I don’t know if you realize this, but the entirety of progress made in the Ontario market in terms of Craft Beer sales was under a Liberal government. The Ontario Small Brewers Association was founded in 2003 and for the entire time that it has existed, including its eventual rebrand as the Ontario Craft Brewers, it has worked to lobby a Liberal government that has had more or less a stable policy on beer sales and taxation.

Now, you might not have liked what they did, but it was fairly coherent from a policy standpoint. From the introduction of minimum price floors from about 2007 onwards, you’ve been looking at a market that has more or less followed COI adjustments in terms of both pricing and excise. If you take the viewpoint that sin taxes are a reasonable thing to collect, then they worked to ensure that the proportionality of those sin taxes remained relatively stable. You get money in the government coffers through the LCBO and provincial excise and that money goes to provide services to people in Ontario. The report 2016-2017 claims a $2.06 billion dividend to the province.

One of the things about the Liberal policies on alcohol sales is that it was at least going to be consistent. It was going to protect revenue to the province and that meant moving forward in a manner that was going to be fairly predictable and usually frustratingly slow. I am frankly surprised that we have come as close to the projected 450 grocery stores the Wynne government allowed expansion towards in this period of time. I still believe it was meant to be a shot across the bow of The Beer Store who have approximately the same number of outlets.

Now that we have got a PC government in the province, I’m curious to know exactly where they align. Basically, we’ve gotten two claims from the PC campaign about beer sales in Ontario. The first is the Buck-A-Beer claim which I have written about a little bit before. I’m going to expand on it a little in a minute. The other claim is probably a more interesting problem: convenience store beer sales. Vic Fedeli, who seems to be part of the brain trust of the incoming government has long been a proponent of this idea.

Buck-A-Beer is, as I have mentioned more or less dead in the water as long as no one makes the first move. The thing is that the taxes on beer are volumetric; they’re based on a per hectolitre flat rate. If you remove the price floor but don’t change the taxation rate, any change in price in the market is going to have to be swallowed by the company making the product. As a brewer for one of the larger companies said to me when I asked about the margin on those beers, “we will absolutely be the second brewery to do that.”

There is the possibility, though, that someone might decide, postmodern economy style, that they want to be a disruptor. Personally, I hear people use the term “disruptive business model” and think “let’s break a working system, pillage it, and run away.” Your mileage may vary. Say maybe Ravinder and Manjit Minhas are still a little shirty about the time in 2010 when Labatt shut down Lakeport and destroyed the facility so they couldn’t open a plant in Ontario. Well, they might very well decide on some manner of Parthian Shot as a kind of delayed retaliation. It would not be a good business decision, but they’d hurt their large competitors nationally and disrupt the market in Ontario.

This is the problem with Buck-A-Beer. It destroys value within the beer industry. Let’s say Ontario produces something like seven million hectolitres of beer annually. A hectolitre is something like 12.5 cases. Average price of a case is something like $39.00. That’s something like $3.4 Billion in revenue (back of the envelope math). You drop the average price of a case to $36.00, you lose something like $37.50 a hectolitre. Revenue for the entire industry drops $252 Million. That’s almost exclusively from very large brewers who have been actively attempting to move away from the segment.

You might make some of that back on volume sales, but I’m not sure the demography exists to support that currently. People under 30 don’t drink the way previous generations did.

They do enjoy some dank nugs, though.

You’ve got the legalization of Marijuana coming as well. I’ve taken the position previously that we’re dealing with finite disposable income in the market. There is some interesting reporting from jurisdictions with legalized marijuana that suggests that craft beer sales tend not to be impacted, especially because the experience of going to a taproom or local bottle shop is part of a larger lifestyle.

We don’t think Doug Ford is going to decrease the taxation on beer (he said as much in the sun). We think that 75% of the tax on legal marijuana will be remanded to provinces by the federal government. Let’s assume your average punter has only so much money to spend on recreational substances. The pricing of marijuana becomes pretty important to large brewers. Stats Canada says the average price across Canada for a gram of pot is something like $7.00. That’s the current gray market. The OCS is floating a $10.00 gram. That’s about a dollar less per gram than a six pack of value brand beer currently costs: $10.95

Let’s say Buck-A-Beer goes into effect. That means that in addition to the excise tax not decreasing, you’ve suddenly got brewers competing with a newly legalized substance in a separate sector and also a higher end craft market that doesn’t have the obligation to compete at the bottom of the range. That’s going to be rough. For the government it’s great. Tax revenue increases because you’ve still got LCBO markup, beer excise, and the brand new OCS revenue stream.

I also have a suspicion that from a demographic standpoint what you’re going to see is an older market for legalized weed. I think everyone my age and younger is already getting everything they want on a mail order basis. I think that the younger cohort of the boomer generation is going to get the munchies in a big, bad way and I think that since they are the ones the Buck-A-Beer thing is predominantly targeting, you’re not going to get volume recovery on value brands.

