WineLaw.ca

My apologies for the following rant which is really a summary of recent frustrations …

News from the BC Government, LCLB and LDB is showing that the lack of accountability and transparency in our retail wine distribution system is reaching unprecedented levels. Generally, it is assumed by the law that when government regulates in an area it is doing so in the public interest. However, the BC government\’s wine and liquor distribution system throws some serious doubt on this assumption. In fact, some recent actions of the BC government seem to show that there is inadequate consideration of the public interest in this area. Consider the following recent issues.

Minimum Shelf Prices. Most people aren\’t aware that the government imposes minimum prices for beer, wine and spirits in BC. The LDB recently increased the minimum shelf price for spirits in BC from $23 to $23.75. A couple of recent articles have showed how off base this policy is. Because the LDB uses a \”fixed markup formula\” for all of its products, any increase in the shelf price will simply result in the supplier increasing the wholesale price charged to the LDB. So all that happens is that the consumer overpays, the government loses out on tax revenue and the supplier gets a windfall profit. Zero benefit to consumers … nice profit for suppliers, minor benefit to the government/taxpayers (but with lost revenue).

Privatization Derailed. The recent deal between the BC government and the BCGEU has the government promising to keep operating nearly all government liquor stores as well as the wholesale distribution system. This comes at a cost to taxpayers of about $300 million per year. The government could have privatized some or all of the retail stores, saving itself tens or hundreds of millions of dollars in operating costs while maintaining all of its existing liquor tax revenue (which is applied at the wholesale level … so it doesn\’t matter whether the product gets sold in a government store, private store or bar/restaurant). In addition, the government could have sold the government stores to the private sector, likely netting itself a one-time windfall of hundreds of millions of dollars at a time when those funds are badly needed. Instead, the government decides to keep the status quo. Zero benefit to consumers & taxpayers, no help for smaller BC wineries trying to get better distribution … but a nice benefit to the BCGEU and some of the other players who like the system the way it is.

For an interesting insight into the inner workings of the liquor system and how your taxpayer dollars are being spent, you might wish to read either this summary or the full labour arbritration decision both of which relate to a 2005 LDB awards dinner where one employee got severely intoxicated, fell over as he was receiving his award and apparently heckled the Premier, the Minister and the Lieutenant-Governor (who were all present) using some rather inadvisable and colourful language. While this is obviously a case of \”one bad apple\”, it casts some light on the use of your taxpayer dollars. The LDB fired the employee afterwards … apparently at least partly because he had caused embarassment to the LDB at a time when they were trying to avoid privatization. The LDB lost an appeal by the union of the dismissal … and the \”over-refreshed\” employee was reinstated.

Increased Distance Separation for Private Liquor Stores. Most
people also aren\’t aware that the government has a legal prohibition
which prevents a new private liquor store from opening if there is
another private store close by. It\’s almost impossible to obtain a
retail liquor license in BC … so there\’s not a great deal of
competition anyway. But, the government has just increased the \”distance
separation\” so that the law prohibits any new stores within 1 km of an
existing store. So for example, if you are lucky enough to have an
existing private liquor store license, you are effectively
shielded from any new competitors within a 2 km radius. No allowance is
made for population density so if your license happens to be in a
densely populated area – lucky you, you get an exclusive right to that
area. As readers will know, I am an advocate of more privatization in
the wine business and many existing operators do an excellent job … but this
government policy is misguided. Since when is it a legitimate function
of government to prevent competition in any retail sector? Just imagine
if this logic was extended to other businesses – e.g. we\’ll make it
illegal for anyone to open another coffee shop within 1 km of yours
regardless of how many people live nearby. Nice perk if you could get
it! Zero benefit to consumers & taxpayers … preferential treatment
for existing store owners who are in densely populated areas.

