Strategy

The Audacity of Hops

In the burgeoning, hypercompetitive craft-beer market, a small brewer needs a growth strategy with an edge.
David RosenbaumSeptember 11, 2012

Craft beer is often defined by what it’s not. It’s not mass-produced. It’s rarely a low-alcohol light lager, like Budweiser or Coors. A craft brewer makes less than 6 million barrels a year (a barrel contains 31 gallons; Anheuser Busch, by contrast, shipped 97.9 million barrels of beer in the United States in 2011), and the vast majority produce significantly fewer. But craft beer is big business: American consumers spent an estimated $8.7 billion on craft beer in 2011, up from $7.6 billion in 2010. And the craft industry is growing rapidly. According to the Brewer’s Assn., it grew last year 13% by volume and 15% by revenue.

To succeed in such a dynamic market, Boston Beer Co. founder and chairman Jim Koch, maker of Samuel Adams, among the most recognizable craft-type beers, told CFO that young brewers should focus on quality and build “your distribution organically so you can manage the growth without needing to create infrastructure (read overhead and rent).” Following his own advice to avoid rent, last year 100% of Sam Adams was produced in company-owned breweries. In 2007 that figure was just 35%. According to Brewers Assn. director Paul Gatza, the decision to transform itself from a contract brand (brewed by third parties) to an in-house brewer was key to allowing Boston Beer to grow “from a small brewer no one wanted to work with” to one that this year reported second-quarter net revenue of $147.5 million (a 10% increase over last year’s second quarter). Those breweries and the capability they give the company to experiment while bringing new efficiencies to operations are Boston Beer’s edge.

But few craft brewers have the cash, or access to it, to buy a brewery. They need to find other edges.

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Somerville Brewing: The Marketing Edge
At its peak in the mid-2000s, Boston-based Silverscape, a digital marketing agency owned by Jeff Leiter and his wife Caitlin Jewell, had 18 full-time employees and several part-time consultants building web sites for businesses and providing marketing applications. The company was billing $1.6 million a year. But Leiter wasn’t happy.

“We were taking on work to pay the rent,” says Leiter, wearing shorts, a T-shirt, and rubber boots in the 350 square foot nano-brewery he set up next to his home in Somerville, Massachusetts. He was checking the temperature of a test batch of mash that next month will become Somerville Brewing Co.’s Slumbrew Attic & Eaves, a toasted brown ale. “The rent was over $90,000 a year,” Leiter continues, and renting parking spots added another $9,600 in overhead. “We needed to take on every opportunity whether we liked it or not to meet payroll. And clients were demanding more for less.”

Then Silverscape’s lease came up for renewal and Leiter asked Jewell, “Do we really want to be doing this?”

The answer was no. They didn’t love Silverscape. They did, however, love craft beer. Leiter had been brewing beer for years in his basement, lubricating regular Friday night parties for ever-increasing and grateful numbers of friends. They traveled the country as beer tourists: visiting breweries, learning about beers and the beer business. So instead of renewing their lease, they moved Silverscape to smaller offices in Somerville (affectionately nicknamed “Slumerville”), scaled back to four full-time employees, started turning down work, and began applying their marketing expertise — their edge — to promoting their beer, Slumbrew. By becoming a brewer, “We could have thousands of customers instead of 100, and build our own brand instead of someone else’s,” says Leiter.

Slumbrew produced 205 barrels in 2011 at Mercury Brewing in Ipswich, Massachusetts. This year, Leiter says, they’re aiming to make 2,000. “This is not a hobby,” he says. “In the past 10 months, we’ve gone from unknown to solid distribution around the state.” Based on revenue for the last three months of 2011, and extrapolating for four full quarters in 2012, Leiter projects revenue growth of 133% this year. He’s shooting for 13 to 14 times growth over the next six to seven years “to finance our ongoing growth, pay a return to our investors, and make the business self-sufficient.”

When people speak of Slumbrew, they usually mention its handsome label, featuring a silhouette of a flag waving atop the turret of Somerville’s armory, designed, of course, at Silverscape. And when people chat about Slumbrew, they’re usually chatting on Facebook.

Jewell buys paid ads on Facebook. “Facebook is the new Internet,” she says. “Facebook is critical for our demographic. People search Facebook. They live on Facebook. They’re checking Facebook five to six times a day.”

