Going Medieval on the Middle-Tier
Forgive me, that title is a bit of a misnomer. My historical reference point is actually the end of High Renaissance, not medieval times. As my tortured readers know, I have been attempting to tackle some of the many books I avoided in my youth. Last spring I decided it was time for “The Prince”. Machiavelli’s classic gives the reader much to consider; perceptions, alliances, ambition, preparation, and fortune; however, the notion of downstream consequences stood out. When my contemplation of downstream consequences commingled with two industry events last summer the result was a desire to express my opposition to the Franchise Reformation™ movement.
I have written before about the potential erosion of the three-tier system; a concern the current system could be undone overtime by a series of attacks that progressively whittle away at the regulatory structure until the three-tier system collapses or is abandoned. Historically that was the nature of the threat, the trajectory of events, and my principal concern. By odds that still should be the principal concern of the middle-tier’s defenders. But Machiavelli’s discussion of Venice’s demise gave me pause. Speaking of the Battle of Vaila, Machiavelli says, “they [Venice] lost that which in eight hundred years they had acquired with so much trouble. Because from such arms conquests come but slow, long delayed and inconsiderable, but the losses sudden and portentous.”
If the three-tier system collapses, the value of beer distributorships will collapse with it. One industry professional recently offered his thoughts on the value implications of franchise protection using non-franchised wine and spirits distributors as an example. Rather than plug that competitor, I instead roughly truncate his suggestion. Without franchise protection distributor values can be halved—with a nothing plus inventory option.
Shatter the notion of a business’ viability as a going-concern and that business’ value is diminished, or perhaps even destroyed. The vast majority of the typical beer distributorship’s value is associated with intangible assets (i.e., distribution rights), and what we valuator types call terminal value. In essence, a huge portion of the business’ value is predicated on the assumption the company’s distribution rights will not go away and those distribution rights will continue to produce earnings in perpetuity. Change the rules from perpetual rights to potential rights and a whole lot of value moves out of the middle.
“You know Ohio is the Lombardy of American beer’s middle-tier.”
“Really?” comes the reply.
“Oh yes,” I say, “and Missouri is Papal Rome.”
That excruciatingly bad joke lacked both humor and historical context. Yet again, I find myself backfilling a humorless joke with selectively chosen facts.
Why did my brain make Ohio into the Lombardy of America’s middle-tier? Because, while I was reading “the impossible to follow and varying fortunes of the Italian Renaissance states,” an assortment of interests and alliances were battling over who would occupy Ohio’s middle-tier. It was a Machiavellian smorgasbord. There were imperial forces seeking to expand their territorial possessions. Perceiving this territorial conquest some were compelled to respond. Others—knowing that they lacked the power to resist the expansion—sought only to preserve their standing. And a few chose to leave the territory with what wealth they could, rather than linger and await an uncertain outcome.
Those who felt compelled to respond saw the expansionary effort for what is was; a tangible indication of the king’s true intentions. That is why Ohio’s princes (not to exclude duchesses) rallied the middle forces for opposition; which provided the essential ingredient of any Machiavellian analog—political intrigue.
The preface to “The Prince” provided what might be called a contextualization of Machiavelli’s sinister reputation. In short, if Machiavelli suggested princes should, on occasion, lie and murder, don’t hold that against Machiavelli or his princes. In Machiavelli’s day, most princes faced a lot of lying and murdering coming at them. Therefore it was essential that princes be up to speed on things like deceit and assassination. In this context Machiavelli was not encouraging immorality per se. He was providing essential tutelage. Thankfully the giant cash-filled pen has replaced the sword. Consequently, I cannot recall there having been a red wedding on St. Valentine’s Day for eons. Nonetheless one can still observe princely acts.
Machiavelli illustrates a variety of circumstances under which it is prudent for a prince to falsely represent his plans and desires so as to conceal his true intentions; basically, whenever the good of the state demands it. Therefore if the empire’s continued prosperity and stability be aided by the acquisition of additional territories, Machiavelli would instruct the king to aggressively pursue those acquisitions but publically dismiss any notion of those ambitions. If Machiavelli were serving the princes of those coveted lands, then Machiavelli would tell those princes that they must prepare as if the proclamations were false. Machiavelli believed that a prince ought never have the subject of war out of his thoughts, and “in peace he should addict himself more to its exercise than in war….” [Machiavelli would recommend colonies not garrisons, btw.]
When ABI says it does not have a specific plan for self-distribution, who in the middle sleeps assured by such qualified declarations? Who does not think that the King of Beers, now ascended to global beer emperor, did not want vast territories and volumes of Buckeye beer? When I contemplate the way ABI must have been looking at Ohio I find myself thinking like a 1970s construction worker staring at a Raquel Welch look-alike. “Wowza! Would you get a look at the cities on that state! And ooh wee fellas, take a gander at the miles of infrastructure. You know what they say about those Buckeyes, their totally C-store and chain driven—just the way I like ’em. And me with my brewery smack in the middle. I would so vertically integrate that state. I can already feel my market share and capacity surging.”
