BALANCING ACT

In this era of “government downsizing,” more control states are examining different ways they can trim their systems, from complete privatization (getting out of both the wholesale and the retail parts of the business entirely) to partial changes, such as switching from state stores to agencies or going to a bailment form of warehousing. The following are several examples of recent developments and initiatives with regard to privatization, as well as the latest results for some states after some degree of privatization.


MICHIGAN


Governor John Engler’s goal was to get the state of Michigan out of the business of warehousing and distributing distilled spirits.


The plan, developed by the Michigan Liquor Control Commission (MLCC), was to shut down the three warehouses and 63 regional distribution centers then run by the commission, and beginning in January 1997, turn the tasks of warehousing and distributing distilled spirits in the state to three “authorized distributor agents” (ADAs). These ADAs are private companies that were to have hauling contracts with suppliers and would, from then on, take orders from, and deliver distilled spirits to, the state’s 14,000 on- and off-premise licensees.


But there were problems. Because the change would result in the elimination of hundreds of state jobs, the Michigan State Employees Union had filed a lawsuit against the plan in early October 1996.


Months later, on January 10, 1997, the Ingham County Circuit Court, in response to the lawsuit, issued a temporary restraining order against the change. But by this time, the MLCC was well into the process of transferring the system to the ADAs, including emptying and closing its warehouses and distribution centers. The state filed for an appeal, and though some licensees were able to pick up their orders at state facilities during this time, in general, neither the MLCC, with its warehouses virtually closed, nor the ADAs, which were not allowed to make deliveries, could fill orders from licensees. A week passed. On January 17, the Distilled Spirits Council of the United States (DISCUS), the trade group representing the distilled spirits industry, filed a writ of mandamus, asking the judge to direct the MLCC to immediately resume accepting deliveries from suppliers. Warning that “retailers are running out of distilled spirits,” DISCUS also stated that “Michigan consumers should not have to pay the price because of disagreements between the MLCC and its employees.”


Finally, on January 21, the State Court of Appeals overturned the orders of the Circuit Court. And after almost three weeks of complete shutdown, private distribution of distilled spirits in the state of Michigan was allowed to start.


“It was a mess,” said Jacquelyn Stewart, the MLCC’s present chairwoman, “but it was no fault of the [new] system.”


Despite the rocky start, the Michigan’s LCC seems to have regained its footing. “We’ve had some problems, as you would when making any mammoth change,” said Stewart, “but we’re getting it all on track.” She cited a recent audit done by the state’s treasury department which showed that the MLCC’s cash receipts are up, and said that licensees have reported a tremendous improvement in the system since January.


The current system, which is now one of the most privatized of any of the control states, requires suppliers to have a contract with one of the three ADAs. Licensees order their products from the ADAs, which then fax the orders to the MLCC. The commission, as wholesaler, makes the purchase from suppliers and adds a 65% markup. Suppliers ship the products to the ADAs, which, in turn, deliver them to the licensees. Off-premise licensees, called “specially designated distributors,” or SDDs, must charge retail prices set by the state.


IOWA


When Iowa’s Alcoholic Beverages Division made changes to its control system in the late 1980s, it also encountered some hurdles. The plan was to privatize the retail tier, going from state stores to private retailers, and to turn the running of the state’s bailment warehouse and the distribution of product over to a private company.


Though the legislation to make these changes was passed at the end of 1986, members of the General Assembly complained that they hadn’t had time to debate the issues and the speaker tabled it until January. Then, near the end of that month, the Speaker suddenly released the new law, though no additional debate had taken place, making it effective by March 1.


“We had about five weeks to close the stores,” said Denny Mitcham, chief of products & customer services for the Alcoholic Beverages Division, now a part of the Iowa Department of Commerce. “Any time a retail store opened, state stores within five miles of it had to close.” In one weekend, the division had to close 195 of its 220 stores. And the new law stipulated that all the state stores had to be closed by June 30.


The rush did cost the state some money. “We didn’t have much of a chance to plan and didn’t get as much out of the stores as we could have,” said Mitcham, who remembered seeing a store’s worth of shelving, probably worth $30,000, sold at auction for $30.


But in many ways, the Iowa plan faced fewer obstacles than Michigan’s. Though the Alcoholic Beverages Division drastically cut its work force, from approximately 1,400 full- and part-time employees down to just 24, it did not face opposition from the state employees’ union, which is a voluntary organization to which only about 3% of the state’s employees pay dues.


