Red Hook Ale - 30 ’ Redhook Ale Brewery Stephen E Bamdt P...

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Unformatted text preview: 30 ’ Redhook Ale Brewery Stephen E. Bamdt P aul Shipman, Chief Executive Officer of Redhook Ale Brewery, knew that he needed to reevaluate his strategy and its execution: Redhook’s rapid growth had ended shortly after ’ .it invested in a major increase in production capacity; Operating at about 50% of production capacity, the company-suffered a net loss in 1997'that continued into 1998. Redhook brewed only specialty beer, referred to as craft beer. Craft beer is a more flavor— ful, fuller bodied premium beer, follows traditional old world brewing methods, and uses high—quality materials. The company started as a microbrewery but grew continually and reached national status by the end of 1996. Shipman, one of Redhook’s founders, had guided the company from a small player in one city to a leading position as a national competitor and aimed at dominating the craft beer segment-of the domestic beer industry. The company’s three small—batch breweries, two in the Pacific Northwest and one in the Northeast, had a combined design capacity of 575,000 barrels (each containing 31 gallons) per year of Redhook branded beer to tap a growing market for craft beer. However, growth'in the craft beer market attracted attention, and competition grew from other microbreweries, brewpubs, regional specialty brewers, and from large mass-market brewers .'- With increased COmpetition, 1996 saw the beginning of a downturn with a reduction in sales and profitability. ' Company History Redhook was started in 1981 by Paul Shipman, with additional investment and assistance from Jerry Jones and Gordon Bowker. Shipman, 45, with an undergraduate degree in English from Bucknell and an MBA from the University of Virginia, had worked as a marketing ana— lyst for Chateau Ste. Michelle winery prior to starting up Redhook. Earlier, he had spent a year in Europe where he was introduced to high quality beer. Jerry Jones was an executive and consultant in the field of ski resort management. Gordon Bowker was also the founder of Starbucks Coffee Company and served Redhook as Vice President, Treasurer, and Secretary. Shipman started Redhook with a belief that US. consumers would respond well to a qual- ity European—style beer made with the best equipment and using the finest ingredients. The company’s initial brewing operations were carried out in a converted transmission shop in Seattle. The company did not have a bottling line and all beer that was brewed was packaged in This case Was prepared by Professor Stephen E. Barndt of Pacific Lutheran University. This case was edited for SMBP— 9th Edition. Copyright © 1998 and 2000 by Stephen E. Barndt. This case was published in the Business Case Journal Summer 1998,Vol. 1, No. 1, pp. 53—69. Reprinted by permission. 30-1 ‘ SECTlON C INDUSTRY NINE: BEVERAGE/FOOD 15.5 gallon kegs. First year production totaled 1,000 barrels and was sold to local taverns and restaurants for on—premises consumption. , Sales and production grew gradually through the mid 1980s. 'Redhook sold through its own distribution group and independent beer distributors. The first major increase in pro— duction occurred in 1989 when Redhook replaced its first brewery with a larger capacity, state-..- . of—the—art brewery located in a converted electric trolley barn in Seattle. In 1993, the company acquired land east of Seattle in the town of Woodinville where it constructed a much larger . brewery. The Woodinville brewery came on line in September 1994, with an initial capacity of 60,000 barrels per year. Sales remained primarily in the state of Washington but ranged throughOut the Pacific Northwest and California. Redhook consummated a long-term distribution agreement with Anheuser—Busch, the largest brewery in the United States, late in 1994. Opening the way for nationwide sales, the agreement enabled Redhook to market its products via Anheuser—Busch distributors seeking increased volume through a broader product line. As a result, Redhook was selling its beer in 48 states in 1998. ' Redhook constructed a new brewery near Portsmouth, New Hampshire, to better serve the eastern United States and lower transportation costs. The Portsmouth brewery came on line in late 1996 with an initial capacity of 100,000 barrels per year. To finance its rapid growth,lRedhook sold a 25% equity interest to AnheuserrBusch and, in 1995, sold 2,193,492‘ shares of stock in an initial'puzblic offering to end the year with 7,683,492 shares outstanding. . The Brewing Industry The U.S. brewing industry was both highly competitive and highly regulated. Several large and many small brewers competed for the $29 billion wholesale market using brand name, distri- bution _channel, or taste to attract consumers. The market consisted of three distinct segments—«national, imported, and craft beeps—each characterized by its own predominant marketing strategy;~Brewers participating in each of the segments were subject to various gov» ' ernment requiremengs in such areas as taxation; product safety, quality, and disclosure; and environmental protection. S ,V: -vq‘.._.