The Dynamics of Industry Concentration for U.S. Micro and Macro Brewers

Review of Industrial Organization (2005) 26:307–324 © Springer 2005 DOI 10.1007/s11151-004-8114-9

VICTOR J. TREMBLAY, NATSUKO IWASAKI and CAROL HORTON TREMBLAY Department of Economics, Oregon State University, 303 Ballard Extension Hall, Oregon 97331-3612, USA

Abstract. In this update we document the changes in industry concentration of macro and micro brewers in the U.S. brewing industry since 1970. Technological change and the continued success of Anheuser–Busch forced the macro brewers into a war-of-attrition game and contributed to rising concentration in the macro sector of the industry. Homogeni- zation of the beer produced by macro brewers, changes in local demand conditions, and a more favorable regulatory environment created proﬁtable niches in many local markets for micro brewery beer, and entry into this sector occurred at a phenomenal rate from 1977 to 1998. Consistent with several models of industry dynamics, over-exuberance led to a shakeout as the number of micro breweries fell by over 16% from 1998 to 2002.

Key words: brewing industry, concentration, micro breweries.

JEL Classiﬁcations: L11 and L66.

I. Introduction The most prominent feature of the U.S. brewing industry is the continual change in industry concentration. The macro or mass-producing sector of the industry consists of large-scale brewers of traditional American lager beer. Since Prohibition (1920–1933), the number of independent macro brewers declined dramatically, from 766 in 1935 to about 20 ﬁrms today. Among these, Anheuser–Busch, Miller (SAB-Miller), and Coors survived and now dominate this sector of the industry. While the macro brewers exited in droves, a handful of entrepreneurs began brewing craft-style beer on a micro scale. This began when Fritz Maytag purchased the failing Anchor Brewing Company of San Francisco in 1965. Maytag turned the company around by reverting to the traditional

Author for correspondence: E-mail: [email protected] 308 VICTOR J. TREMBLAY ET AL. brewing practices of Europe and making all-malt beers and ales. Beginning in 1977, other micro breweries opened for business, primarily in North- ern California and the Pacific Northwest. By 1980 there were eight micro breweries and an astonishing 1492 by 2003. Like the boutique wineries of Northern California, the micro brewers produce quality beers in small batches and in a variety of styles. In contrast to traditional American lager, micro brewery beer is darker and heartier in flavor, consisting primarily of all-malt beers, ales, porters, and stouts.1 As the most successful micro breweries grew beyond the micro size class, all brewers with micro brewery origins have come to be called specialty or craft brewers.2 In 2003, specialty brewers commanded a 3.3% share of domestic beer production and a 2.9% share of total U.S. consumption (domestic plus imported beer). The purpose of this industry update is to document the important changes in domestic concentration for the macro and micro sectors of the industry and discuss the main reasons for change. The macro and micro sectors are analyzed separately because their product characteristics and scope of operation differ. For example, Coors Light is much milder in flavor, lower in calories, and lower in alcohol content than the all-malt beers, stouts, and porters of the specialty brewers. In addition, the macro market is national, while the micro market is local or regional.3 Annual data on the output of the leading 100 brewers in the U.S. were graciously provided by Robert Weinberg of The Office of R.S. Weinberg, St. Louis.

II. Changes in Industry Concentration Concentration is described by the number and size distribution of ﬁrms in an industry. These elements are captured in a “concentration curve,” which plots the cumulative shares of sales on the vertical axis that are attributable to the largest 1, 2, 3,...,n ﬁrms in the industry (plotted on the horizontal

