FTC Staff Comment to the Hon. Randolph J. Townsend Concerning Nevada A.B. 569 to Restrict a Liquor Suppliers Ability to Alter its Distribution System

Bureau of Competition
FEDERAL TRADE COMMISSION
WASHINGTON, DC, 20580
Tpe 	Honorable 	Randolph 	J. 	Townsend
Nevada 	Legislature
Washoe 	No. 	3
P.O. 	Box 	20923
Reno, 	Nevada 	89515
Dear 	Senator 	Townsend:
The 	Federal 	Trade 	Commission 	staff 1 	is 	pleased 	to 	respond 	to
your 	May 	4, 	1987, 	request 	for 	comments 	on 	Nevada 	Assembly 	Bill 	No.
569 	("A. 	B. 	569"), 	a 	measure 	that 	would 	amend 	the 	statute
governing 	franchise 	agreements 	between 	liquor 	suppliers 	and
wholesalers. 2 	The 	bill 	would 	significantly 	restrict 	a 	liquor
supplier's 	ability 	to 	alter 	its 	distribution 	system 	in 	response 	to
changes 	in 	market 	condition~. 	The 	likely 	~esults are 	a 	rigid 	and
inefficient 	distribution 	system 	for 	alcoholic 	beverages 	and
increased 	prices 	to 	~;vada consumers 	and 	visitors.
Congress 	has 	Ch<.>I
nation's 	antitrust 	aT
mandate, 	the 	Commisso
before 	other 	governm'
and 	consumer 	welfar(
Commission 	is 	part~
distribution 	of 	~_C~
recent 	years, 	tht 	FT~
i 	t~.€ 	.ission 	with 	enforcing 	the
;n~' 	protection 	laws. 	Under 	this
)r 	~taff has 	frequently 	appeared
.es 	to 	help 	assess 	the 	competitive
~_ions of 	pending 	issues. 	The
familiar 	with 	competition 	issues 	in 	the
)~verages. 	On 	numerous 	occasions 	in
'f 	has 	presented 	its 	views 	on 	proposed
1
2
These 	commem::: 	r~present the 	views 	of 	the 	Bureaus 	of
Competition, 	,'opsumer 	Protectio~, and 	Economics, 	and 	not
necessarily 	those 	of 	the 	Commission 	itself. 	The
Commission 	has, 	however, 	voted 	to 	authorize 	the 	staff 	to
present 	these 	comments 	to 	you.
See 	Nevada 	Revised 	Statutes 	598.290 	~t seq.

The 	Honorable 	Randolph 	J. 	Townsend
legislation 	governing 	the 	sale 	of 	these 	products. 3
Likely 	Competitive 	Effects 	of 	A. 	B. 	569
2
By 	protecting 	existing 	local 	liquor 	distributors 	from 	market
forces, 	A. 	B. 	569 	can 	be 	expected 	to 	cause 	inefficiencies, 	injury
to 	potential 	entrants, 	and 	higher 	prices 	to 	consume~s. 	The 	bill
effectively 	prohibits 	suppliers 	from 	terminating 	a 	wholesaler 	for
reasons 	other 	than 	"good 	cause." 	sections 	1-2. 	"Good 	cause" 	is
narrowly 	defined 	and 	generally 	will 	not 	exist 	unless 	the
wholesaler 	loses 	a 	necessary 	governmental 	permit, 	is 	in 	serious
financial 	difficulty, 	has 	been-convicted 	of 	certain 	types 	of
crime, 	has 	failed 	to 	act 	in 	good 	faith 	in 	performing 	under 	the
franchise, 	or 	has 	failed 	to 	comply 	with 	a 	franchise 	requirement
3 	See, 	~, 	Comments 	of 	the 	Federal 	Trade 	Commission's
Bureaus 	of 	Competition, 	Consumer 	Protection, 	and
Economics 	on 	the 	Maryland Wine 	Cooler 	Fair 	Dealing 	Act
(Mar. 	11, 	1987); 	Comments 	of 	the 	Federal 	Trade
Commission's 	Bureaus 	of 	Competition, 	Consumer 	Protection,
and 	Economics 	on 	the 	District 	of 	Columbia 	Wine, 	Beer, 	and
Spirits 	Franchise 	Act 	(Aug. 	29, 	1986); 	Comments 	of 	the
Federal 	Trade 	Commission's 	Bureaus 	of 	Competition,
Consumer 	Protection, 	and 	Economics 	on 	the 	Califo~nia Beer
Distribution 	Bill, 	Senate 	Bill 	No. 	1211 	(July 	2, 	1985);
Comments 	of 	the 	Federal 	Trade 	Commission's 	Bureaus 	of
Competition, 	Consumer 	Protection, 	and 	Economics 	on 	the
Rhode 	Island 	Distilled 	Spirits 	and 	Vinous 	Beverages 	Fair
Dealing 	Law 	(Apr. 	3, 	1985); 	Comments 	of 	the 	Federal 	Trade
Commission's 	Bureaus 	of 	competition, 	Consumer 	Protection,
and 	Economics 	on 	the 	Virginia 	Wine 	Franchise 	Act, 	House
Bill 	No. 	1301 	(Feb. 	8, 	1985); 	Malt 	Beverage 	Interbrand
Competition 	Act: 	Hearings 	on 	S. 	1215 	Before 	the 	Senate
Corom. 	on 	the 	JUdiciary, 	97th 	Cong., 	2d 	Sess. 	266-90
(1982) 	(oral 	and 	written 	statements).