¢muuau1‘l—Wflgm‘—a -,\. - anal-am A ' ' um m nun—“mud...r-‘uwwl—umm-u—owkflo-u-‘F JhfixgyfingfifgmuA‘:a;,f,1v:.-jvl‘:¢u NATIONAL BEERS ‘ The national beer segment was the largestby far and exhibited the highest degree of consoli- dation in the industry. The five largest brewers——Anheuser—Busch, Inc., Miller Brewing Company, Adolph Coors, Stroh Brewery, and Pabst-w—accounted for 93%r0f all the domestic beer sold in the United States in 1996.1 Anheuser-Busch was theleader with a 49%market share followed by Miller with 22%, and Coors with 10%. Competitors in this segment brewed large batches in breweries designed for high volume production. Beers brewed for the mass market substituted more com, rice, and other ingredi- ents in place of barley; they were pasteurized to lengthen shelf life, but were considered less flavorful than imported or craft beers. High volume, efficient production, and inexpensive raw- materials resulted in low product cost. The national brewers’ branded products were widely distributed. They favored extensive advertising to capture national recognition in some cases and regional recognition in others. Advertising media used included network TV, spot TV, spot radio, magazines, or sponsored events such as sports spectaculars. IMPORTED BEERS Imported beer played a relatively minor role in the total U.S. market with a 7.4% market share. Competitors in this segment distributed their products widely and catered to consumers who g desired a more flavorful beer.2 Bars, restaurants, and retailers selling bottled goods often car- t CASE THIRTY REDHOOK ALE BREWERY : ried one or more imported brands such as Becks, Corona, Heineken, Labatts, Moosehead, Guinness, and San Miguel. The majority of beers. imported-into the US. were bottled in Mexico, Europe, and Canada‘. Extent of advertising'varied from importer to importer but was generally intensive using such media as radio spots, print, and outdoor signage.‘ CRAFT BEERS Craft beer, with 2.9% of the beer market; was the newest growth segment of the industry.3 During the 19803 and 19905, ever increasing numbers of craft brewers both created and filled a demand for distinctive flavorful beers, using high-quality ingredients brewed with European-style recipes. Some craft beers featured flavors of fruit, honey, spices, oatmeal, Cof— fee, pumpkin, or other additives; _ The market was increasingly fragmented withi,306 craft brewers across the nation as of January 1998, up from 1,042, 803, and 540 at the end of 1996, 1995, and 1994, respectively.4 While the number of firms was continuing to grow, the craft beer market had reached a time in its development where total demand had ceased'to grow at double—digit rates. After grb'wth in demand of about 50% in 1994 and 1995, 1996 saw 225% growth, and, in 1997, total sales only increased 5%. ' - . There were four categories of brewers producing craft beer.Microbreweriesproduced less than 15,000 barrels per year and served limited markets, usually through independent distrib— utors and direct sales. Brewpubs were the smallest volume producers, usually brewing 2,500 barrels or less per year for consumption in the pub. Regional specialty brewers produced over 15,000 barrels per year and distributed through independent distributors both locally and in one or more regional markets. Contract brewers developed beer recipes and contracted with larger national or regional breweries, e.g., Strohs and Pittsburgh Brewing, for the actual brew- ing. Contract brewers usually marketed their branded beers regionally or nationally using independent distributors and their own advertising and promotion. In 1997, LIB-brewers each prbduced over 10,000 barrels of craft beer. Five contract brewers led by Boston Beer and Pete’s Brewing Company each produced 15,000 or more barrels. Twenty—five regional specialty brewers produced at least 15,000 barrels. Anbther 10 micro— brewies each produced betWeen 10,000 and 15,000 barrels. Boston Beer Company, Pete’s Brewing Company, Sierra Nevada Brewing Company, Redhook Ale BreWery, Pyramid Brewing Company, and Widmer Brewing Company all topped 100,000 barrels in 1997.6 The relative craft beer market shares among the top 10 craft brewers in 1996 are presented in Exhibit 1. Eilfifiit 1 ‘ fimBrmer Market Shares ' Source: Adapted from Sarah Theodore, “Domestic Specialty Suffers Growing Pains in ’97,” Beverage Industry, January 1993, pp. 9—18. L « SECTIONC INDUSTRY NINE: BEVERAGE/FOOD THE MARKET FOR BEER Adult per—capita consumption of beer declined from the early 1980s to about 30 gallons in 1997 as federal beer taxes were doubled, blue—collar jobs declined, health and fitness became fashion— able, and the population aged.7 This per—capita decline was offset by growth in the total adult population so total U.S. beer sales were relatively constant at between 185 and 190 million