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Craft Brewing Industry Primer – Behind the Revolution : SAM, HOOK, BUD, SBMRY

August 24, 2011 | About:

Bill Smith

30 followers
For those interested in the brewing industry, in general, or the craft brewing industry, in particular, this article is intended to introduce, or perhaps enhance, your circle of competence by providing a macro-level look of the craft brewing industry. Craft brewers and consumers have succeeded in creating a beer revolution. They’ve set high levels of quality, consistency and innovation, expanding the minds of the beer consumer by creating the most diverse brewing culture in the world. While craft brewers only had just less than 5% of the U.S. beer sales in 2010, there is a tremendous upside for beer drinkers and craft brewers.

Let’s get started.

WHAT IS A CRAFT BREWER?They are:

[/i]Small: they produce 6 million barrels of beer or less annually. Beer production is attributed to a brewer according to the rules of alternating proprietorships. Flavored malt beverages are not considered beer for purposes of this definition.

Independent: Less than 25% of the craft brewery is owned or controlled (or equivalent economic interest) by an alcoholic beverage industry member thatis not itself a craft brewer.

Traditional: A brewer who has either an all malt flagship (the beer which represents the greatest volume among that brewer's brands) or has at least 50% of its volume in either all malt beers or in beers which use adjuncts to enhance rather than lighten flavor.

The hallmark of craft beer and craft brewers is innovation. They interpret historic styles with unique twists and develop new styles that have no precedent. These brews are typically made with traditional ingredients like malted barley and wheat. Sometimes the brewer will use interesting and non-traditional ingredients to make the beer distinct. Craft brewers have distinctive, individualistic approaches to connecting with their customers. They’re small, so they can understand the customer better. They are also able to maintain the integrity of their product due to their independence from any substantial interest by a non-craft brewer.

Craft brewers tend to be very involved in their communities through philanthropy, product donations, volunteerism and sponsorship of events. The number of craft brewers has grown 18% CAGR from 8 in 1980 to 537 in 1994 to 1,759 in 2011. Craft brewers operate in 344 congressional districts and the majority of Americans live within 10 miles of one. [i]

ORIGINS & PHILOSOPHYThe term originated in the UK in the late 1970s to describe the new generation of small breweries which focused on producing traditional cask ale. The first successful example of this approach was Litchborough Brewery founded by Bill Urquhart in 1975. In America, Fritz Maytag purchased Anchor Brewing Company in 1965 maintaining some of the original beer traditions of that brewery during a time when all of America’s unique beers and breweries were disappearing. It took another decade to turn the ailing company around.

Originally, the term "microbrewery" was used to describe the size of breweries. Over time, it gradually came to reflect an alternative attitude and approach to brewing flexibility, adaptability, experimentation and customer service. The term and trend spread to the United States in the 1980s where it eventually was used as a designation of breweries that produced fewer than 15,000 barrels of beer annually.

Micro- or craft-breweries have a different marketing strategy than large, mass-market breweries. They offer beers that compete on the basis of quality and diversity, instead of low price and advertising. Their influence has been much greater than their market share (which amounts to only less than 5% in the US), indicated by the fact that large commercial breweries have introduced new brands intended to compete in the same market as microbreweries over the last 30 years. When this strategy failed, they invested in microbreweries, or in many cases bought them outright.

MICROBREWERIES IN THE UNITED STATESBefore Prohibition, America had a rich brewing heritage brought over with the immigrant population. Unfortunately, Prohibition drove many breweries in the U.S. into bankruptcy — they could not all rely on selling near beer or malt extract for sweetener to stay alive. Several decades later, brewery consolidation took its toll and most American commercial beer was produced by a few very large corporations. The result was a homogenous, mild-tasting lager beer, of which Budweiser and Miller are well-known examples.

The old-world traditions were disappearing. The new light lager was gaining dominance, appearing on market shelves and changing America’s beer preference to it through effective marketing. This new beer began to drive and shape the growth and nature of the beer industry, even to this day. By the end of the 1970s, the industry had consolidated down to 44 brewing companies. Experts predicted that it was only a matter of time before there would be only five left in the US.

However, simultaneously, some beer drinkers craved variety and turned to home brewing. Making the beer yourself was the only way a person in the U.S. could experience the beer traditions and styles of other countries, such as Britain, Germany and Belgium, where artisan beer had never died out. The home brewing hobby thrived and gave birth to what we now call the “Craft Brewing” Industry. Many of these early home brewers started their own brewing companies. Their goal was to reintroduce the public to more flavor and the traditions of beer.

