In 2013, the U.S.Department of Justice required Anheuser-Busch InBev (ABI) to grant a perpetual and exclusive U.S. license to some of its Grupo Modelo Mexican beer brands that were at the time competing in the U.S. market, including Corona Extra, Modelo Especial and other popular brands, to Constellation Brand Inc.[1] In addition to the sale, the DOJ put a number of conditions on ABI to ensure that the Grupo Modelo Mexican beer brands, including Corona, remained competitive in the U.S. market, including critical protections to make sure distribution was open and independent. This summer will be the third anniversary of the sale of the Modelo American portfolio to Constellation and the lapse of important protections could leave many Corona consumers scrambling to find their beer of choice.

Prominent among the conditions the DOJ required in its consent decree was the sale of the Piedras Negras Brewery in Nava, Coahuila, Mexico to Constellation. The sale was required so Constellation can brew the Modelo brands itself for importation into the United States, and not rely on its chief competitor, ABI. Accompanying the sale of Piedras Negras was a condition that Constellation obtain its supply of necessary materials from ABI for a three-year period. That provision is about to lapse.

A couple of months ago, ABI and Constellation agreed to extend their supply agreement by another year, making Constellation dependent on ABI for necessary inputs through June 2017. However, this reliance on its chief rival for inputs with no extension of other important protections will be a recipe for disaster, as Constellation is still in the transition of becoming a fully independent brewer. Reliance on ABI has not entirely helped it in its transition, and Constellation is still in a very precarious position. For example, there have been two recalls of Corona due to defective glass bottles in less than two years.

In addition to the supply agreement, the DOJ required protections for independent ABI beer distributors carrying the Modelo American portfolio brands, which have been pivotal to the success of Constellation’s stewardship of the Modelo American portfolio brands. In its review of the ABI/Modelo deal, the DOJ stated that “[e]ffective distribution is important for a brewer to be competitive in the beer industry.” Recognizing that independent distribution is the artery that spurs consumer choice and the explosion of craft beer, the DOJ prohibited ABI from adversely affecting a distributor’s ability to carry the Modelo American portfolio brands, including Corona, for a three-year period.

ABI is known to offer incentives and other tactics to exclude craft and other non-ABI brands from independent distributors’ brand portfolios. In fact, ABI’s current distributor incentive program already encourages the exclusion of non-ABI brands in exchange for marketing payments and favored position. ABI will soon be able to use these incentives and tactics against the Modelo American portfolio brands, including Corona. Accordingly, there is substantial concern that ABI will attempt to ice Corona out of many distributors’ portfolios once this protection provision expires this summer.

Indeed, ABI has strategically timed the roll out of its Mexican beer brand Estrella Jalisco (also under the Modelo brand, which is controlled by ABI outside of the United States), designed to compete with Corona in the U.S. market, to roughly coincide with the lapse of these protection provisions as well as the important Cinco de Mayo and kick-off of summer sales seasons. ABI will undoubtedly push its independent distributors to shift focus away from the Modelo American portfolio brands, including Corona, to Estrella Jalisco once the DOJ protections expire in June.

The DOJ’s consent decree and the protections put in place for distributors of the Modelo American portfolio brands have undoubtedly allowed it to flourish over the last few years in the United States. Hence, Constellation’s growth has exploded since the acquisition of the U.S. rights to the Modelo American portfolio brands, and its growth has far outpaced the overall growth of the U.S. beer market.

To keep the U.S. beer markets competitive, the DOJ needs to act to extend the consent decree and the protection of Constellation through independent distributors or risk losing this important source of competition that gives consumers choice and keeps prices down. The marketplace will be able to “find their beach” if ABI is prevented from pushing out the competition.

[1] Final Judgment, U.S. v. Anheuser-Busch InBev SA/NV and Grupo Modelo S.A.B. de C.V., No. 13-cv-00127-RWR (D.D.C. Oct. 24, 2013), ECF No. 48.

