NC ABC Workshop Presentation v.1.3

January 10, 2011 North Carolina Alcoholic Control Commission Workshop: Poten.al Restructuring Models and Valua.on CONFIDENTIAL WORK IN PROGRESS / FOR DISCUSSION ONLY
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0 January 10, 2011 Agenda • Introduc3ons and mee3ng objec3ves • Overview of the US alcohol control systems • Historical performance of the North Carolina ABC business • Discussion of value drivers and levers • Alterna.ve models for engaging the private sector at wholesale and retail • Ini.al value es.mates • Next steps CONFIDENTIAL
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1 January 10, 2011 Introduc.on and objec.ves for this mee.ng •  Over the past couple of weeks, we have examined the future value of the NC ABC under various models more fully engaging the private sector in the distribu.on and sale of spirits § 
Modeling approach § 
Value levers •  Today we would like to review some ini.al perspec.ves on the value crea.on poten.al…
as well as some of the key constraints that will impede value crea.on for the private sector •  Before we review the individual levers we'd like to set the stage for the value upside § 
Quick review of the US approach to alcohol control § 
Review of the historical financial performance of the NC ABC business •  Then we will examine the primary levers for a more boVom up assessment of the poten.al upside § 
These are levers currently accessible to the State or to the private sector if they were to be engage the private sector in the business § 
Other levers may require legisla.on or take longer to implement •  We will conclude with some thoughts about poten.al models (or governance structures) and hopefully narrow this down to a subset that we can examine in more detail in the next couple of weeks CONFIDENTIAL
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2 January 10, 2011 Caveats for today, and next steps •  Today § 
Please treat any valua.on numbers as preliminary § 
Some levers have good upside poten.al…but we will discuss ranges for the .me being o 
o 
Need to bundle levers into realis.c packages (not all levers are completely addi.ve) Need to understand governance / legisla.ve implica.ons (some levers will require new legisla.on, especially those involving the expanded availability of spirits •  Moving forward § 
Next round of valua.on work § 
Integra.on with deal structure recommenda.ons § 
o 
Governance o 
Wholesale and retail models o 
Stakeholders and communica.on issues Develop schedule and next steps CONFIDENTIAL
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3 January 10, 2011 Agenda • Introduc.ons and mee.ng objec.ves • Overview of the US alcohol control systems • Historical performance of the North Carolina ABC business • Discussion of value drivers and levers • Alterna.ve models for engaging the private sector at wholesale and retail • Ini.al value es.mates • Next steps CONFIDENTIAL
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4 January 10, 2011 What is alcoholic beverage control? All states control alcohol. A`er Prohibi.on, a three-­‐.ered system to manage and oversee the distribu.on of alcohol was established throughout the United States. States regulate the business along the three .ers. Tier 1 Supplier Tier 2 Wholesaler Tier 3 Retailer §  Dis.lleries, wineries, and breweries that produce alcohol for consump.on §  Local, regional, na.onal or interna.onal §  Brokers or agents who purchase alcohol from the producers, store it, and transport it to retail outlets §  Stores, restaurants, or clubs which sell alcoholic beverages for off-­‐site or on-­‐site consump.on CONFIDENTIAL
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5 January 10, 2011 Control states •  Of these control states, five have proposed priva.za.on of some form within the last year or are currently exploring priva.za.on op.ons. Eighteen states and one county run the spirits or wine business at the second .er, the third .er, or both. These states are designated control states because they control the day-­‐to-­‐
day alcohol business and the remaining states are designated license states because they allow licensed par.es in the private sector to run day-­‐to-­‐day opera.ons. Wholesale monopoly only Retail and Wholesale: Licensed Retail Agents Retail and Wholesale: Contracted Retail Agents State-­‐Run Retail and Wholesale Iowa Maine Ohio Alabama^ Michigan Montana Oregon Pennsylvania^ Mississippi+ New Hampshire Vermont North Carolina West Virginia Idaho Virginia Wyoming Utah* Washington^ ^State control of retail wine as well as spirits +State control of wholesale wine as well as spirits *State control of retail wine, spirits, and beer above 4% ABV CONFIDENTIAL
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6 January 10, 2011 Methods of control •  The designa.on of control or license does not necessarily mean that one group has stricter regula.ons than the other – New Hampshire, a control state has fewer restric.ons on marke.ng and availability than Georgia, a license state Within each .er exist a number of levers of control for the state to use to manage statewide consump.on. These levers are pulled in both control and license states. Control Mechanism Tier 1 Supplier Tier 2 Wholesaler Tier 3 Retailer Consumer §  Product (SKU’s) §  Marke.ng restric.ons §  Exclusivity (brand and geography) §  Pricing regula.ons §  Availability (hours and days of sale) §  Pricing regula.ons §  Marke.ng restric.ons §  Social responsibility CONFIDENTIAL
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7 January 10, 2011 Wholesale and retail control State •  Wholesale: state run, servicing ABC stores and/or on-­‐premise venues •  Warehousing and distribu.on state-­‐run (or contracted) •  Retail: state-­‐run off-­‐premise, which service on-­‐premise outlets •  State controls pricing, product approval, off-­‐