The 1980s was the decade of these new pioneers. The popularity of their products grew and the trend quickly spread. Hundreds of small breweries sprang up, often attached to a bar (known as a "brewpub") where the product could be sold directly. During this period, industry experts refused to recognize their existence as anything serious, dismissing it as a fad. However, the pioneering companies eventually emerged victorious through difficult market conditions. They set the stage for the later proliferation of craft beer in America.

In the 1990s, momentum picked up for microbrewing. Annual volume growth increased each year from 35% in 1991 to 58% in 1995. Between 1997 and 2003, craft volume slowed to between 1% and 5% annually. But in 2004, the industry accelerated again with annual sales growth between 6% and 12% each year from 2004 through 2008. The latest growth statistic is 15% for the first half of 2011. Despite all this double-digit growth, the category represents under 5% of the total market.

As microbrews proliferated, some became more than microbrews. A new definition was needed for the broader category — the term “craft beer” was born, synonymous with high quality beer. The largest American craft brewery is the Boston Beer Company (SAM), makers of Samuel Adams. Portland, Ore., well known for its microbrew proliferation, had 30 microbreweries located within the city limits in 2008. This was more than any city in the world and greater than one-third of the state total. Many of Portland's 46 microbrew outlets have won nationwide and international acclaim.

The Association of Brewers reports that as of July 30, 2010 there were a total 1,759 craft breweries (1,033 brewpubs, 603 microbreweries, and 80 regional craft breweries) in the United States. It has only taken a mere century to reach the levels the U.S. used to have.



718431764.jpg

The craft brewery density chart illustrates the per capita distribution. The top five major microbrewery states include Oregon, Vermont, Montana, Maine and Colorado. Currently, the fortunate citizens of Vermont hold the title — a brewery for every 29,797 people. Mississippi is dead last with a total of two breweries in the state — a brewery for every 1.4 million residents.

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If you’d like to see where your state stands, view this PDF.

The Brewers Association also maintains statistics on the number of brewery start-ups in the planning stages, as a barometer of potential entrants into the craft category. As of June 30, 2011, there are 725 breweries in planning compared to 207 just three years ago. Interest in craft breweries is on the rise. However, not all will make it — the failure rate (the number of yearly closings compared to start-ups) over the last few years has ranged anywhere from 33%-50%.

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MARKET SEGMENTS According to information from the Brewers Association, the craft beer industry is defined by four distinct markets: brewpubs, microbreweries, regional craft breweries and contract brewing companies.

Microbrewery: A brewery that produces less than 15,000 barrels (17,600 hectoliters) of beer per year with 75% or more of its beer sold off site. Microbreweries sell to the public by one or more of the following methods: the traditional three-tier system (brewer to wholesaler to retailer to consumer); the two-tier system (brewer acting as wholesaler to retailer to consumer); and, directly to the consumer through carryouts and/or on-site tap-room or restaurant sales.

Brewpub: A restaurant-brewery that sells 25% or more of its beer on site. The beer is brewed primarily for sale in the restaurant and bar. The beer is often dispensed directly from the brewery's storage tanks. Where allowed by law, brewpubs often sell beer "to go" and/or distribute to off-site accounts.

Contract Brewing Company: A business that hires another brewery to produce its beer. It can also be a brewery that hires another brewery to produce additional beer. The contract brewing company handles marketing, sales, and distribution of its beer, while generally leaving the brewing and packaging to its producer-brewery (which, confusingly, is also sometimes referred to as a contract brewery).

Regional Brewery: A brewery with an annual beer production of between 15,000 and 6,000,000 barrels.

Regional Craft Brewery: An independent regional brewery who has either an all malt flagship or has at least 50% of its volume in either all malt beers or in beers which use adjuncts to enhance rather than lighten flavor.

Large Brewery: A brewery with an annual beer production over 6,000,000 barrels.

INDUSTRY PRODUCTIONThe chart below shows total yearly volume of the beer industry since the end of World War II. After more than doubling in the first 30 years, the beer industry has flat-lined in the last 30 years.

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This effect is explained by the rise of wine during that same time period. During the 1960s, there was very little choice for consumers that wanted to have quality table wine at a reasonable price. It was the pairing of food and wine in the 1970s that was the catalyst unlocking higher demand amongst younger consumers. This phenomena is happening with craft beer today.

Craft beers are now experiencing the attention that wine had in the 1960s and 1970s — as a compliment to dining — and is being paired with menu choices. In fact, events such as SAVOR, held every year in Washington DC, celebrate the pairing of craft beer and food. This year Boston Beer Company (SAM) and the Dogfish Head Craft Brewery of Delaware, collaborated on an exclusive beer for the event which is not available elsewhere. As an anecdotal gauge of enthusiasm, this year’s SAVOR event was sold out in less than 24 hours.