The 	Honorable 	Randolph 	J. 	Townsend' 	3
that 	is 	reasonable, 	lawful, 	and 	nondiscriminatory. 	Section 	1. 4
In 	addition 	to 	defining 	the 	circumstances 	that 	constitute 	good
cause,S 	the 	bill 	requires 	the 	supplier 	to 	show 	that 	it 	acted 	in
good 	faith 	and 	to 	prove 	that 	good 	cause 	for 	termination 	exists.
sections 	1, 	3-4.
A. 	B. 	569's 	restrictions 	would 	make 	it 	difficult 	for 	suppliers
to 	distribute 	their 	products 	efficiently. 	By 	providing 	that
distributors 	cannot 	usually 	be 	terminated 	except 	for 	fault 	or
insolvency, 	the 	bill 	is 	likely 	to 	prevent 	suppliers 	from 	reacting
quickly 	and 	efficiently 	to 	changes 	in 	supply 	and 	demand
conditions. 	Thus, 	suppliers 	might 	be 	unable 	to 	restructure
distribution 	networks 	that 	have 	become 	obsolete. 	The 	higher
prices 	associated 	with 	such 	inefficiencies 	would 	presumably 	be
passed 	on 	to 	consumers.
It 	is 	certainly 	possible 	that 	some 	distribution 	networks 	in
Nevada 	will 	become 	outmoded within 	the 	next 	decade. 	Between 	1970
and 	1980 	the 	total 	annual 	consumption 	of 	distilled 	spirits 	almost
doubled 	in 	Nevada; 	however, 	between 	1980 	and 	1985, 	Nevada
consumption 	apparently 	dropped, 	reflecting 	a 	nationwide 	trend. 6
In 	markets 	where 	sales 	i~ a 	given 	decade 	may 	double 	or 	may
4
5
6
In 	essence, 	the 	legislation 	sharply 	limits 	the 	grounds
for 	ending 	a 	franchise. 	The 	bill 	would 	thus 	overturn 	a
1985 	Nevada 	jUdicial 	decision 	upholding 	franchise
termination 	for 	legitimate, 	prudent 	business 	reasons 	of
the 	franchisor 	notwithstanding 	the 	absence 	of 	franchisee
fault. 	See 	American 	Mart 	Corp. 	v. 	Joseph 	E. 	Seagram 	&
Sons, 	Inc., 	643 	F. 	Supp. 	44 	(D. 	Nev. 	1985). 	Under
A~erican Mart, 	liquor 	distribution 	systems 	can
continuously 	evolve 	to 	remain 	rational 	and 	efficient,
making 	possible 	the 	lowest 	possible 	price 	to 	the
consumer. 	Under 	the 	bill, 	the 	necessary 	flexibility 	for
efficient 	decision-making 	by 	the 	supplier 	is 	eliminated,
with 	a 	likely 	result 	being 	higher 	prices 	to 	the 	consumer.
Even 	when 	the 	supplier 	can 	establish 	the 	requisite 	good
cause, 	the 	distributor, 	in 	some 	situations, 	has 	sixty
days 	to 	cure 	the 	claimed 	default. 	Section 	1.
Jobson's 	Liquor Handbook 	1986 	52-53 	(D. 	Hecht 	ed. 	1986);
Washington: 	First 	in 	Thirst, 	Washington 	Post, 	Aug. 	3,
1986, 	at 	B6, 	col. 	1. 	In 	1984 	and 	1985 	Nevada 	ranked
first 	among 	the 	fifty 	states 	in 	liquor 	consumption 	on 	a
per 	capita 	basis. 	Jobson's 	Liquor 	Handbook 	1986 	46, 	56
(D. 	Hecht 	ed. 	1986); 	Washington: 	First 	in 	Thirst,
Washington 	Post, 	Aug. 	3, 	1986, 	at 	B6, 	col. 	1.

