Mendocino Brewing Company Case

1. Is the craft brewing industry attractive?

To determine the craft brewing industry’s attractiveness, we can start by estimating the Potential Industry Earnings, and followed by Porter’s 5 forces for more detailed analysis:

Potential Industry Earnings
Potential industry earnings are high in this case due to the following reasons:
• Growing industry: The craft-beer industry has exploded over the last decade while the overall beer industry has been stagnant. In 1993, average sales for craft-beer industry grew by 47%.
• Favorable consumer preference shift: Even though Americans are drinking less, they are drinking more fuller-flavored beer, a favorable shift for craft brewers.
• Big potential market: Despite the success of the craft-brewing industry, it captures only 1% of the total beer market. The combined market share held by the 3 largest mass beer production firms still composed of 78%, indicating there is great potential for craft brewers to grow.
• Reducing cost: For beer industry in general, the technological improvements and multi-plant operations have reduced the packaging, advertising and distribution costs. The beer production automation also reduced the labor cost, which on average increased by 7% annually for the past 20 years.
• High profit margin: Craft brewers manage to succeed by producing innovative, richer tasting beers, and were able to charge a price premium for their products.

From the PIE analysis, the craft brewing industry is attractive in general, but we need to be aware that the potential regulations changes in the industry, particularly taxes, might decrease the PIE. We will elaborate the competition craft brewers face through Porter’s 5 forces analysis:

Porter’s 5 forces
• The threat of potential new entrants:
Barriers to entry are low: Minimum investment to enter the industry is as low as $ 500, 000. Furthermore, capital equipment and supplies are easy to obtain. There is also a cadre of packaging and merchandising suppliers and brewing consultants who advise brewers on anything from building a new brewery to designing a new beer, making entry to the industry easier.
• The bargaining power of the buyers:
Buyers are faced with a great variety of beer styles as well as beer suppliers, thus have a strong bargaining power. As is shown in Exhibit 5 in the case, there are 26 styles (including both Ale and Lager types) in the market, and each style has an average of 2.3 sub-styles.
• The bargaining power of the suppliers:
Suppliers have little bargaining power in the industry, which works in craft brewers’ favor. There are 175 manufacturers and suppliers who provide brewing equipment to small-scale breweries. Brewers can also purchase used or refurbished equipment.
• The availability of substitute products:
There is a wide range of substitute products. First of all, richer-tasting imported beers as well as domestic mass production beers are all close substitutes for the domestic craft beers. Other forms of substitutes are non-beer type of alcohol drinks and non-alcohol drinks.
• The existing level of competition among firms in the industry:
The competition in the industry is high. On top of the numerous craft brewing companies currently in play, the large Breweries also try to compete against microbreweries by acquiring microbreweries or using phantom breweries. More details on the competitors can be found in the Exhibit “Major Craft Brewing Companies Analysis” attached at the end of this paper.

Even though the PIE analysis indicates the industry is attractive, Porter’s 5 forces suggest several elements that would put craft brewers at disadvantage. These elements include strong buyer power, low barriers to entry and fierce competition. These explain why out of 109 firms in the beer industry reporting financial statements in 1989, 86% of them are losing money while the rest of the firms are earning a net profit of 42.4 million on average. Almost two-fifths of the defunct microbreweries and three-fifths of the defunct brewpubs discontinue operations within 2-3 years of founding in US. However, as long as Mendocino positions itself well in the value chain, it will still be able to profit from the PIE.

2. Identify Mendocino Brewing Company’s strategy prior to their decision to expand

Mendocino Brewing Company’s elements of strategy are listed below:

Maximize profit by brewing the highest quality beers it can and maintain high standards of customer service and satisfaction and social responsibility.

• Products: MBC’s product line includes Blue Heron Pale Ale, Black hawk Stout, Peregrine pale Ale, Eye of the Hawk, Yuletide Porter, Springtide Ale and Red Tail Ale. Red Tail Ale is the company’s flagship brew, and accounted for 85% of 1993 revenues.
• Geographic Locations: Over 95% of MBC’s beer is sold in California in 1993. Red Tail Ale is also sold in Arizona, Washington, Oregon, the District of Columbia, Massachusetts, and Colorado.

Competitive Advantage
• First mover advantage: MBC established The Hopland Brewery, the first official brewpub in California since Prohibition. Being an early pioneer in the micro-brewery market, the company is able to accumulate knowledge on the manufacturing, distributors and clients
• Strong relationship with distributors: MBC views distributors as customers and partners. It provides them with popular beer and offers competitive margins on a premium-priced product.
• Brand recognition: MBC is still recognized for its contributions as a pioneer in the craft-brew industry. MBC also has a very strong public image through the goodwill it brings about from recycling and money raising events.
• Efficient production & High quality: MBC’s manufacturing system stresses process control to ensure quality and consistency of output, efficiency, cleanliness, and safety. MBC’s high quality beers enable the company to price their products above almost all of its competitors.
• Management team: MBC has a flat, efficient style management team. The management team also leads the company to adopt the TQM system, improving the operational efficiency and employee satisfaction. Furthermore, CEO Laybourn is the Vice President of The Brewers Association of America, putting MBC in a good position to advocate favorable federal initiatives and get the first hand information on regulation changes.

The logic of a successful strategy is predicated on the firm’s positional advantage, capabilities and how they fit into the current business environment. Mendocino has the competitive advantage in beer quality, brand name and distributor/customer relationship, enabling the company to make $138,925 net income in 1993 despite of all the competition.

