have not hindered its bottom line significantly. Perhaps craft brews are a compliment to Anheuser-Busch’s product offering.
To better gauge the effect that the craft brew segment has had on the sales of Anheuser-Busch, I have developed two regressions.[5] The regressions are models to measure how different environmental factors in the beer industry and macroeconomic factors affect the sales of Anheuser-Busch beer. The time frame for both models is 1989 through 2002 and all data is annual data. The first model independent variables are: barrels sold of Boston Beer (a small craft brewer), total personal income, total US population, and the CPI-U. The second model adjusts personal income by dividing the values of personal income for a given year by that year’s CPI-U. Furthermore, an additional variable was added to the second regression, total tax paid, which measures the amount of federal excise tax paid that year by all brewers. The dependent variable in both regressionsis total barrels sold of Anheuser-Busch beer within the United States. The results from the regressions can be seen in table 6 in the appendix.
I will begin by describing the results from the first regression. I have postulated that microbreweries have an effect on the sales of Anheuser-Busch beer. Mr. Hipp from Anheuser-Busch seemed not to think this is true, however; the results from the regression do not verify Mr. Hipp. The coefficient on “Barrels of Boston Beer Sold” is in fact negative, but there are several other factors to keep in mind. The p-value for this particular independent variable is .0133, which indicates that this value is not significantly different from zero. Another gauge of significance is the variables T-Stat, which is obtained by dividing the coefficient by the standard error. The T-Stat for this variable is -3.074 which is greater than two. This means that “Barrels of Boston Beer Sold” is significant and does affect the sales of Anheuser-Busch beer. The coefficient can be interpreted as the following: for every one barrel of Boston Beer Sold, A-B produces 6.3 less barrels.
There are only two other variables with significant T-Stats, personal income and CPI-U. The coefficient for CPI-U is extremely large due to the fact that values used for CPI-U are small and the values used for barrels of Anheuser-Busch beer sold are extremely high. The positive coefficient means that as prices in the CPI-U basket of goods increase, the amount of barrels Anheuser-Busch sells increases. One conclusion that can be drawn from this is that beer is price inelastic; however, this topic will be discussed later in this paper.
The last coefficient with a significant T-Stat is personal income. The coefficient on this variable is .0028 and the T-Stat is 2.11. The coefficient indicates that as personal income increases, the amount of barrels of A-B beer sold increases. The amount of barrelage increase is very small due to the small coefficient. Yet, because this coefficient is significant, I can conclude that beer is a normal good.
The second regression yields very interesting results. Under this regression, “Barrels of Boston Beer Sold” still has a negative coefficient of -1.124, but this time the T-Stat is -.21. This is insignificant and we cannot conclude that the coefficient is different from zero. This regression yields no significant independent variables.
Concentration
It may seem odd that a company of Anheuser-Busch’s size is allowed by the government to maintain such a huge portion of the market. There are many reasons for their great success, much of which will be discussed later in this paper. There are also governmental factors that need to be addressed, which will also be discussed later in the paper. It appears that this industry is extremely concentrated at the top, and in fact this is true. Table 4 illustrates this point. Notice that the HHI in 1998 is well above 1,800, which is the generally accepted number to signify extremely high concentration. Table 5 is an independent analysis of industry concentration done with sales information from 2003.3 This analysis is global and contains seventeen of the largest companies, not just the top five as the previous analysis. The HHI was 1,208.21. An HHI between 1,200 and 1,800 indicates that the industry is concentrated. This analysis also indicates that this industry is concentrated.
There are many factors that contribute to the increase in market concentration as demonstrated by table 4. As stated before in table 2, the number of breweries has decreased dramatically since World War II. However, the size of the market increases almost every day. Apart from the 3% market share that craft brewers like Boston Beer have carved out for themselves, the majority of this expanding market has gone to the biggest brewers, namely Anheuser-Busch. Chart 5 shows the market share of the top four brewers in the United States.[6] Notice that the next closest Company to Anheuser-Busch is Miller at 19%. It would seem that Anheuser-Busch is in a position to dominate the industry. This could be true, but nothing in the way Anheuser-Busch prices products or promotes them is monopolistic in nature. There is still heavy competition with marketing dollars and among different product offerings, but this will be discussed later in the paper.
Market Trends
Clearly the economic impact that microbreweries and craft breweries have had on Anheuser-Busch has been minimal at least. However, this does not mean that Anheuser-Busch is being idol due to their massive success. For instance, in 2002 there was a big surge in the “malternative” segment which accounted for a 23.8% increase in volume and a 30.3% increase in sales.[7] Malternatives are alcoholic beverages like Anheuser-Busch and Bacardi’s Bacardi Silver which is said to be, “one of a small handful – less than 10 – that will hang on as these (malternatives) shake out.” (Tom Pirko, Bevmark LLC)[8] Anheuser-Busch has recognized the demand for products like this early and has used innovation to position itself to make gains. The same is true for other market trends, as is the case with Michelob Ultra.
Anheuser-Busch was the first to realize the large demand for “Atkins” friendly beer. The “Atkins” diet is a low carbohydrate diet intended for lazy Americans to lose weight quickly. Standard premium beer like Budweiser is loaded with calories and carbohydrates and therefore is not allowed on the “Atkins” diet. The introduction of Michelob Ultra isa response to this untapped demand. Anheuser-Busch has seen great success in this product even though it sells at super-premium prices. They have also seen success marketing Ultra to the male audience even though light beers were traditionally consumed by females.8