News Stories Highlight LDB Pricing and the Power of Lobbying

Two recent news stories highlight items that I have recently written about.

The first is a story by Vancouver lawyer, Tony Wilson: "Why BC's Liquor Board Gets Away With Complacency". This article explains why "minimum pricing" for liquor (referred to misleadingly as "social reference pricing" in BC) is a bad idea. It simply results in lost revenue for the government, a windfall for suppliers and price gouging for consumers. The Vancouver Province has also now picked up this story: LDB Overpays Suppliers to Keep Liquor Prices High

The second is a story in Wine Spectator: "In New York, Battle Over Wine in Groceries, Money Talks". This story details the efforts of New York's Governor to permit wine sales in grocery stores. Apparently, his plans were derailed by powerful lobbying from interest groups who liked the system (and the profits) just the way it is. Sound familiar?

BCGEU Deal Curbs Privatization Progress

A tentative deal between the BC Government and the BCGEU will likely put an end to any progress on the privatization of BC's liquor stores. The deal is for 2 years, expiring March 31, 2012. The agreement commits the government to keeping at least 185 of its existing 197 LDB stores open and for it to continue running its distribution system. A reduction of the 185 number is only possible if existing stores are consolidated into "signature stores" on a 2 for 1 basis.

The nature of the agreement means that it will be difficult for the government to reduce the cost of running the LDB (currently about $300 million per year). Taxpayers will now continue to be burdened with the costs and risks of running a retail liquor operation, thus ensuring that retail prices remain excessively high and selection is limited. The government will not be able to raise badly needed cash by selling off existing stores (as was done when Alberta privatized its system). When government does not have sufficient funds to properly fund health care and education, this is perplexing ... why would we continue to spend hundreds of millions of dollars annually to employ government workers as liquor store cashiers when we can't afford a sufficient number of teachers or nurses?

The winners in this are the BCGEU, some existing private retail stores who are shielded from competition by the current system, and the large commercial wineries that control the low end of the market (the "Cellared in Canada" product). Consumers and taxpayers will lose out as the government continues to foster a monopoly system which provides poor selection and which ensures some of the highest retail wine prices in the world. Smaller BC wineries will also lose out as they will continue to be denied access to a fair and accessible retail distribution system.

Regrettably, the Government has now missed an opportunity to transform BC's dysfunctional wine retail system into a model for the rest of Canada. Instead, we will be stuck with the status quo for at least another 2 years. That will make it difficult to solve the myriad of serious problems facing the industry. How will we fix the longstanding trade agreement problems with the distribution system which the EU and US are fuming about? How will we fix the inter-provincial shipping problems? Will the LDB finally create a level playing field and stop acting as wholesaler to both its own retail stores and the private stores with which it is in direct competition? How will the LDB meet its revenue target for next year (which is $100 million higher than this year's target) without increasing prices?

 

BCLDB Raises Minimum Price for Spirits

The BCLDB has announced that it is raising the minimum price at retail for spirits from $30.66 per litre to $31.66 per litre as of May 2nd. This means that the minimum retail price for a 750 ml bottle of spirits will go up from $23.00 to $23.75. Since the BCLDB sells about 25 million litres of spirits per year, this means that they will effectively be raising prices for BC consumers by $25 million. As you will note from my recent comment on the budget, the BCLDB is projected to miss its revenue target by $24 million for the current year ... so is this the way that they hope to get the money back?

Sadly the answer is no. While consumers will have to cough up the extra $25 million, the LDB will actually only realize a part of the increase and the government will get even less. The reason is that the LDB uses a fixed markup formula to establish retail prices: any price increase on the shelf will automatically result in an upward rise in the wholesale price paid to the supplier.

Here's an example. If you apply the fixed markup formula to a $23 bottle of spirits, the wholesale cost works out to be about $4.00 (yes, there is a stunning amount of tax). However, it is actually possible for the LDB to buy spirits cheaper than this. For example, they could buy vodka for about $3 a bottle which would work out to a retail price of about $18 once the formula is applied. But because of the minimum pricing policy, the supplier would simply "work backwards" from the minimum retail price using the fixed markup formula and increase the wholesale price to $4. As a result, the consumer will overpay and the government loses out on extra revenue. This is what will happen on this minimum pricing increase. Suppliers will work backwards from the new $23.75 minimum price and simply increase the wholesale price to the LDB so that the fixed formula generates the new price. The suppliers will get a windfall - the government will lose out on extra revenue - and consumers will overpay.

By the way, and from a policy perspective, this is why "minimum pricing policies" are a bad idea for any liquor products - wine, beer, or spirits.

