I used that interview, alongside one with the Brewers Association Chairman, Rod Tod, to write a piece on whether craft beer growth matters which I hurriedly published on the eve of the CBC. But I left a lot on the cutting room floor from a fascinating conversation with Bart Watson.
So what follows is a full (but lightly edited, for readability) transcript of the conversation. It contains a huge amount of wisdom, straight from the eminently expert mouth of a man who spends more time looking at and analysing the American craft beer industry than anyone else. We discuss oversupply, the movement of capital in craft beer, slowing growth, the nature of brewery closures and sharpening the business practices of small and independent breweries.
This isn’t the sexiest article ever written about the beer industry. But if you’re interested in the economics that drive small breweries in America I hope it offers usable insight.
What is the state of the supply and demand equilibrium in the craft beer sector?
Supply in terms of number of brands is increasing dramatically, but it doesn’t necessarily mean there’s more beer out there.
I haven’t looked at the capacity numbers yet. Last year we were lower than 0.65; but that’s not that unusual for a large manufacturing industry.
This is a maturation, moving to a more competitive market. But a bubble’s not bursting, demand isn’t going away. In some cases we may see people have overbuilt, and some of those breweries will get punished and either go out of business or have to restructure.
We’re seeing that with Speakeasy, which built at just the wrong time and took on a ton of debt that wasn’t supportable in a slower growth market. And we’ll see that with some other breweries I’m sure, but that’s not the end of the world.
What we saw in the late ‘90s was a lot of people coming in, quality standards weren’t that high, and for a lot of consumers that was their first experience and aggregate demand went back down. Which is when things got bad. What we’re seeing right now is that demand is slowing, perhaps not matching some of the enthusiasm on the supply side, but demand’s not going away.
Is the current slowdown reminiscent of the one in the late 1990s?
The base is much larger now, and much more diverse. And I think the consumer base is large enough to have a better understanding of what quality craft beer tastes like. If they try a new brewery here in Maine and they don’t like it, they’ve probably had Allagash before. And they know they can go back to Allagash. They don’t have to give up drinking craft beer.
I see no scenario in the near future where we have fewer breweries than we have right now. Some breweries may close, but we’re still seeing new entrants at such a rate that I don’t think the absolute number will go down. And in fact I think it will continue to rise – there’s an eight to one ratio of openings versus closings right now.
You need to ignore the national picture a little. It doesn’t mean that much if Colorado’s at +0% and Alabama’s at +20%. Understanding where the closures are helps you see the real dynamics. Most of the closures are in mature markets, like Portland or Colorado. Take Boulder County, where we have 40 breweries for 300,000 residents. Most of those breweries will succeed, but not all of them will. It’s a competitive market.
How important is growth?
It depends on who you are. For some businesses, growth is very important. But for a lot of businesses, it’s far less important. For the overall industry, I think growth still matters, but for an increasing number it doesn’t matter as much. That does make something of a disconnect.
My job is not to be a cheerleader. My job is to give the cold, hard numbers; to tell it like it is. Sometimes it’s good to give a dose of cold reality, so that our membership is making business decisions based on reality.
People may read about Speakeasy and take it as a bad sign, but it’s also just not relevant to the vast majority of breweries in the country. If you’re a 1,000 barrel brewery that’s selling 60% of it direct, Speakeasy’s struggles in building a huge production facility and distribution in a market where the high end has a 70% share and real estate is the most expensive anywhere in the country, it doesn’t really matter.
I think we can help in telling a differentiated story. But some investors who have money in mid-sized breweries that have invested a ton of capital into scaling up and expanding distribution should have worries. They should talk to their management and ask them how they’re going to weather this, what their strategy is. And ultimately good businesses will find a way to survive.
The national growth rate is hugely dependent on what happens with Yuengling and Boston Beer. The growth rate for breweries under, say, 2,000 barrels is still very strong. Yes, some of that growth is coming from big craft breweries, but the fact that craft beer is growing as a whole shows a lot of it is coming from elsewhere.
Are you worried by the number of brewery closures?
I probably look at more closings than any other person in the country. I look at every single brewery closure reported, and I spend at least a couple of minutes to figure out why it happened. The vast majority of them, it’s not about the beer market – it’s about a poorly run business, or it’s about someone deciding to do something else. You know, a business that is undercapitalized, or a business in a property that got rezoned. There was one case in New Mexico recently where the landlord decided he didn’t like the brewery, and he didn’t renew their lease.
There were 100 closures last year and I’d say at least 50 of them had nothing to do with market forces. The total number of closings will go up – it has to, as the base expands – but if it stays constant it’s still not high in my opinion.
Look at wine for an example. There are 9,000 or 10,000 active winery licenses now and the wine market is half the size of beer and there’s no real growth. Changes in the number of wineries appears only loosely correlated to changes in growth in the wine market over time.
I wrote something a couple of years ago which I think is still pretty relevant, saying closings are not a terrible thing. At the time I thought there would be a lot more than there have been. I expected a three or four year time lag between openings and businesses deciding whether or not they could make it. But it hasn’t happened – the rate of closing to opening is incredibly low, because demand has been unusually high. But I think we’ll go back to a more normal ratio soon.
I think capital in the industry is getting smarter. It’s figuring out where there is growth, and which business models have potential. It’s less now about buying tanks just to have more tanks. Smarter investors is what will stop us being in a bubble situation. A bubble happens when growth slows but people keep pumping money in; but what we’re seeing is more careful lending. To an extent I like to hear that people are pulling back, because that’s a sign of a healthy market.
I think we’re lucky to have a lot of passion in this industry, which means people work harder and push for their dreams a little more. So long as that passion doesn’t cloud good business judgement I think we’ll be all right.
Do you wish the headline number every year wasn’t percentage volume growth?
At the end of the day, can you pay off your debts, can you pay your workers? Volume sales aren’t necessarily how you do that. Sometimes selling volume is more about pride than about business growth. And we’re seeing business models shift to accommodate slower volume growth; people are more focused on margin now than just building a retail distribution base.
Value growth is harder to track. We had 2,500 breweries send us their volume numbers this year; you’re not going to get that many people to tell you their value sales or profit growth.
I hope that I make people at least a little bit nervous. Nervousness make you think about your business model, and about what makes you a good competitor.
There’s a great chapter in Jim Koch’s book [Quench Your Own Thirst] that every craft brewer should read. Jim talks about enduring the last slowdown in the craft beer industry. When Boston Beer was seeing lower topline growth they took the opportunity to look for efficiency and how they could cut costs. When you run a business there’s a million things you can do to improve profits in a static market.
Seeing a 6% growth number is only a warning sign for less than half the craft breweries in the country.
20% by 2020?
It’s a long shot. It came up in the call last week. Certainly a number of fast growing businesses being pulled out of our number by acquisitions has an effect; but even if they had stayed in, the growth rates would make it a challenge.
That said it was always an aspirational goal. It helped us think about the market, and how realistic it would be to grow raw materials supply sufficiently to provide for that kind of growth rate. It gave the market a framework to change its approach to craft beer.
I would be surprised if we do see 20% market share by 2020, but I absolutely think share gains will keep moving in that direction. At the end of the day, so long as we have happy, healthy businesses in craft beer in 2020 everybody will be fine.