The lines between beer, soda and spirits are blurring as beverage companies seek sales growth

Bud Light is adding cola and orange soda to its seltzer, Mountain Dew is moving into the alcohol aisles and Molson Coors has a whiskey brand.

In the hunt for growth, beverage companies are experimenting in new categories, blurring the lines between beer, soft drinks and spirits to become powerhouses fighting for consumers’ so-called “share of throat.” But some alcohol companies worry about the potential implications of such a change on the three-tier system, which has kept that industry alive — and legal — for 88 years.

In 2020, total beverage alcohol consumption rose 2% — the biggest gain for the industry in nearly two decades, according to IWSR Drinks Market Analysis. Beer was the only category to see declining volume, true to a yearslong trend. Consumers reached for hard seltzer cans or mixed their own cocktails while stuck at home during lockdowns and maintained those habits this year.

“There are premium dollars going into ready-to-drink canned products in a cooler, and there’s growth again,” said Barclays analyst Lauren Lieberman at Beverage Digest’s “Future Smarts” virtual conference in early December.

In response, drink companies are teaming up to benefit from each other’s expertise. For example, Beam Suntory and Boston Beer announced a partnership this summer that would take well-known brands like Truly and Sauza into new categories.

For their part, nonalcoholic companies are diversifying their portfolios as soda consumption shrinks and new regulated beverage markets, like CBD-infused drinks, are on the horizon.

“We’re seeing it not just from beer competitors, we’re seeing it from nonalcoholic competitors — you’ve got Coke with Topo Chico,” said Ann Mukherjee, CEO of Pernod Ricard North America. “The lines are blurring, and consumers are the ones blurring the lines, so it’s allowing a lot more nontraditional companies to come into the space.”

Coca-Cola launched Topo Chico Hard Seltzer with Molson Coors Beverage in the U.S. in early 2021 as hard seltzer consumption soared. According to IWSR, U.S. hard seltzer volume surged 130% in 2020, helping the ready-to-drink category overtake spirits consumption, although growth has slowed this year. Topo Chico is the first alcoholic beverage that Coke has sold in the U.S. since the 1980s.

Molson Coors has said Topo Chico could become a top-three hard seltzer brand, joining White Claw and Truly at the top. The drink is closing out 2021 with a 2% share of the roughly $4.3 billion U.S. hard seltzer market, despite only being available in roughly a third of states. A nationwide launch is slated for January.

In its latest quarter, Molson Coors reported net sales of $2.82 billion, down 2% from the same time in 2017. In the last five years, as beer sales have lagged and the company has begun transforming its portfolio, the stock has fallen 53%. Coca-Cola, on the other hand, has seen its revenue climb 9.9% over the last five years to $10 billion in its latest quarter. The beverage giant’s stock has risen 40% in that time.

PepsiCo wasn’t far behind its archrival Coke. In August, it teamed up with Sam Adams brewer Boston Beer to announce Hard Mtn Dew. The flavored malt beverage will contain 5% alcohol by volume and sell on the soda’s brand equity — without the high caffeine content.  

Even before its launch, the drink is controversial. The National Beer Wholesalers Association has raised alarms against the launch, slated for late February. Pepsi has given a license to Boston Beer to produce the drink and created a new company, Blue Cloud, to distribute it.

“They’re taking an existing product that’s known as a globally recognized soft drink brand and adding alcohol, creating a whole host of challenges as it relates to the regulatory side, but also public health … we’ve never had that before,” said Craig Purser, CEO of the NBWA.

One important concern is that soda branding for an alcoholic beverage could result in underage drinking — accidentally or on purpose. Boston Beer said the design of Hard Mtn Dew cans will feature “adult-oriented graphics” and emphasize that the drink contains alcohol as part of its efforts to separate the alcoholic beverage from the soda. The company also said it will restrict its marketing to only target consumers 21 years of age or older.

But the NBWA’s main argument centers on Pepsi’s potential impact on the competitive environment and, thus, the three-tier system that has long governed the alcohol industry. After the repeal of Prohibition in 1933, the alcohol industry adopted the three-tier system, which separated manufacturers, distributors and licensed outlets. Alcohol producers are only permitted to sell their products to licensed importers, distributors and control boards, which in turn are only allowed to sell to licensed outlets — like liquor stores and restaurants.

The complex system is supposed to ensure a legal and competitive marketplace, while safeguarding against the possibility of a Prohibition redux. Washington is the only jurisdiction where manufacturers can sell alcohol directly to retailers.

“Having all of these separations is good, it’s fair, and it increases the competitiveness, and it really makes it so a consumer can be targeted properly with exactly what they want to buy,” said Tyler Theile, chief operating officer and director of public policy for consulting firm Anderson Economic Group. “If these lines get blurrier, states will have to get more careful about what falls in what category and where they’re allowed to be sold.”

Many states don’t allow large manufacturers to distribute their own products for that reason, although Pepsi is trying to sidestep that by licensing manufacturing to Boston Beer. Unlike Coke, Pepsi owns most of its bottling operations in the U.S., meaning that it has the responsibility of bottling and distributing about three-quarters of all of its North American beverages.

Anheuser-Busch InBev, the largest alcohol producer in the U.S., self-distributes in some markets. Purser estimates that accounts for 6% to 8% of Anheuser-Busch’s total volume.

