Kona and the Case for Transparency in Beer Labeling

The case of some Californians who filed suit against Kona and the Craft Brew Alliance for deceptive labeling is emblematic of a problem that isn't new in beer or craft beer. Consolidation, marketing and the chase for production efficiencies have undermined honest labeling.

You may be aware of Kona's plight. Earlier this year, two California beer consumers filed suit against Kona and corporate parent, the CBA, charging they had been tricked into thinking Kona is made in Hawaii.

In fact, all packaged and draft Kona sold on the mainland is brewed at CBA facilities in Portland, New Hampshire and Tennessee. (With the closure of the old Redhook brewery in Woodinville, packaged Kona is no longer produced in Washington, if you're wondering.)

There's a bit of a back story, if you don't mind a slight detour. Years ago, before it became part of the CBA, Kona began using Widmer and Redhook to brew its bottled beer for the mainland and Hawaii. Whether you were buying bottled Kona on the Big Island or in Phoenix, it was produced on the mainland. Yup.

Brewing for the mainland on the mainland makes sense, right? Much more efficient. The Hawaii strategy was evidently driven by production efficiencies here and the fact that Hawaii at the time (perhaps still) had a 50 cent per case tax on empty bottles entering the state. It was apparently more efficient to brew and package the beer here and ship it to Hawaii.

I don't have the labels to prove it, but my recollection is that Kona has always represented itself as being produced in Hawaii, regardless of where the beer was actually produced. I'm always amazed that many are unaware of that deception, even in the beer geek crowd.

In recent times, Kona has increasingly cashed in on its connection to place, in much the same way that Corona and other Mexican imports benefit via that connection. As referenced many times in these pages, Kona is the only brand floating the CBA boat at the moment. Consequently, it has been useful to maintain the fiction that the beer is produced in Hawaii.

Back to the lawsuit. The plaintiffs claim the Hawaiian imagery found on the packaging, the map of Hawaii and address of Kona's Hawaiian brewery, as well as the invitation to visit said brewery, qualifies as false and deceptive advertising.

I went to my nearby ghetto Fred Meyer to investigate. Sure enough, there's a map of Hawaii and invitation to visit the brewery on the 12-pack box. There's also nothing on the packaging to suggest the beer is produced anywhere other than Hawaii. Once you open up the box (or six-pack), labels on the bottles list the various places where the beer may have been produced.

The CBA pointed to the bottle labels in an effort to get the lawsuit dismissed. No dice. The judge noted that the labels are not visible on the outer packaging and ruled the map of Hawaii and invitation to visit the brewery are enough to make a reasonable consumer believe the beer is produced there.

This case is now headed to the discovery phase of litigation. Kona and the CBA will soon be forced to decide if they will risk a court case or negotiate a monetary settlement. The expense involved in such cases typically causes defendants to pursue a settlement at this point, sources say.

Whatever happens, the CBA will surely revise Kona packaging to avoid similar legal entanglements going forward. It would be nice if the entire industry would take a look at labeling practices. Because Kona is far from the only example of intentional chicanery.

The Baby Buds come instantly to mind. Some portion of their beer is now produced in giant factory breweries, yet they maintain the fiction via labeling and advertising that they are still small local brands. Some legacy macro brands, now owned by big beer, do something similar.

Transparency in beer labeling and packaging is good for consumers. The reason we don't have it is there's money to be made in not being transparent. Regulations preventing the practice either aren't stiff enough or aren't seriously enforced. That leaves lawsuits as the lever of change.

How many lawsuits will it take to affect change? Maybe a lot of them. Fine with me. Nothing wrong with challenging misrepresentation and duplicity.

Liquid Aloha to the Craft Brew Alliance

Last week was a good one for the Craft Brew Alliance. The company's stock price reached an all-time high of over $20 per share on Friday. Two days earlier, the CBA released details of an agreement that puts in motion its sale to Anheuser-Busch. Those details are most certainly related.

Back in June, I wrote a piece predicting an imminent buyout. The deal announced this week isn't quite that; it isn't final and there are still details to be worked out. But the arrangement is the precursor to a completed deal, make no mistake.

The fact is, now is not a great moment for a buyout. In approving its merger with SABMiller, the Department of Justice nullified certain AB practices and told them future acquisitions would receive careful scrutiny. Now is a good time for Anheuser-Busch to keep a low profile.

Anyway, the CBA and Anheuser-Busch have been virtually joined at the hip for about 20 years. As one industry publication noted, "it seems AB and the CBA are engaged to be married, after having shacked up for a while." A buyout is imminent unless something strange happens, including the possibility that DOJ could block it.

"Collaborative independence" is the phrase both AB and the CBA are using to describe their relationship for now. In this scenario, there are three areas of commitment in place, all of which serve the interests of the CBA. It's quite bizarre, really.

Master Distributor Agreement
Anheuser-Busch will continue as the CBA's master distributor through 2028. Fees remain at 25 cents per case. That's good news for the CBA, which was bracing for a tripling of fees when the old deal expired in 2018. If volumes exceed today's 11 million cases, the CBA will save an estimated $6 million per year starting in 2019, escalating with growth over the contract term.

