Vertical Integration

What is the value chain for beer?  Beer is essentially four main ingredients combined to produce a delicious product; grain, hops, yeast and water. What does this mean for a craft brewer like New Belgium?  They must source hops, grain and yeast from alternative sources.  Generally the water comes from wherever the brewery is located.  This too is important and water quality greatly affects a brewery’s decision where to build.  As for the other ingredients, yeast usually comes from one of the handful of commercial yeast labs, but many run in house strains selected in their own labs. Some breweries are even secretive and highly protective of their in-house strains as a portion of production that is impossible to replicate. The source for hops and grain are farms in the Northwest and Midwest respectively.  Once the beer is produced from these ingredients, it must be distributed to retailers through distributors.  Craft brewers reside firmly in the middle of this value chain with almost none participating in farming activities for hops or grains, nor owning the distributors who bring the finished product to retailers. New Belgium falls into this category as well, essentially eschewing vertical integration to maintain focus on the production of beer itself.  The large conglomerate of AbInBev is different in that they own over 500 distributors and their recent merger with SABMiller highlighted the concern in the craft brewing world that I wrote about here.  AbInBev’s vertical integration strategy continues to cause much angst among craft brewers as they must rely on those same distributors that big beer owns.

Tacit Collusion

A brewer the size of the New Belgium is less likely to engage in tacit collusion by the nature of their business.  Additionally, craft brewers are fiercely independent as most began as one or two individuals following a dream.  New Belgium is no different. That is not to say that tacit collusion does not affect New Belgium and other craft brewers. As the Washington Post pointed out in their 2015 article, “The price increases that we estimate exceed the predictions of a standard economic model, accounting for changes in demand and cost conditions. This is consistent with tacit collusion between ABI and MillerCoors that emerges after the consummation of the MillerCoors joint venture,” Miller and Weinberg wrote in response to questions.” The two biggest brewers in the country are merging and there appears to be tacit collusion between their products.  While New Belgium is independent and has made every attempt to stay that way with their 100% employee-owned move, their beer is sold through similar distribution channels as ABI and SABMiller products.  Collusion between the big boys will definitely have effects on smaller players like New Belgium. As I pointed out last week, the rosy market for craft beers is finally feeling the squeeze, with Stone laying off employees.

Flexibility: Real Options

I have written in the past about the growth in the craft beer market and how strong it is. This would appear to indicate a low level of market uncertainty.  While there are many new combinations that result in great new beers coming to market, there is little substantive change to the brewing process itself, indicating relatively low technical uncertainty as well. In looking at the McGrath and MacMillan model, this would seem to indicate breweries should stick to enhancement launches, or in other words, incremental changes to current offerings. New Belgium has certainly done this over the years by expanding their different beers and slowly expanding from their home base in Colorado to distribute further and further away. Recently they made a big leap more like a stepping stone option that would give them many new options for expansion going forward, by building a second brewery in Ashville, NC. While the technical and market level of uncertainty would seem to indicate this might not be a great move according to the McGrath and MacMillan model, New Belgium is not the first growing craft brewery to make this leap. Another west coast brewery, Stone Brewing, opened two new breweries in 2014 and 2015, one in Richmond, VA and one in Berlin, Germany. Like New Belgium, Stone is a fast growing independent brewer who is known for very unique beers. This week we learned that Stone experienced a setback and will be laying off approximately 5% of their workforce. Maybe this is unique to Stone’s situation and only time will tell whether New Belgium will experience similar issues after their new east coast location comes online.

Mega mergers

Came across this article that I need to share.  The merger on the table between ABInBev and SABMiller is near to closing as the Justice Department appears to be signing off on it.  Regardless of how you feel about this, it is important to remember the issues that Yuengling brought up last week. You can read their position in the post here.

Product Differentiation

It is easy in the craft brewing world for brewers to achieve product differentiation and New Belgium is no different.  New Belgium offers 15 year round beers and many seasonal brews as well.  In these many seasonal brews, there is an enormous amount of differentiation just among their own beers with styles ranging from the beer that started the company, Fat Tire Amber, to several different IPA’s, to the Belgian style Trippel.  Even among the four IPA offerings, there is great differentiation in both hop flavor and alcohol content.  This allows consumers to pick different flavors as well as a beer more suited for a different time, like the session IPA, Slow Ride. Session beers are the latest craze in the craft beer world as they are big on flavor but with low alcohol, allowing for more drinking. Because craft beer is so diverse it is easy to differentiate on taste and style and New Belgium has mastered many styles in this pursuit.

 

Cost Leadership

Craft breweries rarely choose a business strategy based on cost leadership and New Belgium is no different, but there are certain aspects of the brewing industry related to cost leadership issues that all must be aware of to survive.  The chief issue is economies of scale, but this usually relates to small startup breweries attempting to compete.  There is generally a minimum production size necessary to turn a profit when starting a brewery mainly due to the amount of capital required to purchase the equipment needed to produce beer.  The factor that affects a brewery the size of New Belgium is diseconomies of scale.  Of the four major sources of diseconomies of scale, the distances to markets is the driver that New Belgium has most recently tackled.  Beer is a perishable product and craft beer, especially highly hopped beers, are more perishable than the American light lager sold by the big breweries.  The original brewery for New Belgium is in Fort Collins, Colorado.  While positioned well to serve the west, New Belgium decided to open its east coast location in Ashville, NC.  This new brewery adds 500,000 barrels to its annual capacity and positions their beers closer to east coast markets.  This results in a reduction in transportation costs as well as opening up new markets. The challenge to opening the new brewery will be to maintain the unique corporate culture that makes New Belgium so special, in a completely new part of the country.