Saturday, 10 December 2016

So Excised

A whole four years ago I tried to contribute to a discussion on the price of beer in New Zealand with this piece. As an aside in that I wondered whether it would be more fair for everyone if excise tax were charged at the point of sale rather than when alcoholic beverages enter the supply chain.
Four years later I’ve been thinking about that idea a bit more and it still seems really valid. Here’s why.

Excise tax on alcohol has an awful lot wrong with the way it’s applied. I’ll list a few here, but it’s the third one in particular that I’m gunning for:
  • it discriminates blatantly. That is, excise is charged at different rates for different drinks. To the best of my knowledge there is no evidence that a millilitre of alcohol in a whisky is more dangerous than a millilitre of alcohol in a beer. Nor that a millilitre of alcohol in a beer is more dangerous than a millilitre of alcohol in a wine. But our excise rates are calculated as if that is the case. It seems obvious then that what our excise rules are doing is profiling the consumers of these different kinds of beverage and intentionally penalising one category of consumers more than another. If only someone’s choice of drink correlated with religion or sexuality – then the way we apply excise would breach the Human Rights Act. (In fact, if I could suggest that the preferential treatment given to wine drinkers has to do with wine’s biblical/Judaeo-Christian history, then maybe this is a form of religious discrimination. Any lawyers out there want to do some pro bono, human rights work?)
  • It assumes that all alcohol entering the supply chain gets consumed. Brewers and other producers have to pay excise whether the beverages they make are consumed or not. If drinks sit on a shelf without being sold for so long that they have to be dumped, no-one gets an excise refund. If drinks are spilled, lost, broken or boiled off in a casserole the naughty tax is still paid. This is even though excise tax is supposed to be a brake on alcohol abuse. As far as I can tell the only way you get your excise refunded is if you export the goods or show that they were somehow tainted at the time of production. (Going off and becoming undrinkable doesn’t count.)
  • Finally, as dscussed below, the financial burden of excise tax is multiplied in the supply chain. 
Now it’s easy for anyone to look up the rates that excise is charged at, look at the ABV and size of the drink in front of them, and work out, for example, that a 330ml bottle of 5% beer has had 47 cents of excise applied to it. But that would only tell half the story.

Let’s assume that that 330ml bottle of 5% ABV beer was sold by a brewery to a distributor for $3 (excluding GST) and by the distributor to a bar for $3.60 (excluding GST) and by the bar to a consumer for $10 (including GST). And yes, for the distributor and bar to stay in business, those are the kinds of margin they need to charge.

It’s common to assume that the amount of excise that the consumer has effectively paid is still 47 cents. But imagine if that excise hadn’t been applied back at the brewery. The brewery might have sold the beer to the distributor for $2.53. Assuming the distributor applies that same margin as before, they’d be selling it for $3.03. And assuming that the bar applies the same margin then they’d be selling it for $8.42. A whole $1.58 less. So has excise cost the consumer $0.47 or $1.58? I think the answer is $1.58. What has been passed onto the consumer is not only the cost of the excise, but the cost of everyone in the supply chain adding their percentage to it.

The supposed purpose of excise tax is to levy consumers of this dangerous product (some more than others) and collect the income and put it to good use. But if the effect of excise is to put a drink up by $1.58, yet only $0.47 is being collected in tax, something is going wrong.

What’s going wrong is that excise is supposed to be a levy on alcohol consumption, but it’s collected at the point of production (or for imported goods at the time of entry into New Zealand). And where is the extra money being charged to the consumer going? It’s going to whoever funds the purchases made by the companies in that supply chain. You might think that it’s the operators of those businesses. But it’s just as likely to be banks. I.e. excise tax inflates the cost of buying stock for distributors and retailers and they fund that purchasing from their working capital, which may be their investors’ money, or may be a bank’s money.

This makes it sound like this is a windfall for those parties funding this money-go-round. But in reality I think that they would prefer it if these goods were cheaper and the whole business didn’t have the added risk of paying all this tax in advance.

Now in the 2015/16 year, New Zealand collected $947M in alcohol excise tax. Most of this would have been purchased at off-licences rather an on-licences. I’m going to make a wild guess that 80% of alcohol is sold at off-licences.