Nor was there any opposition from groups concerned with excessive alcohol consumption. “We did expect some, but we didn’t hear a word,” said Mitcham, who pointed out that sales of distilled spirits in the state had been experiencing a decline over the five years prior to the changes.


Since then, the changes have enabled the division to contribute $115 million more into the general fund over the years. In the first year alone, not running state stores saved the division about $8 million, while contracting out the warehousing and distribution tasks saved $800,000.


In the first year of the changeover, the division contributed approximately $18 million to the state’s general fund. Last fiscal year (1997), it contributed $53 million. “The amount we save from not running our own stores just keeps going up,” said Mitcham. “The change has been financially fantastic for us.”


Still, Mitcham pointed out, what worked so well in Iowa would not necessarily be the best plan for another control state. “Each state has to look at its own situation,” he said.


OHIO


Where the Iowa Alcoholic Beverages Division privatized its retail tier, the Ohio Department of Commerce’s Division of Liquor Control (DLC) chose a different course: not to privatize, but to convert its retail outlets to agencies. “Privatization didn’t truly happen here,” said Patty Haskins, analyst of planning and merchandising for the Division. She pointed out that the state still maintains ownership of all distilled spirits until they are bought by the consumer, determines what products agents will carry and sets the retail prices. “It is still a very controlled situation,” she said.


And that was a concern that had to be balanced with the goal of increasing the system’s efficiencies and raising the amount of money the DLC contributes to the state’s general revenue fund.


Indeed, the changeover took almost six years to accomplish. Conflicting requirements could be seen right from the outset. For the fiscal year of 1992-1993, the DLC was required to increase its contribution to the state’s general revenue fund by $10 million. Yet, when Ohio Governor George Voinovich and the DLC introduced a Senate bill in 1991 that would allow all the state’s stores to be converted to agencies in order to achieve cost savings, that bill was defeated.


One issue for the bill’s opponents was control. Some voiced concern that, since the agents would be paid a commission for the spirits they sold, a profit motive would be introduced into the sale of distilled spirits in Ohio, increasing the likelihood of sales to minors and problem drinkers.


To achieve its needed savings, the DLC began to make changes where it could under the existing law. By law, agencies, rather than state stores, could exist in areas with populations under a certain level, and where it was already legal, the DLC did close about 70 state stores and establish agencies. At the same time, the DLC introduced a series of three other bills, from 1993 to 1995, that changed and then eliminated these population caps. By June of 1995, the law had been changed to allow complete conversion to agencies throughout the state.


The DLC conversion from state stores to agencies was completed when the last state store closed on November 18, 1996. A total of 257 retail and six wholesale state stores had been closed. There are now 393 agencies in the state, 274 of them combination retail/wholesale outlets.


In the end, perhaps, the gradual nature of the change was a good thing. “The way it was approached helped allay fears. These problems were not surfacing,” said Haskins.


When it came to the selection of businesses who would be agents, the process was anything but rushed. A panel of experienced state employees visited nearly 1,000 sites and made their selections based on that on-site inspection. The panel focused on matters such as the amount of parking, the store’s retail shelf space and its wholesale storage space, as well as the business’s history, including, in many cases, its record for handling the sale of beer, wine and low-proof mixed beverages. “This worked very well for us,” said Haskins. “The time frame meant there was no pressure, no major change needed to happen overnight.” About 80% of the agencies in the state are carry-out and convenience stores, 15% are supermarkets and groceries and 5% are drug stores.


Then there was the issue of laying off state employees and the subsequent opposition of the employees’ union. In the end, the DLC reduced its staff by 1,577 employees, including 101 liquor-enforcement officers who were transferred from the DLC to Department of Public Safety in 1995. “Bottom line, the reality was that people were going to lose their jobs,” said Haskins, “and the department tried to do everything possible to help.” Employees were encouraged to apply to be agents themselves and about 20 of them did. Meanwhile, other agents were encouraged to consider hiring former state-store employees as managers and sales clerks. As mandated by state law, the employees were offered early retirement and the DLC offered training and information through job clubs as well. The cost to the DLC of the early retirement plan and unemployment contributions was more than $9.1 million.


