Wednesday, April 14, 2010

Beeronomics & Econ 101: Economies of Scale

Over at the Beervana Blog, Jeff Alworth notes (and photos) a new set of tanks being delivered to Coalition Brewery near his house.  To the economist in me this picture says one thing: economies of scale.

Economies of scale simply refer to any productive activity whose average costs decrease with output.  In many cases this is due to large fixed costs - those costs that do not depend on the quantity of the output.  Take this brewhouse for example: the cost of these tanks will be the same if they brew no beer or if they brew to capacity.  Alex at Upright, for example, has a beautiful brewhouse but is only brewing at about 60% capacity - if memory serves.  So if Upright brews more, the average cost of the beer they brew will go down - the fixed cost will be spread across more beer.  Since breweries require a lot of large scale equipment, it is an industry prone to economies of scale. There are other sources of economies of scale that are relevant to the beer industry as well: bottling, distributing and marketing to name three.

The implications of economies of scale have been discussed here at length, but the main one is a tendency for such an industry to be prone to concentration.  It is no accident that the big macrobrewers have become bigger and bigger through acquisitions and mergers.  [I have noted in a previous post how the fact that craft brew is an artisanal product and an experience good creates a countervailing force for small scale brewers to exploit]

The good news for Portland and Oregon craft brewers is that, like these internal economies of scale (that depend on the firm's activity alone), external economies of scale exist.  For example, with a lot of local craft brewers there is more demand for ingredients.  This high demand allows farmers and other input providers to achieve their own economies of scale, promotes competition and allows for efficiency in distribution of inputs.  So it is likely that inputs costs are low in Portland and Oregon not just because of proximity to the growers but because of all the brewing that goes on in Oregon.  [There is also a demand side effect, but that is a topic for another day]

So this external economies of scale is a pretty groovy story: the more local craft brewers brew, the lower are the costs for their fellow brewers.  Once again we see that competitors can also help each other out - even unintentionally.  For an industry that is remarkable for its sense of community and fellowship, this shows that they are not just deluded hippies - they are also savvy businesspeople.


Dann Cutter said...

I think an interesting side effect of this is the discounted growth allowance of some of the successful brewers over the 'deaths' of some of these transitional brewers. A subject you've hinted at, if not stated outright, in previous blogs.

I've been looking into costs of scale expansion recently, and there is a clear advantage to picking over the remains of those without a stable financial core... regretfully, a great example may be the future of the heavy growth of the new Oregon golden child Ninkasi. They are growing at a substantial accelerated pace, with a good product, but one must assume that a lot of this infrastructure growth is debt driven presuming acceptance and continued expansion of product at a high growth rate. However, unlike some other brewers which have branched into the brewpub venue, they have yet to clearly establish a 'backup' revenue source.

This may be fine, and not having an understanding of their financial picture, that may not be a concern, however they may prove a similar example to those brewers who came out strong in the mid 90s before the expansion leveled off, and they got caught needing growth that was not longer available.

However, my point is more to their facilities. These type of quickly growing entities are often the scraps that the more astute long term brewers tend to use to continue to slowly expand their base operations. It is worth noting that the biggies tend not to be big due to huge infrastructural expansion, but by slow and steady production ramp up while reinforcing with secondary profit centers.

ElGordo said...

I once wrote a paper for an economic sociology class about the consolidation of the American brewing industry during the post-war era. Of course, that centered on the commodity-style macrobrewers and would have little relevance here. Still, one of my main sources for that paper provides an interesting view from an economist's perspective. Check out the book "Beer Blast" by Philip van Munching.

Kari Chisholm said...

Of course, as you allude, the opportunities of economies-of-scale lead to consolidation, which tends to lead to lowest-common-denominator products. Bud Light, etc.

That's why it's so good to see venues like the Carlton Winemakers Studio - where a bunch of small winemakers have come together to build a single facility that's used as a co-op.

That's not a new thing - Tillamook Cheese is a dairy farmer co-op - but it's good to see it happening with wine.

Maybe beer can be next? (Maybe it already is, and I just don't know about it. Jeff?)

Patrick Emerson said...


Well there is Green Bottling which is an example of a mobile bottling line that works because it achieves economies of scale by being able to be mobile. But this is an interesting business model: create a brewery and then let brewers rent it out. I think, in fact, if memory serves, Coalition Brewing itself is thinking a bit along these lines.

Jeff Alworth said...

A quickie comment on the photo: it was taken last night (Tuesday) at the brewery. Those are brewers and members of the media in the foreground.

Kari: no formal co-ops that I know of, though it's a fascinating suggestion. If you could get a distributor to become a member of the co-op, it might really have some utility.

It is worth noting that the level of support among the brewers in Oregon is pretty astounding. They consider themselves colleagues far more than competitors--even the little guys and big guys. They borrow equipment and ingredients from each other and regularly collaborate on events. In order to get their doors open, newly-launched Migration used Lompoc's brewery to make their first batch.

Of course, that's easy when the market is growing and there's elbow room all around. We'll see what happens when capacity exceeds demand.

By the way, Dann's point is, as usual, an astute one.