Implementation of the HST Means Increases in Liquor Board Markup. Theoretically, the introduction of the HST at a combined rate of 12% would have meant a small reduction on the taxes on wine (which are currently 10% PST + 5% GST = 15% total). However, the government has decided that this can\’t be allowed so they have directed the LDB to INCREASE the already outrageous liquor board markups. So, for example, the markup on wine, which is currently 117% will go up to an even more absurd level. Once you add the liquor board markup, the sales taxes and various liquor board fees, you have combined tax and markup rates which approach 150%! And this is on wine, a product which is actually good for you when consumed as intended, in moderate amounts. By contrast, if I chug soda pop which is not good for me in any amount, I am currently not taxed by the BC government at all and will only be taxed at 12% after the HST is added. For complicated reasons (which you can read about here if you are interested), there may actually be a small benefit to BC wineries but there will be zero benefit to consumers and taxpayers.

The sum of all of this is obvious … in my view, the government is not paying sufficient attention to the public interest on important policy decisions which affect the wine industry and wine consumers. Most monopolies in Canada have historically had a corresponding regulator whose purpose it is to protect the public interest. However, Canada\’s liquor monopolies have never had this oversight … it\’s time for consumers and taxpayers to demand change.

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?

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?

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.

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.

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.

The wine industry trade publication, Wines & Vines, has just posted an excellent article on border trade issues: Canada\’s Wine Duties Hinder Trade. In my view, this is a serious problem which could cause difficulties for the BC wine industry in the short term. I have posted a related analysis which should highlight the issues, problems and potential consequences: BC Wine & Trade Agreement Trouble. I would be very interested to hear back from the industry on these issues.

Effective yesterday, February 15 2010, the BC LCLB has increased the distance separation requirement for new or transferring LRS licenses (licensee retail stores – i.e. the newer style private retail store license) from 500 meters to 1000 meters. This will make it more difficult for licensees to transfer store locations if there are other LRS stores in the vicinity. The policy rationale stated in the LCLB Policy Directive 10-02 is to \”provide greater market certainty for LRS operators and prevent further market saturation\”. It is true that existing operators will get \”greater market certainty\” because they are effectively being provided with a 2 km radius government shield from competition. It is likely that existing LRS store operators will be pleased as this makes it difficult if not impossible for competitors to open stores in the immediate vicinity of an existing store. This change may have been made to partly compensate LRS owners for a possible increase in competition resulting from the recent \”uncoupling\” of their licenses from the liquor-primary licenses (bars/pubs) with which they were previously associated. However, consumers are unlikely to be impressed as this policy further restricts selection and price competition. Government policy does not prevent cigarette vendors, fast food outlets or gas stations from opening close to each other … since when it is a \”core function of government\” to prevent competition in the retail liquor business?

Today\’s BC Throne Speech advocated freer trade between Canada\’s 3 western provinces as well as within the Pacific Northwest to Washington, Oregon and California. As you know, no industry is affected more adversely with artificial trade barriers than the wine industry. Wine still cannot be shipped from wineries direct to consumers in other Canadian provinces and any wine coming across the border is subject to unreasonably high liquor board markups and a glacially slow distribution system. Let\’s hope the BC government is serious about fixing these trade issues. In addition, the throne speech promises a sweeping review of various regulatory bodies such as transit and electricity. While liquor distribution was not specifically mentioned, perhaps it will also be included? After all, the LDB costs $300 million annually to run. That\’s a lot of cash that could be used for social programs.

Cash strapped state governments in the U.S. are also considering increased privatization of liquor retail in order to raise money to fight ballooning deficits. The basic argument is correct: government makes money from liquor retail by imposing taxes (or hidden taxes) at the wholesale level. Government involvement at the retail level is actually a drain on the wholesale revenue because the private sector can run retail operations more efficiently and less expensively than government can. This is true in B.C. and in most U.S. states with government involvement in retail. If government got out of the retail side, it would actually generate more money to fund social programs or fight deficits. Retail is simply not a \”core government service\”. Pretty basic economics really. No doubt there will be more to come on this issue.