1 Most specialty beers are brewed in the spirit of Germany’s Reinheitsgebot law, which requires that beer be made from four ingredients: water, malted barley, hops, and yeast. According to Goldammer (1999), traditional American lager is made by substituting 25– 60% of malted barley with cheaper adjuncts (usually corn or rice). This produces a lighter and milder beer. Ales, porters, and stouts are top fermented, and lagers are bottom fermented. Bottom fermentation also produces a lighter product. 2 Technically, specialty brewers include true micro breweries [craft brewers that sell less than 15,000 (31 gallon) barrels per year], brewpubs (restaurants that brew and sell less than 15,000 barrels per year of craft-style beer and sell most of their beer on site), and larger craft brewers (micro breweries that have outgrown the 15,000 barrel limit). The 15,000 barrel limit is established by the Association of Brewers (www.beertown.org). 3 For similar reasons, imports are considered a separate, although increasingly important, group. In 2003, imports accounted for about 11.6% of U.S. beer consumption. To obtain beer industry data and to read more about the import sector, firm strategy, and economic performance in the U.S. brewing industry, see Tremblay and Tremblay (2005). CONCENTRATION IN U.S. BREWING 309 axis). When firms are of equal size, the concentration curve is a straight line from the origin, where the slope of the line is 1/n. A market with fewer firms will have a steeper concentration curve. If firms are of unequal size, the concentration curve will be a concave function that becomes more concave as n decreases or as the variance in firm size increases, ceteris paribus. A steeper and more concave curve implies greater industry concentration. Common indices of industry concentration are the k-firm concentration ratio (CRk) and the Herfindahl–Hirschman index (HHI). CRk is defined as the market share of the k largest firms in the industry and can be observed directly from values of the concentration curve at k on the horizontal axis. When market share is measured in percent, CRk is bounded from 0 to 100 for a particular value of k. CRk approaches 0 as the number of firms increases and the largest firms command a smaller share of the market; CRk equals 100% when there are k or fewer firms in the market. HHI is defined as the sum of the squared market shares of all the firms in the industry. HHI approaches 0 as the market becomes more competitive and equals 10,000 in a monopoly market. Unlike the CRk, HHI contains market share information from all of the firms in the industry, not just the k largest firms. While the CRk weights the market shares of the k largest firms equally and applies zero weight to all other firms, HHI employs variable weights, with smaller firms weighted less heavily than larger firms. When market share is measured in decimal form, HHI has the added desir- able feature that it equals 1/n + var(msi), where var(msi) is the variance in firm market shares. When firms are of equal size, HHI = 1/n, which is called the numbers equivalent of HHI. Like the concentration curve, HHI decreases in the number of competitors (holding the variance constant) and increases with the variance in firm market shares (holding n constant).4 Hereafter, we measure market share in percent and divide HHI by 100; in this case, both CRk and HHI are bounded from 0 to 100. In the remainder of this section, we describe the level of industry concentration at the national level for the macro and micro brewers.5 This is appropriate for defining the market in the macro sector of the industry, which is national in scope, but not for the micro sector where markets are

4 One drawback of HHI and all indices of industry concentration is that they ignore higher order moments of the distribution (e.g., skewness). If a change in skewness favors the largest firms, for example, their market share would grow and produce a higher concentration curve. We ignore this issue in subsequent discussion, since, unlike the mean and variance, skewness fluctuates but reveals no long-term trend in brewing between 1970 and 2003. 5 A handful of brewers blur the macro-micro distinction (e.g., the Yuengling, Latrobe, and High Falls brewing companies). These hybrids are regional brewers of traditional American lager that have recently added brands of craft-style beer. 310 VICTOR J. TREMBLAY ET AL. local or regional. Nevertheless, information on the number of firms and the variance in firm size in the micro sector is still valuable if one is inter- ested in analyzing the relative size of these local brewers. We focus on the 1970–2003 period, since the macro market was national in scope by 1970 and the micro sector did not have more than 1 firm until 1977.6

