A New Reality for Craft Beer
Photo: ctbeerwine
Originally published: April 2, 2019 via LinkedIn
A Look Into the Future...from the Past
Almost three years ago, I penned a white paper that outlined my views on the then-current issues and outlook emerging in the beer category. The white paper was used as a "context document" for discussions that I was having with large and small brewers in the category.
It is interesting to, now, look back and observe how some of these developments have turned out and also how I also missed the mark on some of my assertions at the time.
Here are the contents of that white paper:
This is How I See Things (as in April 2016!)
Craft Beer is at a critical juncture. A number of game-changing challenges are emerging, and they will shape the entire beer category for decades to come.
The big squeeze will tighten for brewers caught between macro beer and an elongating tail. High rotation levels, limited tap-handle placements and constrained off-premise shelf-space are the 800-pound gorilla in the room. Busting these retail bottlenecks will determine sustainable growth and profitability and separate winners from losers.
“Barrel roll-ups” and “mash networks” are being spawned and are creating new operating systems and supply networks. Technology breakthroughs will create new brand and go-to-market business models.
The scarcest resources will not be brewing materials but rather the deep and inspired talent pools needed to drive authentic and agile brand cultures.
The Big Squeeze will Tighten
For now, the ongoing tsunami of new micro-brewery entrants and their wide product offerings will further stretch the growing long-tail of craft brewing. Macro beer, regional breweries and the larger craft breweries will continue to be plagued by the “death by 1000 cuts” phenomena.
Increased macro beer FMB “Hail Marys” and malt-based offerings will further blur alcoholic beverage categories as competition to thwart spirits and wine category momentum intensifies. These beer, spirit and wine industry dynamics are chipping away share and dampening growth prospects in beer. Depending on where you sit on the micro-macro beer spectrum, it is a segment growth and/or share steal fight in a zero-sum category game. For now.
Macro beer is in the process of recalibrating their stagnant prospects. Some of the incumbents, like AB InBev and Constellation will unfold a very deliberate and bold path. MillerCoors initially started with a more conservative approach but its full absorption into Molson Coors, coupled with tough US and international conditions will accelerate their search and acquisition of regional champions to a) offset mainstream losses and b) to match AB InBev with wider portfolios in big retail.
Both AB InBev and MillerCoors will continue to hollow-out supply chain and corporate muscle in order to re-invest in efforts that will reverse or stabilize their big brands. They will use opportunistic M&A and short-term internal innovation efforts to buy some time as they try figure out how to create or buy the next million-barrel brand.
In spite of high valuations, the economics of M&A on established high growth brands to establish a “craft” leadership category position can still be justified (versus organic small brand growth or risky internal innovation efforts).
The tough place to be in will be occupied by those midsize to larger regional brewers who are stuck in the upper quartile volume range within the long tail. The big squeeze for these US brewers is real and will strengthen in intensity as some new large big players M&A or JV their way into creating a new macro beer oligopoly and industry dynamic.
Many of these dynamics will occur at a quicker rate in the US than previously, given the new structural shifts created by AB InBev’s global re-alignment and brand/talent shakeout.
The big squeeze is as much a function of macro beer scale as it is with respect to the changing sensibilities and nature of Millennials’ discovery vs. loyalty engagement relationship with brands. In 10 years, when the Gen Z cohort starts reaching a critical mass of LDAC consumers it is likely that they will be similar in many ways to Millennials and will expect that technology plays a seamless role in how they discover, choose and prefer brands.
Scale determines the squeeze today. Technology will create the squeeze tomorrow.
Tapping into New Money
There is a growing interest by VCs and PEs to explore and jump into funding natural, specialty and craft consumer brands. This phenomenon, which has both positive and negative aspects, will steadily permeate into the craft beer space.
Bets are being placed on how the industry will evolve and the extent to which lucrative strategic or IPO exits can be achieved. This will occur in spite of the craft brewing reality, as articulated by Jim Koch of Boston Beer Company, that “the barriers to entry are low but the barriers to exit are high”.
High near-recent valuations, that have mimicked tech industry funding dynamics and fervor, have helped fuel the entry of new funding sources in the alcoholic beverage space. For some seasoned craft veterans and for craft startup newbies, the increased funding activity has provided previously-unavailable opportunities to access expansion capital. Importantly, this flow of capital has created leveraged routes-to-market. For other craft beer stalwarts and startup brewery entrepreneurs with grit, this new money has offered a once-in-a-lifetime opportunity to monetize hard earned gains and sell-out. - Well before the big crunch arrives.
The recent correction within the tech sector has, to some extent, moderated exit expectations within craft brewing. But opportunities will still persist as capital looks to flow to seasoned players with traction, innovative startups and high-growth consumer segments.
There will be smart money that enters the category. Unfortunately, as is the case with tech funding, you will see “ignorant” money entering the system but thankfully also some smart money.