The 	Honorable 	Randolph 	J. 	Townsend 	4
decline, 	consumer 	demand 	patterns 	may 	be 	quite 	volatile. 	In 	order
for 	distribution 	networks 	to 	remain 	economically 	efficient, 	supply
patterns 	must 	be 	free 	to 	change 	with 	equal 	speed. 	A law 	that
fails 	to 	allow 	for 	such 	changes 	could 	impose 	significant 	costs 	on
consumers.
The 	constraining 	effects 	of 	A. 	B. 	569 	may 	be 	especially 	severe
in 	areas 	where 	suppliers 	have 	established 	exclusive 	sales
territories 	for 	their 	distributors. 	Since 	the 	bill 	prohibits 	the
supplier 	from 	terminating 	or 	refusing 	to 	renew 	a 	franchise 	except
under 	certain 	circumstances, 	a 	supplier 	that 	has 	assigned 	an
exclusive 	sales 	territory 	may 	not 	be 	able 	to 	create 	new
distributorships 	in 	that 	territory 	without 	triggering 	a 	claim 	from
the 	existing 	distributor 	alleging 	that 	the 	territory 	is 	being
terminated 	or 	reduced.
As 	a 	result 	of 	the 	proposed 	statute, 	suppliers 	may 	find 	it
difficult 	to 	improve 	their 	distribution 	networks 	by 	introducing
additional 	distributors, 	or 	by 	consolidating 	territories 	to
achieve 	scale 	efficiencies. 	Even 	though 	a 	supplier 	may 	have 	a
legitimate 	and 	procompetitive 	business 	reason 	for 	wanting 	to
modify, 	reduce, 	or 	eliminate 	a 	distributor's 	territory, 	it 	could
not 	act 	in 	the 	absence 	of 	franchisee 	fault 	or 	franchisee
insolvency. 	Furthermore, 	even 	in 	some 	cases 	of 	franchisee
misconduct, 	a 	supplier 	might 	be 	reluctant 	to 	undergo 	a 	court
battle 	and 	the 	costs 	of 	proving 	the 	existence 	of 	"good 	cause."
. 	....A. 	B. 	569 	may 	also 	have 	the 	h~ghly undes~rable effect 	of
making 	entry 	into 	the 	market 	more 	difficult. 	Under 	current 	law,
distributors 	have 	an 	incentive 	to 	provide 	retailers 	with 	adequate
liquor 	supplies 	at 	competitive 	prices. 	They 	know 	that 	if 	they
attempt 	to 	charge 	more 	than 	the 	competitive 	price, 	their 	suppliers
can 	give 	franchises 	to 	new 	distributors 	that 	are 	willing 	to 	charge
lower 	wholesale 	prices. 	By 	limiting 	possible 	entry 	into 	the
territory, 	however, 	A. 	B. 	569 	may 	eliminate 	this 	competitive
pressure 	and 	may 	therefore 	increase 	the 	prices 	paid 	by 	consumers.
In 	addition, 	by 	increasing 	the 	suppliers' 	costs 	of 	altering 	their
distribution 	systems, 	the 	bill 	will 	reduce 	the 	incentives 	of
existing 	suppliers 	to 	introduce 	new 	brands 	into 	Nevada 	and 	of 	new
suppliers 	to 	enter 	the 	market.
In 	short, 	A. 	B. 	569 	would 	protect 	some 	existing 	distributors
at 	the 	expense 	of 	other 	existing 	distributors, 	potential
distributors, 	suppliers, 	consumers, 	and 	competition. 	Changes
sought 	by 	suppliers 	to 	meet 	different 	market 	conditions. are 	not
abusive 	demands 	that 	require 	statutory 	remedies. 	Suppliers 	have
no 	incentive 	to 	mistreat 	their 	distributors 	because 	good
distributors 	are 	necessary 	for 	the 	efficient 	marketing 	of 	liquor.
There 	is, 	therefore, 	no 	need 	for 	new 	legislation 	to 	skew 	contracts

The 	Honorable 	Randolph 	J. 	Townsend 	5
between 	suppliers 	and 	distributors 	in 	favor 	of 	the 	distributors.
Conclusion
A. 	B. 	569 	will 	interfere 	unnecessarily 	with 	market 	forces 	by
increasing 	the 	supplier's 	costs 	of 	adding 	or 	eliminating
distributors 	or 	switching 	from 	one 	distributor 	to 	another. 	The
stimulus 	to 	efficiency 	resulting 	from 	competition 	for 	the
supplier's 	patronage 	will 	be 	reduced 	if 	it 	is 	more 	costly 	for
suppliers 	to 	make 	changes 	and 	easier 	for 	distributors 	to 	challenge
any 	changes. 	In 	the 	absence 	of 	the 	bill's 	proposed 	restrictions,
competition 	is 	likely 	to 	encourage 	alcoholic 	beverage 	suppliers 	to
maintain 	more 	efficient 	distributional 	arrangements 	and 	to 	retain
necessary 	flexibility 	to 	respond 	effectively 	to 	shifting 	consumer
preferences 	and 	demand 	patterns. 	The 	FTC 	staff 	therefore
concludes 	that 	enactment 	of 	A. 	B. 	569 	would 	not 	serve 	the 	pUblic
interest.