Beer Industry Despite the Recent

Beer Industry

Despite the recent spate of small brewery openings and a dramatic increase in the import business, in many ways the beer industry remains an oligopoly. The industry is dominated by a small handful of firms. With the exception of a couple of major imports (Heineken, Corona), these firms (SABMiller, a-B InBev, Coors) are the only players to serve the mass market. The big three of American brewing had a combined market share of 77.7% in 2007 (Progressive Grocer, 2008).

Competition in the beer industry has been largely driven by brand-building. Brewers spend hundreds of millions of dollar building brands, then extending them. Some extensions, such as Bud Light, have essentially become independent brands in their own right, spawning extension families (Reuters, 2009). Brewers protect against price competition by segmenting their brands into categories based on price -- standard, premium and superpremium. The flagship brands are priced at the premium level. This keeps price competition away from the biggest brands, although many of the beers in the standard segment are among the top sellers in the country.

Pricing in the beer industry is driven largely by factor costs. Raw ingredient costs, such as those for barley, hops, corn and rice, are the main drivers in beer prices (CBS, 2008). The large brewers seldom engage in price competition with one another. They prefer to price based on market segments. If any price competition is conducted, it is in these segments. In the higher-end segments, margins are tightly controlled and the industry succeeds based on high volume sales.

Price elasticity in the beer market is unique. Microbrewers generally have low price elasticity. Imports have reverse price elasticity. The premium prices charged by imports help to drive their sales by enhancing the prestige value of those products. These elasticities are incongruous with the beer market overall, however. In the mass market segments, it has been shown that elasticity for beer is -0.3 (Chaloupka, et. al. 2002). This is lower than the elasticity for other alcohol products, but reflects that consumers will decrease consumption as prices increase.

This has a significant impact on beer producers in a couple of key ways. One is that beer producers must constantly work to hold the line on costs. Price increases result in a loss of business; yet price increases are often a result of changes to the tax regime. Thus, beer producers have limited ability to increase prices on their own, particularly in years where the beer tax is increased. As a result, beer producers must constantly walk a tight line, especially when factor costs are increasing. Some companies have vertically integrated in order to gain better control over factor costs, Anheuser-Busch in particular.

The other impact is that consumers trade down from premium brands to standard brands (CBS, 2008). The financial crisis has convinced drinkers in some markets, such as California and Florida, to trade down as a result of lower incomes. This changes the dynamic of competition because the standard brands received substantially lower promotional budgets compared with the flagship premium brands. Brewing companies must therefore not only fight for incremental market share with competitor's brands, but must address the issue of consumers trading down by highlighting the appeal of the premium brand vs. The budget brand.

Game theory comes into play in the beer market because the mainstream beer market has been static for many years. While the import and craft beer segments have grown steadily in recent years, the mainstream market has stagnated. Thus, the mainstream beer market has become a zero-sum game. This has increased the focus in the industry on lifestyle advertising in an attempt to steal customers from competing brands. This is doubly important because all companies must contend with limited capacity for price increases and therefore can improve margins primarily through cost reductions. This leaves all major brands with recipes that involve cheap ingredients in sparse quantities -- there is little differentiation in terms of product quality.

Profit in the industry is presently not maximized. The lack of market growth has resulted in a situation where firms are spending heavily on marketing to win incremental market share. Moreover, the impact of government taxation and elasticity of demand has left firms unable to raise prices as often as they otherwise would. Both of these factors put the beer industry into a suboptimal equilibrium. Optimal equilibrium would imply that producers are able to control prices to consumers better and spend less on marketing. This would generate higher profits for the same amount of sales.

Competition in the beer industry is beneficial to consumers. For one, the rise of imports and craft beer has broken the oligopoly in the U.S. beer industry. In a no growth, low-margin scenario, the industry faced declining competition as brewers such as Pabst and Stroh's closed their doors or curtailed their operations. However, specialization has increased consumer choice. In terms of prices, consumers see benefit from competition as well. Given the constraints of the industry, reduced competition would allow for greater incidence of oligopolistic practices. The beer industry players would be able to increase prices without fear of losing critical volume. Thus, the intensity of competition works alongside the market constraints to produce a situation where even under an oligopoly the major brewers have limited capacity to raise prices.