Mistakes will be made, and returns will be challenged as the industry seeks to find the right venturing model that addresses the very particular nature of scaling craft breweries. This includes growth curve characteristics and dynamics that exceed the traditional VC/PE 10-year fund horizons and expensive step-change capital expansions to support that growth.
Furthermore, given that local physical presence is such an important component of the craft brands proposition — capital expansion vs. geographic sales infrastructure decisions cannot just be made on a traditional financial return basis alone.
Barrel Roll-ups and Mash Networks
What is new and different is the rise of equity-backed, regional-national roll-ups and business models that I call “mash networks”. You are going to see a few more of these types of deals taking place in 2016 and 2017. Generally speaking, these are healthy developments and will help build a vibrant craft-brewing category that can sustainably compete with the macro beer and larger beer incumbents. But there are different routes to get there. And there can be some important differences between barrel roll-ups and mash networks.
Barrel roll-ups can be seen as the systematic bundling of craft brewing brand assets and territory strengths to create scale and to create a new tier of big beer players to challenge AB InBev and Molson Coors. Capturing a meaningful share of the growth opportunities in craft brewing and select import categories is going to be vital for these players. Constellation, a re-energized Pabst and Heineken will fight for this space. I suspect, however that within the next two years, you will also see heightened activity by Mahou San Miguel, Carlsberg and Asahi. The divestiture of brands and re-alignment of portfolios and alliances, resulting from AB InBev’s acquisition of SABMiller will play a big part in this.
Barrel roll-ups will however not only be limited to the mega-players. There will be an increase in the number of US craft brewers who, backed by PE money, will roll-up into larger entities. The ultimate goal here is the bundling of scale and the extraction of back-office and sales synergies that will lead to a strategic exit to big beer or to other mid-size players or even an IPO. While their preference is to secure a strategic exit, these opportunities will diminish over time as the large players fill out their “optimum” go-to-market portfolios. It is my belief that over the next few years you will see about 5 to 6 such entities evolve that will be significant.
Mash Networks are also built with PE money and are probably more suited to Family Office funding. They will evolve as new highly collaborative business models that not only provide the benefits of scale to thwart off big beer dominance but that also preserve independence and fund sustainable growth. Mostly, this new approach will manifest itself in a number of “mash” networks made up of strong national/regional craft brands as well as select groups of smaller next-wave, hyper-local brewers. Over time, viable indie craft breweries will be able to competitively build their brands as they leverage common problem-solving and channel-scaling resources. And, by partnering with smart PE/Family money, they can eventually pursue alternative exit options or creative buy-back approaches without having to only rely on an exit to one of the few larger players.
I believe that there will be some creative PE funds that will play a major role in shaping the market structure for the independents. This will occur for craft brewers individually or for groups that create some form of “federated” mash network approach across the US and even globally. I also believe that mash networks (or whatever you want to call them) can provide a highly meaningful halo effect for distinctive indie craft brands.
Time will tell whether some of the recent activities will end up being pure roll-ups with an eye to exit or whether they are the beginning of sustainable mash networks. It is likely that some of these structures will be somewhere in-between. And, of course, there will be a select group of high-end, independent craft brewers who have the authentic brand power, top-tier distinctive brews and the talent depth to “go-it-alone” and continue building on their mid-size momentum and success.
Barrel roll-ups and mash networks will evolve and will play a defining role in shaping the beer landscape within the US. For macro beer and craft brewers alike, they create a new and potential game-changing competitive threat or opportunity. What large brewers fear most is not the increasingly long tail of micro-brewers. The real threat is the emergence of well-structured and managed brewery networks and roll-ups that retain the critical attribute of independence and agility.
The Placement Bottleneck will Dictate Scaling & Profitability
Early signs are emerging. The big elephant in a craft brewer’s taproom that few want to address is the brand clutter competing for placement and shelf/tap space when looking for brand and territory expansion opportunities. Heightened new entrant and competitive activity that is increasing the long tail has resulted in unprecedented levels of product and pack proliferation. While space initially expanded to accommodate the new consumer interest and demand, overall rates of sale are being tempered as the low rates of sales of many undifferentiated and average quality brands drag the shelf-set down.
The reality is that this brand fatigue is not just driven by the consumer. Retailers and distributors do not want to (and do not need to) manage this level of complexity and are thus questioning and starting to systematically cut back on the nature of assortments going through valuable space. Placement and shelf-space constraints are becoming the primary bottleneck and constraint for craft brewers scaling beyond their taprooms and self-distribution limits.
The bottom line, figuratively and literally, is that access to and performance at the shelf or tap will determine and drive profitability and growth across the entire supply chain and go-to-market system. And so, in many ways, it does not matter how much downstream or upstream capacity or potential consumers there are. It is what happens at the point of constraint that matters. Constrained tap and shelf-space is the chasm that shapes the gateway to mainstream consumers. Macro beer knows this and understands it well.