Andre Barlow
(202) 589-1838
abarlow@dbmlawgroup.com

The three-tiered system was put in place to prevent brewers from having too much control over what consumers purchase.  Truly independent distributors and retailers want to sell beer driven by consumer demand, and do not want to be beholden to one or two powerful brewers.  Consumers can seek out whatever beer tastes the best, and retailers can get a diverse array of brands from their independent distributor.

However, large beer brewers are actively working to reverse the benefits of a three-tiered system by exerting control over distribution.  To be sure, craft brewers are raising alarm bells over Anheuser-Busch InBev (ABI) incentive programs that significantly reward distributors whose ABI sales reach 98% of their total volume.  Besides employing its incentive programs, ABI has become the largest and fastest growing distributor in the United States.  ABI is also adding retailer locations at a fast clip so it is involved in all three tiers in various locations around the country.  Recently, ABI has employed a strategy of actually purchasing craft brewers in an effort to destroy the craft brews that do not sell out.  Indeed, ABI recently announced purchases of Four Peaks Brewing and Breckenridge Brewery.  ABI’s purchases of craft brewers harm the remaining independent craft brewers in a round about way.  Distributors carry craft brews to meet retailers and its consumers demand for craft brews, but with these craft brew purchases, ABI can replace independent craft brands currently carried by a distributor for ABI owned craft brands.  ABI’s move into craft brews allows distributors to meet the demand for craft beer while also hitting ABI incentive targets.  Accordingly, distributors will likely carry fewer independent craft brews in the future.

It’s no wonder that the consumer fallout from the merger of the two largest beer makers in the world, ABI and SABMiller, hinge on what happens with beer distribution.  Last month’s Senate hearing on the deal rightly focused on distribution issues, as did the Department of Justice during its investigation and challenge of ABI’s previous purchase of Grupo Modelo.  The DOJ has previously stated that “[e]ffective distribution is important for a brewer to be competitive in the beer industry.”

There are significant competitive concerns about the deal because it will provide both ABI and SABMiller the incentive and ability to further exert control over distribution.  As Senator Amy Klobuchar stated at the hearing on the merger, MillerCoors needs to be as independent after the merger as it is today.  And ABI will be in greater control of a tremendous global profit pool that it can turn towards increasing its ownership of distributors and craft brewers in the United States.

ABI CEO Carlos Brito repeatedly said during the Senate hearing that the deal will have no impact on the U.S. market because of ABI’s proposed divestiture of SABMiller’s interest in the MillerCoors joint venture.  But the only way that will be true is if the DOJ secures three very important remedies to safeguard independent distributorship.

First, the DOJ must ensure there are no terminations of independent distributors by parties to the merger.  A termination or threat of termination by ABI or Molson Coors would effectively shut down a distributor’s business and disrupt other brewer’s access to market.

Second, there must be conduct rules in place that prevent ABI as well as MolsonCoors from exerting its power to shut independent craft and importers out of distributors or creating incentives for distributors to not sell beer brewed by other breweries.  ABI’s incentive programs are extremely problematic for competition, especially when they are accumulating a craft beer portfolio that can allow distributors to drop independent craft brewers without angering craft seeking customers.  This is an issue that is currently plaguing the craft beer industry and there is no reason to not address it during the DOJ’s review of this enormous deal.

Third, the DOJ needs to force ABI to divest or at a minimum greatly reduce and cap its ownership of distributors.  This is an issue that ABI CEO Mr. Brito repeatedly danced around during the Senate hearing – first appearing to commit to a 10% cap and then clarifying that they will stop at “around” 10%, possibly 11% or 12%.  Mr. Brito’s justification for owning distributors was to learn from them, but it is unclear why ABI needs 12% or possibly more of U.S. distributors in order to do so.  There is no competitive reason to own so many distributors, which are solely beholden to ABI and not to market demand.

Today’s craft beer renaissance depends on open and independent distribution, and independent distribution depends on the DOJ getting it right on remedies.