1. THE MACRO SECTOR Figure 1 plots the number of firms in the macro sector during the post- Prohibition era. It demonstrates that the decline in the number of independent macro brewers is not a new phenomenon. Firms exited the industry at a remarkable rate through 1975, and the number has now stabilized at about 20 firms. In 2003, HHI was over 41 and the largest four firms, An- heuser–Busch, Miller, Coors, and Pabst, accounted for over 98% of sales in the macro sector of the market. This figure understates concentration if measured by production, however, since all of the Pabst brands are brewed under contract by Miller. Brewers such as Pabst are called “contract” or “virtual” brewers, since they are entirely marketing entities that do not produce their own beer. A comparison of concentration curves confirms the dramatic rise in concentration from 1970 to 2003. This information is summarized in Figure 2 for 1970, 1980, 1990, and 2003 for the largest 40 firms.7 The rise in concentration results from the decline in the number of brewers and an increase in the variance in firm market share. The steady increase in the variance can be seen in Figure 3 for the 1970–2003 period. This reflects growing inequality of share between large and small macro brewers. Tra- ditional indices of industry concentration, reported in Figure 4, also reveal this increase in concentration. For example, CR4 has increased from about 44% in 1970 to 98% in 2003. Special circumstances explain deviations from trend in CR4 and HHI for the 1970–2003 period. The decline in 1976 corresponds to a 95-day strike at Anheuser–Busch, which caused the industry leader to lose market share. Merger activity caused the jump in concentration in 1982 when Stroh purchased the Schlitz Brewing Company. In 1981, Stroh was the seventh largest brewer, and Schlitz was the third largest, albeit failing, brewer. In the same

6 In the macro sector, Horowitz and Horowitz (1969) argue that the stronger regional brewers were potential competitors in every region of the country by the late 1960s, and Greer (1981) defines the beer market as national by the 1970s. For a discussion of concentration in brewing before 1970, see Elzinga (1971), Greer (1981), and Tremblay and Tremblay (2005). 7 For illustrative purposes, we ignore smaller firms in 1970. There were 82 macro brewers in 1970, but firms 41 to 82 accounted for only 1.1% of macro beer production. In 1980 there were 40 firms, and there were less than 40 thereafter. CONCENTRATION IN U.S. BREWING 311

Figure 1. Number of U.S. macro brewers: 1934–2003.

Figure 2. Concentration curves for macro brewers: 1970, 1980, 1990, 2003. year, the fourth largest brewer, Heileman, purchased a portion of Pabst. These mergers substantially boosted the market shares of the new third (Stroh) and fourth (Heileman) largest brewers. The decline in the growth rate of concentration from 1991 to 1995 reﬂects the rapid decline in market share of Stroh, the fourth largest brewer at that time. In 1996, Stroh purchased the 312 VICTOR J. TREMBLAY ET AL.

Figure 3. Variance in market share of macro brewers: 1970–2003.

Figure 4. The four-firm concentration ratio (CR4) and the Herfindahl– Hirschman Index (HHI) for the macro sector: 1947–2003. now failing Heileman, the fifth largest brewer in the previous year, a merger that caused a substantial increase in concentration.8

8 Stroh’s decline resulted from its inability to turn around its failing Schlitz brands and from an unsuccessful attempt to market its ﬂagship brand at the national level. Heileman CONCENTRATION IN U.S. BREWING 313

Although it is difficult to classify the structure of an industry from concentration indices alone, it appears that the macro sector of the U.S. brewing industry was oligopolistic by about 1970. CR4 first surpassed 40% in 1968, a cutoff that Scherer and Ross (1990, p. 82) and Shepherd (1990, p. 14) use to distinguish competitive from imperfectly competitive markets. According to the Merger Guidelines established by the U.S. Department of Justice and the Federal Trade Commission (1992, 1997), the macro sector would be classified as “moderately concentrated” by 1972 and “highly concentrated” beginning in 1982.9 These descriptions are consistent with Elzinga (1971) who classified the industry as “concentrated” in the early 1970s and with Shepherd (1990, p. 441) and Greer (1998, p. 32) who char- acterized the industry as a “tight oligopoly” in the 1990s.