premise opera.ons, and on-­‐
premise licensing –  Mark-­‐up revenues and license fees return to state –  Enforcement is state responsibility State Government Tier 1: Supplier Dis.lled Beverage Manufacturers Alcoholic Beverage Control Commission Tier 2: Wholesaler Tier 3: Retailer ABC Stores On-­‐ Premise Consumers ABC Stores On-­‐ Premise Consumers CONFIDENTIAL
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Agency Store On-­‐ Premise Consumers 8 January 10, 2011 Wholesale control State •  Wholesale: state run, servicing both off-­‐ and on-­‐
premise venues •  Warehousing and distribu.on state-­‐run (or contracted) •  Retail: private licensed •  State controls pricing, product approval, and retail licensing –  Mark-­‐up revenues and license fees return to state –  Enforcement is state responsibility State Government Tier 1: Supplier Dis.lled Beverage Manufacturers Alcoholic Beverage Control Commission Tier 2: Wholesaler Tier 3: Retailer Private Stores On-­‐ Premise Private Stores On-­‐ Premise Private Stores On-­‐ Premise Consumers Consumers CONFIDENTIAL
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Consumers 9 January 10, 2011 License State •  Wholesale: licensed private wholesalers servicing both on-­‐ and off-­‐premise retailers •  Private distribu.on and warehousing •  Retail: private licensed •  State may approve products, hours of sale, and wholesale and retail licensees –  Excise tax revenues and license fees return to state –  Enforcement is state responsibility State Government Tier 1: Supplier Dis.lled Beverage Manufacturers Alcoholic Beverage Control Commission Private Wholesalers Tier 2: Wholesaler Tier 3: Retailer Private Stores On-­‐ Premise Private Stores On-­‐ Premise Private Stores On-­‐ Premise Consumers Consumers CONFIDENTIAL
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Consumers 10 January 10, 2011 Current North Carolina model •  Wholesale: by NC ABCC, servicing local ABC boards •  Contracted distribu.on and warehousing •  Retail: off-­‐premise run by local ABC boards, which service on-­‐premise outlets •  State ABCC approves pricing, products, hours of sale, and on-­‐premise retail licensees •  Local ABC boards approve products for their stores –  Mark-­‐up revenues and license fees return to local boards, who must pay for enforcement –  Enforcement also state responsibility State of North Carolina Tier 1: Supplier Tier 2: Wholesaler Tier 3: Retailer Dis.lled Beverage Manufacturers North Carolina Alcoholic Beverage Control Commission 167 Local ABC Boards 167 Local ABC Boards ABC Stores ABC Stores 167 Local ABC Boards On-­‐ Premise 167 Local ABC Boards ABC Stores Consumers CONFIDENTIAL
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11 January 10, 2011 Agenda • Introduc.ons and mee.ng objec.ves • Overview of the US alcohol control systems • Historical performance of the North Carolina ABC business • Discussion of value drivers and levers • Alterna.ve models for engaging the private sector at wholesale and retail • Ini.al value es.mates • Next steps CONFIDENTIAL
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12 January 10, 2011 Neighboring state revenue from spirits •  Sales tax revenue for license states is es.mated Per Capita Revenue Composi3on (millions) 40.00 Control States 35.00 30.00 25.00 ABC Profits 20.00 Sales Tax and Other Fees 15.00 Mark-­‐up / Excise Taxes 10.00 5.00 0.00 North Carolina Virginia South Tennessee Georgia Carolina West virginia *2007 Revenue data from the Dis.lled Spirits Council of the United States CONFIDENTIAL
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13 January 10, 2011 North Carolina ABC profits are less than most control states Mark-­‐up / Excise Tax and Sales Tax Revenue Per Capita $70.00 Full Wholesale and Retail Control $60.00 $50.00 $40.00 $30.00 $20.00 $10.00 $0.00 2007 ABC Profits Per Capita Excise Tax Revenue Per Capita Sales Tax Revenue per Capita *2007 Revenue data from the Dis.lled Spirits Council of the United States CONFIDENTIAL
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14 January 10, 2011 Historical income and expenses •  ABC profits as a percentage of sales decreased from 10.5% in 2009 to 9.1% in 2010 •  Cap-­‐ex is not included in this graph: $12.2 million in 2010 Income and Expense (In millions) 900 800 700 600 Taxes 500 Profit 400 Opera.ng Expenses Cost of Goods Sold 300 200 100 0 2005 2006 2007 2008 2009 2010 CONFIDENTIAL
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15 January 10, 2011 Historical tax revenue •  Excise tax rate increased from 25% to 30% on September 1, 2009 •  Liquor sales tax rate increased from 7% to 8% on September 1, 2009 Annual Tax Revenue (In millions) 250 Mixed Beverage Tax Support to Local ABC Opera.ons 200 2010 Revenue Change: •  14.8% increase in excise tax receipts •  17.3% increase in liquor sales tax receipts •  The state provides support to local ABC boards through the mixed beverage tax (MBT) •  Local boards receive 45% of MBT receipts •  This Support totaled $11.8 million in 2010 150 Mixed Beverage Tax Expense Mixed Beverage Tax Liquor Sales Tax 100 State Excise Tax 50 0 2005 2006 2007 2008 2009 2010 CONFIDENTIAL
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16 January 10, 2011 Distribu.ons are higher than retail profits •  Distribu.ons have increased or remained unchanged while ABC profits have decreased Annual Profits and Distribu3ons (millions) 70 2010 Distribu.ons: •  County Distribu.ons: $45.8m •  Alcohol Educa.on: $9.0m •  Law Enforcement: $6.8m 60 Compound annual growth rate since 2005: •  Profits: 1.8% •  Distribu.ons: 5.9% 40 50 Profit Distribu.ons 30 20 10 0 2005 2006 2007 2008 2009 2010 CONFIDENTIAL