Markups at bottle stores and super markets are much lower than in bars. By the time a bottle of some kind of alcohol is sold at an off-licence, it’s probably going for about 50% more than the producer sold it for. But bars and restaurants probably sell goods for 250% more than the producer sold it at.

Turning these percentages into dollars, I estimate that every year, excise tax gets inflated by $380M for alcohol sold through bottle stores and by $470M for alcohol sold through bars and restaurants. That’s $850M sucked out of the pockets of New Zealand consumers because that $947M of excise tax is levied at the point of production, not at the point of consumption.

The alternative then, is to levy excise tax at the point of retail sale. Even saying it sounds intrusive, but I think a little scrutiny shows it’s actually quite workable. It is the 21st century after all and we have this thing called electronic point of sale software. We use one at Hashigo Zake called Vend. It knows everything we buy and everything we sell. I’m sure that its developers would be happy to add functionality – for a fee – that records the serving sizes and ABVs of all the products we bring in then tells us and Inland Revenue or Customs the excise payable on any and every sale. It’s only a fraction more demanding than calculating GST. It would mean that retailers would never pay excise, only collect it and forward it. And because they aren’t paying excise when buying stock there’s no need to add a margin to it.

There’s $850M to gain every year by doing it this way. That gain can be split. I.e. excise tax could be increased, perhaps by bringing the rates for wine into line with beer and cider, so the tax take goes up. But prices to consumers would fall at the same time. Outlets could pocket a share of the savings to fund the extra functionality needed in point of sale systems. I believe “win win” is the appropriate cliché.

Whole industries (brewing, distribution, hospitality) would be less risky. Consumers would save money.

But of course it won’t happen. I’ll try to second guess some of the reasons.
  • Firstly the idea of making excise tax collection more efficient and passing on savings will appal the neo-prohibitionists. They want to punish us for liking a drink. It probably pleases them that an inefficient system needlessly adds cost.
  • Secondly "it’s just not done this way". Customs collect excise, not Inland Revenue. How would it be policed? But these are insignificant issues. Every business is already a tax collector (GST, PAYE). For decades we've even been using the tax system to collect, of all things, student loan payments. Every vendor of alcohol already needs a licence and is monitored by city councils and police. The bottom line is that we can organise the collection of taxation any way that we, as a nation, see fit, and a change like this is no more challenging than raising the GST rate.
Now my $850M figure is a bit of a guess. And maybe for bars and bottle stores to pass on everything they save from buying excise-free stock is a little hopeful. Nevertheless I think my point about this and other absurdities in our excise taxation stands. And if we weren’t so ridiculously Victorian in our attitudes to alcohol we’d be fixing it.

Wednesday, 17 August 2016

Craft Beer, Industry and Insights

It's been a while since I wrote anything. So here is probably ten posts' worth of ranty text.

For the last couple of years, at this time of year, the ANZ bank has put out a report on the New Zealand craft brewing industry. I had a go at critiquing last year’s here. Last week in the lead-up to Beervana the bank released the third edition of this report. I haven’t been able to find any criticism of the report online, so it looks like I’m going to have to give it a crack again.

For context (and disclosure) the ANZ have loaned my business a lot of money and they could put us out of business at the stroke of a pen, so voicing dissent on their work may not be the smartest thing for me to do.

The gist of the report is that in New Zealand, the brewing of a category of beer called Craft continues to thrive, it has a big and rapidly growing chunk of the beer market and is rich with opportunities – including exporting - for plucky local startups.

All the optimism is pretty much based on two foundations:
- lots of hearsay from brewers about the export markets they’re selling into and
- the announcement that sales of craft beer have grown 35% and account for 15% of the market.

There’s a footnote attributing that growth figure to “Statistics NZ, industry sources, NZ Customs data, ANZ analysis”. (In last year’s paper a corresponding claim of growth was footnoted: “Sample represents approximately 15% of New Zealand’s off premise liquor sales. Sources: Statistics NZ, ANZ analysis Sources: Statistics NZ, news reports, ANZ analysis”.)

So this year the bank seems to have done away with sampling bottle store sales, which is probably a good thing because it would be disastrous to try and extrapolate results from one chain of stores or from one region of the country.