2. THE MICRO (SPECIALTY) SECTOR The micro or specialty sector began in 1965 when Fritz Maytag bought the Anchor Brewing Company and started brewing craft-style beer. Anchor was the sole micro brewer until 1977, and by 1985 when there were 37 micro breweries, Anchor accounted for over 45% of all specialty beer production. Figure 5 documents the emergence of this new sector of the industry and the fervent entry of specialty brewers.10 Their numbers increased steadily through 1985, grew at an increasing rate through 1995, and reached a peak in 1998 with 1,631 specialty brewers. Over-exuberance appears to have caused a shakeout, as the number of specialty brewers fell to 1,466 in 2001. Since then, the number of specialty brewers appears to have stabilized. Today, there is great diversity among the specialty brewers. A few experienced rapid growth by contracting with other brewers to produce all or most of their beer.11 The largest specialty brewer, the Boston Beer Com- pany, followed this route. Boston is the only national specialty brewer, with annual sales of over a million (31 gallon) barrels and a specialty-beer market share of about 20% in 2003. In contrast, the second largest specialty brewer, the Sierra Nevada Brewing Company, produces all of its own beer in a single plant in Chico, California. Sierra Nevada serves the west coast and has annual sales of over half a million barrels. In spite of these grew by purchasing failing regional brewers, a strategy that was no longer viable once most regional brewers exited the market. See Tremblay and Tremblay (2005) for further discussion of individual ﬁrm success and failure in brewing. 9 The Merger Guidelines deﬁne an industry to be moderately concentrated when re- scaled HHI ranges from 10 to 18 and to be highly concentrated when HHI exceeds 18. 10 These include true micro breweries, brewpubs, and larger specialty brewers. 11 Modern Brewery Age (March 17, 1997, 9) estimates that there were about 130 contract brewers in the U.S. in 1996. 314 VICTOR J. TREMBLAY ET AL.

Figure 5. Number of U.S. specialty brewers: 1980–2003.

Figure 6. Concentration curves for top 10 specialty brewers: 1980, 1990, 2003. exceptions, most specialty brewers produce their own beer on a small scale for local consumers. Figure 6 provides national concentration curves for the largest 10 ﬁrms in the micro sector. Although markets are local and not national, these curves provide information on the evolution of relative ﬁrm size in the specialty sector. In contrast to the macro sector, concentration curves in the CONCENTRATION IN U.S. BREWING 315

Figure 7. Variance in market share of micro brewers: 1980–2003. micro sector fell from 1980 to 2003 due to entry and a diminishing variance in ﬁrm size (see Figure 7). The number of specialty brewers serving a particular geographic market varies widely across the country. Consumers in most U.S. cities can purchase Boston’s Samuel Adams brands, and many can purchase Redhook’s brands. The Redhook Brewing Company of Seattle is partially owned by Anheuser–Busch, giving it access to Anheuser–Busch’s national distribution network. Portland, Oregon has 13 specialty brewers, while the larger city of El Paso, Texas has none (Modern Brewery Age Blue Book, 2003). In part, these dissimilarities reﬂect differences in consumer tastes. For example, the specialty share of the domestic beer market exceeded 22% in San Francisco but was less than 1.7% in the state of Texas in 2001 (Beer Industry Update: A Review of Recent Developments, 2002). Even though there may be only a few specialty brewers that compete directly in local markets, they are hardly tight oligopolies. In the mid-1990s, the macro brewers began marketing their own versions of craft beer, called “phantom” or “microclone” brands of specialty beer. Although these brands met with little success, the macro brewers remain potential entrants into the specialty sector. In addition, entry barriers are not pro- hibitive, since the capital, marketing, and sunk costs of starting a micro brewery are relatively low. The specialty brewers face perhaps their stiffest competition from import suppliers, as import and domestic craft beers have similar qualities. In general, the import brewer is in a better position to take advantage of economies of scale, while the domestic craft brewer brings a fresher product to market and is in a better position to cater to 316 VICTOR J. TREMBLAY ET AL. local and regional tastes. In any case, a handful of micro breweries in a local market does not necessarily imply a lack of competition in this sector of the economy.

