How Politics Can Brew Supply Chain Risk

July 15, 2016
Understanding the drivers of demand, including legislation, is critically important, even when an industry such as craft brewing is enjoying healthy growth.

As Britain’s recent Brexit vote underlined, shifts in the political landscape can create risk for supply chains. This type of risk can also arise from seemingly benign political changes that turn out to be more harmful than envisaged. An example here in the U.S. is government efforts to spur growth in the craft brewing industry.

The boom in craft brewing is creating nearly two new breweries every day in the U.S, but it’s not just brewers that are riding this mini-gold rush. Hop farming has become a highly lucrative business too, and new growers are taking root at a rapid rate.

State governments are bending over backwards to foster this pocket of economic growth. But efforts to help hop farming expand could backfire. Legislation designed to promote in-state craft brewing is creating imbalances between supply and demand that could stifle long-term growth in hop farming if not addressed.

The U.S. craft brewing industry grew at an annualized rate of almost 19% from 2010 to 2015, and generated some $5 billion in revenue over that period. As the industry has grown, so has its thirst for hops.

Craft beers derive much of their distinctive flavor from the type of hops used in the brewing process, and flavor is the top selling point for an estimated 97% of craft customers. But taste is not the only deciding factor. A recent study by the Brewers Association revealed that 67% of buyers are swayed by whether or not a beer comes from a local brewery when making a purchase.

A “local” beer can be one that is produced by a brewery in the locale. But in order to promote a revival in hop farming, some states are actively promoting the use of locally grown hops and barley in the production of these beers.

The most striking example of this strategy is New York State (NYS). In 2012 NYS passed the Farm Brewery Act that created a new brewing license category: Farm Brewery. These entities might or might not be located on a farm, but the key requirement is that they are based in the state, and manufacture, store and sell NYS-labeled beer.

The legislation provides various financial and service incentives for farm breweries. And it stipulates what ingredients need to be used to qualify for an NYS label. The stipulations are tiered. By December 31, 2018, no less than 20% by weight of the hops used have to be NYS-grown. This figure reaches 90% by January 1, 2024.

The economic incentives created by the law drove the majority of new brewery formations into adopting the license category. It also created a dedicated source of demand for NYS-grown which spurred rapid growth in the industry.

As demand has soared, hop farming in the state has become very profitable. A farmer can sell his or her entire crop at premium prices before a single hop has been picked. An acre of hops can drive revenues of up to $ 20,000 per year. Compare this to the $700 an acre generated by corn and cotton, or $600 an acre by hay.

Clouds on the Horizon

But there are clouds on the horizon. NYS-grown hops are significantly more expensive than product grown in the Pacific Northwest, a long established hop producing center in the U.S. Farms in the region are much bigger and achieve economies of scale that are beyond the small holdings in NYS.

As craft brewers scale up to meet demand—there is significant room for growth based on national and regional demand patterns—the ingredient price will become a larger portion of their total operating expenses. Eventually, they will be forced to find cheaper sources of hops, and if New York farmers can’t close the price gap with growers in the Pacific Northwest, they will struggle to sell their hops.

A detailed analysis of the hop supply in NYS and projected demand for craft beer shows that the state’s suppliers should be able to keep up with demand over the next three years.

The long-term picture is much riskier, however. The last tier of the NYS legislation comes into effect on January 1, 2024, at which time farm breweries will be expected to source 90% of their hops from state-based suppliers. The analysis shows that based on current production trends, the supply of hops in NYS will max out in 2019, and the industry will have to double in size by 2024 to support market growth.

Other states that are trying to capitalize on the craft brewing craze have similar supply capacity issues. Vermont has passed legislation that is almost identical to the NYS law. Maryland, Massachusetts, New Jersey and Virginia have passed legislation that aims to support local hop growing, although the incentives in these states are structured differently.

Expanding supply capacity in NYS will require significant investment in bigger farms. That requires more land and more automation; after a certain size threshold growers need to mechanize hop picking.

Whether the industry will meet these challenges is uncertain. The broader lesson is that understanding the drivers of demand, including legislation, is critically important, even when a business is enjoying healthy growth. Hopefully, the 100-plus farmers in the nascent NYS hop industry will heed these signals.

Nathan Stempel is the founder and owner of hop farm Hill Top Hoperation LLC. He has carried out a detailed study of the U.S. hop farming industry for his MIT Supply Chain Management Program master’s thesis.

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