barrels per year. However, major differences existed among the 3 segments. Since 1995, sales of national brands declined about 5%, popular brands declined 9%; imported beer sales increased 25% to ‘ 14 million barrels; and craft beer sales increased 32% to 5.2 million barrels.8 Taste, demand for greater variety, and a “trading-up phenomenon” were offered as reasons for the continuing growth in demand for craft and imported beer.9 While craft beer sales were expected to continue growing, the rate of growth was expected to be lower as the market matured, and importers used larger advertising budgets and marketing skills to increase their share. :- A national survey found that beer consumers who drank craft beer were more likely to be young (less than 45 years of age), to be college educated, and to have above—average incomes (greater than $50,000)» Greater numbers of men than women were drawn to craft beer, although a greater share of beer—drinking women had an interest in craft beers than did beer~drinking men. Craft beer drinkers also tended to drink more than the average drinker. However, 80% of those who drank craft beer consumed less craft beer than other types of beenm'ln addition, there were regional differences in craft beer consumption. Craft beer was most popular in the West, followed by the Northeast and Midwest. While craft beer was most popular in the upscale segment of the population, it had seen increasing popular~ ity in middle-income households. This increased acceptance was reflected in a study that showed 19% of surveyed adults had tried craft beer in 1996, up from 13% a year earlier.11 COMPETITIVE PRACTICES Imported and craft beers were aimed at beer drinkers who sought prestige products and who desired superior flavor. However, a high level of substitutability existed among the three classes of beer. Consequently, national brand, import, and craft beer companies competed and attempted to get the beer drinking populace to switch to their types of beer and thus increase _ their market share. Imported and craft beers competed head to head since both were at the premium price, distinctive flavor end of the beer spectrum. The national brewers used extensive advertising, often through costly mass media. However, they faced the threat of restrictions on what, how, and where they could advertise as a result of political and news media concerns that drinking was harmful. They developed and relied on wide distribution through networks of wholesale distributors. These distribu- tors sought to saturate the market by placing their products in bars, restaurants, grocery stores, convenience stores, and other outlets. They provided regularly scheduled deliveries withsecured and stocked shelf space and rotated retailers’ inventory to insure freshness. Imported beers, with a much smaller market share, used selective targeted advertising and relied more on their distributors to push their higher margin product through on~site con- sumption and consumer retail channels. Distribution was the key for craft brewers as well, but actual methods of distribution varied depending on size of the company. For example, brew— pubs selling only for consumption in their own establishments, relied on creating a pleasant“ atmosphere, complementary foods, and the idea that the pub itself was something special. Many of the microbreWeries, regional specialty brewars, and contract brewers also had their own pubs and attempted to create a local identity using similar methods. Smaller microbrew- eries often distributed only kegged beer to local restaurants and bars and’tried to instill a local a pride in their premium beers. Larger microbreweries usually sold both kegged and bottled products by using independent distributors in a broader local or regional area. Across all craft brewers, the split between packaged (bottled) and draft (kegged) beer was 72 to 28%.12 CASE THIRTY REDHOOK ALE BREWERY Microbrewery advertising and promotion were limited and most often took the form of displays in drinking establishments; giveaways such as glasses, mugs, and coasters; and spon— sorship of concerts, festivals, or seasonal events. Most regional specialty breWers and contract brewers used the same distribution and promotion strategy as the large microbreweries. Boston Beer and Pete’s Brewing Company became the first exceptions when they introduced local TV advertising. Growth of the craft beer market was noted by the large national breWers and they entered the craft segment with their own specialty beer products. Anheuser—BuSCh sought to have 60%“ of the craft beer market by 200513” while Miller’s objective was 25% by 2000.14 Anheuser— Busch, Adolph Coors, Miller, and Strth all set up specialty units with separate staff to manage " their new brands.15 By the end of 1996, Miller and Strohs each had acquired control or an interest in two microbreWeries,..while Coors had one. Anheuser-Busch had a 25% interest in Redhook and distribution alliances with both Redhook and Widmer Brewing. Brand names offered