Growth of craft beer, a story of scale economies

Beer. It is delicious and according to a wise American statesman, is ‘evidence the God wants us to happy.’ Beer has been with us for thousands of years. In fact, there is evidence of brewing in ancient Mespopotamia around 6000 BC.

History & the growth of the beer behemoths

Beer. It is delicious and according to a wise American statesman, is ‘evidence that God wants us to happy.’   This tasty elixir has been delighting mankind for thousands of years. In fact, there is evidence of brewing in ancient Mesopotamia around 6000 BC.

So how did we get to where we are today?  Let’s go back to the US in the early 1900’s when there were thousands of local brewers.   In 1910, there were 1,568 independent brewers.   However, as expected, prohibition wiped out the vast majority of breweries and by the time prohibition had come and gone, the number of breweries plummeted to 331 by 1934.

To understand how we got to thousands of brewers over the ensuing decades, we can start by examining beer through the lens of ‘economies of scale.’  Economies of scale refers to the phenomenon in which companies earn a competitive advantage, usually cost related but not always, by selling more volume.

In general, there are economies of scale in beer production.  After the Industrial Revolution, brewing processes became more efficient and able to take advantage of larger batch sizes, which allowed larger brewers to experience advantages over smaller ones.  If you have a 5-barrel system, it will require a lot more labor per barrel produced than if you had a 30-barrel system. Further, if you are purchasing raw materials for multiple large breweries across the country or even the world, you will have better negotiating power against your suppliers and get favorable pricing terms.

Another scale advantage opened up when advances in refrigeration allowed brewers to transport their beer over long distances.   Prior to this technology, you couldn’t keep expanding your brewhouse because you would saturate your local market.  However, once you could more easily transport beer over long distances, you could begin to take advantage of a large facility and then sell it to many different cities.

An advantage that paved the way for global beer behemoths was scale in  mass marketing.  Mass marketing avenues such as national television commercials offered an unprecedented ability for companies to reach millions of consumers with a single advertisement.

Let’s say the cost of a commercial is $1M.   If you sell 1M BBLs of beer in a year, your cost per BBL is $1. However, if you sell only 10K BBLs of beer, your cost per BBL for this same commercial is $100! This economic reality provides a huge competitive advantage for any brewer able to expand the scope both nationally and internationally.

It’s no surprise that during the 1970s and 80s, the industry saw a wave a major players dominating and consolidating the market. Anheuser-Busch, Miller Brewing Company, Coors Brewing Company and Pabst had almost 75% of the US market in the 1980s.

In 1980, there were only 92 breweries in the US.

However, by 2014, that number exploded to 4269.

What happened?                                                                                                                          

David vs Goliath

So two critical drivers of consolidation were economies of scale from production and marketing.  As expected, the multi-national breweries began competing heavily along these two dimensions. They sucked out all the cost, and arguably all of the flavor, from the brewing process, creating bland, uniform beers. Saving a couple cents per barrel of beer amounted to millions of dollars in increased profits.

Further, they threw millions of dollars into the marketing game. Superbowl commercials from Budweiser became a fixture in pop culture with famous campaigns such as the bud bowl, the frogs, the penguin and Wasssaaaaa! What do penguins and frogs have to do with expressing the quality of the beer? Nothing. They invested in positive recognition and the ethos of the industry moved further and further away from the notion of high quality beer.

As mass produced beer began tasting more uniform and mass produced, many consumers demanded more. In the UK, a voluntary consumer organization called the “Campaign for Real Ale” or CAMRA began promoting high quality craft beer.

In the US, the regulatory tracks for the craft brew train began in the 1979 with the Cranston Act, which legalized home-brewing.  The government also decreased the excise taxes for brewers selling less than two million barrels per year.

Combining a groundswell of consumer preferences with the regulatory structure to encourage new brewers to get in the game, created a significant shift in beer consumption patterns.

While not able to take advantage of the same economies of scale or distribution reach, craft brewers where able to fill a significant gap left by the multi-nationals. This shift in consumer preferences not only appreciated more flavorful beers but also an interest in supporting local businesses.

Another major shift in economic structure is the Internet and the decline of monolithic channels such as television and radio. This allowed many craft brewers to achieve regional and national reach. Further, new brewers could access a wealth of information through the internet as well as connect with other brewers who cultivated an open community the helped each other.

This change changed the benefits of economies of scale as nimble breweries were able to build strong customer traction by promoting high quality beers from local businesses.  Even regulators managed to hop on board since craft breweries provide significantly more jobs per barrel brewed than the macro brewers.

According to a study by the Brewer’s Association, there are over 4,000 breweries in the United States in 2015 representing an increase in almost 20% from the prior year.

It’s a great time to be a beer drinker. 

What’s next?

While craft beer continues its rapid growth, one area looks ripe for improvement. In 2014, the Brewers Associated estimated that there are 34.6M BBLS of production capacity in the market. However, brewers are only producing 22.2M BBls. That means that more that 35% of all brewing capacity is paid for and not used. While this may be growing pains, it also  means that the industry as a whole could be more efficient.

We are optimistic about the continued growth in the industry but want to help brewers increase the use of their capacity already in the market.

Let’s hope that the market continues its current trajectory. Since 2012, the dollar value of craft beer has grown from 11.9% of the total market value to nearly 20%. Only a decade ago, this would have sounded crazy.

As new technologies come online and the discerning millennial becomes a larger part of the beer market, we expect to see continued growth in both demand and innovation.


Leave a Reply

Your email address will not be published. Required fields are marked *