What about the other sources? Statistics NZ publish figures on what they call “Alcohol Available for Consumption” which pretty much reports on payments of excise by anyone putting alcohol into the New Zealand market. In other words, Customs collect data as they collect excise tax and Stats publish it. Then we’re left guessing about what “industry sources” and “ANZ analysis” might be. My guess is that Lion Nathan’s and DB’s annual reports reveal a little about their sales. But to the best of my knowledge no-one is gathering production reports from all the smaller breweries.

Now the NZ Customs/Statistics data reports only volumes of beer, stratified into bands of alcohol strength, for which excise has been applied. There are five bands - up to 1.150%, 1.151%–2.500%, 2.501%–4.350%, 4.351%–5.000% and more than 5.000%. This year’s release, which is of numbers from the 2015 calendar year, show that overall consumption has dropped but there has been a shift away from the middle bands (2.5% – 5%) towards those above and below (1.5% – 2% and 5% and over).

Customs and Statistics NZ don’t tell us anything about the breweries filling out the customs declarations on which these statistics are based. But it has become accepted practice to assume that breweries known as “craft” typically brew stronger beer and to then interpret the shift in volume to “more than 5%” as a sign that “craft” breweries are growing their market share.

Now this might not be as arbitrary and risky as it sounds. It’s pretty hard to find any mass-market bland lager that’s over 5%. Of course it would include a lot of beer made by those big breweries’ “crafty” subsidiaries. I’ll come back to that later.

But about these records of beer over 5% ABV that’s available in the market... Here’s a plot of that statistic over a few years:
source: Statistic NZ.

That's not the steadily rising trend we're supposed to see. I see two possible explanations here. Either
- the market for beer of this strength is only just recovering from a massive slump that seems to have gone unreported.
- OR these statistics are ropey as anything.
Any other interpretation?

Moving on then… the ANZ report asserted a couple of things:
- Something called “Craft” is 15% of the market and
- This thing called “Craft” has grown at 35% in the last year.

Now, according to Statistics and Customs, between 2014 and 2015 there was a 38% increase in beer stronger than 5% ABV available in the market. So I think this might account for a lot of that 35% growth figure. But there needs to be a little more to it, because the total beer market in New Zealand is, according to the same Statistics publication, 281 million litres, but this greater-than-5% stuff is only 18.7 million litres, which is 6.6% of the market. But if “Craft” is 15% of the market then it must be producing 42 million litres of beer. So 23.6 million litres of “Craft”’s output must come from less strong beer (as you’d expect) and it must have grown from 17.8 million litres the year before.

Now none of these numbers are outlandish, but to be credible you really have to accept a few givens. 15% growth for “Craft” is 11 million litres. To have produced an extra 11 million litres, the industry probably needs to have installed around 11 million litres of additional capacity. If you assume that on average (and this varies a lot) a batch of beer stays in a stainless steel fermenter or bright tank for two weeks, then that tank space can be used 26 times a year, so the industry must have added 423,000 litres of fermentation/conditioning space between 2014 and 2015. If tanks are, on average, 2000 litres (and again this varies a lot) that’s more than 200 such tanks added to our “Craft” breweries in that time. Again it’s a not outlandish figure and we know plenty of ParrotDogs and Liberties who were busy adding tanks in that time.

But 200 such tanks? And 42 millions litres of total annual production at a time when only a handful of our “Craft” breweries have passed the 1 million litres mark? And remember that plenty of our breweries and brewing companies are doing about 50,000 litres a year.

The explanation that ANZ literally couldn’t bring themselves to say is that they’re including the brands Mac’s, Monteith’s and Boundary Road, which are subsidiaries of corporate breweries, as well as recent acquisitions by those big breweries, such as Emerson’s and Founders. (The statistics pre-date the Panhead sale.)

Which is fine if you come out and say it. But for some reason the report’s author told the audience at the launch that they didn’t want to get into a definition of “Craft” and that they’d leave that to drinkers. Anyone else as dumb-struck by that as me?

