FTC Staff Comment Before the Council of the District of Columbia Concerning C.B. 6-442, The Wine, Beer, and Spirits Franchise Act of 1986

COMMISSION 	~;,~ ~.;.
APPROVED
Commcnts of the Burcaus of
Competi tion, Consumer P:-otection and Economics
of the Federal Trade Commission
on
Council Bill 6-442
The Wine, Beer, and Spirits Franchise Act of 1986
Council of the District of Columbia
August 29, 1986

COM.J\1ENTS OF THE BUREAUS OF COMPETITION,
CONSUJ\1ER PROTECTION, AND ECONOMICS
OF THE FEDERAL TRADE COJ\1~llSSION
ON THE
DISTRICT OF COLUMBIA, BEER AND
SPIRITS FRA~CHISE ACT 1
We 	\velcome 	the 	opportunity 	to 	present 	the 	views 	of 	the 	Bureaus 	of
Competition, 	Consumer 	Protection, 	and 	Economics 	of 	the 	Federal 	Trade
Commission 	on 	the 	proposed 	District 	of 	Columbia 	Wine, 	Beer 	and 	Spirits
Franchise Act of 1986 (the "Act"). 	Our comments are offered in response to
an 	invitation 	from 	Councilman 	H.R. Crawford 	to express our 	views on 	the
competitive ramifications of this proposed legislation.
The 	Act 	grants 	all 	existing 	wholesalers 	of 	wine, 	beer, 	and 	spirits
certain 	contractu:l! 	rights 	(discussed 	below) 	that 	may 	not 	be 	provided 	by
current 	franchise 	agreements 	between 	wholes:l!ers 	and 	suppliers. 	The 	Act
would 	restrict 	the 	ability 	of 	suppliers 	of 	alcoholic 	beverages 	to 	switch
wholesalers 	or 	to 	increase 	the 	number 	of 	wholesalers 	handling 	suppliers'
brands in 	response 	to changes in 	market conditions. 	It would 	also increase
barriers to entry of new, more efficient wholesalers. 	The end result will be
higher 	costs 	of 	distribution 	of 	alcoholic 	beverages 	and 	higher 	prices. 	We
see °no benefits to consumers from this legislation.
It is especially important to examine carefully any regulatory change in
private 	contractual 	relationships 	in 	the 	alcoholic 	beverage 	industry 	because
existing 	District 	of 	Columbia 	regulations 	already 	impose 	severe 	restrictions
These 	comments 	represent 	the 	views 	of 	the 	Bureaus 	of
Competition, 	Consumer 	Protection, 	and 	Economics 	of 	the 	Federal 	Trade
Commission and do not necess:lrily represent the views of the Commission or
any individual Commissioner. 	The Commission, howe'o'er, has authorized 	the
submission of these comments.

on 	the 	distribution 	process. 	Under 	existing 	regulations, 	for 	example, 	all
liquor retailers are required to purchase brands carried 	by local wholesalers
from those wholesalers and can obtain permits to import directly only brands
not carried by District of Columbia licensed wholesalers. 2
It is also important to examine carefully any regulatory change because
the distribution of alcoholic beverages in the District of .columbia is highly
concentrated. 	Any 	change 	that 	restricts 	entry 	or 	entrenches 	incumbent
wholesalers 	in 	such 	a 	market 	must 	be 	carefully 	considered, 	since 	it 	could
have a significant anticompetitive effect. 	Thirteen companies arc licensed in
the 	District 	to 	distribute 	distilled 	spirits, 	wine 	and 	beer 	(Class 	A
wholesalers), 	and 	an 	additional 	twelve 	companies 	are 	licensed 	to distribute
light wine and 	beer (Class B wholesalers). 	Not all license holders arc active
distributors. 	Thc 	four 	leading 	distributors 	account 	for 	approximately 	80
percent of the sales of distilled spirits and wine in the District.