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17 January 10, 2011 At current rates the distribu.on gap will grow to $50 million by 2020 Compound annual growth rates since 2005: •  Profits: 1.8% •  Distribu.ons: 5.9% •  Law Enforcement: 3.2% •  Alcohol Educa.on: 4.5% •  Local Distribu3ons: 6.6% Forecasted Profits and Distribu3ons (In millions) 120 100 80 60 Profit Distribu.ons 40 20 0 CONFIDENTIAL
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18 January 10, 2011 Agenda • Introduc.ons and mee.ng objec.ves • Overview of the US alcohol control systems • Historical performance of the North Carolina ABC business • Discussion of value drivers and levers • Alterna.ve models for engaging the private sector at wholesale and retail • Ini.al value es.mates • Next steps CONFIDENTIAL
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19 January 10, 2011 Levers within an ABC system: value drivers •  Control can be defined within a framework of Value Drivers and Value Moderators along the different .ers of the ABC business § 
Levers that add value to the alcoholic beverage business Lever Descrip3on Availability §  Quality (e.g. specific stores / loca.ons) §  Retail penetra.on rate (# of stores per capita) §  Hours and days of sale §  Harmoniza.on of beer and wine Product §  Number of SKU s §  Approval of specific products Pricing §  Post and hold legisla.on §  Variable pricing §  Minimum pricing Marke.ng §  Total adver.sing spend §  Point-­‐of-­‐sale marke.ng Exclusivity §  Brand §  Geography CONFIDENTIAL
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20 January 10, 2011 Levers within an ABC system: value moderators § 
Levers that restrict value in the alcoholic beverage business Lever Descrip3on Social responsibility §  Substance abuse educa.on §  Law enforcement Taxes §  Amount of excise tax or mark-­‐up §  Sales taxes §  Other taxes (e.g. mixed beverage) CONFIDENTIAL
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21 January 10, 2011 Other States have flexed value drivers Lever Benchmarks from other States Impact on Value Availability §  Sunday sales throughout the US §  Harmonized beverage sales in Iowa and Pennsylvania §  Allowing Sunday sales is es.mated to generate a 2.5% to 4% increase sales Product §  Deregula.on of SKU s in Michigan §  Tiered SKU s in Pennsylvania §  Michigan experienced a 2.1% increase in sales by increasing SKU s from 1100 to 4500 Pricing §  Michigan switch from uniform pricing to minimum pricing §  Value es.mates pending §  Pennsylvania compe..ve border pricing §  Georgia post and hold Marke.ng §  Pennsylvania and New Hampshire programs §  Pennsylvania has generated $85 million in new sales (5%) annually through a targeted marke.ng program Exclusivity §  Private management in Maine §  Crea.ng value at wholesale with franchise legisla.on in Georgia §  Maine s wholesale management contract brought in $125 million in up-­‐
front payment and revenue sharing of a growing business CONFIDENTIAL
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22 January 10, 2011 How other States have approached value moderators Lever Descrip3on Social responsibility §  Michigan licensee revenue sharing for local law enforcement Taxes and Mark-­‐up §  Tennessee dedicates part of beer gallonage tax to local communi.es CONFIDENTIAL
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23 January 10, 2011 Value driver impact on State revenue: availability •  North Carolina has the second highest number of total retail alcohol outlets (beer, wine, spirits) per capita in its peer group, but just 3% of outlets allow purchase of spirits –  Reduced availability of one type of alcoholic beverage leads drinkers in North Carolina to subs.tute across beverage types, reflected in the state s low spirits consump.on rate: Per Capita Off-­‐premise Liquor Outlets* Control States –  Spirits as a percentage of Consump.on: •  North Carolina: 28.0% •  South Carolina: 31.6% •  Neighboring states: 29.9% •  Control states: 30.8% •  Non-­‐control states: 33.9% *Per 100,000 residents. Figures from NABCA Survey Book 2008 CONFIDENTIAL
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24 January 10, 2011 Increasing revenues but not consump.on •  What if North Carolina s Consump.on PaVerns looked liked those seen in other states? •  North Carolinians currently consume an average of 2 gallons of alcoholic beverages a year* –  Spirits: 0.56 gallons –  Beer: 1.16 gallons –  Wine: 0.28 gallons •  Consump.on of spirits as a propor.on of overall alcohol consump.on is low in North Carolina when compared to other states •  From a purely business standpoint spirits is the State s highest margin product •  The following factors may contribute to lower than average consump.on § 
Demographics and local taste § 
LiVle or no marke.ng of spirits § 
Limited availability compared to beer and wine § 
Rela.ve cost of alcohol by type •  If spirits can command a greater share of the consumer wallet State tax revenue could increase between $90 and $225 million over ten years Scenario 1 Scenario 2 Scenario 3 Spirit consump.on comparable to neighboring States Spirit consump.on at average of all control States Spirits consump.on at average of license states Spirits sales increase – 6.9% Spirits sales increase – 10.1% Spirits sales Increase – 21% Annual new tax revenue -­‐ $9 million Annual new tax revenue -­‐ $15 million Annual new tax revenue – S22.5 million *Na.onal Ins.tute on Alcohol Abuse and Alcoholism. (2007) CONFIDENTIAL
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25 January 10, 2011 Agenda • Introduc.ons and mee.ng objec.ves • Overview of the US alcohol control systems • Historical performance of the North Carolina ABC business • Discussion of value drivers and levers • Alterna3ve models for engaging the private sector at wholesale and retail • Ini.al value es.mates • Next steps CONFIDENTIAL
