Craft Beer and the Great Mirage

Predicting the future is a sketchy business. That's just as true of the beer industry as it is of sports gambling. We look at the scenery and think we know what's coming. Then everything flips and we're left holding the bag. Look at what happened to Virginia last night.

Over the past few years, craft beer growth rates were stupendous. Easy money fueled a breakneck expansion of brewing capacity across the country. The rationale was simple: double-digit growth suggested there would be a market for virtually unlimited beer.

By one publication's reckoning, the expansion of brewing capacity during the past five or so years is comparable to what happened at the end of Prohibition. If you don't recall, the brewing industry, wiped out almost completely, had to be built back up from nothing to meet demand.

Of course, we now know the growth many expected to continue unabated has guttered. Demand for beer is flattening. The double-digit growth of craft beer has slowed to perhaps half that. The result is a lot of unused brewing capacity, similar to what happened in the late 1990s.

The excess capacity scenario generally foreshadows declining prices. Brewers look to sell beer and keep their doors open by lowering prices. There's some evidence of that happening. After years of increases, the big brewers are, indeed, backing off on prices.

Craft is a little different. In the big picture, we're seeing smaller price increases than in recent years in the mainstream beers. There's an interesting caveat at the top, where specialty product pricing appears to be no object. Consumers don't care. Premium and Super Premium craft, which account for only a fifth of the business, are responsible for 75 percent of craft dollar growth. Crazy.

But not everyone plays in the Premium sandbox. Most craft breweries sell mainstream product to folks who aren't beer geeks. Their challenge, given the situation with unused capacity and downward pressure on price, is figuring out what to brew that will allow them to stay in business.

The continued implosion of domestic premiums looks like an opportunity for craft brewers to chase dollars with lighter, lower ABV products at attractive prices. Breweries like Firestone Walker, New Belgium and Founders, among others, are doing so.

By the way, that strategy fits in well with demographic realities. Millennials, who drove a lot of craft's growth in recent years, are moving out of their twenties and getting fat. They're starting to look for lighter options. We've seen this movie before with prior generations.

So the idea of targeting the domestic premium space seems valid. The problem, as industry analyst Bump Williams recently noted on the Brewers Association Power Hour, is that craft brewers cannot beat the big brewers on price. The big guys are too efficient. They will prevail.

Thus, thoughts of escaping the craft slowdown with lighter, cheaper product in the domestic premium space is largely a mirage. As soon as that market blooms, big beer will enter the fray with aggressive discounting and swallow up the business.

Yeah, just one more reason these are scary times for craft brewers.

About Craft Beer's 'Big Funk'

Craft beer is in a bit of a funk. That subject has been discussed widely, of late, including here. The numbers are quite shocking, honestly. But there may be an explanation that doesn't spell imminent doom for the industry.

It's no secret that 2016 was a shitty year for craft beer. For the first time in a long time, growth lagged badly. That was the theme carried forth by Dan Wandel of IRI in his year-in-review presentation for the Brewers Association. Craft beer growth "slowed suddenly and substantially," Wandel said.

Below are a few gory details from his presentation:

• Off-premise craft growth, double-digit 2004 to 2015 in supermarkets, dropped to 6.3 percent in 2016. That was better than the beer category as a whole (up about 3 percent), but a fairly alarming decline from recent years.
• Though every region saw double digit growth in 2015, not one region performed as well in 2016, although the Southeast was close at 9 percent.
• More than half of the country's top craft brewers lost share in 2016.
• Seasonals, the second largest craft sub-category after IPA, were down 6.3 percent. They lost 2.3 share points (16.7 percent share of the craft category). Yikes!
• New brands, which consumers are turning to, helped offset seasonal losses. But if new brands were removed from the numbers, craft would be in modest decline for the year.
• Things aren't improving in early 2017. Craft velocity in supermarkets is the slowest its been since 2014, the worst slowdown in the history of craft tracking.

There's a lot of speculation as to why we're seeing this apparent collapse. Everyone has an opinion, obviously, and there are bad guys, trolls and whipping boys lurking. I'll get to what I think it is a reasonable explanation momentarily. For now...

Bad hombre #: Marijuana, which is is growing like crazy where it's legal and, some believe, stealing share from beer. Wandel mentioned a survey that suggests legalized marijuana is leading to decreased alcohol consumption and, eventually, a 7 percent decline in beer industry revenue.

Bad hombre #2: Canned wine. Yep. There are now more than 30 varieties of wine available in cans and, per Wandel, they're selling like mad in supermarkets. Millennials apparently love the stuff. The wine hucksters even had the gall to advertise during the Super Bowl.

Bad hombre #3: Turbulence in the industry. Something like half of the top 25 craft breweries have experienced leadership changes over the course of the last two years. Hard to know the specifics of why that's happened, but some think it has destabilized the industry to some degree.

Bad hombre #4: Unsustainable numbers. When craft growth was consistently in the teens, it was up, up and away. But many people figured that kind of growth couldn't last forever. For one, it's tough to keep putting up such numbers once you reach a certain size. It becomes impossible.

As I said, everyone has an opinion. Many in the industry are grasping for answers, desperately wondering why craft beer is in a funk. This is big business, after all, with a lot of money involved. It's easy to understand why everyone demands answers.

I have a hard time buying most of the suggested answers. Marijuana is legal in a handful of states. It's sucking significant share from craft beer? Doubtful. Canned wine? Fine. It's selling. So are spirits. There's competition. Nothing new. Leadership upheaval? Exactly how is that causing sales to bomb? The unsustainable numbers argument is the only one that makes sense.

In fact, craft beer probably isn't in as much trouble as IRI (or Nielsen) stats suggest. Independent craft brewers will face serious challenges in grocery as AB expands its High End brands into new markets and pushes smaller brands out. But that project will take some time.

What's going on is that craft growth is happening outside the view of IRI, which mainly tracks sales in large national chains. More and more beer is being sold directly to consumers in breweries, pubs and taprooms. For the most part, IRI isn't getting a whiff of those numbers.

This altered model is a result of new breweries opening around the country. Local craft beer is more readily available than ever. Consumers who once bought craft beer in supermarkets now have other options. That change is causing an apparent drag on growth due to the way IRI data is collected.

How many more breweries can we support? Who knows? It isn't infinite. I think there's still room for smaller breweries targeting mostly local clientele. Distribution in grocery isn't going to be a viable option for most small breweries due to the power and reach of big beer.

For now, don't get too excited about stories announcing doomsday scenarios for craft beer. Most of those stories are based on data that's hopelessly obsolete. The industry faces challenges, for sure, but those challenges probably aren't quite what they appear to be.