III. Forces Affecting Industry Concentration A number of theoretical determinants of industry concentration have been discussed in the literature. First, demand and cost conditions have an important influence. An increase in scale economies relative to the size of the market causes the minimum efficient scale at the firm level (MES) to increase and the number of firms required to minimize industry production costs to fall. In the long run, only a few large firms can survive and concentration increases. Higher sunk costs also raise entry barriers and concentration. Sutton (1991, 1999) shows that the effect of market size on concentration depends on whether sunk costs are exogenous or endogenous. When exogenous, an increase in the size of the market will cause concentration to fall, ceteris paribus, since market growth has no effect on sunk costs and therefore MES. This relationship may not hold, however, for endogenous sunk costs like advertising and research and development. As with the exogenous case, an increase in the size of the market puts downward pressure on concentration. In the endogenous case, however, a larger market also induces greater expenditures on advertising and research and development, which raises sunk costs and puts upward pressure on MES and concentration. On balance, a larger market need not lower concentration when sunk costs are endogenous. Second, variable growth patterns among firms can shape industry concentration. Gibrat’s Law of Proportionate Effect provides a simple example.12 Consider a market with a fixed number of firms that start out with equal market shares. Firm growth is random and normally distributed with zero mean and a variance that is positive, constant, and independent of firm size. Under these conditions, Gibrat (1931) shows that the size distribution of firms approaches log-normal over time. The main conclusion of this and other stochastic growth models with similar features is that the variance in firm size will increase over time and cause concentration to rise. Such patterns of random firm growth can result from stochastic shocks to firm demand or cost conditions. For example, Jovanovic (1982) shows that random shocks to production costs can cause an increase in concentration. Similarly, Doraszelski and Markovich (2004) show that concentration can rise when advertising success is random, with some firms gaining a marketing advantage from a series of lucky advertising campaigns.

12 See Gibrat (1931) and Kalecki (1945). For an excellent review of this and other stochastic growth models, see Hay and Morris (1993, pp. 537–541). CONCENTRATION IN U.S. BREWING 317

Of course, variable growth patterns among firms within an industry may result from a competitive advantage rather than purely random shocks (Demsetz, 1973; Agarwal and Gort, 1996). For example, one firm may be more innovative, giving it a cost or marketing advantage over its competitors. If a firm-specific competitive advantage endures, then this could lead to a sustained increase in the firm’s market share and in industry concentration. Government policy can also influence industry concentration. Patent laws are an obvious example, as they reward firms with monopoly rights of 20 years for new inventions and 14 years for new designs (Carlton and Perloff, 2005, p. 527). Trade barriers, tax breaks to small businesses, and merger policy can also influence entry, firm size, and industry concentration.

1. THE MACRO SECTOR It appears that increases in scale economies and high sunk costs due to advertising are important causes of rising concentration in the macro sector of the brewing industry. After reviewing the evidence, Tremblay and Tremblay (2005) conclude that MES at the firm level rose dramatically from 1950 to 1990. New technologies that led to greater plant automation, increased speed of canning and bottling lines, and lower transportation costs gave large scale brewers a cost advantage. Improved water treatment techniques and size efficiencies in marketing, investment flexibility, and risk management generated multi-plant economies.13 To take advantage of all multi-plant economies, industry experts estimate that a brewer would need 3 to 4 strategically located plants in the 1970s and 5 to 6 in the 1990s (Scherer et al., 1975; Modern Brewery Age, March 16, 1992). Only the Fal- staff and Pabst brewing companies operated more than one plant in 1948. Today, Anheuser–Busch operates 11 plants, Miller operates 6, and Coors operates 3. Information in Table I allows us to compare the existing industry structure with the productively efficient structure. Efficient Market Share is defined as the market share needed to reach MES. The Efficient Number of Firms is defined as the productively efficient number of firms (i.e., the number of firms producing at MES that are needed to generate total industry output). For example, if total industry output is 120 and MES is 10, then the Efficient Number of firms is 12. According to the estimates in Table I, a firm would need to produce 0.1 million barrels in 1950, 8 million barrels

13 For a more complete discussion of the causes of rising scale economies in brewing, see Scherer et al. (1975), Keithahn (1978), Scherer (1996), Greer (1998), and Elzinga (2005). 318 VICTOR J. TREMBLAY ET AL.