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26 January 10, 2011 1. Full priva.za.on of retail and wholesale •  Wholesale: licensed private wholesalers servicing both on-­‐ and off-­‐premise retailers •  Private distribu.on and warehousing •  Retail: licensed private, liquor sale harmonized with beer and wine •  Local boards removed •  State ABCC approves products, hours of sale, and wholesale and retail licensees –  Excise tax revenues and license fees return to state State of North Carolina Tier 1: Supplier Dis.lled Beverage Manufacturers North Carolina Alcoholic Beverage Control Commission Mul.ple Private Wholesalers Tier 2: Wholesaler Tier 3: Retailer Func.on State Gov. Tax Control/Revenue Collec.on $T Licensing Control/Revenue $L Availability (Product & Hours) A@ Grocery Stores Private Stores On-­‐ Premise Consumers Consumers Consumers Local Gov. Priv. Operator Marke.ng Enforcement Pricing !E $P$ Priv. Retail Priv. Wholesale A@ A@ M* M* $P$ $P$ !E CONFIDENTIAL
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27 January 10, 2011 2.a State-­‐run wholesale; private retail •  Wholesale: run by NC ABCC, servicing both on-­‐ and off-­‐
premise retailers •  Contracted distribu.on and warehousing •  Retail: licensed private; liquor sale harmonized with beer and wine •  Local boards removed •  State ABCC approves products, hours of sale, and retail licensees –  Mark-­‐up revenues and license fees return to state State of North Carolina Tier 1: Supplier Dis.lled Beverage Manufacturers North Carolina Alcoholic Beverage Control Commission (Contracted Warehouse and Distribu.on) Tier 2: Wholesaler Tier 3: Retailer Func.on State Gov. Tax Control/Revenue Collec.on $T Licensing Control/Revenue $L Availability (Product & Hours) A@ Grocery Stores Private Stores On-­‐ Premise Consumers Consumers Consumers Local Gov. Priv. Operator Pricing Priv. Wholesale A@ Marke.ng Enforcement Priv. Retail M* !E $P$ !E CONFIDENTIAL
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$P$ 28 January 10, 2011 2.b State-­‐run wholesale, liberalized retail •  Wholesale: run by NC ABCC, servicing both on-­‐ and off-­‐
premise retailers (ABC stores may service on-­‐
premise) State of North Carolina Tier 1: Supplier •  Contracted distribu.on and warehousing •  Retail: licensed private in compe..on with exis.ng stores run by local ABC boards •  Local ABCs publically managed along same criteria as private owner •  State ABCC approves products, hours of sale, and retail licensees –  Mark-­‐up revenues, excise taxes, and license fees return to state Dis.lled Beverage Manufacturers North Carolina Alcoholic Beverage Control Commission (Contracted Warehouse and Distribu.on) Tier 2: Wholesaler Tier 3: Retailer ABC Stores Private Stores On-­‐ Premise Consumers Func.on State Gov. Tax Control/Revenue Collec.on $T Licensing Control/Revenue $L Availability (Product & Hours) A@ Marke.ng Enforcement Pricing On-­‐ Premise Consumers Local Gov. Priv. Operator Priv. Retail A@ A@ M* M* !E !E $P$ $P$ CONFIDENTIAL
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Priv. Wholesale $P$ 29 January 10, 2011 2.c Private wholesale, liberalized retail •  Wholesale: licensed private, serving both on-­‐ and off-­‐
premise retail (ABC stores may service on-­‐premise) •  Contracted distribu.on and warehousing •  Retail: licensed private in compe..on with exis.ng stores run by local ABC boards •  Local ABCs publically managed along same criteria as private owner •  State ABCC approves products, hours of sale, and wholesale and retail licensees –  Excise tax revenues and license fees return to state State of North Carolina Tier 1: Supplier Dis.lled Beverage Manufacturers Mul.ple Private Wholesalers Tier 2: Wholesaler Tier 3: Retailer ABC Stores Private Stores On-­‐ Premise Consumers Func.on State Gov. Tax Control/Revenue Collec.on $T Licensing Control/Revenue $L Availability (Product & Hours) A@ Marke.ng Enforcement Pricing On-­‐ Premise Consumers Local Gov. Priv. Retail Priv. Wholesale A@ A@ A@ M* M* M* $P$ $P$ !E !E $P$ $P$ Priv. Operator CONFIDENTIAL
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30 January 10, 2011 3.a Contracted wholesale with private retail •  Wholesale: contracted private providing ordering, payment processing, and distribu.on services, restricted to 3-­‐4 statewide •  Contracted wholesaler provides own distribu.on and warehousing •  Retail: licensed private; liquor sale harmonized with beer and wine •  Local boards removed •  State ABCC approves products, hours of sale, retail licensees and contracted wholesalers –  State can set retail price floor –  Mark-­‐up revenues and license fees return to state State of North Carolina Tier 1: Supplier Dis.lled Beverage Manufacturers Tier 2: Wholesaler North Carolina Alcoholic Beverage Control Commission Private Distributers Private Distributers Private Distributers Private Distributers Grocery Stores Private Liquor Private Liquor On-­‐ Premise Tier 3: Retailer Consumers Func.on State Gov. Tax Control/Revenue Collec.on $T Licensing Control/Revenue $L Availability (Product & Hours) A@ Local Gov. Priv. Operator Pricing Priv. Wholesale $T Marke.ng Enforcement Priv. Retail A@ M* !E $P$ CONFIDENTIAL