Andre Barlow
(202) 589-1838
abarlow@dbmlawgroup.com

On Tuesday, the heads of Anheuser-Busch InBev (“ABI”) and Molson Coors testify before the Senate Judiciary Subcommittee on Antitrust, Competition Policy and Consumer Rights in a hearing aptly titled “Ensuring Competition Remains on Tap: The AB InBev/SABMiller merger and the State of Competition in the Beer Industry.”  Like Obi Wan they will try to create an illusion and tell the senators that there is no reason to worry about the merger of the two largest beer companies in the world, which will account for over 1/3rd of all global beer production.

This is an illusion the senators should treat with extreme skepticism.

ABI CEO Carlos Brito is expected to say that they have presented the perfect remedy, the divestiture of SABMiller’s 58 percent share of MillerCoors to Molson, and that there is no reason to look under the hood of the deal. Brito will likely say that since MillerCoors already controls the brands of SABMiller in the U.S., that nothing will change.

If it was that simple there would be no reason for a hearing and there would be no army of ABI funded lobbyists pushing the deal forward. Like all illusions, saying that the divestiture resolves all problems in the deal shows a warped view of reality. There are many unresolved issues that need to be carefully examined, and the senators should ask the tough questions.

Let’s remember the rules of the game.  Under the antitrust laws a merger remedy must “fully restore competition.”  No half measures are permissible.  Consumers should not be forced to suffer increased prices or less choice.  And when a divestiture is used the acquirer must have the same incentives and ability to fully restore competition.

Under the standards of the law the proposed “remedy” faces some really tough questions.

To begin, will MillerCoors owned by Molson be as effective as MillerCoors jointly owned with SABMiller? Under the SAB powerhouse MillerCoors was part of the second largest beer producer with a strong international presence. There is no guarantee that MillerCoors will be as strong of a competitor under a much smaller parent (industry reports estimate that SABMiller is over three times larger than Molson in terms of global beer production). Will a Molson owned MillerCoors be able to act independently, or will it simply follow ABI’s strategic conduct in important matters such as pricing and distribution?

We also don’t know how dependent Molson will be on ABI in the operation of MillerCoors.  MillerCoors controls important import brands of SABMiller including Pilsner Urquell and Tyskie. These brands will be produced by ABI after the merger and Molson will have to rely on ABI for their U.S. supply. And ABI will become by far the dominant buyer of key beer inputs such as hops, with the ability to manipulate those markets.  Under the law, a merger remedy can be rejected if the acquirer of the divested assets is overly dependent on the merged firm.  It was that concern that led the Department of Justice to sue ABI when it offered a half hearted remedy to resolve competitive concerns over its acquisition of Modelo (eventually the deal was permitted when ABI agree to divest a brewery in Mexico). Shouldn’t ABI be required to do the same in this deal?

And looking at divestitures misses the critical issue in this market – the role of independent distribution.  Key antitrust advocates recognize independent distribution is the artery that spurs consumer choice and the explosion of craft beer. Neither does ABI’s proposed remedy do anything to stop its long march to dominance through the acquisition of craft brewers, buying of independent distributors, and setting up retail operations. ABI has made a series of additional strategic moves to shut out independent craft from the market, primarily through pressuring independent distributors to stop carrying imported and craft beers and controlling space on retail shelves. What’s to stop ABI from leveraging this acquisition to further these goals?  And what will prevent Molson from following ABI’s lead to extinguish competition?

It’s also important to step back and look at the bigger picture. Merger remedies can often fail despite their good intentions. For example, the joint venture between SABMiller and Molson Coors was permitted by antitrust enforcement agencies in large part because they believed it was necessary to create a strong competitor to ABI. However, a study by former DOJ economists found that consumers got a bad deal.  Even though the joint venture produced cost savings, these benefits were not passed down to consumers in lower prices.  In fact, the joint venture led to higher prices – with MillerCoors docilely following ABI’s regular price increases. How do we know this coordination won’t increase when ownership of MillerCoors is consolidated under a single owner and Molson’s former partner is owned by ABI?

