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New Brewing Equipment Entering Hanger 24 Brewery as part of their
expansion earlier this year. (Photo from Hanger 24 press release) |
A bubble brought me to California. It was the year 2000 and fiber optic networks were all the rage. I moved from Detroit to take a job selling optical test equipment to companies making fiber optic components to build up all those high speed fiber optic networks. Problem was, the world was pretty much drowning in a glut high bandwidth communications. There were too many companies selling optical components for the few fiber optic networks being built. Lots of high flying companies run by really smart people failed. I survived a couple layoffs while my company transitioned to other markets. Less than ten years later, I witnessed a similar bubble in the solar panel industry, where once again, demand for a product was growing but way too many firms entered the solar panel market and most were not be profitable.
Usually when bubbles occur, a bunch of smart people say complex things using big words, sounding very deep and philosophical. But in reality, the nature of industrial bubbles are pretty simple. Way too much supply come online and there's not enough demand for most of the suppliers to be profitable. The key thing to remember about bubbles is this:
Bubbles often occur even as demand rises dramatically. Many firms jump into the market to cash in on this rapid growth, and even though the market is growing, it simply can't support all the new entrants. Plenty of companies full of smart, talented and hardworking people with great products still fail spectacularly.
So with lots of new craft breweries forming and with existing breweries expanding capacity, there's been plenty of speculation about whether the craft brewing industry is headed for a bubble. If it is, plenty of great breweries making good beer with good business plans will go bust. Such is the unfortunate nature of bubbles.
I've read a number of interesting speculations on a craft beer bubble which has inspired me to take a closer measure of the issue. If you bare with me, I'm going to use a little math the investigate the whole bubble question. Don't worry, it'll be just some simple addition, subtraction and multiplication that hopefully I'll make clear enough along the way.
To get right to the punch line, some straight forward "back of the envelope" calculations suggests tough going ahead for craft breweries even under fairly optimistic conditions. We appear to be coming to a point where too many breweries are producing far more beer than the marketplace can absorb. While there will still be room for small breweries and brewpubs producing less than 1,000 barrels a year, there will be increasing pressure for larger breweries to remain profitable with so much excess capacity coming online that can't all be sold in the marketplace.
This matters because breweries can't sell enough beer, or need to heavily discount their pricing due to the excessive supply, they will struggle to pay off the loans most of them have on their books. Breweries require large capital equipment costs, and most new breweries operate under some form of financing. Of course, they also need to pay for operating expenses like payroll, materials, and rent.
Let's delve into the numbers that cause me to reach for this conclusion, starting with the demand side of things.
Demand
Everyone knows the recent growth of craft beer is nothing short of remarkable. The latest release by the Brewer's Association
cited an estimate of 7.3 million barrels of craft beer sold in the first half of 2013, a growth of 15% over the previous year. Recent growth rates of 10-15% in the craft beer industry recently are pretty common. And the good news is that since craft beer is only about 10% of the beer currently produced, the 15% growth level can compound for quite some time before the beer industry output by volume is produced by a majority of craft breweries..
Whether or not this 15% growth is sustainable for the next few years is an open question based on other factors such as market penetration, changing customer preferences, distribution systems and current demographics. Of course, if this growth rate settles down to a more modest 10%, the compounded demand will slow considerably. Just take that 7.3 million barrel figure for the first half of 2013, or 14.6 million sold annually. If the current rate of growth stays at 15%, that means 16.8 million barrels will be sold in 2014, or 2.2 million additional barrels. But if the growth rate slows instead to 10%, then instead only 16.1 million barrels will be sold, or 0.7 million barrels less than with 15% growth. I'm going to use the current 15% growth rate in my analysis, even though it may be optimistic to expect the craft beer industry to continue this torrid rate of growth with a mature product.
Year Additional Barrels over 2013, 10% Growth Additional Barrels over 2013, 15% Growth
2014 1,500,000 2,200,000
2015 3,100,000 4,700,000
The Supply Question
In addition to numerous new breweries in the works, plenty of existing breweries have announced expansion plans or in some cases have announced building second breweries. So to look at the Supply side of the craft beer bubble question, let's look at both expansion plans of craft breweries couple with reasonable expectations of the output of all these new breweries.
Supply Due to Increased Capacity of Existing Breweries
Through a simple search of press releases online, I count approximately 2,800,000 barrels of brewing capacity available to come online between 2013-2015 by some of the largest craft brewers listed below.