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$P$ 31 January 10, 2011 3.b Private wholesale manager with private retail •  Wholesale: administered on behalf of NC ABCC by private manager •  Private manager determines warehousing and distribu.on prac.ces •  Retail: licensed private; liquor sale harmonized with beer and wine •  Local boards removed •  NC ABCC approves products, hours of sale –  Mark-­‐up revenues and license fees return to state –  Revenue share calculated for private operator based on performance State of North Carolina Tier 1: Supplier Dis.lled Beverage Manufacturers North Carolina Alcoholic Beverage Control Commission North Carolina Alcoholic Beverage Commission Administered by Private Manager Tier 2: Wholesaler Tier 3: Retailer Func.on State Gov. Tax Control/Revenue Collec.on $T Licensing Control/Revenue $L Availability (Product & Hours) A@ Marke.ng Enforcement Pricing Grocery Stores Private Stores On-­‐ Premise Consumers Consumers Consumers Local Gov. Priv. Operator Priv. Retail Priv. Wholesale $T A@ A@ M* M* !E !E $P$ $P$ CONFIDENTIAL
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$P$ 32 January 10, 2011 Agenda • Introduc.ons and mee.ng objec.ves • Overview of the US alcohol control systems • Historical performance of the North Carolina ABC business • Discussion of value drivers and levers • Alterna.ve models for engaging the private sector at wholesale and retail • Ini3al value es3mates • Next steps CONFIDENTIAL
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33 January 10, 2011 Ini.al valua.on methodology •  Purpose § 
Explore the order of magnitude of value levers § 
Intended to encourage discussion but not to provide precise indica.ons of business value •  Assump.ons for Priva.za.on Scenarios § 
Excise and other beverage taxes are not treated as revenue § 
Corporate income taxes paid at 40% § 
Law enforcement, alcohol educa.on and city/county distribu.ons are not deducted § 
Revenue changes are based on changes in volume consumed with no changes in price assump.ons § 
Private operators will use leased facili.es •  Informa.on U.lized in Analysis § 
Historical financial performance of ABC § 
Industry forecasts § 
Risk Management Associates § 
Historical financial performance of various public companies CONFIDENTIAL
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34 January 10, 2011 Scenario 1 & 2: base case •  1: Exis.ng opera.ons § 
Nega.ve cash flows exist a`er local distribu.ons and capital expenditures are deducted •  2: Exis.ng opera.ons (without distribu.ons) § 
Posi.ve cash flows § 
Not as profitable as other priva.za.on scenarios CONFIDENTIAL
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35 January 10, 2011 Scenario 3: priva.za.on of exis.ng opera.ons •  3: Private opera.ons con.nue in exis.ng warehouse and retail loca.ons § 
Wholesale becomes a for-­‐profit opera.on § 
Local boards are replaced with private management Indicated Value Range for Licenses (millions) Ten Year $129 To $151 Thirty Year $213 To $313 CONFIDENTIAL
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36 January 10, 2011 Scenario 4 & 5: priva.za.on; expanded opera.ons •  4: Private opera.ons expand availability through increased store/shelf space § 
25% increase in availability and consump.on § 
Expansion into exis.ng retail space (e.g., Costco) results in higher profit margins Indicated Value Range for Licenses (millions) Ten Year $184 To $218 Thirty Year $306 To $452 •  5: Private opera.ons expand availability through increased store/shelf space § 
50% increase in availability and consump.on § 
Expansion into exis.ng retail space (e.g., Costco) results in higher profit margins Indicated Value Range for Licenses (millions) Ten Year $240 To $282 Thirty Year $398 To $588 CONFIDENTIAL
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37 January 10, 2011 Agenda • Introduc.ons and mee.ng objec.ves • Overview of the US alcohol control systems • Historical performance of the North Carolina ABC business • Discussion of value drivers and levers • Alterna.ve models for engaging the private sector at wholesale and retail • Ini.al value es.mates • Next steps CONFIDENTIAL
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38 January 10, 2011 Recommenda.ons for capitalizing on value •  Products § 
Increase number of SKUs available - 
If state con.nues to run wholesale opera.ons, establish looser criteria for delis.ng products, including: –  Tiered product selec.ons, with stringent criteria for products always available on shelves - 
If state steps away from wholesale opera.ons, limit products available by requiring annual brand registra.on with registra.on fees to cover cost of quality tes.ng •  Exclusivity § 
Create an economy of scale at the wholesale level through exclusivity: - 
- 
Limit the number of wholesalers to two or three statewide to ensure that wholesale costs aren't t passed along in the form of high retail prices Establish exclusive rela.onships between wholesalers and suppliers by brand •  Pricing § 
Remove uniform price restric.ons CONFIDENTIAL
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39 January 10, 2011 Recommenda.ons for capitalizing on value (cont.) •  Marke.ng § 
§ 
View marke.ng from the perspec.ve not of increasing consump.on, but of encouraging NC ABC's already existent customers to trade up by brand and beverage type: - 
Harmonize marke.ng restric.ons across beverage types - 
Allow point of sale adver.sing Create a comprehensive marke.ng plan for NC ABC - 
- 
Marke.ng statewide by consumer cluster and category management, using promo.ons and adver.sing to get customers in the store, will improve sales Coordinate marke.ng campaigns with those of suppliers to stretch marke.ng dollars and avoid oversatura.on •  Availability § 
Harmonize hours and days of sale along with point-­‐of-­‐sale across beverage types - 
Allow sale of spirits everywhere beer is sold CONFIDENTIAL
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40 January 10, 2011 Recommenda.ons for capitalizing on value (cont.) •  Other § 
Take advantage of private sector exper.se through contrac.ng private management opera.on of ABC system § 