by the majors included Augsburger, Blue Moon, Celis, Elk Mountain, George Killian, Icehouse, J. W Dundee, I. I. Wainwright, Jacob Leinenkugel, Michael Shea’s, Red Dog, Red River Valley, and Red Wolf. In most cases the brands were marketed under a name other than thew-controlling company’s name, e. g., Northern Plains Brewing (Strohs), Plank Road BreWery (Miller), and Blue Moon Brewing Company (Coors). In 1995 Anheuser-Busch alone had seven craft—type beers that sold 650,000 barrels.16 In addition, in 1996, Anheuser-Busch initi- ated a program to increaseits exclusive distributor force from 40% of the total Anheuser— Busch distributors to. 70%. This would reduce the incidence of competitors benefiting from the services of Anheuser-Busch distributors. While Anheuser—Busch could not use punitive l measures because they could be considered to be in restraint of trade, it could encourage "its distributors to voluntarily carry Anheuser—Busch products, including Redhook, exclusively. Incentives Were provided to reward this exclusive distribution. Some speculated that eventu— ally pressures would be placed on distributors to cause them to volunteer.” Miller and Coors also appeared to be interested in getting their distributors to devote more effort on their own spetialty beers and less on microbrewery beers.18 In addition to pressures from major national brewers on their distributors to reduce product lines to a narrower spectrum of selected brands, the sheer number of craft and other brands in the United States overwhelmed distributors. With about 4,500 brands and ever increasing numbers of craft brewers seeking to add their brands to the market, distributors... began to cull less popular brandsland restrict themselves to the higher volume brands for which they could reasonably expect to secure shelf space. . Growth was a widely sought goal among craft brewers. The large contract and regional spe- cialty brewers were moving toward national distribution. By 1996, Boston Beer had already reached all 50 states and Redhook sold in 47 states, Pete’s in 40 states, and Pyramid Brewing in 27 states. A number of microbreweries were operating more than one brewery and several brewpubs hadstarted chains. Starting in 1995, seven of the largest craft brewers went public or announced a public offering to raise funds for growth; these included Boston Beer, Brandevor Enterprises, Pyramid Breweries, Pete’s Brewing, Portland Brewing Company, Redhook, and Widmer Brewing. Redhook’s Objective and Business Strategy Redhook had set an objective to be the leading craft brewer through market development into unserved regions of the nation and continued market penetration once established in a V region. The company articulated a business strategy in its 1995 annual report and prospectus with six key elements: 1. Production of high—quality craft beers 2. Control of production in company~owned breweries SECTION c INDUSTRY NINE: BEVERAGE/FOOD 3. Operation of regibnal brewing facilities 4. Production economies through technologically advanced equipment 5. Strategic distribution alliance with Anheuser~Busch 6. Promotion of products within local markets19 Products and Production Distribution Redhook did not pasteurize its craft beers: Not pasteurizing ensured that the flavor was not degraded, but it reduced shelf life to about three months. I In 1997, Redhook produced nine different branded products and from time to time pro- duced small batches of experimental brews that it test marketed under its Redhook Blueline label. These products were brewed and packaged in both kegs and bottles at its own operating breweries. The Fremont brewery in Seattle had a capacity of 75,000 barrels per years-The brew— ery was installed in an old trolley car barn under a lease with an option to buy. The company also owned and leased adjacent properties for kegging, warehousing, and other uses. This brewery was temporarily closed early in 1998. The Woodinville, Washington, brewery, con- structed on 22 acres owned by the company, started with a capacity of 60,000 barrels, reached 170,000 barrels in 1995, and 250,000 in 1996. The Portsmouth, New Hampshire,-brewery con- structed on 23 acres of subleased land started with a capacity of 100,000 barrels to’ be ‘ increased in stages to 250,000. Portsmouth was chosen as a site because of its central location in a large market and the high cost of transporting kegged and bottled beer from the Northwest. Only the highest quality malts, grains, hops, and other ingredients were purchased from a few regular suppliers at competitive prices. Alternative sources were available, if needed. The ingredients were processed in state—of—the-art automated brewing equipment designed in Europe for efficient production of small batches. The bottling line was fully integrated and automated with fast changeover capability. . As a producer of premium craft beers, Redhook emphasized quality in product formula— tion, brewing, and bottling. Eac...
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