Apart from the sheer academic negligence of refusing to offer a definition of the category that is the subject of the report, there’s a big problem. A lot of the report talks fairly vaguely about the challenges and opportunities that exist for “Craft” breweries. They talk about access to market, logistics, capital raising options and exit strategies. At one point the report uses the term “artisan producers”. Every word of text suggests that they’re talking about small and independent brewers. But every production statistic clearly includes the subsidiaries of the big breweries.

What else does the report talk about? There’s a lot about export. A lot of breweries boast that they’re exporting and apparently it adds up to 50 countries. From what I know of the importing operations in those destination countries, a lot of them are small businesses bringing over a pallet at a time. And it could be that if enough breweries each have small-time importers in a few dozen countries then those small orders will add up to a lot of value.

But I’m sceptical for a simple reason. New Zealand is just about the worst country in the world to export beer from. I say this because it costs more to produce beer here than in other places (for reasons such as lack of scale and high ingredient costs) and then because the cost of shipping beer to markets is high. (Remembering that unpasteurised beer generally needs to be shipped cold which puts a New Zealand brewer in competition with other agricultural industries for the use of refrigerated shipping.)

Shipping small orders to the curious in a few markets is one thing, but when the people like Tony Magee make it their mission to bring American beer to the world, and beer leaves American breweries at about half the price of ours, the ANZ needs to get specific about how we’re going to compete.

I can imagine a couple of possible answers to that. One is to brew in the market that is being “exported” to. Yeastie Boys and ParrotDog already do some of this. I know others have looked at it. Exactly what it does for New Zealand Craft Brewing, other than hopefully bring some profits home, isn’t clear.

Another answer is to assert that we will produce beer at the higher end of the market. There is a small but growing international market for beers that command wholesale prices of $20 a litre or more. And breweries like 8 Wired are indeed already exporting such beer. At these prices beer becomes economically a little more like wine, which, as we know, is such a lucrative business that it has never run into any crises that have resulted in bankruptcies or producers being sold to off-shore conglomerates whatsoever.

In fact, as an aside, can I suggest a really good way to develop an export market for beer? By distilling it. The resulting beverage trades at high prices, doesn’t go off and can be shipped without refrigeration.

But my biggest issue with the ANZ report is this. It has nothing to say about the two really big issues that small New Zealand brewers face.
1. their access to the on-premise market is still, for the most part, blocked and
2. very very few are making any money.

Maybe this is a good time to bring in the Oregon example. After all, the Oregon delegation that were here for Beervana were also at the ANZ report’s launch. Oregon is an economy with a similar population to New Zealand, a similar climate and with beer’s ingredients also produced locally. And their craft brewing industry began at about the same time as ours. And they’re producing 200 million litres of what might be categorised as “Craft”, with a third consumed in the state and the other two thirds exported. (I will concede that their export markets are far closer, which is a massive advantage.)

As people are probably tired of hearing from me, it’s all about access to market. In Oregon there are no obstacles stopping breweries from selling to bars and their craft breweries have 63% of the on-premise draught market. In New Zealand there are massive obstacles stopping breweries selling to bars and our craft breweries (if you exclude the big breweries’ subsidiaries) have about 2% of the on-premise draught market. It’s as if the ANZ are padding out the numbers with sales by the industrial breweries’ subsidiaries to compensate.

Here are some other issues that the industry, and people commenting on the industry, might want to consider:
- The (small and independent) brewing industry needs to decide whether it wants to pay for distribution. That means breweries finding some margin to share when there isn’t really enough to go around but also not going behind the backs of distributors the moment they develop a large customer.
- The current moral panic over alcohol hurts everyone. It interferes with good, responsible brewers and bars going about their business and adds costs at several stages in the supply chain.
- Brewers are still disadvantaged by excise rules compared to winemakers. The Brewers Guild correctly identified inequality over rules about storing wine. But then they forgot to mention the more egregious problem that wine is simply charged excise at a lower rate.

While plenty of industries grow with the help of government assistance, brewing is generally self-reliant. This should be a good thing, but when an industry is materially handicapped by regulation, tax and an anti-competitive business environment then it's expecting too much for it to thrive.

Almost forgot. Have a read of this. It's talking about a different market that's in a different phase of its development, but it rings pretty true.