Dismantle local boards § 
Protect local revenues by using a percentage of licenses or fees to cover local enforcement costs CONFIDENTIAL
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41 December 8, 2010 Appendix: Priva3za3on Case Studies CONFIDENTIAL WORK IN PROGRESS / FOR DISCUSSION ONLY
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42 January 10, 2011 Overview of priva.za.on •  No state agency has completely priva.zed in the United States since prohibi.on Since the 1980s, control states have been stepping away from the alcohol control business to improve government efficiency and/or to increase state revenues. • Most agencies which priva.zed in the 1980s and early 1990s completely sold their assets in the retail sphere, either of one or more beverage type. -  Michigan, Iowa, and Alberta permanently sold retail opera.ons in 1987, 1989, and 1993, respec.vely -  Quebec completely priva.zed its retail wine opera.ons during the period of 1978-­‐1984 • Priva.za.on in the last decade has consisted of a series of public/private partnerships on a contract basis; in most instances, contracts run a set dura.on and assets ul.mately remain with the state, most o`en due to public pressure to protect state assets and nega.ve press portrayals of priva.za.on: -  West Virginia con.nues to lease the majority of its retail units through auc.ons held once every decade -  Maine Bureau of Alcoholic Beverage and LoVery Opera.ons entered into a ten-­‐year contract for wholesale services with Maine Beverage Company, rather than permanent sale CONFIDENTIAL
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43 January 10, 2011 ABC profile: Alberta, Canada •  Alberta Gaming and Liquor Commission priva.zed retail opera.ons in 1993 with the aim of increased governmental efficiency and downsizing of opera.ons •  System change: government-­‐run retail (202 outlets) and contracted agency stores (604 outlets) to private licensed retail (1,187 outlets by 1995) •  Financial impact: revenue neutrality maintained for five years a`er priva.za.on; asset sale brought in $82 million Process § Warehousing and distribu.on contracted to private party; supplier owns stock in warehouse § Licenses changed from beer and wine off-­‐premise licenses to a cross-­‐
beverage type “liquor store license” for beer, wine, and liquor sales § Ad valorem taxes and volume-­‐based price control replaced by flat-­‐tax § Revenues were frozen for five years a`er asset sale § Hours for sale standardized across the province Results § Province sets wholesale prices and products selec.on § Asset sale brought in C$82 million § Taxes lowered four .mes to insure revenue neutrality § 90% of AGLC employees cut, with severance packages totaling C$17 million; liquor-­‐related employees province wide up from 1,300 in 1993 to 4,000 in 2005 § SKUs up from 950 units to 12,000 units in one decade § Revenues up from C$454.5 mill in 1993 to C$559 mill in 1994 Sources: Ontario Department of Finance. Beverage Alcohol System Review. March 2005; Alberta Gaming and Lottery Commission. Liquor—Quick
Facts. January 2010; Alberta Gaming and Lottery Commission. A New Era in Liquor Administration. 1994.
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44 January 10, 2011 ABC profile: West Virginia •  West Virginia Alcohol Beverage Control Administra.on began priva.zing its retail outlets through auc.on in August 1990, January 1991 and May 1991 •  System change: government-­‐run retail to licensed private retail (216 stores) •  Financial impact: immediate revenue generated from the auc.on reached $26.5 million, 28.8% of the system s annual revenues Process § Licenses available for minimum bid taking into account demographics, historical sales data, and popula.on served § Licenses valid for ten years § Auc.ons held again in 2000 and in 2010, with an op.on to purchase added to the 2010 auc.on for small outlet Results § State maintains wholesale control and product selec.on § License auc.on brought in C$26.5 million § Only 162 of 216 available stores were opened in WV ABCA’s first auc.on § Dismantling of state run alcohol venues led to an immediate decrease in consump.on of 4.1% Source: West Virginia Alcohol Beverage Control Board. 2010; Pulito, J. and Anthony Davies. Government Run Liquor Stores: The Social Impact of Privatization.
Commonwealth Foundation. October 2009.
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45 January 10, 2011 State ABC profile: Iowa •  Iowa Alcoholic Beverages Division priva.zed its retail outlets through licensure in 1987, two years a`er priva.zing its wholesale and retail wine opera.ons •  System change: government-­‐run retail (207 outlets) to licensed private retail (410 stores) •  Financial impact: ten years a`er sale, state was bringing in $10 million more in revenues a year Process § Retail off-­‐premise outlets licensed according to a schedule that addressed store square-­‐footage and popula.on size Results § State maintains wholesale control and product selec.on § Change from uniform pricing to variable pricing § 491 full-­‐.me and 790 part-­‐.me employees cut; by 1989 all but 46 had found employment in state or private sector § Outlets’ hours of opera.on increased § Costs per boVle rose 6.1% a`er priva.za.on § Warehousing outsourced un.l 2003 when state took up opera.on again using prison labor § Spirits consump.on immediately increased by 9.5% but leveled off by mid-­‐90s § Priva.za.on of wholesale discussed in 2002, but found to be too expensive Sources: Iowa Alcoholic Beverages Division. Iowa Alcoholic Beverages Division Responses to Legislative Oversight Committee. June 24, 2004; Effects of the elimination of a state
monopoly on alcohol.