“If successful, [Pepsi’s] foray into alcohol to capture a wholly new white space opportunity (while ultimately better leveraging its pre-existing and extensive network of distribution assets) could drive meaningful new sources of revenue and profit growth over the next three to five years, while challenging the near oligopolistic beer distribution networks of [AB InBev] and [Molson Coors] as a viable third alternative in beverage alcohol distribution,” wrote Deutsche Bank analyst Steve Powers in a Dec. 12 note to clients.

However, Pepsi is entering uncharted regulatory territory as their product lines blur. Many consumer goods companies pay retailers “slotting fees” for more shelf space or premium territory in grocery stores. For alcohol producers and distributors, paying such fees is illegal.  

“While PEP will contend that it does not offer ‘slotting fees’ as a rule in the US, any such perceived payments for placement on PEP’s part (whether direct or indirect), or any signs of camouflaging such payments could have significant implications (including fines and/or alcohol license suspension) for PEP and its distributors,” Powers wrote.

Powers also said that Pepsi has acquired a small fleet of trucks that will be dedicated to alcohol distribution, at least in the early days, although it will likely move to ship Hard Mtn Dew to retailers down the line using the same trucks that carry its other products like Gatorade and Quaker Oats.

Emiliano Di Vincenzo, general manager of Pepsi’s alcohol business unit, said in a statement to CNBC that Blue Cloud has filed applications and has received federal approval to operate as a beer wholesaler in several states. It will distribute alcohol products made by independent brewers, while Hard Mtn Dew will be distributed by Blue Cloud, Pepsi bottlers and independent local beer distributors, according to Di Vincenzo.

As Coke and Pepsi move beyond soda, some beverage giants are adding the product to their drink lines. AB InBev announced Dec. 16 that it will launch Bud Light Seltzer Hard Soda in January.

Traditional soda has come under fire over the last two decades from health experts who worry about obesity and diabetes. In 2020, consumption of carbonated soft drinks fell 4.7%, according to Beverage Digest’s annual report. Bud Light Seltzer’s take on soda won’t contain any sugar and comes in under 100 calories.

“Given that a significant amount of seltzer fans also purchase soda, we believe Bud Light Hard Soda is perfect for seltzer and soda fans alike,” said Andy Goeler, vice president of marketing for Bud Light.

After an initial pop in sales, beer-branded hard seltzers have seen their growth lag. MKM Partners analyst Bill Kirk wrote in a note to clients that he predicts Bud Light Seltzer and Constellation Brands’ Corona Seltzer will get pulled from the market. Corona Seltzer has reformulated its recipe to rejuvenate sales, while Bud Light Seltzer has focused on introducing seasonal variety packs and new lines.

Brewers are also pushing beyond hard seltzer and flavored malt beverages and into spirits. The category has seen consumption climb in recent years, boosted by mezcal and whiskey, while beer has lagged.

Molson Coors launched Five Trail Whiskey in September, starting in Colorado and expanding to three more states. It’s another step in the company’s pivot beyond beer, which included dropping “Brewing” from the company name in favor of “Beverage.”

“The [whiskey] category’s size and growth is hard to ignore,” said David Coors, vice president of Molson Coors’ next-generation beverages unit and great-great-grandson of original brewer Adolph Coors.

The whiskey uses Coors malt and Rocky Mountain water, a touch that Coors said gave the spirits brand more credibility.

“There are always critics out there, and we’ve tried to build the product and the brand as tightly as possible to minimize the critics that have tried to come after it,” he said.

And while some distillers might grumble about a beer giant edging into their territory, Coors noted that the two industries have been battling for some time, with spirits companies pushing canned cocktails.

“It’s as competitive of a landscape that I think anyone’s ever seen,” he said.

The alcohol industry is on edge, waiting to see whose products become consumers’ new favorites and whose disappear from shelves after failing to catch on.

“There’s a lot of new muscle that companies need to learn if they’re going to succeed in this space, and every competitor brings a different set of competencies to the game, but ultimately it’s the consumer who’s going to decide who gets to stay and win,” Pernod Ricard’s Mukherjee said.

The partnerships forged to make these new drink products may dissolve at the end of this learning curve, experts say. Goldman Sachs analyst Bonnie Herzog said at the Future Smarts conference that companies are in the learning stage now, trying to understand how to market and distribute their new drinks. In the future, they may push more aggressively into those categories, or choose acquisitions over organic growth.

For Coke and Pepsi, the push into alcohol could help the companies’ eventual entry into a newer market with the potential for even greater growth: CBD drinks.

CBD, or cannabidiol, is derived from the marijuana plant and some people believe it provides therapeutic relief. It does not include THC, which is what gives cannabis users a high. The Food and Drug Administration currently forbids selling food and drinks with CBD in it, making the beverage industry’s biggest players cautious to try it in the U.S. Upstarts like Recess Sparkling Water and Empress Teas, however, haven’t been as reluctant.

Cannabis company Canopy Growth, which is partially owned by Corona brewer Constellation Brands, also launched a line of CBD-infused sparkling waters in the U.S. earlier this year. Meanwhile, through Rockstar Energy, Pepsi debuted a line of hemp-infused drinks in Germany earlier this year.

“When you consider CBD beverages coming into the market, that’s going to change a lot in the next 10 to 20 years,” Anderson Economic Group’s Thiele said. “Getting themselves into the regulated beverage market with alcohol, that gives them a foot in the door to potentially continue to be in the regulated beverage market with CBD in the future.”