In a few weeks, millions will be seeing the latest installment of Star Wars to find out what happened to the Empire. Tomorrow, the Senate will be facing a different kind of empire. Hopefully, the Senate recognizes that the proposed remedies are simply inadequate and many hard questions remain before any merger should be allowed to go through. Otherwise it will take more than a rebel alliance to restore beer competition.

Andre Barlow
(202) 589-1838
abarlow@dbmlawgroup.com

A straightforward merger between the two would raise antitrust alarm bells that would awaken the dead.  Together, the companies control over 70% of the U.S. market by volume and 65% of the market by sales value.[1]  Recognizing such a deal would be a nonstarter, ABI has suggested that any competitive concerns in the United States will disappear because MolsonCoors will acquire control of the MillerCoors joint venture.  Of course, the DOJ has become increasingly skeptical of negotiated attempts to restructure a market to resolve competitive concerns for deal approval – recently rejecting a massive divestiture in Comcast/Time Warner — and as we explain below they should do the same in this deal unless there are substantive amendments.

There is a tremendous amount at stake in this merger.  The increased size and scope of ABI on a global basis will likely have effects in the U.S. market.  Molson Coors taking over the control of the MillerCoors portfolio may also result in significant changes in how the business operates today.  Moreover, economic studies have shown a simple truth – increased beer consolidation leads to higher prices.[2]  The recent expansion of the high end U.S. craft beer market is remarkable in light of the 2007-2008 big brewer (ABI and MillerCoors) mergers thanks to a robust and independent distribution market which has facilitated the explosion of craft beer entry.[3]  But the craft beer segment is increasingly threatened by ABI’s acquisitions of independent craft brewers and increasing efforts to cut off distribution of competition brands within the ABI aligned distribution channels.  Not only is ABI the largest U.S. brewer, it is also the largest U.S. distributor – currently controlling over 135 million cases with $3 billion in sales across distributorships in multiple states.[4]

Regardless of the public facing attempts to firewall antitrust issues, the proposed acquisition threatens competition in wholesale beer distribution and input markets to brewing and packaging.  This deal produces far more competitive issues than ABI’s acquisition of Groupo Modelo, which was challenged by the DOJ.  At the time, Groupo Modelo commanded only 7% of U.S. market share.[5]

Consumer Harm

There is a simple truth borne out by history.  Beer mergers harm consumers.   In this case, the merger is presumed illegal under the Horizontal Merger Guidelines.[6]  The antitrust enforcement authorities measure market concentration using the Herfindahl-Hirschman Index (“HHI”).  A market with an HHI over 2,500 is considered highly concentrated and a transaction that increases HHI by more than 200 is presumed to be likely to enhance market power.  The HHI of the beer market as of 2014 is 2,751 and the acquisition of SABMiller by ABI would increase that HHI by 2,998 if there are no divestitures.[7]  Even with divestitures it would only take less than 3 points in market share gain for ABI to pass the 200 HHI threshold.

It is difficult to understate these competitive concerns.  In 2008, the DOJ permitted Miller and Coors to form a joint venture.  A careful and thorough econometric study has demonstrated that, since then, tacit collusion between ABI and Miller/Coors has increased over time, substantially increasing the cost of beer to consumers.[8]  The study discovered that prices were stable leading up to the consummation of the joint venture but the prices of ABI and MillerCoors sharply increased after the merger.  The study concluded that tacit collusion best explained the price data.

This tacit collusion is likely to increase now that Molson will take ownership of MillerCoors.  At least with the joint venture, there were two equal voting partners to keep each other honest.  Now, that Molson is taking over MillerCoors, its management incentives may change.  Both Molson and ABI will have significant debts as a result of these acquisitions and could face pressure to increase prices.  Additionally, the U.S. market may exhibit even more characteristics of a duopoly now that MillerCoors is united under a single leadership, meaning that MillerCoors may be more likely to follow ABI on its strategies including price, dealings with suppliers, and dealings with distributors.