Dc<:cription of the Bill
The 	bill 	requires 	that 	suppliers 	designatc 	onc 	wholesaler 	as 	the
exclusive 	distributor 	of 	each 	of 	the 	suppliers' 	brands 	in 	the 	district, gives
the 	\\'holcsaler 	an 	absolute 	right 	to 	transfer 	his 	exclusive 	distributorship
rights 	to 	a 	membcr 	of 	his 	family, 	and 	mandates 	that 	"No 	supplier 	shall
cha'nge 	wholesalers 	and/or 	amend, 	terminate, 	cancel 	or 	refuse 	to 	renew 	an
exclusive distributorship without good cause." 	Grounds which constitute good
cause include bankruptcy, rcvocation of the wholesaler's license, and failure
of 	the 	wholesaler 	to 	maintain 	sales 	of 	a 	supplicr's 	brand 	or 	brands
2 See 	Distilled 	Spirits 	Council 	of 	the
State 	Laws 	and 	Regulations 	Relating 	to
Edition, 1985, p. J8.
2
United 	States, 	Inc. Summary 	of
Distilled 	Spirits, 	Twenty-fifth

"comparable to that of other similarly situated wholesalers of that brand, in
light of all the circumstances of the market for those brands in the District
of 	Columbia." 	Under 	this 	provision, 	the 	transfer 	of 	ownership 	of 	brands
from one supplier to another does not constitute good cause for a change in
wholesalers.
Any 	supplicr desiring 	to 	make 	any 	change 	in 	whol~salers must 	notify
the 	District 	of 	Columbia 	Alcoholic 	Beverage 	Control 	BO:lrd 	90 	days 	in
advance and 	provide a detailed explanation for the requested change. 	If the
conditions 	leading 	to 	the 	request 	for 	a 	change 	can 	be 	rectified 	by 	the
wholesaler within 60 days, the wholesaler is afforded that amount of time to
improve 	conditions. 	In 	Board 	proceedings. 	the 	supplier 	has 	the 	burden 	of
proving the existence of good ca use.
If a supplier is found to have acted without good cause, the wholesaler
can 	elect 	to 	have 	the 	exclusive 	distributorship 	remain 	in 	effect 	or 	be
reinstated. 	Alternatively, 	the 	wholes:l!er 	can 	require 	the 	supplier 	pay 	the
reasonable value of his distributorship (including good will) as determined by
mutual agreement or by an appraiser.
Like!\' Effect .. of the Act
The 	impact 	of 	the 	bill 	is 	perhaps 	best 	assessed 	by 	considering 	the
changes 	it 	would 	impose 	on 	the 	terms 	of 	existing 	wholesaler 	contracts.
Existing 	contracts 	do 	not 	grant 	exclusive 	distributorships 	to 	wholesalers
(although 	virtually all 	brands are 	distributed 	on an 	exclusive 	basis) nor do
they 	require 	purchasers 	of 	a 	supplier's 	brands or 	business 	to 	use 	the 	same
distributors. 	Moreover, 	current 	contracts 	provide 	for 	supplier 	approval 	of
any 	change 	in 	wholesaler 	ownership. 	including 	transfer 	to 	other 	family
members. 	Existing 	contracts 	thus 	enable 	suppliers 	to 	change 	methods 	of
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distribution to meet the changing conditions of the marketplace in a manncr
which 	maximizcs 	efficicncy. 	Enactment 	of 	Council 	Bill 	6-442, 	howevcr,
would change 	the tcrms of thcse contracts and could prevent suppliers from
efficicntly distributing thcir products in the District of Columbia, leading to
highcr priccs to consumers.
Thc 	mandatory 	contract 	terms 	envisioncd 	by 	the 	p.:oposcd 	lcgisl:ltion
are 	for several rcasons unncccssary to protect distributors from arbitrary or
unfair trC:ltmcnt by supplicrs. 	First, suppliers engaging in such conduct will
be exposed 	to competitive disciplin:lry forces. 	Suppliers and wholesalcrs are
mutually 	depcndcnt 	on 	cach 	other. 	Supplicrs who systcmatically 	terminatc
distributors "without causc" will find that distributors will be more rcluctant
to 	handle 	their 	brands or 	to promotc them activcly. 	Such actions will also
make 	it 	more 	difficult 	for 	those 	suppliers 	to 	attract 	distributors 	in 	new
markets or to obt:lin distribution for ncw brands in existing markets.