Brewery Estimated Increased Output in barrels
Sierra Nevada 300,000 (2nd brewery to be operational early 2014)
New Belgium 400,000 (2nd brewery to operational late 2014/early 2105)
Deschutes 115,000 (Expandable to another 100,000)
Lagunitas 600,000 (2nd brewery operation in late 2013)
Bell's Brewing 300,000 (Additional capacity for expansion completed in 2012)
Boulevard Brewing 400,000 (Additional capacity from 2006 expansion)
Dogfish Head 100,000 (Estimated growth in two years from 2013 expansion)
Anchor Brewing 500,000 (2nd brewery to begin construction 2014)
It should be also noted the Craft Beer Alliance, technically not a "Craft Brewery" due to a substantial ownership by Anheuser-Busch added
140,00 barrels of capacity in the last year. Furthermore, another one of those pesky
"crafty" breweries, Goose Island has transferred much of their production to larger Anheuser-Busch facilities
as part of a nationwide roll-out so we should expect at least a few extra hundred thousand barrels of capacity a year as part of that development. Of course, Blue Moon is still out there,
selling more beer than the entire craft brewing industry. Since I'm using Brewer's Association data, I can't really include these breweries defined as non-craft in the analysis, but needless to say, these breweries are also capitalizing on changes in the beer market and certainly aren't making it any easier for a new enterprising craft brewery.
Given the steady drumbeat of press releases announcing brewery expansions and new distribution deals, it seems pretty plausible the 1,300 remaining micro and regional breweries as defined by the Brewers Association, each add an average of 920 extra barrels each of brewing capacity meaning another additional 1,200,000 barrels of capacity is coming online. I'm excluding the brewpubs from the equation as we don't normally expect them to expand their operations much. (Of course, some brewpubs do make the leap into retail sales often requiring expanded operations, but I'll set these expansions aside to simplify things.)
Supply Due to New Breweries
According to Brewers Association, another
1,605 breweries are in the planning stages. If existing breweries will bring an estimated 4,000,000 barrels of beer online in the next two years, how much room is left in the marketplace for these new breweries? If the growth of craft beer declines to 10% growth, it's looking a bit grim for all these new breweries, since existing craft breweries have enough extra capacity to supply 900,000 more barrels of beer that will be demanded in 2015 at 10% compounded growth.
Suppose for the next two years, it's full steam ahead and growth continues at 15%. By the end of 2015, all 1,605 of these new breweries will fight over the remaining 700,000, a mere 436 barrels per brewery. That's the yearly output of a small brewpub. Since roughly half of the current number of craft breweries are defined as brewpubs that should be fine for many of them. For the other half aspiring to be a successful microbrewery or regional brewery, their 436 barrel per year share is likely to be way too low to be profitable. The craft brewing industry makes about $850 in revenue per barrel of beer, so 436 barrels translates to $370,000, ost likely insufficient to support a stand alone brewery. A brewery this size could exist through contract brewing.
Yes, it's possible that the growth of craft beer could further accelerate to 20% growth but that would be highly unprecedented. Call me a pessimist, but 10% growth next year seems much more realistic than 20% growth. Don't forget, the assumptions above are all based on what I think is a reasonably conservative 4,000,000 barrels of capacity coming online by existing breweries and recent expansions by the Craft Brew Alliance and Goose Island have been left out of the analysis. Even under the rosiest scenario, we see that a lot of breweries are clearly going to be under considerable pressure to stay in business and a number of them will probably fail.
Final Thoughts
How many breweries will fail? There's not enough precision in the numbers to make that sort of prediction. However, lots of people make bold predictions all the time while totally ignorant of the relevant data, so why should that stop me?
I predict starting next year, life starts getting pretty difficult when Sierra Nevada's and Lagunitas's new breweries come online, Boulevard Brewing and Dogfish Head continues their expansions, and Goose Island's national roll out is in full swing. The current failure rate of craft breweries is 1-2%. It's reasonable to expect this number to grow to 5-10% starting in 2014, which means 100-200 breweries will close per year. Given the chumminess of the industry, I expect smaller breweries to join forces in the face of tough business climate and some brewery consolidation to occur. In addition, I expect some breweries founded with aspirations of becoming 50,000+ barrel operations will find themselves stuck struggling to barely keep afloat selling 2,000-3,000 barrels each year and fold up their tents for greener pastures. Things could turn into a blood bath, with failure rates as high as 25%, but more likely, the industry will go through a difficult 2-3 year correction as the weaker players are weeded out, and then things stabilize. That's my best guess.
On a personal level, I have friends and acquaintances who work for, or in some cases founded craft breweries in the past couple years. They are all smart, hard working experienced professionals who are passionate about making great beer. It gives me no joy to realize they will have an increasingly tough time staying profitable, may fall well short of their ambitions, and run an increasing risk of complete failure. I also sense the normally cheerful craft brewing community is in a bit of denial over what many perceives as coming.
To end things on a more optimistic note, for decades craft beer has been about home brewers turned businessmen launching carefully aimed rocks at brewing Goliaths. Those days have ended. While I anticipate a difficult period ahead, what will likely emerge is a varied mosaic of breweries across the United States, with large national and multinational firms competing against stronger regional and microbreweries. Plenty of unique brewpubs will be found sprinkled throughout the landscape. There will always be room for another brewery doing innovative and creative things, as long as they are willing to keep things small. The brewing industry will emerge as colorful and vibrant as ever.
The latest news bits with a more autistic emphasis than times past.......