Harm to Craft Brewers

One of the biggest concerns of the proposed merger is whether it will lead to a decrease in small brewers’ access to distributors.  The beer market in the United States is a predominantly a three tiered system because state regulation in most states generally requires that the brewer sell to a distributor who then sells to retailers.  This distribution has become the safety valve that keeps beer markets competitive – as the DOJ demonstrated in its challenge to ABI/Modelo, “[e]ffective distribution is important for a brewer to be competitive in the beer industry.”[9]  However, large companies can use their market power to exert a tremendous amount of influence over what beer brands distributors carry.

This is important because ABI and MillerCoors have so far pursued different strategies when it comes to their dealings with distributors.  ABI has pursued a strategy of exclusivity, and has in the past given more favorable terms to distributors who only sell brands owned by ABI.  The 100% share of mind strategy has led ABI to pressure distributors to drop other brewers’ brands.[10]  Recently, the DOJ opened an investigation into ABI’s practices and acquisition of two distributors in the San Jose and Oakland markets.[11]  On the other hand, to date, MillerCoors has been more tolerant of its distributors carrying rival brands.[12]  However, there are no guarantees or provisions in this deal to even require this open practice to remain in place.

In fact, there is a good chance that a 100% Molson owned MillerCoors will follow ABI’s lead in its dealings with distributors.  A Molson owned MillerCoors may have new incentives to adopt different policies towards distributors.  Before the MillerCoors joint venture, SABMiller and Molson Coors successfully shared distributorships and recognized the importance of being open to many suppliers.  Likely, they chose this strategy, because each had relatively small market share compared to ABI.  MillerCoors kept this same strategy as it was under the management of SABMiller and Molson.  Given the change in management and Molson’s new increased size and scope in the U.S. market, Molson’s management may have different incentives.    For example, Molson could change its policy and pressure distributers to stop carrying white beers that compete with Blue Moon, which Molson will get U.S. rights over in this deal.

This problem is further compounded by the fact that ABI is currently the largest distributor in the United States, with $3 billion in sales and 135 million in case volume, and the largest beer supplier with 44.7% of the market.[13]  After the transaction, Molson will have monolithic control over 26% of beer sales.  That’s more than the next 8 largest brewers combined.

Abusive Buyer Power

ABI’s new global scale gives it increased leverage over commodities used in brewing and many other facets of the beer industry that could affect competition in the U.S. market.  ABI and SABMiller are responsible for 21% and 9.6% of world beer production respectively.[14]  The proposed merger would greatly increase ABI’s buyer power by potentially controlling over 30% of total worldwide beer production.[15] The combined ABI –SABMiller entity would have 58% of the global beer profit pool which far outweighs its next closest global competitor Heineken (11%).[16]  Antitrust enforcement agencies are increasingly looking at buyer power and leverage when examining deals.[17]  Abusive buyer power can harm not only input sellers, but also other buyers.

Smaller buyers can be disadvantaged by abusive buyer power due to the “waterbed effect.”[18]  A powerful buyer demanding lower prices or other concessions from suppliers can cause suppliers to increase prices to smaller buyers or otherwise worsen their terms.  The beer industry is particularly vulnerable to waterbed effects due to capacity issues of many inputs involved in the brewing and packaging of beer.

Can maker, Crown Holdings, has recently reportedly dropped both new and existing small craft beer customers and lengthened lead times, implying that they are becoming capacity limited.[19]  Hops shortages occur frequently.  Hops can only be grown in a limited geographic area and requires a lot of water to grow.  Hop growing also has high startup costs and high quality hop plants can take years before they hit full production.  These factors lead to frequent hops shortages that disproportionately impact craft brewers.[20]