According to David Decker, president of Consumer Edge Insight, a market research and consulting firm, people who drink a craft brew at least once a week “skew to ages 21–27.” Jewell knows that demographic. “Thursday nights are hunting nights,” she says, when guys and gals go out to look for dates. Those are the nights the bars and clubs are busiest, the nights when Slumbrew has to make its presence felt. “Friday and Saturday nights are for dates.”

Leiter and Jewell’s marketing expertise was important to Michael Gonnerman, who sits on Somerville Brewing’s board and serves as its part-time CFO. Leiter calls him his “financial guru.”

“The knowledge of social marketing is critical,” says Gonnerman, who admits he knows very little about Facebook. What he knows, with 44 years of experience as a consultant, CFO, and auditor, is finance.

“Jeff and Caitlin have high aspirations in a highly competitive space. Sales were up 10 times this year. I don’t think they’ll be 10 times next year, but they’ll be good. And investors will view that as a significant way to get return on investment,” says Gonnerman. But to get ongoing investment to support the growth Leiter and Jewell envision, “the founders will have to justify significant top-line growth. How does one do that? Not by putting up a billboard. Social networking.”

And although high sales are nice, Gonnerman says, it will take more than that to grow. “In addition to beer, part of the revenue stream should come from ancillary goods: T-shirts, glassware.” Fortunately, Jewell and Leiter have a dedicated design firm that can help them develop those revenue streams.

Leiter dreams of building a brewery in Somerville, and making it “a destination, a tasting room, where we can sell merchandize — beer, T-shirts, mugs — and make smaller, more unique batches without worrying about getting on Mercury Brewing’s production schedule.”

More immediately, he hopes he and his wife can begin drawing a salary from Slumbrew.

Maybe next year.

Mercury Brewing: The Facility Edge
The flies were thick in the office Mercury Brewing Co. owner and president Rob Martin shares with several other people inside the unlovely 8,000 square foot tin-roofed brewery in Ipswich, Massachusetts, where he makes his own Ipswich Ale (22,000 barrels last year) and between 12 and 15 other craft beers on contract for other brewers. That means Mercury Brewing makes the beer and charges the brewer a fee that includes ingredients, labor, excise taxes, and Mercury’s 10% margin.

The brewery opened in 1991, and Martin began working there for free in 1994. A year later, he was hired to drive the delivery truck. But by November 1998, says Martin, the brewery’s owners had run the business into the ground. They laid off everybody except Martin because he could brew, drive the truck, and chat up the retailers.

Two months later, in January 1999, Martin, then 31, offered to buy the brewery. He got a Small Business Administration loan, raised money from friends, and bought the brewery, lock, stock, and barrels, for $293,000. His first-year revenue was $300,000. Now he says annual revenues are $6 million, or 2,000% revenue growth over 12 years. And late this fall he plans to move operations to a new facility he’s building in Ipswich. It will be 36,000 square feet, and on “day one,” he says, “it will double our brewing capacity.” The new brewery will feature a “high-end” restaurant, and Martin will also have his own office . . . without flies.

The new brewery cost Martin $5 million to create out of an abandoned clam-processing plant. Beyond increasing capacity, he’s banking on the restaurant to generate a new and higher-margin revenue stream. As a brewer, Martin shoots for a 10% margin. The margin for wholesalers, the people who distribute beer to retailers (stores, restaurants, and bars), is about 30%. Retailers, says, Martin, make about 35%. But a bar or restaurant. . . .

“A bar pays about $145 for a keg,” says Martin. “There are 140 pints in a keg. If you sell each pint for $4 or $5, that’s about a 400% margin on each keg. Now . . . ask me again why we’re going to have a restaurant in our new brewery.”

Martin says he tries to dissuade people who come to him to brew their beer. “The perception is that it’s cool. Then come the problems. People have other jobs, other lives. You’ve got to work hard to support a brand. The last thing I want,” he concludes, “is a lot of beer I can’t move.”

But Martin took on Slumbrew because he recognized Leiter and Jewell’s “passion.” “Passion is important,” Martin says. “Serious is important. Capital is nice.” Slumbrew, says Martin, is doing well. “I like the product; the imagery of the label is really good. It stands out. The label is very important, especially on a 22 oz. bottle,” the favorite size among craft brewers because it’s the most distinctive and profitable.