The other claim to address here is convenience store sales.

You may remember several years ago, before the grocery store thing happened, an economist named Anindya Sen had written about the cost savings that The Beer Store represented to the large brewers. He said something like $700 million. Adrian Morrow, in the Globe, said it was probably closer to $400 million.

If you are Molson and Labatt and you more or less own The Beer Store (yes, yes, theoretically there are now 33 owners and they would also like to sell you a bridge), you reap significant savings by sharing logistics for delivery, labour force, administration, and the lack of competition represented by the monopoly of sales through The Beer Store channel. I don’t claim to know which figure is correct, but both Sen and Morrow are credible thinkers. Split the difference and call it $550 Million. Maybe less now that grocery is in play.

Now, the LCBO also has centralized efficiencies in the same way in a slightly larger chain. You’ve got 700 stores and if I can be anecdotal for a moment, I have to tell you that when I was doing the odd tasting at the LCBO, I was always impressed by the behind the scenes standardization. It’s not just that the LCBO is the largest purchaser of beverage alcohol in the world. Each store has a dump room and a kitchen and the contents of the kitchen are practically identical store to store. If you’re the LCBO and you want a good or service you put out an RFP and you get an excellent deal and you get uniformity of materials across the chain. It’s like equipping an army. This is one of the reasons that the LCBO is not able to turn on a dime from a supply chain stand point.

This is the issue with the addition of sales channels: It disrupts the internal efficiencies of industry stakeholders in existing sales channels.

The Liberal government added something like 450 alcohol retailers across the province of Ontario. We’re not quite there yet, but probably it happens by next year. The margin on beer sales for grocery stores is pretty low because they’re essentially just outsourced LCBO departments. The LCBO went from having something like 700 retail outlets to effectively having 1150 retail outlets. The only difference is that some of them sell frozen pizza. Probably, you end up by 2025 with liberalized grocery store sales that allow all of the grocery outlets in Ontario to sell beer. That would effectively give the LCBO something like 2200 retail outlets.

Compared to The Beer Store’s ~450 stores, that’s an incredibly significant advance. It also means that the large brewers who are expected to play on all of those shelves are losing their internal efficiencies through The Beer Store.

It’s no great secret that there are already LCBO agency stores out there that are effectively in convenience stores. If you’re the PC government, maybe someone like Vic Fedeli wants to make a splash with convenience store beer sales. It sounds good to the common Ontario voter, because some of them have been places where that already exists. Since there are already agency stores in convenience stores, a clever administrator might do the same thing that happened in grocery. Allow convenience store sales while retaining the profit that the LCBO derives from sales. It’s still difficult logistically, but the supplier tends to be eating the cost for deliveries.

See, beer sales in Ontario are incredibly byzantine. People still think the government owns The Beer Store. From a public relations perspective it might be a pretty good idea to make it look like the grocery stores and convenience stores are privately owned despite an enormous amount of the margin flowing into public coffers. I mean, the thing you’ll notice with all three current channels is that the prices are standard across them. No thinking government is going to let convenience stores set their own prices. They might let them charge a little more to make margin as a sop to the OCSA, but probably not. Probably it’s a loss leader.

You might think that the large brewers would benefit from convenience store sales. You’d be unjustified in that conclusion. Think about the long term direction of alcohol sales from the point of view of Labatt or Molson. You had 450 Beer Stores that handled all of the logistics and delivery and kept your product cold and shelf stable. They basically handled all of your consumer facing retail and licensee delivery and they did it on a cost recovery basis. If you’re those guys, the larger the amount of retail presence retained outside of The Beer Store channel, the less profitable it becomes to operate. There are 9000 convenience stores in Ontario. It will dilute profit immensely. I don’t believe they would sell very much more beer either. For all we complain, I think access is currently pretty ready. I think it would just spread out the sales that already exist.

So check this out. A craft brewery can open in East York, grow to a reasonable size, do something like 50% of their business out their front door and make a profit.

If you’re a really large brewer, on the other hand, it is a terrible time to be you in Ontario. The new PC government is threatening to erase your annually increasing price floor that allows you to raise your prices without blame. That might be $250 million. The legalization of marijuana threatens to eat away at a core demographic for premium and value brand beers, negating volume recovery in the value brand sector. The likelihood of liberalized grocery store beer sales is less than six years away and probably eats any margin you saved with the internal efficiencies at The Beer Store. Convenience stores would be less an opportunity than an anchor. You’re talking a loss of $400 million in internal efficiencies. The PC government’s promises probably stand to cost large brewers a half billion dollars as a conservative estimate.

The question craft brewers should be asking themselves is how to leverage that additional sales channel should it arise. There’s no guarantee that the PC government keeps their word on any of the promises they floated. They might be difficult to pull off administratively. It wouldn’t hurt to have a think about it, though. Maybe request the same 20% craft presence caveat that grocery ended up with. That would be an enormous amount of shelf space.