It’s hard to pick on ABI beyond the dubiousness of its carefully qualified non-branch policy declaration. Everybody gets it. There is no official self-distribution policy. The idea of buying up all the large markets possible might have been contemplated, and those markets might also approximate 50% of ABI’s U.S. volume. And, certainly, the synergies and cash flow might look utterly delicious to La Máquina. But there is no official plan. You know, it’s a case by case, market by market, facts and circumstances kind of thing. There’s nothing definitive—per se.
Who can blame ABI for wanting its very own place right there in the heart of it all? As Machiavell said, “The wish to acquire is in truth very natural and common, and men always do so when they can.…” That’s why the distributors in Ohio had to scramble to revise the rules. They moved swiftly and discretely. Props to them! For, as one author put it, “Machiavelli moralizes on the resemblance between Fortune and women, and concludes that it is the bold rather than the cautious man that will win and hold them both.” Now those princes can reflect upon another Machiavellian maxim, “He who thinks new favours will cause great personages to forget old injuries deceives himself.”
Honestly, I don’t have any inside scoop on Ohio. It has been argued the actions taken by the Ohio distributors and Ohio government were mere clarifications and enhancements of existing rules and original intent. There are at least a couple of problems with that line of argument: (1) ABI had a branch in Canton for years; and (2) the distributors were almost at once overtaken by an urgent need to have Ohio law changed (yes, I know, say “clarified”). The fact is if ABI had signed deals with Cleveland, Cincinnati, and Columbus 12 months earlier it would have been legal. ABI would have been playing by the rules. That’s why Luis Edmond could at last year’s Beer Marketers Insights seminar state without qualification that ABI had not pursued a single legislative change since acquiring Anheuser-Busch.
That’s enough about ABI and Ohio. It’s time to move on to Missouri and the sacking of Rome. A popular bit of historical speculation is that after the sacking of Rome in 1527 it was impossible for the Pope to grant Henry VIII the annulment he sought for his marriage to Catherine of Aragon (the Holy Roman Emperor’s aunt) due to his virtual imprisonment at the hands of the Emperor and his fear that Rome might be sacked again. The result was that Henry VIII eventually broke with Rome and created the Church of England. Christian Reformation thus was pushed forward. Well, for some time now I’ve been mulling over the notion of Franchise Reformation, and in Missouri that movement just seized a monumental victory.
In case you missed it, a judge said something like, “Yeah, there’s franchise protection, but that franchise protection doesn’t protect your business’ existence. Suppliers can individually (or perhaps in coordination) lay siege to your business and bring it to ruin. The courts cannot enjoin your destruction; however, the courts will be there should you seek restitution for your now damaged or dispatched business.” Comforting isn’t it? The judiciary that blessed your destruction will be there to determine fair compensation. I insist the process of determining and obtaining fair compensation warrants deeper consideration than it is receiving.
Three-tier advocates can hope that Missouri was an isolated incident, but as I am a non-lawyer and an individual inclined towards paranoid hyperbole, I see the Missouri ruling as a pillar smasher. It appears to me that a judge just said suppliers and their largest distributors can, if they chose to, annihilate those in the middle-tier with whom they no longer wish to do business. If a long-term operator without any material deficiencies falls out of favor or is simply less favored, it can be driven from the middle-tier, so long as the company is compensated.
How preposterously strained is the notion of an independent middle-tier in this context? It’s like telling you that we’ll play a normal chess game only I get to choose the pieces and set them how I wish. When suppliers express their commitment to an “independent” middle-tier and in the next breath talk about the share of mind of aligned anchors, am I the only one wanting to phone Orwell for a ruling?
While I was reading “The Prince” and thinking about downstream consequences I found myself wondering, “If Anheuser-Busch had not become ABI, would the outcome in Missouri have been different?” That was my mind’s link to the sacking of Rome. The historical supposition is that had the Pope not been subjugated to Charles V, then the process of Christian Reformation (and history) would have been markedly different. My franchise analog to that historical speculation being, “Had the King of Beer not been dethroned, would the franchise reformation movement have failed in Missouri?” Presuming the legal outcome would be independent of the king’s circumstance is hopefully logical. The law is the law. However, I think this reasoning denies the practical realities of stately politics, and that is perilous. Machiavelli said, “Men will not look at things as they really are, but they as they wish them to be—and are ruined.”
So that no one thinks I am devoted solely to the inquisition of ABI’s middle-tier intentions, I will turn my attention to other actors in the franchise reformation drama. The undertakings of MillerCoors and craft brewers deserve their own attention.
When the steward of MillerCoors suggests that invoking trademark law was about the brewery’s right of first refusal and then proceeds to note the recently formed joint venture’s right of refusal has never been challenged, one hears Machiavelli’s tutelage. Old Nic would appreciate the sematic sleight of hand. Yes, perhaps MillerCoors’ right of first refusal provision had not been challenged previously. Never mind the allegation that the seller was not being made whole, or the question of whether any supplier’s right of first refusal previously had been adjudicated in Virginia. Ignore the dubiousness of the trademark claim and its questionable relation to the right of first refusal. As a subject of the realm you are obliged to accept these kinds of proclamations with due fidelity.