Hops come in many varieties that can be roughly divided into two categories: bitter hops used in traditional lagers and aroma hops used predominantly by craft brewers to make more flavorful beers.  ABI is a powerful buyer in the bitter hops market, which is highly commoditized, but does not yet have much market power in the aroma hops market.[21]  The deal could depress prices in the bitter hops market due to ABI’s buyer power and other purchasers who put pressure on their suppliers to compete with ABIs lower costs.  An interesting side effect of this could see more U.S. farmers abandoning the bitter hops market in favor of more profitable aroma hops, further decreasing the ability of other buyers to compete on lager style beers.[22]

ABI’s increased buyer power means that it is more likely to get the inputs it wants, in the quantities it wants, and at the terms it wants.  This is likely to disadvantage input providers, as ABI is notorious for demanding extremely favorable terms like 120 day payment terms.[23]  ABI’s increased monopsony power could also mean worse terms for every other buyer in the market, not just because suppliers may need to raise prices to make up lost profits, but because it may be necessary due to capacity issues.  Smaller buyers could experience delays, poorer terms, or even unavailability.  ABI would also be able to exert its buyer power strategically to disadvantage rivals in this way.

The Proposed Remedies Are Inadequate

Mergers and acquisitions are subject to the Section 7 of the Clayton Act, which prohibits the acquisition of stock or assets where “the effect of such acquisition may be substantially to lessen competition, or to tend to create a monopoly.”[24]  Mergers and acquisitions that would ordinarily violate Section 7 can sometimes proceed if a remedy is crafted that would restore the competition lost.[25]  But the law is unequivocal that any remedy must fully restore the competition lost from the merger.  Structural remedies, such as divestiture, are preferred over behavioral remedies.[26]

Typically, merging companies work with antitrust enforcement agencies to identify areas of concern and agree to appropriate remedies to ensure that the merger can proceed without harming consumers.  Unfortunately, this has not been the case with ABI.  ABI proposed inadequate remedies after its announced plan to purchase Grupo Modelo.[27]  The DOJ had to take ABI to court in order to obtain adequate remedies.  Like here, ABI believed that all problems could be solved simply by selling Modelo’s share of Crown to Crown’s joint venture partner Constellation.[28]

The proposed remedies in this transaction, like Modelo, simply aren’t enough to prevent a disastrous loss of competition.  There are two simple and compelling reasons.  First, no remedy would be complete that did not fully maintain independent distribution and prevent ABI from attacking independent distribution in the future.  ABI’s control of distribution, through ownership and exclusivity arrangements, greatly jeopardizes competition, limits the rivalry of craft beers and leads to higher prices.  This is a problem that many states recognize by prohibiting brewer ownership of distributors.  Craft brewers especially need access to distributors in order to innovate, enter and thrive.  Any remedy should include the sale of ABI owned distribution, a prohibition on exclusivity pressures on distributors, and a moratorium on distributor purchases.  Molson’s purchase of the remaining share of MillerCoors should also be conditioned on remedies that protect independent distribution.

Protection of the distribution channel has already proven to be essential in beer mergers.  In the Modelo transaction, the DOJ imposed conditions on ABI that included barring ABI from using a Distributor Incentive Program to harm Modelo and giving Constellation the right to transfer rights of distribution for Modelo beer from ABI owned distributors to distributors of their choosing.[29]  The judgment also increased reporting requirements for future acquisitions.[30]

Additionally, ABI and Molson will command even greater positions as worldwide input buyers.  As the dominant buyers they will be in the cat bird’s seat, able to manipulate these markets to raise costs to rivals, particularly craft brewers.  This has an immediate impact on the bitter hops market, which will be dominated by ABI and Molson.  ABI and Molson will be able to command the prices and terms they want on a greater percentage of the worldwide hops yield and other competitors will face higher costs impairing their ability to compete.  This problem will be exacerbated by future supply constraints.  Any remedies should take account of this increased purchasing power.

Sometimes the right answer is to say no.  That’s the right answer for the DOJ in this case to the deal as currently proposed.

Andre Barlow
(202) 589-1838
abarlow@dbmlawgroup.com