The end result? The DLC is saving a substantial amount of money. It estimates, once the costs of its early retirement program and unemployment are paid, that the change to agencies will save the DLC $21.4 million per year.


By keeping the commission rates low, 6% for retail sales and 4% for wholesale, the DLC ensured that agents would not look at liquor sales as a source of profit. “Basically, it’s just a draw for them,” said Haskins of the agents, all of which are other types of businesses. In addition, agents and their employees go through a course, the Responsible Alcohol Sales Through Employee Awareness class, and are subject to monthly compliance visits as well as two or three additional audits throughout the year.


VERMONT


The Vermont Department of Liquor Control (VDLC) also converted from a system of state stores to one using agencies, in the summer of 1996. “Simply, in the modern world, running state stores — with rent, utilities, employees and other operating expenses — is a lot more expensive than paying existing grocery stores what is a quite low commission,” explained Norris Hoyt, commissioner. According to Hoyt, Vermont’s DLC saves about $400,000 to $500,000 a year because of the change.


In Vermont, unlike Ohio, there wasn’t opposition to the plan because of concerns over increased consumption. But the system set up by the VDLC did allow for plenty of control over its agents. “We prescribe everything in the world,” Hoyt joked, including prices, hours and how the store’s alcohol section is set up.


The VDLC provides each agent with a point-of-sale device for the sale of beverage alcohol. Every night, that device is polled, sending its sales information to the VDLC’s computer system over phone lines. At the end of every day, the agent has to deposit the money from alcohol sales into the state’s bank account. The agents are then paid their commissions every two weeks. “Everything is totally computerized,” said Hoyt. “Every day, every bottle in the state system is accounted for.” Currently, there are 75 agents in Vermont, most of which are grocery stores.


As in Ohio, the Vermont DLC took pains to make sure there would be no profit motive. In Vermont, agents receive a commission of 7.25% on the first $75,000 worth of sales. After that, the commission goes down. “It’s exactly the opposite of the private sector,” said Hoyt.


One aspect of the change that did concern the VDLC was the effect on customer service. That’s why, unlike some states that require their agents and retailers to buy their spirits upfront, the Vermont DLC went with a plan where it stocked the agents and paid them a commission after a sale was made. “The problem would be if agents couldn’t afford to buy the full line and would just choose [to stock] the few products they thought would be good sellers,” explained Hoyt. In Vermont, each agent carries a full line of 600-plus distilled spirits and fortified wines.


Presently, the Vermont DLC is experimenting with one adjustment to its system: opening “mini-agencies” in sparsely populated areas. In these areas of the state, which include some tourist destinations, the nearest agencies can be quite far away. “In fact, in one instance, the most direct route [to a store selling spirits] was into New Hampshire, which we don’t want,” said Hoyt. The mini-agencies, which would carry about 200 products, are meant to solve this problem.


MONTANA


While the systems in Ohio and Vermont maintain ownership of their products in their stores, the Montana Department of Revenue, in 1996, went from a system of 26 state-run stores and 82 agencies, to a system of retail outlets, still called agencies. These outlets own the products on their shelves and can set their prices as high as they would like, although they cannot set them below the state’s posted price. At the same time, the MDR changed to a bailment form of warehousing, in which suppliers own the products stored in the state’s warehouses until they are actually ordered by an agent.


The new system, designed to save the state money, also resulted in a reduction in the number of state employees working in the control system. However, in Montana’s case, the employees’ union decided to work with the Department of Revenue in making changes rather than oppose it. “The writing was on the wall. [The change] had been a hot topic for a number of legislative sessions and this administration was going to back it,” explained Larry Logan, distribution accounting supervisor. “The union’s stance was to get in, get involved and get the best possible package for the people it represents.”


The result was that a large number of the employees who lost their jobs because of the change were able to find other state government positions. Managers of the state’s 26 stores were also offered the right of first refusal for taking over their stores and becoming agents and, according to Logan, “a high percentage did that.” And all the employees slated to be let go were offered bonuses if they stayed until the conversion of state stores to agencies was completed.


