Chapter 5 Market Structure: The Rise of the Craft Brewery 5.1 History: Market Size From 1980 to 1990, the number of breweries in the United States nearly tripled, rising from 101 to 286. However, production rose much more slowly - from 188.4 million barrels1 to 201.7 million barrels. Per capita2 consumption even fell slightly, from 23.1 gallons to 22.6.3 While the "Big 3" brewers (Anheuser-Busch, Miller, and Coors) produced millions of barrels per year, an increasing number of new breweries produced only small amounts. In 2000, Anheuser-Busch produced 99.2 million barrels, Miller produced 39.8, and Coors produced 22.7. Meanwhile, many of the new breweries, nicknamed microbreweries, produced between 5,000 and 100,000 barrels; in 2000, these comprised around 5-7% of the market. 5.2 History: Market Concentration The concentration level in a market is measured using a statistic called the Herfindahl-Hirschman Index (HHI). HHI is calculated by squaring the market shares of all producers and totaling the squared market shares. For simplicity, HHI is often calculated using only the top 5 producers. An HHI of below 1500 is considered "unconcentrated" by the US Department of Justice for purposes of evaluating mergers; between 1500 and 2500 is considered "moderately concentrated" while above 2500 is considered "highly concentrated."4 1A barrel is 31 gallons. 2"Per capita" means "per person." 3Stack, Martin H. A concise history of America's brewing industry. Retrieved from https://eh.net/encyclopedia/a-concisehistory-of-americas-brewing-industry/ 4DOJ-FTC 2010 Horizontal Merger Guidelines, available at doj.gov. 1 From 1947 to 1998, the HHI consistently increased, while the share of production by the 5 largest producers tended to increase with periodic drops. Figure 1 traces the time series of production share by the 5 largest producers, with points colored darker for a smaller HHI and lighter for a larger HHI. HHI rose from 140 in 1940 to 2789 in 1998. Curiously, even as the number of breweries nearly tripled, the HHI rose from 1545 in 1981 to 2555 in 1990. Even as the number of breweries increased, the largest breweries continued consolidating their market share. Ordinarily, increasing the number of competitors would be expected to decrease concentration, so why did the brewing industry behave differently?5 5.3 Competition Some authors6 speculate that the reason breweries became more concentrated despite the increase in the number of competitors had to do with competition based on advertising. During the 1980s, advertising spiked upward, led by Coors and followed by the other major breweries. Advertising serves two main purposes: to attract customers away from competitors and to attract new customers into the market. "Brewers both large and small," said Newsweek, "are racing to locate new consumers and invent new products to suit their taste."7 By the end of the decade, brewers had expanded their brands - Anheuser-Busch from 5 in 1980 to 10 in 1990, Coors from 2 to 10, Miller from 3 to 9 and Pabst from 10 to 17 - but primarily did so by producing lighter or drier versions of their core brands.8 This led to a greater fragmentation of the customer base: beer was, during that period, "essentially ... a no-growth business."9 This was the beginning of a market that competed based on increasing personalization of the product. 5This paradox is discussed in Gokhale, J., & Tremblay, V. J. (2012). Competition and Price Wars in the U.S. Brewing Industry. Journal of Wine Economics, 7(2). Retrieved from http://commons.erau.edu/db-accounting/3. 6See, e.g., Tremblay and Tremblay, 2005). The U.S. Brewing Industry: Data and Economic Analysis. Cambridge: MIT Press.; Bulow, J. and Klemperer, P. (1999). The generalized war of attrition. American Economic Review, 89, 439468. 7Newsweek. The battle of the beers, September 4, 1978, 6070. 8Fisher, Lawrence M. (July 21, 1991). All About/Beer; Behind All the Bonhomie, the Brewing Industry Gets Tough. New York Times. Retrieved from https://www.nytimes.com/1991/07/21/business/all-about-beer-behind-all-the-bonhomie-thebrewing-industry-gets-tough.html 9Lazarus, George (July 5, 1990). Light beers still gulp market share. Chicago Tribune. Retrieved from https://www.chicagotribune.com/news/ct-xpm-1990-07-05-9002240061-story.html 2 These products are called differentiated. When goods are identical, there are essentially two methods by which producers can compete. Traditionally, economists model competition by price (in which producers attract customers by selling similar goods at lower prices). However, in a market with high