Contract Brewers Discover the Growing Importance of Brick & Mortar

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The gypsy brewers are finally settling down.

Lured by increased revenue from taproom beer sales, a growing number of nomadic brewers are deciding to build their own brick-and-mortar operations.

Over the years, companies as large as Boston Beer and as obscure as Slumbrew have shifted away from contract-focused business models and into their own physical locations. Contract brewing’s advantage is that it gives a brand the opportunity to scale up production without investing in hard assets from the outset. But as breweries mature, they are increasingly thinking about recapturing margin lost to distribution, spurred by an ongoing consumer shift toward consuming beer at the point of production.

Earlier this year, notable brands such as Mikkeller and Notch Brewing moved into their own brick-and-mortar spaces and, in recent months, Grimm Artisanal Ales, Backlash Beer Co. and others have announced plans to build their own small breweries and taprooms.

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Backlash president and co-founder Helder Pimentel said chasing those increased margins is the reason why he’s making a $1 million bet and signing a 10-year lease to open a flagship brewery in a former piano factory in Roxbury by summer 2017.

“Serving beer over the bar changes the economics of everything,” Pimentel told Brewbound. “Having someone sit there and experience our brand and drink our beers and walk out with a four-pack of cans, we’ve recaptured the entire distributor margin.”

More than recapturing the margins, however, Pimentel said building a dedicated brewery will allow Backlash to take control of the quality, consistency and freshness of its beer. The brewery will also be able to start barrel-aging and sour beer programs.

Once the company’s 15-barrel brewhouse comes online, Backlash — which had been contracting its brewing operations through Paper City Brewing Company in Holyoke, Mass., and Foolproof Brewing Company in Pawtucket, R.I. — won’t need to outsource, Pimentel said.

“It really depends on how well the taproom does,” Pimentel said. “Obviously, we want any and all production to be focused on the taproom.”

Pimentel knows the decision to settle down in a permanent location doesn’t come without built-in risk.

“When you think about it for us, there’s enormous risk,” Pimentel admitted. “But what other options do you have? It’s worth it. It’s not a last-ditch effort. In a way, we’re taking control of our own destiny and drawing people into our brand built over five years.”

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Notch Brewing founder Chris Lohring had a pretty practical reason to start out as a contract brewer: to save money.

After all, back in 2010, Lohring, who had previously co-founded Tremont Brewing, wanted to start a brewery built entirely around session beer — a concept that, at the time, was both somewhat unpopular and totally unproven.

Building a brick-and-mortar facility on session beer would have been “financially irresponsible,” Lohring told Brewbound, so he identified contract brewing partners and quickly began scaling up production of his session offerings.

But Lohring had also long desired to one day serve beers over his own taproom bar.

“We needed a home because consumers care about it,” Lohring said. “They want to visit you. They want to know who makes the beer.”

Lohring’s company was brewing at a scale where it made sense. Notch was producing about 7,000 barrels of low-alcohol beer annually by the time his new 10-barrel brewery opened in mid-July, in Salem, Massachusetts.

He financed the project using a combination of cash flow as well as a $425,000 equipment loan from MassDevelopment. The decision was financial as much as it was aspirational, he said, explaining that volume-driven session beer sold through the traditional three-tier system doesn’t carry the same kind of margins as other high-end craft products.

“The taproom is the great equalizer for it,” Lohring said. “The enterprise starts paying for itself pretty quickly.”

Taproom-focused business models are becoming an increasingly important differentiator in a crowded craft beer market that now includes more than 5,000 breweries. And with sales to more traditional on-and-off-premise retailers beginning to slow, Brewers Association chief economist Bart Watson said brewers making an investment into “own-premise” is a higher risk move with a potentially higher payout.

“Arguments can be made on boths sides of making the jump,” he said. “It’s much riskier to make investment in the craft space now, but it also may be a necessary cost of entry.”

Watson estimates that a 10-barrel brewery and taproom costs about $1 million to build, a sizeable price to pay just for the chance to sell beer over your own bar.

But there’s a payoff: Many brewers can sell a barrel of beer directly to consumers for around $1,300, versus $200-to-$400 to a wholesaler, according to those familiar with industry pricing.

Taprooms can do more than just add incremental dollars to the bottom line, however. They can also help build the brand.

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Take Narragansett Brewing Company, a top 50 craft brewery that will produce more than 100,000 barrels of beer (most of which is contract-brewed lager) in 2016.

“We resurrected a brand that was humongous that had died,” brewery president Mark Hellendrung said. “Part of the brand story is brewing locally. It’s just such an awesome way to connect with and interact with beer drinkers.”