WEST VIRGINIA


When the West Virginia Alcohol Beverage Control Administration (WVABCA) privatized its retail tier in 1990, converting from a system of state stores and agencies to one composed entirely of private retailers, it faced the task of reducing its work force from approximately 500 people to 90. As in other states, there was opposition from the employees’ union. A two-year order signed by the Governor, giving preference to former state-store employees for openings in other state agencies, helped, as did the fact that a lot of the state-store employees were hired by the new retailers. “Let’s face it: there was no one else with experience in selling distilled spirits in the state,” said Ron Moats, director of operations. “Most [of the retailers] had no idea of what to buy or what to do.”


In addition to cost savings, the WVABCA felt there were other benefits to having private retailers replace state-run stores. “The state didn’t do a good job of marketing,” said Moats. “Everything was political: where the stores were, who they were rented from, what rent was being paid. The stores were not being run like a business.”


And control would not be put in jeopardy, it was felt. The private retailers bid on franchises, the right to sell distilled spirits in the state for a period of 10 years. “They paid lots of money, put in a big investment. They are not going to take the chance [of making an illegal sale],” said Moats. “We have as much or more control now as we did before.”


The result of the change? The WVBCA is making the same amount of money it had before, with 400 fewer employees. And the move out of retail has allowed the Administration to focus on other duties. For instance, it recently increased its number of enforcement officers from 20 to 35.


A modification of the present system may be on the horizon. As it stands now, retailers will need to rebid for the right to sell distilled spirits in the year 2000. But some have begun lobbying for legislation to keep their licenses permanently without having to go through a bidding process.


IDAHO


Some control states have experimented with changes to their systems and decided not to go forward with them. In Idaho, the State Liquor Dispensary (SLD) experimented with its “Retailer Program” in 1995. In addition to its state stores and its agencies, which don’t own the distilled spirits products on their shelves but are paid a commission on their sales, the SLD, under a previous administration, allowed 22 retailers to buy products from the dispensary and sell them at state-controlled prices, making a 12.8% markup.


“It was always a bit controversial,” said James “Dyke” Nally, the SLD’s present superintendent. “Some thought it was a move toward privatization without legislative approval.”


Because that controversy has never been settled, Nally has let the Retailer Program slowly wither. He gave all 22 existing retailers the opportunity to convert to agencies. All but eight of them did. Those eight have been allowed to keep functioning. “The biggest excuse for not becoming agents was because they didn’t want to be involved in bureaucracy and paperwork,” said Nally, “but the ones who did change over have not complained of that. At the present time, we have no plans to demand that [the last eight] change.”


Besides that controversy, Nally saw other problems cropping up in the Retailer Program. One was that it was difficult to track sales. “Monitoring is, by state statute, our responsibility, and it’s hard to have much of an audit trail,” he explained. Also, because retailers buy their liquor upfront, Nally noticed that the selection in their stores sometimes suffers.


MONTGOMERY COUNTY, MD


In Maryland, the Montgomery County Department of Liquor Control (DLC) started an experiment in 1992 in which some of the county-owned stores were managed privately. The private companies “supply the personnel and management and assume responsibility for all bad checks, breakage and theft, while everything else — the lease, the products, the utilities — are the county’s responsibility,” explained Frank Orifici, chief of operations. “It’s a county store, but somebody else runs it.”


Out of the county’s 22 stores, four are contracted out. But though this experiment was slated to progress, the legislature passed a bill not allowing any more contracts to be made, although the four existing contracted stores have been allowed to continue operating .


“Of course, that’s subject to change,” said Orifici, noting that the legislature had just begun its session.


After all, for control system administrators, change can seem like the only constant.


With 650 stores and almost 3,000 full-time employees, the Pennsylvania Liquor Control Board (PLCB) is one of the largest beverage alcohol retail operations of any kind in the country and a major employer in the state. Indeed, the PLCB is widely recognized as running a very successful retail operation, yet even Pennsylvania has seen its share of privatization initiatives. The latest, introduced last spring by Governor Thomas Ridge, proposed to change the system from state-run stores to private retail operations. John Jones, PLCB’s chairman, described this latest proposal as currently “sitting in suspended animation,” after being debated by both the Senate and the House last term.


Even when changes do commence, there is often as much opposition from politicians, state employees and public safety groups as there is support, and there are always costs as well as benefits to consider.


What this means for control state administrators is that change does not always come easily — and sometimes it does not come at all. Meanwhile, the goal is stay on the tightrope between increasing efficiencies and maintaining control, between raising revenue contributions but not retail prices.

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