concentration, producers can compete based on quantity as well as price (in which a large producer can swamp the market with large amounts of the product, while fringe producers try to compete based on offering lower prices). When customers have different preferences, however, and products are tailored to those preferences, they may have a reason to prefer one producer over another. This is the type of competition that the beer industry seemed to be in during the late 1980s. 5.4 Into a Modern Beer Market During the late 2000s, craft brewers positioned themselves as artisans: "... on April 22, 2009, at the Brewers Associations annual conference when toasts are raised by a room full of brewing entrepreneurs, who have just viewed the debut of the provocative 'I am a Craft Brewer' video to great acclaim. ... After all, the 'I Am A Craft Brewer; video featured dozens of small U.S. brewery owners extolling their independence while simultaneously calling out large beer company executives as 'snake oil salesmen,' and criticizing those companies for brewing 'lowest common denominator' products with ingredients such as rice and corn."10 This is a powerful form of product differentiation, designed to attract consumers who are concerned about quality and variety. In 2009, there were around 1600 craft brewers producing about 9,000,000 barrels. In the nine years since, both numbers have grown: in 2018 there were over 6300 craft breweries producing about 25,000,000 barrels. Thus, even though the number of breweries has nearly quadrupled, the amount of production has not quite tripled. In addition, some of the alleged competition is an illusion. A large portion of this stems from the fact that many of the craft brewers shown in the "I Am A Craft Brewer" video have sold their breweries to major producers. "When you look at the beer aisle and your local taprooms beer list, it looks like a broad array of choices. As we're going to illustrate here, however, the following companies are actually narrowing those choices through acquisitions and diversification. The battle for shelf and tap space is real, and these are the companies fighting hardest for it," said MarketWatch's Jason Notte in 2015.11 One of the largest brands was Constellation, which sold imported brands including Corona and Tsingtao. Two major mergers have concentrated brands: Anheuser-Busch was purchased by European brewer InBev (now known as ABInBev) and Miller and Coors are now a combined venture known as SABMiller. In 2017, the market looked like this:12 Brewer Share ABInbev 41.6% SABMiller 24.3% Constellation 8.9% Heineken USA 3.8% Pabst 2.3% All others combined 19% In addition, from 1999 to 2016, the number of different types of beers (measured by the number of stockkeeping units produced) ballooned from 185 to 1025. This indicates increasing numbers of products, which may also be increasingly specialized to consumers. 5.5 Conclusion The beer industry has grown in the number of producers and the number of distinct products offered for sale. However, this does not seem to have tracked with increased competition. The major producers have 10Furnari, Chris (April 12, 2018). Time Traveling: How Craft Beer Has Evolved Since 1990. Retrieved from https://www.brewbound.com/news/time-traveling-craft-beer-evolved-since-1990 11https://www.marketwatch.com/story/these-11-brewers-make-over-90-of-all-us-beer-2015-07-27 12https://www.nbwa.org/resources/industry-fast-facts 3 grown, largely through acquisitions of smaller craft brewers. There appears to be significant preference by customers for beer that is marketed as craft-style, but the major producers continue to dominate the market. Questions 1. (2 points) Using the information given in the table for 2017, calculate the HHI for this market. (Use only the five largest producers.) Would this market be considered concentrated by the Department of Justice? 2. (1 point) Using the information in your textbook, which of the four market structures (perfect competition, oligopoly, monopolistic competition, or monopoly) does the beer industry most closely resemble? Provide evidence for your claim. 3. (2 points) The beer industry has seen a gradual increase from three major sellers (in 1990) to several hundred. Meanwhile, the number of cigarette manufacturers has stayed relatively constant. Although both goods are considered vices and thus unpopular, the industries have moved in different directions. What economic theory can you suggest to explain this difference? ("Cigarettes have a negative reputation" is not a sufficient answer, as drinking is also considered a vice.