Table I. MES, market share, and number of ﬁrms in the macro sector of the U.S. brewing industry

Year MES (Million barrels) Market share Number of ﬁrms

Efﬁcient Actual Efﬁcient Actual

1950 0.1 0.12% 0.29% 829 350 1970 8.0 6.40% 1.22% 15 82 1980 16.0 9.14% 2.38% 11 42 2001 23.0 13.06% 4.17% 8 24

MES is an estimate of minimum efficient scale at the firm level, and the 2001 estimate of MES is a lower bound. Efficient market share is the minimum market share needed to reach MES. Actual market share is the market share of the average firm in the industry. The efficient number of firms is the number of firms that would exist if all firms produced at MES. The actual number of firms is the number of brewers in the macro sector of the U.S. brewing industry. Source: Tremblay and Tremblay (2005). in 1970, and 16 million barrels in 1980 to reach MES. The raw data suggest that MES may have been over 23 million barrels by 2001. In that year, Coors produced 23 million barrels at a unit cost of $66.70, Miller produced 39 million barrels at a unit cost of $55.33, and Anheuser–Busch produced just under 100 million barrels at a unit cost of $57.26.14 Higher unit costs for Coors suggests that MES may have exceeded 23 million barrels in 2001. If these estimates are accurate, they suggest that a firm would need a market share of only 0.12% in 1950 but more than 13% in 2001 in order to reach MES. These figures also indicate that there have been too many firms in brewing, at least since 1970, and that only Anheuser–Busch and Miller are scale efficient today. Sutton (1991) and Tremblay and Tremblay (2005) provide evidence to support the hypothesis that advertising raised sunk costs and contributed to rising concentration in the macro sector of the brewing industry. This was at least partially due to national television advertising. The advent of television induced national brewers to increase their advertising spending per barrel, which raised sunk costs and put smaller regional brewers at a marketing disadvantage.15 The continued success of the industry leader, Anheuser–Busch, also affected industry concentration. Anheuser–Busch is the largest and most profitable brewer in the U.S. and the only macro brewer to experience continued growth in market share from 1970–2003. Trade journals and

14 These are unit cost-of-goods-sold figures (Beer Industry Update: A Review of Recent Developments, 2002), which exclude marketing and administrative expenses. 15 See Nelson (this issue) for further discussion of the link between marketing activity and concentration in brewing. CONCENTRATION IN U.S. BREWING 319 industry experts attribute the company’s success to its devotion to product quality, efficient multi-plant production, and its ability to avoid mistakes (Forbes, March 1, 1968, p. 30; Modern Brewery Age, March 27, 2000). Thus, Anheuser–Busch has enjoyed a competitive advantage, which led to its continued growth and contributed to the rise in industry concentration. Ironically, strict enforcement of the antitrust laws may have contributed to the high level of concentration in brewing today. The Department of Justice successfully challenged all merger attempts by the leading brewers during the 1950s and 1960s.16 The Department also successfully stopped mergers involving failing national and smaller regional brewers, including proposed mergers between Pabst and Carling (1978), Heileman and Pabst (1982), and Heileman and Schlitz (1982). It appears that a strict stan- dard was applied to brewing because concentration was rising and because MES was underestimated by economists and industry experts (Keithahn, 1978; Tremblay and Tremblay, 2005). In any case, permitting mergers such as these may have slowed the growth of Anheuser–Busch and produced a greater number of viable competitors today. Changes in technology, the success of Anheuser–Busch, and strict enforcement of the antitrust laws created a fiercely competitive environment, since these changes forced brewers into a war-of-attrition game (Bulow and Klemperer, 1999). This occurs when n firms compete in a market that will profitably support m < n firms. Recall that the actual number of macro brewers has exceeded the efficient number needed to reach MES from 1970–2001. Competition remained high, as an excessive number of firms were battling to profitably reach MES.17 Today, Anheuser–Busch and Miller are scale efficient but not Coors. Production at Coors is just shy of MES, and the company will need to build 2 or 3 additional plants in order to exploit all multi-plant efficiencies. It is likely that Pabst, which no longer produces its own beer, will continue to decline, and its remaining brands will eventually be absorbed by Miller, Coors, or a foreign brewer. Although inefficiently small, the remaining macro brewers survive by serving regional niche markets. These brewers produce their flagship brands that retain local brand loyalty and many have started brewing specialty style beers. A good example is the Genesee Brewing Company (now called High Falls), which brews its traditional Genesee brands, contract brews for