Judge Criticizes Manitoba Wine Retail System

A recent judgment (Banville & Jones Wine Co. Inc. v. Manitoba Liquor Control Commission) from the Court of Queen's Bench in Manitoba deals with the difficult issue of the trade practices of a provincial liquor board when they act as wholesaler to both their own chain of retail liquor stores and to private retail wine stores. This judgment is the culmination of a long dispute between the private stores and the Manitoba Liquor Control Commission (MLCC) under which the private stores alleged that MLCC was acting in ways preferential to their own stores and which harmed the interests of the private stores. The judge described the dispute as "contentious" and introduced the dispute by commenting as follows:

Despite what was initially to be an operational relationship whereby the MLCC would facilitate a functioning co-existence with the private wine stores (and by extension, the variety and choice that would flow therefrom), the MLCC has instead chosen to compete head-on with the stores.  Complicating such competition is the fact that it takes place while the MLCC is simultaneously occupying, what is for the private wine stores, a suspicion-engendering position by which the MLCC regulates and controls significant aspects of how the MLCC’s competition is able to do business.  The resulting relationship is such that it produced from the arbitration panel, after having heard the evidence, the following clear and justifiable comment:

… This relationship, we think, has given rise to the problems which have led to the allegations in the Notice to Arbitrate and in the suspicions of the stand alone specialty wine store operators about the motives of the MLCC and, in particular, of Crawford.  It is, we believe, time to reconsider this relationship.

In the end, for technical reasons related to the applicable legal standard of review, the judge upheld an arbitration panel's award which favoured only one of the private stores' complaints. However, both the arbitration panel and the Court indicated strongly that an arrangement whereby a liquor board acts as wholesaler to both its own stores and to private stores should be avoided. At the conclusion of the judgment, the Court stated:

After having reviewed the entirety of the record, rife as it is with the undercurrent of animosity and examples of the contentiousness about which I wrote at the beginning of this judgment, I would be remiss if I did not make the following comments.

Although I have dismissed the [private stores'] appeal — largely on the basis of what I believe is a rigorous application of the appropriate standards of review — my determinations in that regard ought not to be seen as a judicial benediction of the conduct of the MLCC.  Although the members of the arbitration panel (unanimously or as a majority) variously made findings of fact and drew inferences to which I have deferred, there was, in the case of some of the allegations in the notice to arbitrate, evidence adduced that could have equally resulted in findings and inferences less favourable to the MLCC’s position.  I say that not for the purposes of second-guessing the arbitration panel (whose findings and inferences contained no palpable and overriding error), but rather to underscore its own conclusion that the time has come to revisit the relationship between the private wine stores and the MLCC. [emphasis added]

The judgment is interesting reading because it illustrates the formidable difficulties that private retail wine stores have when dealing with a wholesaler/supplier who is also their major competitor. At one point in the judgment, the court reviews evidence provided by the CEO of the MLCC whereby he candidly admits that the liquor board was surprised at the loss of business to the private stores and was unhappy about losing that business from its own retail stores.

Of course, the structural problems that exist in Manitoba also exist here in B.C. The private wine and liquor stores here must also obtain their product from the BCLDB which is their major competitor. As readers will know from my previous comments, I think it makes more sense for government to get out of the retail liquor business entirely. However, if government wants to stay in it to any extent, there should at least be a complete separation of the wholesale and retail aspects of the business so that the LDB's current conflict of interest is eliminated. While the Banville judgment is only a single precedent, it provides a useful view from the bench as to how judges might view these issues in the future. The message is sensible and fair: don't permit a government monopoly wholesaler to also act as a retailer if it is supplying private stores with which it's retail operations compete.

 

BC's Budget - Effects on Wine Industry

The Liberal government introduced its budget for 2010 yesterday. There wasn't too much mention of wine or liquor. However, there were a couple of interesting points which will likely have some consequences for the industry.

As was reported earlier, the government confirmed that the introduction of the HST is not intended to affect "shelf prices" on wine (or other liquor). This is significant because the combined sales tax rate on liquor (which is currently 10% PST and 5% GST = 15% total) will actually go down when the combined HST rate (7% PST + 5% GST = 12% total) is introduced in July. One might have hoped that this would result in a modest reduction in retail prices. However, given the government's current financial situation, this was wishful thinking. As a result, the government has indicated that it will adjust liquor markup rates to eliminate any price reduction.

Unfortunately, this is not easy to do in a uniform way because BC wine (i.e. real BC wine not CIC product) is either exempt from markup (if it is sold through direct delivery) or has reduced markup applied due to the operation of the VQA rebate (if it is sold in LDB stores). It remains to be seen how the LDB will tackle this but it seems likely that BC wineries will benefit from the introduction of the HST because the sales taxes will go down by 3% and it will not be possible to increase markup on direct delivery wines since they are markup exempt. Since the government is intending to keep overall revenue the same, the corresponding increase in markup rates will likely affect imported wines to a slightly greater degree than BC wine. For example, if total direct delivery sales are around $80 million annually, then the 3% sales tax loss would be about $2.5 million. That money would then have to be recouped through larger increases in markup on CIC product, BC product sold through LDB stores, and imported wine. While the numbers are not large, this may produce a small benefit for BC wineries and, conversely, may pour some more fuel on the trade issues problems that I outlined in my earlier article.

It was also noted in the budget that the LDB will miss its revenue target for government by $24 million this year (the new forecast is $872 million down from $896 million). However, for next year the budget indicates that the LDB will generate $974 million for government, a big increase of over $100 million from the current year. No indication is made of how they are hoping to do this ... guess we will have to wait and see.