My view is that, unless creative and alternative go-to-market channels can be innovated, constrained access and space will act as a form of craft beer “reset” and will also result in the “forced” moderation of growth aspirations and opportunities for many indie craft brands. This will create both opportunities and threats, depending on where you sit on the craft beer long tail curve. What is important here is not that this will happen but rather that macro beer is enhancing and shaping their portfolios to disproportionately influence and capture share and “flow” through the very same shelves. And they will do this through enticing retailers and distributors with increased marketing spend, promotional activities and carefully fine-tuned pricing action.
Unfortunately, an unintended consequence of the craft beer explosion and heightened proliferation is that it makes it easy for macro beer, macro distributors and macro retail to “justify” moving back to an easier time. Here, managing limited portfolios with little category innovation was less complex and could be synchronized with planned promotional and pricing events a year in advance. Even if that is not what consumers expect now, there is a real risk that channel constraints will force a key part of the craft beer category there. It’s the only way macro beer can win in craft.
The manner in which indie craft brewers morph sustainable go-to-market approaches that manage, bust or side-step constraints will be crucial. I do believe that over time, technology-enabled brand constructs and new business models will emerge that will alleviate and by-pass these constraints. Even within the confines and guardrails of the three-tier system. Interestingly enough, this is a space that craft brewers should explore more as it can provide huge opportunities to level the playing field. Macro beer has already started laying out some solid foundations to achieve a head start here. In particular, AB InBev is investing heavily in resources that are searching and testing transformative growth and business models.
What will Macro Beer and some of the larger Craft players do?
My view is that AB InBev and MillerCoors see the craft outlook differently. MillerCoors likely sees the craft landscape as plateauing in the med to long term and believe that they can compete in this space by doubling down on their existing Tenth and Blake portfolio. Their preference is probably to pursue a limited national portfolio of “craft” brands with more mainstream and crossover appeal. M&A activity will likely be ad-hoc and “conservative” as portfolio gaps widen and as valuations moderate. They see spirits as a greater threat and will likely continue to funnel and increase funds in FMBs and Hard Soda type innovations that will be pipelined internally. Over the next two years, MillerCoors will be somewhat distracted by their synergy targets and in their targeted efforts to reverse the decline and fortunes of their two light brands. This will not be easy given the competitive overlap of the taste profiles, consumer targets and “refreshment” propositions that both light brands are trying to own (versus Bud franchise brands and Mexican imports).
AB InBev will take much bolder steps. They know that their big brand, macro beer strategy is perfectly suited for exploiting opportunities in developing countries, where many of the US brands are treated as higher priced imports. They are quickly disposing of bulky low growth SABMiller assets in Europe and it looks like that they are replace them with the higher growth crafts. Craft portfolios are very strategic and important for them.
In the US, they will most likely aggressively build and support three or four national “craft” brands that they have acquired. They will do this so as to provide a substantial portfolio that they can take to their distributors and retail. It’s not only a defensive and margin substitution strategy for their declining mainstream brands but also an opportunity for a retail pipeline and space grab. More worrisome is that they have already started to lay the foundation that could allow them to dominate the #1 or #2 “craft” positions in targeted regional geographies.
My sense is that they will do this in a way that aligns closely with regional sports, food and cultural assets. They will maintain taprooms as long as they can. The consumer engagement data and the “local” optics of the physical space are more important for them than the real brand building opportunities and need. I suspect that once they gain the traction they want in chain retail accounts, they will likely sell those assets and retailing rights to arms-length “friendly” retail chains. Not too dissimilar to some of the distributors relationships they have.
An open question is where does that leave Sierra Nevada, New Belgium and other large national and regional Craft Brewers? And what role will BrewDog’s physical entry in the US play? I believe that their highly distinctive and compelling brand equity will work well in the US and will suck some oxygen from the space as they tread on the toes of brands with similar rebellious positions. But will their rapid global growth pressurize their ability to match and scale the quality of people and brews needed to sustain that growth?
The Hardest Element to Scale will be Brand Culture and Deep, Agile Talent Pools.
Having laid out my personal views on some of the headwinds and opportunities in the section above, I also believe that macro beer does not possess the capability to maintain the highly dynamic and spirited culture of craft breweries that they acquire. But I am also not sure that they will attempt to do that.
The Manner in which Indie Craft Brewers will Scale, Matters! A Lot!
While there are a number of strategic choices that top-tier craft brewers can take to push through to the next-frontier levels of 150 000, 300 000 and then 500 000 bbls, the manner in which smart growth strategies and scaling capabilities are orchestrated and executed matters! Not just from the perspective of physical capacity, distribution networks and go-to-market tactics, but also from the perspective of preserving and nurturing the same dynamic and entrepreneurial culture and ethos that has always been a foundational component of the brands themselves.
There will only be a handful of independent craft brewers who, through a triad of distinct brand portfolios, smart growth strategies and deep talent pools, will be able to capture a meaningful share of regional and national craft volume growth over the next 10 to 15 years. I have confidence that strong indies will strengthen and solidify their position here and that the beer-focused PE funds will help the next batch of indie craft brewers to do the same.