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Prepared Witness Testimony The House Committee on Energy and Commerce
E-Commerce: The Case of Online Wine Sales and Direct Shipment
Subcommittee on Commerce, Trade, and Consumer Protection
Mr. David P. Sloane
Good morning, I am David Sloane, President of WineAmerica (formerly the American Vintners Association), the national association for America's wineries, with over 700 members in 48 states. The vast majority of our members are small family owned and operated farm enterprises, producing less than 10,000 cases of wine per year. I wish to commend and thank the Subcommittee for holding this important hearing to examine state barriers to the interstate shipment of wine, and whether such barriers serve rational policy purposes, or amount to economic protectionism. My statement will provide the Subcommittee with the following information:
The Burgeoning U.S. Winery Movement The number of wineries in the U.S. has expanded dramatically in the last quarter century, rising from some 600 in 1975 to over 3,000 in 2002 - an increase of more than 400 percent. Since 1990 alone, the industry has more than doubled from 1,400 wineries to its current number of over 3,000. In addition, local wineries now exist in all 50 states, a development that Thomas Jefferson, a visionary of America's wine producing potential, could not have predicted. California is the premier winegrowing state comprising roughly half the nation's wineries and over 90 percent of the production. There are also high concentrations of wineries (in rank order), in Washington, Oregon, New York, Ohio, Virginia, Pennsylvania, Texas, Missouri, Colorado, New Mexico, Illinois and Michigan. All these states have at least 30 wineries, and the top three - Washington, Oregon and New York - have more than 150 each. Wineries and vineyards comprise one of the fastest growing sectors of American agriculture, and have become a major force for economic development and rural stability. The vast majority of American wineries are small, family owned businesses, which invest heavily in vineyard and winery development. Indeed, behind every bottle of wine sold at a winery is an investment of almost $50 in land, development, equipment and working capital. In addition to bringing capital investment to rural communities, wineries are also an important source of stable, mostly year round employment, and are a magnet for tourism. Wineries also promote crop diversification and farmland protection - two additional elements that are critical to the stability of rural communities. Virtually all wineries have on-site retail operations to receive visitors. Through their "tasting rooms," craft wineries expose a wide and diverse population to their products. Many visitors seek to continue that relationship even though they may reside in other states. Similarly, because America has a very mobile population, many customers who have discovered and developed relationships with particular wineries while living in one state want to continue purchasing those wines after moving to another state. Most states have recognized the tourism-generating potential of wineries by featuring them in their tourism publications. Almost a dozen states now have wine regions that are major tourist attractions, welcoming between 50,000 and 700,000 visitors per year from almost all states. This tourism also helps other agricultural enterprises and rural communities to gain visitors and customers. Where wineries have become concentrated - in Eastern Washington, Oregon's Willamette Valley, the Finger Lakes in New York, Michigan's Leelanau Peninsula, Grand Junction in Colorado, and the Blue Ridge foothills in Virginia - economic prospects have greatly improved. This trend is now spreading to a much broader range of geographic regions, including the hill country of Texas, Iowa, Missouri, southeast Pennsylvania, and many other parts of the country. Wineries have a unique capacity to generate sales through direct contact with customers. Out-of-state visitors, wine club members, preferred customer groups, national media exposures, and other opportunities create a pool of qualified customers who know the product they want and can initiate the purchase directly from the winery. Advantages of such marketing include a much more limited need for dispersed inventory, and much better alignment of product with actual sales. However, because of restrictive laws in many states, it is impossible for wineries to fulfill orders from consumers who reside in states that do not allow the direct shipment of wine. In addition to the negative public relations implications of not being able to fulfill all customers orders, the lost sales opportunities isolate and limit the geographical marketing reach of wineries, diminish their revenues and undercut their potential for growth. Marketing Realities for Small Wineries While America's wineries are an exemplar of the country's entrepreneurial and craft spirit, they are also, unfortunately, "poster children" for the problem of state impediments to e-commerce. Under the guise of "protecting citizens against the evils of alcohol" more than half of the states - including big states like New York, Texas and Florida - have effectively shut all but the top 100 wineries out of their markets by prohibiting direct sales to consumers from out-of-state wineries, and by requiring out-of-state wineries to market their products exclusively through the so-called "mandatory three-tier system of distribution." Under the three-tier system - broadly adopted by the states following the repeal of Prohibition - out-of-state wineries are only permitted to sell their products to licensed in-state wholesalers, who in turn sell to licensed in-state retailers (both on and off-premise) who then sell to consumers. Herein lies the conundrum for small wineries: the three-tier system is simply not a viable method for distributing their products. Indeed, with the exception of the highly branded products of the 100 largest wineries, most wine is "hand sold." Advertising, or mass brand identification, is unheard of in this market. Instead, such wine is sold through the knowledge and recommendation of members of the wine trade in direct, one-to-one contact with the person who is going to purchase and consume the wine. This fact illustrates, in a dramatic way, the limited influence of wholesalers on the marketing of wine. Their sales personnel never come directly in contact with the ultimate customer. At best, they help fulfill a sale made by a winery, retailer