The growth trajectory of craft beer is similar to that of the wine industry during the last 30 years. If the wine story is an instructive guide, then craft beer has plenty of headroom. Quality table wine is about one-third of its industry by volume, whereas craft beer holds a small 5% sliver by volume, and 9% by sales. Craft brewing, which exploded onto the scene in the 1980s, has enjoyed steadily growing recognition and availability, and has recently started growing again at double-digits.

For a sense of scale, the overall U.S. beer market in 2010 was $101 billion, selling over 203.5 million barrels of beer. In comparison, craft brewing represented 9.95 million barrels in the U.S., or a 4.5% market share. SAM maintains a 22% market share in the craft beer space, is No. 1 in craft beer sales volume, and No. 5 in overall U.S. sales.

The growth of the craft brewing industry in the first half of 2011 was 15% by volume and 14% by sales. In contrast, U.S. beer sales were down 1.1% by volume during the same period. The craft brewing industry grew 11% by volume in 2010 and 12% by dollars compared to 2009. Overall, U.S. beer sales were down 2.2% in 2009 while import beer sales were down 9.8% in 2009.

Craft brewers provide approximately 100,000 jobs in the U.S., and because many of them are brewpubs, they contribute greatly to local commerce.

PROCESS & INGREDIENTSThe brewing industry has favorable economics, owing in part to its ingredients and process, which is based on natural, biological processes and has remained unchanged for the last 5,000 years since man discovered it. Although there’ll be some minor variations in process, the typical brewing operation looks like this chart below:

934700875.jpg

Input ingredients (barley, wheat, hops, water, yeast, corn, rice, etc.) are typically inexpensive and lead to high gross margins. These ingredients are combined, cooked, and cooled in the brewhouse and then transferred to fermenters. Once fermented, this new beer will go through an aging process before being packaged into kegs, bottles, or cans. Aging can last a few weeks to many months, depending on the beer style being brewed.

Brewing equipment is bulky and capital intensive up front. It is typically made of stainless steel and is a long-lived asset. Once it’s in place, though, it requires little in the way of maintenance capex. Additional brewing capacity is achieved by augmenting existing fermenter capacity rather than wholesale replacement of existing equipment. Fermenters are the chokepoint for any brewery, as inventory must stay in them during the entire fermenting/aging process. If a brewery wants to continue producing beer, they must have a multiple fermenter brewhouse.

Technology in brewing equipment is a productivity enhancer and allows for refinements in techniques along the way to speed the process or make it easier.

American microbreweries typically distribute through a wholesaler in a traditional three-tier system, others act as their own distributor (wholesaler) and sell to retailers and/or directly to the consumer through a tap room, attached restaurant, or off-premise sales. Because alcohol control is left up to the states, there are many state-to-state differences in the laws. Additionally, local, state, and federal governments heavily tax beer through excise taxes levied at the point the beer physically leaves the brewery.

SUMMARYCraft brewers and craft beer drinkers are participants in a beer revolution. There has never been a better time or place to drink beer than in the US right now.

DISCLOSUREI have a long position in SAM at the time of this writing.

DISCLAIMERThis analysis is provided for informational and entertainment purposes only and is the opinion of the author. The information and content contained herein should not be construed as a recommendation to invest or trade in any type of security. Neither the information, nor any opinion expressed, constitutes a solicitation of the purchase or sale of any security or investment of any kind. Conduct your own research and due diligence.

About the author:

Bill Smith
I'm an IT professional and a private individual value investor with degrees in electronic engineering and business economics. My major investment influence is Warren Buffett--finding "wonderful companies trading at wonderful prices".

Rating: 4.1/5 (16 votes)

Comments

tkervin
Tkervin - 3 years ago
Very well written. Thanks much. I am lucky to live in Beervana (Portland) and have a huge and constantly growing number of choices. I love red ale. I am doing a comparison tasting of all the local Red's........a massive task but someone has to do it! Bridgeport's Kingpin Double Red Ale is the current leader....but many more to try.
thewiz12
Thewiz12 - 3 years ago
I'm one of those lucky Vermonters with an embarrassment of local frothy liquid riches to choose from here in the Green Mountains. A great write up on the industry. SAM is definitely the strongest player with HOOK being the other publicly traded option at this point. I wouldn't be surprised if someday they merge or they're bought by one of the big breweries.
Bill Smith
Bill Smith premium member - 3 years ago
Hey, guys, thanks much, sorry for the delayed response. Glad to hear the two of you are in the lands of frothy liquids. I'm a Buckeye and it's a bit of a brewing wasteland for now in Ohio, save for Great Lakes Brewery. Prost!

v/r

Bill

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