Contract Brewing
The CBA will have the opportunity to brew up to 300,000 barrels (more than a third of its 2015 output) within AB's network at a cost savings of $10 or more per barrel compared to their current cost. Transitioning those barrels to AB's factory breweries will take a couple of years, after which the cost benefits will gradually be realized.

You will recall that the CBA brewery in Woodinville, Wash. is currently leased to Pabst, which has an option to buy it within three years. The CBA brewery in Portsmouth, N.H., might meet a similar fate. Or the CBA could use it to build partnerships with smaller craft breweries, whose beer would be contract brewed in Portsmouth and distributed via the AB network. There are some significant financial windfalls here, regardless of which way things go.

International Distribution
The CBA awarded AB exclusive rights to distribute its beer in countries not covered by existing agreements. Starting in 2019, AB will pay a royalty of $30-$40 per barrel, pay production and material costs and reimburse the CBA for out of pocket shipping costs.

Until 2019, AB will make fixed international payments of $3 million in 2016, $5 million in 2017 and $6 million in 2018. As an incentive for "international volume development," AB will pay an additional $20 million in 2019. What's $20 million between friends, huh?

Stuck With Me
Of course, there's more. Anheuser-Busch is obligated to carry out all elements of the new agreement unless it makes a "qualifying offer" to purchase the CBA and the CBA rejects it. At that point, AB could reconsider any or all of the agreement. What's a qualifying offer? I'll get to that. Just remember AB's only way out is if the CBA turns down an offer or shifts control to someone else. Fat chance of that happening given the pork in this deal.

Okay, qualifying offer. It's an offer to acquire CBA for a minimum of $22 per share during the first year of the agreement. The minimum bumps up to $23.25 a share in the second year and to $24.50 a share in the third year. The stock price was hovering around $14 before the new deal was announced, but finished the week above $20. Wall Street loves this deal.

Timelines and Plotlines
It's clear AB and the CBA have established a framework for a delayed buyout. That scenario seems well-suited to both parties. What's the timeline? The way the agreement is structured and the way certain internal CBA details line up, the pressure to acquire the CBA increases in each of the next three years. A finalized deal is likely by 2019, if not sooner.

The elephant in the living room is this: Why did Anheuser-Busch agree to terms that are slanted so wildly in favor of the CBA? These are not reckless business people. They are accustomed to acquiring brands, squashing competition and winning. They like getting their way. Why so many concessions to the CBA?

The answer is Kona. AB wants it and the CBA has it. In fact, Kona is the only CBA brand with broad potential. It will be the biggest fish in AB's kettle of craft fish due to its national and international appeal. The big shots in St Louis and Brazil intend to market Kona against arch-rival Constellation's trio of Corona, Modelo and Ballast Point. For starters.

The rest of the CBA portfolio is junk, by comparison, likely to be sold piece-by-piece once a buyout is finalized. Redhook, relegated to discount status, likely ends up with Pabst. What happens to Widmer? That's an open question. It might be reformed as a boutique brand known for unique and innovative beers. That can't happen under the current regime of corporate profiteers, but it might happen if AB sells the brand to the right person or group.

What's the impact of the impending deal? Obviously, executives and big shareholders are going to rake in some serious cash. Past and present employees with stock or stock options will make some money. Some jobs will be lost after AB takes over and implements the cost-cutting initiatives it's famous for. But, then, you can't make an omelet without smashing a few eggs.

The official passing of the CBA torch to Anheuser-Busch will have no significant or lasting impact among consumers. The CBA may or may not cease to exist. It won't matter since most knew it only vaguely via the brands it represented, brands that will henceforth be owned by big beer.

Liquid aloha, folks.

Good and Sketchy Times at the Craft Brew Alliance

The Craft Brew Alliance, represented by the Widmer, Kona, Redhook and Omission brands, released its preliminary financial results for 2014 last week. If you keep your gaze fixated on that report, the news is all good. You have to look a bit deeper to see potential problems.

Some Highlights

• Net sales increased 12 percent over 2013, topping the $200 million milestone.
• Shipments grew 10 percent, compared to 4 percent in 2013.
• Contract brewing and related sales increased 33 percent.
• Diluted earnings per share reached 16 cents, compared to 10 cents in 2013.
• Gross margin expanded to 29.4 percent, compared to 28.1 percent in 2013.

The report paints a picture of a company that is doing quite well. The CBA is based in Portland and has strong roots in the Northwest, but its brands are making a strong statement in markets throughout the country. The first full quarter of brewing in Memphis helped contribute to what was, in fact, a record year for the company.

The Sketchy
If it's true that every grey cloud has a silver lining, then the reverse must also be true. In the case of the CBA's 2014 results, there are some issues. For example, growth slowed to 7 percent in the fourth quarter, when sales to retailers were up just 2 percent. The report says that "primarily reflects the SKU rationalization of seasonals across the portfolio." Fine.