When craft brewers say they want franchise carve outs based on fair market value, my immediate response is define fair market value (FMV). If you want to get a sense of how slippery the notion of fair market value can be when real facts and circumstances are injected into the argument, go spend some time digging through the IRS code along with all the pronouncements and rulings related to the notion of fair market value. After a fortnight of that most tedious imprisonment you’ll have barely scratched the surface. As you exit your FMV Bridge of Sighs, contemplate the prospect of experts and advocates settling disputes using comparable sales from states with different definitions of fair market value.
Beyond the failure to define fair market value, it is impossible to ignore the fact that a forced sale hardly fits one of the most traditional and elemental conditions of a fair market value transaction. Specifically, fair market value commonly is defined as the price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell. Sure, I get it. That’s why franchise reformation laws would be written to specify fair market value—because the circumstance under which those laws are to be applied are expected to be so markedly inconsistent with the notion of fair market value.
The paying of fair market value at the time of a causeless termination is offered all too conveniently. No definition is offered. Others are to do that—separately—state by state. Similarly, a carved-out brewer need only initiate the change. Simply state a desire to change; that’s it. Then it’s up to the distributors to work out the price. If the seller’s notion of value is too high in the buyer’s eye, then those distributors get to litigate or arbitrate what is FMV at their mutual expense. The brewer would apparently grab a free seat in the audience section of the courtroom. You know what would make me more receptive to these carve-outs? Forcing brewers terminating without cause to pay both the buyer’s and the seller’s legal fees should a dispute over FMV arise.
I suppose that decrying the franchise reformation movement makes me a craft heretic. I have no doubt some distributors have given small brewers reason to feel constrained and imprisoned by franchise laws. Without question distributors need to be more willing to accommodate the desires of small suppliers to move. I just can’t get comfy with the notion of causeless terminations. Moreover, as America enjoys a brewing renaissance, I find it difficult to believe distributor franchise protections are truly thwarting craft brewer success. That said, I must note that Machiavelli spent some time discussing how fortresses can become a liability and how the greatest security is found in being loved by the people.
Distributors are supporting limited self-distribution throughout the country for a reason. In that context a thwarting notion has legs. If limits on size, market share, and geography are delineated, then every entrepreneur below those limits should have the opportunity to flounder to success unimpeded during their branding adolescence, especially in their home market. I strongly believe that if a small brewer is successful using self-distribution then that brewer ultimately still will want to capitalize on an independent distributor’s infrastructure and customer relationships—especially outside their home market. It’s the economics of broad distribution, and it is how small brewers hitch a ride to the next level.
Now after having too long floundered about the end of the high renaissance, I come back to the notion of Going Medieval on the Middle-Tier. If craft brewers get their franchise carve-ups, I see the possibility of them awakening from their franchise imprisonment rage to find before them the corpse of the three-tier regulatory structure that facilitated their renaissance. Machiavelli said, “It must be considered that there is nothing more difficult to carry out, nor more doubtful of success, nor more dangerous to handle, than to initiate a new order of things.”
I recall one author suggesting that the age of global brewing empires would force supplier-distributor relationships to be more businesslike. I, being a HUGE “Godfather” fan, could not help but think of Michael saying, “It’s not personal, Sonny. It’s strictly business.” Machiavelli believed that a prince must be both man and beast. The same might be said of corporations. It’s a dog-eat-dog world after all.
The global beer powers have made qualified declarations of commitment to America’s three-tier system, and some of their actions have been inconsistent with fidelity to the notion of an independent middle-tier. Some years ago a very smart analyst said something to the effect of “ABI operates to create wealth for its controlling shareholders,” and SABMiller is on record saying its duty is to shareholders, not the American three-tier system. The middle-tier should remember what Machiavelli’s said, “The promise given was a necessity of the past: the word broken is a necessity of the present.”
“Everyone who wants to know what will happen ought to examine what has happened: everything in this world in any epoch has their replicas in antiquity,” was Machiavelli’s instruction. “The Prince” turned 500 this year, so there have been tributes. An exhibit quotes “the great 20th century scholar Isaiah Berlin: Machiavelli, he said, ‘helped cause men to become aware of the necessity of making agonizing choices between incompatible alternatives in public and private life.’” Machiavelli believed, “Wisdom consists of knowing how to distinguish the nature of trouble, and in choosing the lesser evil.” Conflict and change are ever present.
Best of luck Lords and Ladies of Lager.
I apologize to those troubled by my casual and imprecise references to historical era. I do understand Machiavelli wrote “The Prince” at the end of the High Renaissance, after medieval times, and that after the High Renaissance the arts saw Baroque styles and the Mannerist movement. Baroque Mannerism is the title of my next article, which is an exploration of my own socio-political adeptness.