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46 January 10, 2011 State ABC profile: Maine •  Maine Bureau of Alcoholic Beverages and LoVery Opera.ons (BABLO) signed a 10-­‐year contract with Maine Beverage Company (MBC) for wholesale opera.ons in 200 Process § Wholesale opera.ons and marke.ng contracted to private operator (subsidiary of Mar.gne|) •  System change: government-­‐run wholesale, contracted agents for retail sale to privately contracted wholesale (10 year term), contracted agents for retail sale § State-­‐run liquor outlets closed; 364 licensed agency stores receive wholesale from MBC •  Financial impact: MBC paid upfront sum of $125 million; revenues shared 50:50 between MBC and BABLO over 36.8% profit § MBC subcontracts warehousing and distribu.on § State Bureau of Liquor Enforcement closed to balance state budget and further improve efficiency § Term of contract is ten yeas (2004-­‐2014); discussion of permanent sale of wholesale opera.ons to MBC has been discussed Source: Maine Final Report. 2004.
Results § State receives one-­‐.me payment of $125 million and 50% revenue share above 36.8% profit (es.mated at the .me to be $24 million over 10 years) § Gross dollar sales up $119.1 million, but ini.al dollar contribu.ons to state general fund down § Current es.mate of profit share to the State is now $80 million over the remaining term of the contract § Average per-­‐boVle prices for top ten most popular spirits products over $1 -­‐ $3.50 more per boVle than same product in New Hampshire and $2 -­‐ $4 more than in Vermont CONFIDENTIAL
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47 January 10, 2011 State ABC profile: Michigan •  Michigan Liquor Control Commission (MLCC) reduced its du.es as state wholesaler in 1996 •  System change: fully government-­‐run wholesale to private distribu.on and warehousing with limited control over products in MLCC system Process § Three state warehouses, 63 wholesale stores, and transporta.on equipment sold § Suppliers required to establish exclusive contracts for brand distribu.on with wholesale agent, registered in Michigan as Authorized Distribu.on Agent (ADA) !"#$%&'()*'(+,-')*"(+'.
Results § MLCC cut employees by 71.4% § Without state having to run warehouse, SKUs rose from 1,100 to 4,500 (currently at 5,500 SKUs) § Sales up 2.1% in first year of new system •  Financial impact: MLCC § MLCC pays ADAs per case price of increased sales by 2.1% $6.97, suppliers add $1.35 per case a`er reducing wholesale § Retailers place orders via MLCC, du.es and shi`ed roughly /'0()!"#$%&'(12,-'3#''4
sold; ADAs have expressed who passes order on to ADA for $29 million in opera.ng dissa.sfac.on with this system costs to $24 million in supplier; state owns item for one 5#)$6')!60,()%7)$6')8,-6,903)2,:"%()!%3$(%;)!%&&,##,%3)<82!!=4)>)?03$)$%)$603@).%")7%(
transporta.on fees day before sale to retailers 9,+,39)"#)$6')%AA%($"3,$.)$%)#'(+').%"B)C;'0#')6';A)"#)#'(+').%")D'$$'()D.)$0@,39)0
-%"A;')%7)&,3"$'#)$%)$';;)"#)0D%"$)$6')'EA'(,'3-')$60$).%")60+')60F)?,$6)82!!B
§ State sets minimum retail price floor, allowing for 20% discount to G')0(')&%(')$603)H"#$)('9";0$%(#)03F)?')?%";F);,@')$%)$0@')$6,#)$,&')$%)'&A60#,I')$60$
retail outlets on alcohol purchased &0@,39)#$(%39)D"#,3'##)A0($3'(#);,@').%"),#)?60$)?')0(')0;;)0D%"$B
G')0AA('-,0$').%"()D"#,3'##'#)03F)?03$)$%)&0@')#"(')?')&''$).%"()'EA'-$0$,%3#)0#
Source: Maine Final Report. 2004.