Second, existing distribution agreements appcar to reflect the legitimate
expect:ltions of suppliers and 	wholesalers, so 	that 	wholesalers arc 	protected
from 	unfair 	treatment 	by 	contract 	and 	antitrust 	remedics. 	The 	fact 	that
thcre arc dozens more supplicrs than wholcsalcrs in the District of Columbia
docs 	not 	suggcst 	the 	existence of 	a 	gross disparity 	in 	bargaining 	powcr 	in
favor 	of supplicrs. 	Imposing 	contract 	terms 	different 	from 	those 	mutu:llly
agreed upon runs countcr to the policics undcrlying the Uniform Commercial
Codc.
The 	Act 	could 	have 	scvcral 	delctcrious 	cffccts 	on 	compctition 	in 	the
industry. 	It 	could 	create 	a 	potcntially 	serious 	barricr 	to 	entry 	at 	thc
wholes:de level. 	New wholesalcrs would bc able to enter the market only if
thcy could convince suppliers to terminate or not renew existing distribution
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agreements. 	However, given the statutory presumptions and allocation of the
burden 	of 	proof, 	suppliers 	may 	be 	reluctant 	to 	risk 	civil 	actions 	by
terminated dcalers.
The 	Act 	will 	also 	interfere 	unnecessarily 	with 	market 	forces 	by
increasing 	the 	supplier's costs of switching from one distributor to another.
The stimulus to efficiency In distribution resulting from c;pmpctition for the
supplier's patronage among existing and potential distributors will be reduced
as it becomcs more costly for suppliers to change distributors. 	These higher
costs 	will 	also 	reduce 	the 	incentives of existing suppliers to 	introduce 	new
brands into the District and of new supplicrs to enter the markct.
Furthermore, 	the 	restrictions 	on 	termination 	and 	non-renewal 	of
distribution 	agreements 	make 	it 	more 	costly 	for 	suppliers 	to 	replace
wholesalers 	who 	collude. 	This 	reduces 	the 	penalties 	existing 	wholesalers
would bear should they decide to collude and thereby makes collusion 	more
likely.
In 	addition, even 	if an exclusive distributorship were, at one 	point In
time, the 	most efficient type of distribution system, the need to have "good
cause" for 	not 	renewing a 	particular arrangement with a wholesaler, as well
as 	the 	ninety-day 	notification 	requirement, 	could 	prevent 	suppliers 	from
reacting 	at 	minimum 	cost 	to 	changes 	in 	supply 	and 	demand 	conditions.
Often, suppliers choose 	to discontinue particular distributional arrangements
not 	in 	response 	to 	poor 	performance 	on 	the 	part 	of 	their 	individual
wh 01 esa lers, 	bu t 	ra the r 	ou t 	of 	desi re 	to 	rest ructu re 	d ist rib u tion 	ne {\\lOr ks
that have become obsolete and inefficient. 	In these cases, for good business
i
reasons, suppliers 	may 	not 	be able 	to satisfy the proposed 	requirement that
wholesalers 	be 	given 	an 	opportunity 	to 	correct 	their 	conduct 	before 	an
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agreement is discontinued. 	As a 	result, suppliers m3Y 	find 	themselves with
increasingly inefficient distributional arrangements. 	The higher coSts caused
by 	this 	inefficiency 	would 	undoubtedly 	be 	reflected 	in 	higher 	consumer
prices.
Conclu'iioll
Unregulated 	contracting 	between 	alcoholic 	beverage 	wholesalers 	and
suppliers insures that suppliers maintain distribution:l1 arrangements that, in
the 	judgment 	of 	the 	marketplace, 	are 	as 	efficient 	as 	possible. 	The 	Act
replaces this free contracting solution with 	mand:ned 	contr3ct terms th3t (I)
make 	it 	difficult 	for 	suppliers 	to 	switch 	to 	more 	efficient 	wholesalers, (2)
reduce the probability of entry by new, efficient wholesalers, and (3) require
that suppliers designate exclusive distributors for e3ch of their 	brands. 	By
substituting 	regulation 	for the forces of the marketpl3ce, the Act may raise
the 	costs 	of 	distribution 	and 	thereby 	permit 	the 	survival 	of 	inefficient
distributional arrangements that can result in restricted supply and increases
in 	the 	prices 	that consumers 	must 	pay. 	For these 	reasons, the Commission
staff opposes the enactment of this bill.
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