Martin does not believe, however, that Slumbrew’s future lies in brewing its own beer. “It’s a question of scale,” he says. He thinks Slumbrew’s potential market will never be large enough to justify the capital investment, or operating expense, of owning its own brewery. “As the beer market evolves, there are more products,” says Martin, and, consequently, more competition. “We sell a little Ipswich in Chicago, but we have the same problem as Slumbrew: we’re tied to a place. Ultimately, Slumbrew will see that 90% of its sales will come from within 10 miles of Somerville, just as 90% of Ipswich Ale’s comes from the North Shore, within 60 miles of here.”

And Martin foresees increased competition driving down prices and margins. Rumor has it that Sierra Nevada, along with Samuel Adams a dominant force in the craft-beer business, is contemplating coming out with a 22 oz. bottle for $2.99 instead of the usual $6.99–$9.99 and up. A price war, says Martin, would be bad for everybody. But as he contemplates his new brewery, ringed with raised beds of perfumed hops, the late summer sun is shining and Martin knows his new facility will provide him with an edge.

Clown Shoes Beer: The Distribution Edge
Gregg Berman, whose Clown Shoes beer line includes Happy Feet, Tramp Stamp, and Vampire Slayer, works the comic side of the street when marketing his craft beers, but there’s nothing whimsical about his business strategy. Indeed, one of the reasons Clown Shoes produces so many varieties (there are 16 beers listed on its web site) is that the craft-beer audience is young and restless. According to a survey by Consumer Edge Insight, 68% cite “new brands/flavors” as their main reason for drinking more craft beer.

“Diversity gives us more power to sell more Clown Shoes,” says Berman, who will produce between 7,000 and 8,000 barrels this year and hopes to do 20,000 barrels next. Berman also sees the proliferation of Clown Shoes labels as a way of mitigating risk. “I don’t like single points of failure,” he says.

Berman grew up in the business. His great-great-grandfather drove a truck, selling meat door-to-door; his grandfather opened a grocery store. After Prohibition, his family obtained a liquor license from a local politician grateful that during the Depression the Berman grocery extended credit to needy families. Berman’s father started Arborway Imports wine and beer distribution in 1990. Today, his family owns Berman’s Wines and Spirits in Lexington, Massachusetts, where Berman worked as manager, and where “there’s a little shrine to Clown Shoes in the store.”

Berman was running Arborway, learning about importing, distribution, and sales. But it was “not exciting.” He thought it would be cool to have a beer, and in 2009 went to Mercury Brewing with an idea for a “hoppy, California-style beer.” The brewmaster at Mercury came up with a recipe; Berman came up with the name Clown Shoes, and he was in business, not only making beer but also distributing it through Pipeline Distribution, which he founded as a branch of Arborway in 2010. (Pipeline also distributes Ipswich Ale, Slumbrew, and Three Heads, a New York–based craft brewer.)

Using Pipeline as Clown Shoe’s distributor gives Berman an edge. It helped minimize his beer’s start-up costs, and, he says, Clown Shoes made “money out of the gate. Our first batch of Clown Shoes at Mercury cost me $9,000, including labels, and we turned it into roughly $14,000.”

Controlling his own distribution helps Berman avoid the wholesaler’s 30% margin, and ensures that the salespeople will push Clown Shoes. This is a problem for craft beers: distributors are also selling Budweiser and Coors. “There’s no question that having a dedicated distribution sales force is the only way to get consistent, undivided attention when [the craft brewer] calls on accounts,” says Consumer Edge Insight’s Decker. “It’s certainly a go-to-market advantage.” Or, as Mercury’s Martin says, if you’re a salesperson and you can “drop 50 cases of Bud in five seconds, or spend five minutes talking about Slumbrew, what will the salesman do?”

Berman says he’s not looking to build his own brewery (“That’s a whole new set of headaches.”). But he foresees a future where he’ll need a compliance expert to manage state-by-state licensing requirements, regional reps for the areas in which he hopes to expand, and a data-entry person to keep track of his growing business.

Berman is about to come out with a new beer called Third Party Candidate. “It’s a beer for the election season,” he says. He plans to brew 1,000 cases, sell them fast, and move on.

“When you think you have the best of it,” says Berman, explaining his business philosophy (which he developed playing poker), “be aggressive and never let up. Push every perceived advantage to the limit and maybe beyond.”

In other words, find an edge and leverage it to the hilt.