$6')#$0$'J#);,:"%()-%3$(%;)D%0(FB
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*,3-'(';.4
K,F0)LB)*0&%30
48 December 8, 2010 Appendix: Prac3ces in Other States CONFIDENTIAL WORK IN PROGRESS / FOR DISCUSSION ONLY
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49 January 10, 2011 State prac.ces: products •  Discussions with the players in the first .er of the industry indicate that control states have more supplier price nego.a.ng power due to the limited number of SKUs permiVed in the state Removing restric.ons on number of SKUs § 
MLCC stopped regula.ng number of SKUs in 1996 when they moved from a state-­‐
contracted warehouse to private warehouse/distribu.on opera.on paid per case - 
- 
SKUs increased from 1100 to over 4500 in the ini.al years a`er par.al priva.za.on (currently at 5,500 SKUs) 2.1% increase in sales seen as a result Tiered products protect state s ability to nego.ate supplier price and keeps number of products available manageable while sa.sfying customers with diversity of items § 
PLCB offers over 55,000 SKUs for sale in its system, but maintains nego.a.ng power with its suppliers by offering a limited number of products on shelves - 
- 
- 
Regularly stocked items – most popular brands – have stringent sales criteria to remain listed, Chairman s Selec.ons use a Trader Joe s model–merchandise a supplier wishes to offload quickly purchased at a favorable supplier price and sold at a low retail price, these represent 15% of agency sales annually, 30,000 to 40,000 SKUs of special orders are available on demand only, with processing and shipping costs, along with mark-­‐up passed on directly to the consumer CONFIDENTIAL
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50 January 10, 2011 State prac.ces: exclusivity Private Management accesses the exper.se of the private wholesale sector to grow the business § 
Maine Bureau of Alcoholic Beverages and LoVery Opera.ons (BABLO) entered into a 10-­‐year contract for opera.on of its wholesale business with Mar.gne| subsidiary Maine Beverage Company - 
- 
§ 
Though profit-­‐sharing arrangements and service fee were unfavorably nego.ated, the rela.onship allows state access to private-­‐sector exper.se in areas like wholesale marke.ng that will help grow the over BABLO wholesale business by the end of the contract term BABLO/MBC contract also includes s.pula.ons for contribu.ons to alcohol preven.on campaigns and enforcement programs Illinois LoVery private management contract of 2010 outlined s.pula.ons to grow the business while providing annual payments backed with a leVer of credit Crea.ng an economy of scale through exclusivity clauses will help wholesalers maintain reasonable pricing structures and thus increase the value of wholesale licenses § 
Discussion with industry players has indicated that: - 
- 
Wholesalers desire guaranteed territories of opera.on in order to off-­‐set the high cost of warehousing and distribu.on Wholesalers expect to make a profit of 20% regardless of opera.ng costs or changes in supplier price; any addi.onal costs are passed on to the consumer CONFIDENTIAL
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51 January 10, 2011 State prac.ces: pricing •  Note: removal of uniform prices may increase boVle prices: -  In moving from province-­‐
set uniform prices to variable retail prices, Alberta s per boVle spirits cost rose 8%; Iowa rose 6.1% •  Raising spirits prices modestly decreases overall consump.on, but rather leads to decreased spirits consump.on and trading down across beverage types Removal of uniform pricing at the retail level allows for retailers to make adjustments based on the needs of their community § 
MLCC replaced retail uniform pricing in 2004 with a minimum price - 
Retailers must meet price floor requirements, but can increase costs in .mes of high purchase to balance out sales losses at other .mes in the year Cross-­‐border losses can be managed by allowing sales venues on the border to offer alcohol at prices compe..ve to the neighbor state § 
PLCB places its specialty stores, which o`en offer items at prices lower than non-­‐
control states, next to the borders - 
Extrapola.ng from data on cigareVes in cross-­‐border purchasing, consumers travel 2.7 miles for every dollar saved, up to a distance of 40 miles Prevent boVoming-­‐out of pricing at the wholesale level by Post-­‐and-­‐Hold regula.on § 
Georgia uses Post-­‐and-­‐Hold legisla.on to limit compe..on between wholesalers and thus prevent wholesale price cu|ng - 
Wholesalers are required to set prices one month in advance; prices are posted in a forum where other wholesalers have access to all prices in the region. Wholesalers are given a set amount of .me to adjust their ini.al price proposal before a final pos.ng CONFIDENTIAL
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52 January 10, 2011 State prac.ces: marke.ng Create a comprehensive marke.ng plan for the NC ABC § 
Pennsylvania Liquor Control Board (PLCB) revamped its marke.ng department in 2004-­‐2005 to begin marke.ng in consumer clusters and using category management - 
Conserva.ve es.mates see a li` in sales of $85 million annually, or 5% aVributable to marke.ng and promo.on dollars (0.3% of PLCB annual opera.ng budget) Market from a perspec.ve not of increased volume sales, but increase dollar sales § 
PLCB uses a combina.on of promo.onal adver.sing and online media campaigns to get customers in the door, but focuses efforts primarily on point of sale adver.sing to encourage customers to trade up Incorporate marke.ng efforts with those of spirits § 
Suppliers do the majority of marking in Pennsylvania; PLCB is beginning to coordinate marke.ng campaigns with suppliers to save money and to avoid oversatura.on Harmonize marke.ng restric.ons for spirits with those for beer and wine § 
Par.al ad bans have been shown to result not in a decline of overall consump.on, but in a subs.tu.on of beverage type, most o`en from spirits to wine. CONFIDENTIAL
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53 January 10, 2011 State prac.ces: availability •  Alcohol is a subs.tu.on beverage. Drinkers purchase alcohol that is available -­‐ by making beer and wine available in the grocery store but keeping spirits in separate venues, the state pushes consumers towards lower margin beverages Add addi.onal sales day •  NC ABC can reduce its number of overall venues where alcoholic beverages are sold by streamlining retail licenses across beverage types Adjust points and hours of sale to be the same as those for beer and wine § 
Studies on alcohol consump.on in the US and in Sweden have found adding an addi.onal day of business to increase sales - 
New Mexico, Oregon, Delaware, Kansas, Maine, New York, Pennsylvania, Idaho, Kentucky, Ohio, Rhode Island, Virginia, and Washington liberalized Sunday sales between 1995 and 2005, resul.ng in boosts of sales between 2.5 – 4% § 
Alberta Gaming and Liquor Commission streamlined licenses and venues of sale when it priva.zed retail in 1993 § 
PLCB launched a store-­‐within-­‐a-­‐store campaign in 2010, offering wine for sale at vending machines inside grocery stores. CONFIDENTIAL
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