or restaurateur to a customer; at worst, they actually impede a sale by adding a layer of bureaucracy and unnecessary cost to the process. As such, outside of their own immediate markets, small wineries simply do not have the volume, brand clout or financial wherewithal to secure wholesaler representation - and wholesalers are not inclined, as a rule, to work with small wineries. However, when small wineries do enter into relationships with wholesalers in other states, these arrangements rarely last long or end happily. Indeed, the most common complaint we hear is: "The wholesaler never expended any effort to sell my wine, and when I wanted out, I was unable to recover my inventory, or get paid by the wholesaler for my wine." Like other small companies that specialize in marketing limited quantities of unique products with limited but more than adequate demand, small wineries must rely on remote sales to be profitable - either through catalogs, newsletters or increasingly the Internet. It is clearly impractical to convince retail stores with very limited shelf space to make that precious space available to the small winery, which might sell less than a case per year. Yet if direct shipment were allowed on a nationwide basis, a winery could market 10,000 cases (70 percent of America's wineries produce less than 10,000 cases per year) without too much difficulty. Coupled with tasting room sales, which typically account for 50 percent or more of a winery's receipts, this could make the difference between mere survival and profitability for most small wineries. As such, opening up a national market for the remote sale of wine is of vital interest to our members. The Federal Trade Commission Report The FTC is to be commended for its report, "Possible Anti-Competitive Barriers to E-Commerce: Wine," issued this past July. This report explores the benefits to consumers of online wine sales, and the public policy issues surrounding the direct shipment issue. WineAmerica was pleased to be a participant in the workshop series convened last October by the FTC to examine state barriers to e-commerce for many different products. The report also examines in considerable detail the most commonly cited reasons for prohibiting the direct shipment of wine to consumers from out-of-state wineries - underage access and tax evasion - and concludes that they are not sufficient to justify prohibitions on the interstate shipment of wine. Importantly, the FTC suggests that barriers to trade should only be acceptable when there are no less restrictive means for meeting public policy goals - a policy that this Subcommittee may find useful in developing any generic legislation to discourage unnecessary barriers to e-commerce. The report states, "Without a showing of likely harm, restraining competition in a way that is likely to hurt consumers by raising prices and eliminating their ability to choose among competing providers is unwarranted." To quote from the report's summary: ".consumers could reap significant benefits if they had the option of purchasing wine online from out-of-state sources and having it shipped directly to them. Consumers could save money, choose from a much greater variety of wines, and enjoy the convenience of home delivery..[M]any states appear to have found means of satisfying their tax and other regulatory goals that are less restrictive than an outright ban. These states generally report few or no problems with shipments to minors or with tax collection." Underage Concerns The FTC report examines whether allowing the direct shipment of wine would significantly exacerbate the problem of underage drinking. Their findings are instructive. Commission staff contacted officials from states that allow the interstate shipment of wine to their citizens. The agency concluded that there were "few, if any, problems with interstate shipment of wines to minors.. [N]one of them report more than isolated instances of minors buying or even attempting to buy wine online." The "laboratory of the states" has more than adequately demonstrated that direct shipment of wine can be accomplished without unacceptable risks. California, the nation's most populous state, has allowed the intrastate shipment of wine for 50 years and the interstate shipment of wine for more than 35 years. In 1999, Manuel Espinoza, then Chief Deputy Director for the Department of Alcoholic Beverage Control, wrote to Congressmen Mike Thompson and George Radanovich, stating that "California has permitted direct wine shipments [from sources outside of California] to consumers since 1963... At no time was a complaint received indicating the wine was used for illegal purposes, i.e., re-sale by a retailer or purchase and consumption by an underage person." He also said, "we have . experienced no enforcement problems or impediments to our ability to enforce laws relating to sales to minors as a result of [remote sales of wine or other alcohol beverages]." At this time, 40 states - covering approximately 87 percent of the nation's population - permit consumers to order and have shipped to their homes wine from in-state wineries. In addition, despite extraordinary pressure from wholesalers to erect or maintain protectionist barriers to out-of-state wines, 26 states and the District of Columbia - representing 52 percent of the population - permit the direct shipment of wine from out-of-state sources. This number is actually somewhat higher because a recent Federal statute [P.L. 107-273] permits wineries to ship to a purchaser's home that amount of wine the consumer could have lawfully carried back to his/her state so long as the consumer makes the purchase while visiting the winery. All of this state action begs the question: "If direct shipment posed such an enormous risk of underage access, why have so many states enacted laws to permit it?" Tax Concerns The FTC also examined in some detail the question of tax collection and the potential for evasion. Here it reached the same conclusion it did with respect to underage access, indicating from its survey work that states permitting direct shipment report few if any tax collection problems. The Commission also suggested that, by choosing to license out-of-state wineries that are engaged in the direct shipment of wine to consumers and requiring the payment of taxes, states could reduce the potential for tax evasion. At the state level, wine is subject both to an excise tax based on gallonage, and to sales/use taxes based on a percentage of the value of the product, as would be applicable