16 These include mergers between Anheuser–Busch and American (a small brewery in Miami) in 1958, Pabst and Blatz (1958), and Schlitz and Burgermeister (1961). For further discussion of antitrust issues involving mergers in brewing, see Elzinga and Swisher (this issue) and Tremblay and Tremblay (2005). 17 Scale inefficiency is even more apparent when we investigate the market share of the median firm, which is much smaller than the market share of the average firm. Data are unavailable for 1950, but the median firm had a market share of 0.18% in 1970, 0.10 percent in 1980, and 0.03% in 2001. 320 VICTOR J. TREMBLAY ET AL. other specialty brewers, and has started producing its own line of specialty beer under the Dundee label. Thus, these brewers blur the micro-macro boundary. Most recently, the major U.S. brewers have been involved in mergers at the international level. In 2002, South African Brewers of the United King- dom purchased Miller to form a new company called SAB-Miller (Mod- ern Brewery Age, Weekly News Edition, June 10, 2002). In the same year, Coors acquired Carling Breweries of the United Kingdom (Modern Brew- ery Age, Weekly News Edition, June 10, 2002). Anheuser–Busch and Miller currently are battling for a presence in China, the world’s largest beer market, as state owned breweries seek foreign help with privatization. In 2004, Anheuser–Busch outbid Miller for the Harbin Brewing Group of China (Modern Brewery Age, Weekly News Edition, June 14, 2004), and there is speculation that the company will buy China’s Henan Beer Group (Modern Brewery Age, Weekly News Edition, October 25, 2004). Miller is purchasing three breweries in Shanghai (Modern Brewery Age, Weekly News Edi- tion, September 17, 2004). Closer to home, a merger is underway between Coors and the Molson Brewing Company of Canada (Modern Brewery Age, Weekly News Edition, July 26, 2004 and October 11, 2004).18 Accord- ing to Coors, the merger will enable the company to gain “critical mass” and to reduce marketing and administrative expenses (Modern Brewery Age, September 13, 2004). Although it is too early to evaluate the success of these mergers, increased international merger activity is consistent with rising MES, domestic antitrust constraints, and a market that is becoming increasingly international in scope.

2. THE MICRO (SPECIALTY) SECTOR The specialty sector emerged for a number of reasons. Changes in demand conditions began to favor the specialty brewer. While most consumers pre- ferred traditional American lager, rising income led to a growing demand among some consumers for greater variety and for high status goods (Veblen, 1899; Silberberg, 1985). The exit of most regional mass-producers created local niche markets that were soon served by specialty brewers. These local specialty brewers offered high-priced, craft-brewed beer to appeal to more afﬂuent consumers who wanted something different from the nearly homogeneous American lager produced by the few remaining macro brewers.19 In many local markets, equilibrium prices were high

18 At the same time, Miller had considered a hostile takeover of Molson (Modern Brewery Age, Weekly News Edition, September 20, 2004). 19 Carroll and Swaminathan (2000) argue that specialty brewers also benefit from consumers who prefer to buy from small local producers rather than national or multina- tional corporations. CONCENTRATION IN U.S. BREWING 321 enough to cover the higher cost of craft beer production on a small scale.20 Changes in government policy also benefited micro brewers. First, the legalization of home brewing in February of 1976 stimulated entry, since most early micro brewers began as home brewers.21 Second, states began lifting prohibitions against brewpubs in the early 1980s. Brewpubs were legal in only six states in 1984; Mississippi was the last state to legalize brewpubs in 1999. Third, the government granted a tax break to smaller brewers in February 1977. According to the new law, brewers with annual sales of less than 2 million barrels paid a federal excise tax rate of $7.00 per barrel on the first 60,000 barrels sold and $9.00 per barrel on additional sales. Brewers with more than 2 million barrels in sales paid an excise tax rate of $9.00 on every barrel sold. In 1991, the tax rate rose to $18 per barrel, but brewers with annual sales of less than 2 million barrels continued to pay only $7.00 per barrel on the first 60,000 barrels sold annually. This benefited the specialty sector, as all micro breweries and brewpubs have annual sales of less than 60,000 barrels and all of the larger specialty brewers have annual sales of less than 2 million barrels. The short-run entry and exit patterns in the micro sector of the industry are also of interest, as they appear to be consistent with the “contagion,” “feed- back,” and “organizational ecology” theories of industry dynamics (Geroski and Mazzucato, 2001; Horvath et al., 2001; Van Kranenburg et al., 2002). To summarize, these theories claim that new markets begin with a small number of risk taking buyers and sellers. If and when a new market becomes successful, secondary entry occurs with a lag because information about firm success is difficult to observe. Once success becomes apparent, however, entry takes off. These same information lags then lead to excessive entry, falling profits, and an eventual shakeout. In the micro sector, there was not a second entrant until the late 1970s in spite of Anchor’s much earlier growth and success. Addi- tional entry did not begin until Anchor’s success became obvious. For example, owners of new micro breweries in the early 1980s attribute their decision to start a microbrewery to Anchor’s success, and by 1983 over 100 individuals had asked Anchor’s owner for advice about opening a new microbrewery (Wall Street Journal, March 15, 1983; Rhodes, 1995; Barron’s, May 9, 1983, p. 41). Entry continued at a rapid rate until over-exuberance led to the shakeout of