So, to recapture some of that local feel, Narragansett invested in Isle Brewers Guild, a Pawtucket R.I.-based startup that will brew on behalf of other craft brands but will also dedicate a large portion of its brewery and taproom space to ‘Gansett.

“It’s a great way to build your brand,” Hellendrung said.

Nevertheless, Narragansett plans to maintain its contract relationship with North American Breweries in Rochester, New York, where a majority of its beer will still be made.

“I think everyone would be shocked if they knew how much contract brewing is going on within craft brewing,” Hellendrung said.

Still, there are companies who have ditched the contract model all together.

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San Francisco’s 21st Amendment, which first entered the craft scene as a brewpub and later decided to expand its marketplace presence in 2008 through the contract production of its beer in cans, has since come full circle.

“We didn’t know if it would be something that would catch on,” co-founder Nico Freccia said. “We were lucky and had good growth right off the bat.”

21st Amendment Brewing started off contract brewing at Minnesota’s Cold Spring Brewing Company. That arrangement allowed the brewery to scale up quickly and begin shipping its beer to the East Coast, Freccia said. It also let the team focus on marketing its brand “without constantly spending” on capital projects.

“It allowed us to scale from 1,000 barrels in our first year to 40,000 barrels three or four years later,” Freccia said. “We would never have been able to do that in our own facility.”

However, in 2014, the brewery announced plans to build a $21 million, 95,000 sq. ft. production facility in San Leandro. Freccia said he didn’t want 21st Amendment’s business to be reliant on outsiders. If a partner brewery had a misstep or went out of a business, it could possibly take 21st Amendment down with it.

“That’s not a good position to be in,” Freccia said.

When 21st Amendment broke ground on its brick-and-mortar brewery, it did so with the help of bank loans from Union Bank and available cash flow. Ultimately, he said, the decision to back away from contract brewing again came down to margin.

“We get up to 10 improved margin points by brewing at our own facility versus. brewing at a partner brewery, depending on our own facility’s capacity utilization,” Freccia wrote in an email. “The easy math will show that at 100,000 BBLs capacity and $270 per barrel revenue, 10 margin points equals close to $3 million in annual savings in an owned facility versus a partner facility. Add to this savings potential in shipping by producing more volume locally and there is a significant ROI here.”

But even as more craft owners shift some or all of their production out of contract facilities, there are a number of breweries still focused on serving the needs of gypsy brewers.

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Louisiana-based Abita Brewing Co. — which has grown to produce about 151,000 barrels of its own labels annually — is offering its excess capacity to prospective contract-brewing clients.

“We have the capacity,” Abita president David Blossman told Brewbound. “It’s as simple as that.”

Abita has had conversations with several breweries but no contracts have been signed, Blossman said. He said he wants to form long-term contract relationships with breweries.

“We’re growing this thing slowly,” Blossman said. “We’d like to do about 30,000 barrels next year and then 100,000 the next year. We’ll see where we are.”

Abita is joining a market that already includes several contract-brewing focused operations, including established players like Cold Springs, Minhas, F.X. Matt, Brew Hub and Two Roads, as well as newcomers Great Central Brewing, Sleeping Giant and Brew Detroit, to name a few.

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Sleeping Giant, the first dedicated contract brewing company west of the Mississippi, produces about 35,000 barrels of beer a year for about a dozen clients such as Colorado’s Weldwerks Brewing Co., House Beer, Texas’ Guns & Oils Brewing Co., among others. Next year, the brewery plans to add more tanks to reach about 50,000 barrels of capacity, Sleeping Giant president Matthew Osterman told Brewbound.

“The demand has been there,” he said. “From Day One, we’ve been playing catch up with keeping up with demand. That’s a good problem to have.”

Sleeping Giant, which doesn’t brew its own brands, is 100 percent focused on brewing its clients’ beer.

“We’re not just filling excess capacity to do stuff on the side,” Osterman said. “My goal is they achieve a 30 percent margin, but I don’t guarantee that. We don’t grow and succeed without our partners succeeding.”

But even the contract brewery operators themselves are recognizing the importance of taproom sales. Many of the above-mentioned breweries, including Brew Hub and Brew Detroit, pour partner brews as well as their own small-batch offerings to thirsty visitors.

That’s a model Sleeping Giant might try to replicate.

“The taproom dollars are hard to ignore,” Osterman said. “I would consider building a taproom here at some point. I still wouldn’t have any of our own brands, but I’d sell on behalf of our clients.”

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