By far the most significant factoid on the grey side of the ledger is the fact that CBA volume was down 5 percent in Portland, Seattle and Bay Area grocery stores, according to IRI (Information Resources, Inc.) data. These are the top craft markets in the country and the CBA is traditionally a big player in each (#1 in Portland and Seattle; #3 in Bay Area).

The CBA report doesn't mention or attempt to explain...no reason to in a stellar year. But volume losses in traditional core markets in a record year mean the company did extremely well somewhere else. Info in the report and IRI data suggests the CBA's most robust 2014 growth occurred in underdeveloped craft markets in the East.

That makes perfect sense if you think about it. Mainstream CBA beers are in a tight spot in mature craft markets like Portland, particularly in grocery stores, where competition for shelf space is brutal. The place where their beers shine is markets that have recently jumped on the craft bandwagon. There isn't much competition in these "soft" markets and the CBA is tapping them with gusto.

None of this means the CBA makes crappy beer. Far from it. I'm not a big fan of the standards, but I've enjoyed some fantastic specialty beers on recent trips to Widmer's Gasthaus pub. They always seem to have seasonals and specialty beers on the board. CBA beers may not have a strong presence in the area's elite taprooms and beer bars, but they are brewing some great beer.

Future Angst
OLCC stats for 2014 (through November at this point) put the CBA at the top of the heap for barrels sold in Oregon. Of course, they are selling far more beer outside the state and Northwest. A big reason for that is the arrangement they have with Anheuser-Busch, which owns roughly 30 percent of the company and has an extensive, nationwide distribution network.

Some wonder where CBA products fit into AB's strategy going forward. With the acquisitions of Goose Island, 10 Barrel and Elysian, and their efforts to acquire and operate branch distributors wherever the law allows it, will AB shift its focus to fully-owned brands at the expense of partly-owned CBA brands? Inquiring minds wonder how that will play out.

Let Me Tell You How it Will Be...Taxman!

Throughout history, there are countless examples of events that were driven less by ideology than by economic forces. Sometimes you have to look a little deeper to see how a particular outcome was motivated by money. In fact, tax policy is often involved. How is beer wrapped up in this statement? Read on.

Lets' start with Prohibition...13 of the darkest years (1920-1933) in American history. The standard story line is that Prohibition came about because the Anti-Saloon League, part of a movement that dated back to the mid-19th century, convinced a majority of Americans that it was a reasonable idea. That helped them get people elected who supported the notion.

However, Prohibition could never have happened had the federal government not changed the way it collected revenue. Awake yet? You see, prior to the implementation of the federal income tax in 1914, the federal government relied mainly on customs duties and the liquor tax. From 1870 to 1912, the government got two-thirds of its revenue (more than 75 percent in many years) via these two taxes. Congress could not seriously consider approving an ideal that would strangle the national treasury. 

That changed once the income tax was implemented in 1914. It supplied increasing amounts of revenue each year, receiving a further boost with the War Revenue Act of 1917 (the United States had entered WWI and needed more cash). By 1918, the income tax was generating the same amount of revenue as the customs duties and liquor taxes. By 1919, liquor tax revenues were trivial next to the income tax. 

Once it became economically feasible, Congress approved Prohibition legislation...and the 18th Amendment was ratified by the states. The law was largely ignored by many Americans and it boosted the fortunes of organized crime in many areas. But those aren't the main reasons it was repealed in 1933. A good part of the reason it was repealed is the Great Depression had seriously reduced federal tax revenues. The government needed more money. The 21st Amendment (repeal of the 18th) helped with that, although it took the brewing industry years to recover from Prohibition.

Fast forward 60 years for another tax-induced fish story. When I first learned Widmer was contract brewing Kona beer in the late 1990s, I assumed Kona simply wanted better access to the mainland market. I suspect there was some element of that. You brew and package your beer here and it's more efficient in a lot of ways if you're targeting mainland sales.

But there was more involved. What really happened is the state of Hawaii changed the tax code in the 1990s. The revised code penalized brewers for bottling beer in the state. Hawaii, which had (and still has) one of the highest excise taxes on beer (nearly $29 per barrel vs. about $8 in other states) established a tax (50 cents/case) on empty beer bottles shipped to the islands. Since there was no bottle manufacturing in Hawaii, brewers who bottle there were stuck with the excise tax and the bottle tax. 

The new tax hurt brewers throughout the Hawaiian islands. Many went under. Kona is the only one that prospered and they did it by off-shoring (if you will) their bottling to Oregon. They continued to brew keg beer in Hawaii, but bottling in Oregon, even with transportation costs back to Hawaii, saved them money. Kona has been part of the Craft Brew Alliance for several years, a relationship launched at least nominally by tax policy.

Cue George Harrison...

Let me tell you how it will be,

There’s one for you, nineteen for me,
‘Cause I’m the Taxman,
Yeah, I’m the Taxman.
Should five per cent appear too small,
Be thankful I don’t take it all.
‘Cause I’m the Taxman,
Yeah, I’m the Taxman.