20 Some specialty brewers (e.g., Boston and Pete’s Brewing Company) overcome the high cost of small scale production by contracting with larger brewers to produce their beer. 21 Senator Alan Cranston of California introduced a federal bill to legalize home brewing, which was signed into law by President Carter, effective February 1, 1979. This allowed a single adult household to brew up to 100 barrels of beer annually for non-com- mercial use. A household with two or more adults could brew up to 200 barrels annually. 322 VICTOR J. TREMBLAY ET AL.

1998–2002. In general, more experienced firms survived the shakeout, suggest- ing benefits from “learning by doing” and a “first mover advantage.”22 Although the shakeout appears to be over, substantial new entry is unlikely since most local markets are saturated with specialty beers. Con- tinued growth of the sector as a whole will depend on economic prosperity and competition from the imports and the microclone and super-premium (e.g., Michelob) brands of the macro brewers. With continued economic prosperity and growing foreign competition, this is one segment of the market that will remain dynamic.

IV. Concluding Remarks With a domestic market share approaching 4%, the specialty sector is becoming an increasingly important part of the U.S. brewing industry. Entry into this sector was slow at first, but there are over 1,400 microbrew- eries, brewpubs, and larger specialty brewers in the U.S. today. Specialty brewers compete in local or regional markets, and the degree of concentration in these markets varies by region. Even when regional concentration is high, however, competition remains stiff since entry barriers are low, the macro brewers remain potential competitors, and import brands are close substitutes. Rising scale economies, high sunk costs associated with advertising, and the continued success of Anheuser–Busch contributed to the high level of concentration in the macro sector of the industry. Today, the fourth largest firm, Pabst, no longer brews its own beer, continues to lose market share, and will likely be absorbed by another major brewer in the near future. This will leave the three leading brewers with more than a 98% share of mass-produced domestic beer. With so little of the market left for the remaining regional macro brewers, it will be difficult if not impossible for any of them to become national in scope. Their survival will depend upon their success as hybrid brewers, brewers that cater to local niche markets by producing both traditional and craft-styles of beer. Although less so than in the past, the U.S. brewing industry will remain dynamic. The microbrewery boom appears to be over, but firm turnover and market competition will remain high in the specialty sector given low entry barriers, foreign competition, and consumer demand for variety. In the future, industry structure will continue to change in the international arena as the market becomes more international in scope and as firm behavior becomes more heavily influenced by foreign partnerships and increasing international competition.

22 This is consistent with Horvath et al. (2001), who found that more experienced ﬁrms were more likely to survive a shakeout in the brewing industry during the pre-Prohibition era. CONCENTRATION IN U.S. BREWING 323

Acknowledgments The authors wish to thank Kenneth Elzinga, Jon Nelson, and Anthony Swisher for providing helpful comments on an earlier version of the paper. Any remaining errors are our own.

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