to any other consumer product. Much has been made about potential revenue losses that might arise from the interstate shipment of wine to consumers. Careful analysis suggests that these arguments are grossly overstated. The average state excise tax on table wine is about $0.65 per gallon, so each bottle is subject to an excise tax obligation of just over thirteen cents. WineAmerica estimates that the maximum potential for out-of-state direct shipment of wine is 0.5 percent of the total U.S. table wine market of about 500 million gallons. Even if states did not collect a single penny of excise taxes from these sales, the total revenue loss from excise taxes would be approximately $1.6 million! Some perspective on potential revenue losses associated with sales/use taxes is also helpful. As this Committee is fully aware, remote commerce in general poses serious tax collection problems for the states. A national study estimates that states lost approximately $16.4 billion in uncollected sales and use taxes in 2001 on remote sales of all types of goods (Donald Bruce & William F. Fox: State and Local Sales Tax Revenue Losses from E-Commerce: Updated Estimates, Center for Business and Economic Research, University of Tennessee, 2001). Wine is a tiny portion of this potential loss. Using the WineAmerica estimate of interstate shipment potential at 0.5 percent of total wine market, and valuing the wine shipped at an average of $20 per bottle, the annual sales/use tax obligation engendered by interstate wine shipments ($250 million in sales) would amount to about $16 million (using an average sales tax of 6.5 percent), or 0.12 percent of the projected loss in sales/use taxes the states could incur. However, as the FTC pointed out in its report, there is no need for states to lose any revenue because of the interstate direct shipment of wine. Several states - including Georgia, Louisiana, Nebraska, Nevada, New Hampshire, North Dakota, Wyoming and in 2003 Virginia, South Carolina and North Carolina - have chosen to establish a system for a wine shipper's permit where all taxes, including excise and sales taxes, are collected by the shipping winery, and are remitted to the states based upon those sales. Another way to recapture virtually all of the potential lost revenue would be for Congress to solve the global problem of uncollected use taxes by requiring businesses to collect and remit those taxes as is currently recommended by the National Governors Association. For the Subcommittee's information, WineAmerica endorses a model direct shipment bill which includes provisions for a shipper's permit, reporting requirements and collection of both excise and sales/use taxes. The bill also provides that all wine be shipped in packaging that is clearly marked: "CONTAINS ALCOHOL: SIGNATURE OF PERSON AGE 21 OR OLDER REQUIRED FOR DELIVERY." So-called "shipper permit" bills provide a workable mechanism for the collection of both excise and use taxes from interstate wine shipments. This approach, now law in ten states, requires all shippers to be licensed by both the state where the shipment originates and the state where the consumer receives the wine, thus providing both nexus and enforceability. Litigation and State Legislative Action The appellate courts considering direct shipment litigation, like the FTC, have concluded that there are less restrictive mechanisms for states to meet their regulatory goals than outright bans on the interstate direct shipment of wine. The courts have pointed the way for proper analysis by indicating that the public policy concerns of the states can be met by less restrictive means than banning direct shipment, especially when in-state wineries are allowed to ship directly to their customers. To date, the 4th (VA & NC), 5th (TX), 6th (MI), and 11th (FL, though still seeking more details on the tax issue) Circuits have ruled that this type of discrimination - permitting in-state wineries to ship wine to consumers while prohibiting out-of-state wineries from doing the same - in unconstitutional. The 2nd Circuit (NY) heard oral arguments in early September and a ruling is expected soon from that jurisdiction. The 6th Circuit, ruling that Michigan's prohibition on interstate direct shipment was unconstitutional stated, "The proper inquiry.is whether (the three-tier system) 'advances a legitimate local purpose that cannot be adequately served by reasonable nondiscriminatory alternatives.' We find no evidence on this record that it does." Thus far in 2003, three states - Virginia, North Carolina and South Carolina - have adopted permit laws opening their borders to the direct shipment of wine. In addition, the 5th Circuit Court of Appeals has declared the Texas law restricting shipments from out-of-state wineries unconstitutional, and wineries may now ship to consumers in Texas. Recommendations for Congress While we do not recommend that Congress take any specific legislative action at this time to reduce barriers to online wine sales, given the importance and potential of the Internet, we do, however, recommend that Congress consider developing legislation to provide more generalized guidance to the states and courts in this area. Specifically, Congress could indicate that commerce - especially e-commerce - should be allowed in the absence of good, sufficient reasons to erect barriers, and when there is no alternative and less disruptive mechanism. The alternative - that of allowing states to erect barriers without regard to the Commerce Clause - will forever limit the potential of the Internet. The FTC found that reasonable and minimally restrictive means of protecting the public policy goals, such as requiring an adult signature at the point of delivery and requiring out-of-state suppliers to obtain a permit, are effective and states that have experience with these approaches report few, or no problems. The U.S. Supreme Court captured the dilemma faced by America's wineries: "Our system, fostered by the Commerce Clause, is that every farmer and every craftsman shall be encouraged to produce by the certainty that he will have free access to every market in the Nation.. Likewise, every consumer may look to the free competition from every producing area in the Nation to protect him from exploitation by any. Such was the vision of the Founders; such has been the doctrine of this Court which has given it reality." H. P. Hood & Sons, Inc. v. Du Mond, 336 U.S. 525, 539 (1949). Our member wineries are both farmers and craftsmen!
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