However, to sustain in such a fierce competition, MBC needs to seek expansion so it can offer more product varieties and increase product availability for clients/distributors while at the same time, benefit from economies of scale. MBC currently relies too much on Red Tail Ale and its distributors often face product shortages. Those problems can be alleviated through the expansion.

3. Evaluate MBC’s expansion plan
a. Is this a change in MBC’s strategy?
b. Is it externally consistent?
c. Is it internally consistent?

a) The expansion plan is in line with MBC’s goal—maximizing profit by brewing the highest quality beers it can and maintain high standards of customer service and satisfaction and social responsibility, for the following reasons:

Improving customer satisfaction by meeting their demand and improve the facilities: While the average craft brewer increased sales by 42 % in 1992, MBC grew by only 15% due to its capacity constraint, suggesting there’s an unmet customer demand, which usually results in customer dissatisfaction. Through the new brewery, MBC will be able to provide more capacity, build hospitality room, and design planned tours, enabling the firm to service customers better.

Consistent Quality and Efficient Operations: MBC believes the new facility will improve production efficiency and make it easier to produce consistent brews. Furthermore, as the company grows, the importance for efficient process flow will increase, forcing the company to adopt better inventory control and supply chain management.

Better Human Resource practice: One benefit for the expansion is that MBC will be able to increase earnings, thus raise the standard of pay to their staffs. Currently, half of MBC’s employees are part timers and their compensation is slightly below the industry average. While the company focuses a lot on employee satisfaction, through the expansion, the company can move some current employees to full-time status and use the capital raised from expansion to give stock options to employees.

Better Finance Outlook: For the first look, going public seems to go against MBC’s long-held traditions. However, the stock offering has been designed to ensure that it would be difficult for anyone else to gain control of the company, decreasing the risk of cultural impact from outside. Being the public company will push the firm to perform more efficiently, hence increases its profitability. Moreover, the stock issuance to employees, distributors and customers will help the company to motivate stakeholders to work together for one common goal.

Market expansion: MBC’s growth strategy is to expand production capabilities and increase wholesale distributions through further penetration of existing and targeted regional markets with a broader line of specialty beers. MBC’s market expansion plan is two fold, linking tightly with their growth strategy:
• Through product expansion: After constructing the new facility, MBC plans to use the original Hopland Brewery to experiment with new brews to add to its product portfolio.
• Through alliances: The company is considering using alliances to expand domestically and abroad. The alliance will enable the company to produce beer closer to market, decrease delivery time and cost, yet save the company from massive capital expenditure. Alliances could also give MBC fiscal and marketing strength and enable them to produce products that they currently lack the expertise and equipment. However, MBC needs to be cautious in selecting their partners so that the product quality will not be compromised.

Stronger distribution: While the marketing strategy after expansion remains very similar to before, ie: word-of-mouth marketing, there is one major change in terms of managing distributors. The company will initiate a distributor management program and build a working relationship with distributors, through which MBC will evaluate all the distributors and replace weak ones. Currently, distributors are on an allocation system due to the limited capacity, with the working relationship in place, the company will be able to focus on the high quality distributors and make sure they have enough supplies.

To sum up, the expansion plan will impact MBC’s current business in many ways as described above, but those impacts will enhance the company’s current competitive advantage and are in line with the company’s strategy.

b) The expansion plan is externally consistent. The industry analysis (PIE) suggests that the industry demand is growing. Customers are shifting their preference towards craft-brewed beers. The high premium price the micro brewers are able to charge as well as the cost savings from the technology improvement make the profit margin in the industry very attractive. MBC is able to price above almost all of its competitors due to its high quality. However, the Exhibit “Major Craft Brewing Companies Analysis” attached at the end of this report shows the company relies too much on Red Tail Ale and is weak in terms of geographic coverage.

To meet the goal of the company, Mendocino’s challenge is really to increase its share in the PIE and reduced competition by providing more differentiated products through offering more varieties of high quality beers and broadening geographic distribution. Thus the expansion plan is consistent with the strategy of the firm and will help the company achieve its goal.

c) The expansion plan is also internally consistent after we examine the fit between the plan and the organizations (ARC). To help improve efficiency, quality and service after the expansion plan, MBC plans to design the organization as below:

MBC embraced Total Quality Management movement throughout the firm. The quality council, safety team, team management system and formal suggestion system will still stay after the expansion. Other potential architecture changes arising from the expansion plan are more full-time hires, better distributor management programs, more competitive compensation through stock options, and better production efficiency. These are all in line with the company’s strategy. There are other architecture changes such as going public and alliances with other firms that might bring some risk. However, as we have discussed earlier, these changes will create more benefits to the firm as long as they are managed carefully.

The company values good public image and new ideas. Practices such as recycling and fund raising are most likely to stay after the expansion. The routine will not change much from the expansion.

Some valuable elements in the company’s culture are quality, teamwork, focusing on customers, being a good public citizen. Those can still be maintained after the expansion. The bigger challenge will be keeping the tight-knit culture among customer/employees and employees themselves as the organization expands. However, the management team plans to bring customers closer by the use of new facility’s hospitality room and planned tours. The team also plans to bring employees together through more social events.

The strategy will only work when various external and internal elements complement each other and are consistent with the strategy itself. Mendocino’s management team adjusts the ARC to fit the expansion plan is an example of consistency.