Short Cases / Discussion Memo - Business Strategy

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A -B InBev Explores Consolidating Distribution Network

JUNE 24 , 2009 , 8:15 A.M. ET

By David Kesmodel

Anheuser-Busch InBev NV is looking into consolidating its network of independent U.S. beer distributors—perhaps by

owning many more distributors itself—according to an analyst report that represents a potential blow for the beer

titan's roughly 600 distributors.

Management at the maker of Budweiser and Stella Artois is studying the concept of someday selling as much as 50% o f

its U.S. beer volume directly to retailers through its own distributors, up from 7% today, according to the report

Wednesday by Melissa Earlam, a UBS analyst who recently met with company leaders.

Such a move would allow Anheuser, the world's largest brewer by sales, to lower its costs and grab gross margins

currently flowing to distributors. Even if the brewer doesn't pursue that path, the threat of such a shift could compel

more of its independent distributors to merge, which would help lower the brewer's costs, Ms. Earlam wrote.

"At the least, we believe this is a powerful negotiating tool with distributors," she said.

The report marks the first serious indication that the Leuven, Belgium-based brewer intends to put the squeeze on its

distribution network to improve its own profitability. Potentially billions of dollars currently flowing to distributors

could be at stake.

InBe v rapidly has reduced costs at Anheuser since acquiring the company for $52 billion last fall. But its distributors

so far mostly have been spared the knife.

In the U.S., the vast majority of alcohol products are sold through distributors under a complex regulatory system

erected after the repeal of Prohibition. State laws generally require that makers of alcoholic beverages sell them to

distributors, which mark up the prices and ship the products to bars and stores, which then sell them to consumers.

Anheuser today has 13 distributors of its own in cities such as New York, Denver and San Diego, and could seek to

acquire more of them as opportunities arose. But such ownership isn't permitted in some states. Also, existing

distributors enjoy certain legal and contractual protections that can make it difficult for alcohol producers to replace

them.

Some retailers and producers have gone to court to challenge the so-called three-tier system in recent years, seeking to

cut out distributors and conduct sales directly from suppliers to consumers or suppliers to retailers. Some efforts, most

notably in the wine industry, have been successful, but in many cases courts have upheld state laws that require sales

to go through distributors.

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The UBS report suggests Anheuser intends to work within the existing regulatory system—rather than challenging it—

to explore consolidation. "At the time of the A-B acquisition ... ABI had thought that 20% direct distribution was

possible in the U.S. market," Ms. Earlam wrote. "ABI now believes in theory 50% of volumes could ultimately be sold

through direct distribution."

The brewer's chief rival, MillerCoors LLC, has pushed for consolidation among its distributors since SABMiller PLC

and Molson Coors Brewing Co. combined their U.S. units to form the joint venture last year. However, it hasn't tried to

buy distributors itself. The process has sparked controversy and a number of lawsuits by distributors, but has resulted

in a more consolidated network.

MillerCoors's distribution network is more streamlined than Anheuser's. For instance, in Indiana, Anheuser works

with 20 distributors, while MillerCoors works with two.

Some industry observers, such as Credit Suisse analyst Carlos Laboy, have predicted that Anheuser eventually would

try to overhaul its distribution model in the U.S. "Wake up and smell the coffee," Mr. Laboy told distributors at

industry newsletter Beer Business Daily's annual conference earlier this year. "There are many family firms who have

misestimated their vulnerability to ABI's wealth-creation agenda."

The beer company dramatically reduced its number of independent distributors in Brazil over the years, although that

country lacked so-called franchise laws that protect many U.S. distributors from being jettisoned arbitrarily by beer

makers.

Anheuser is working on slashing debt incurred from the deal that combined Brazil's largest brewer with the dominant

U.S. producer. Anheuser recently agreed to sell its Korean unit for $1.8 billion, among other asset sales.

W rite to David Kesmodel at [email protected]

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