Owners of former state liquor stores struggle to stay in business

Staff writerDecember 7, 2013 

For dozens of small entrepreneurs, last’s year’s auction of former state liquor stores seemed to hold great promise. The state, courtesy of voters’ approval of Initiative 1183, was getting out of the spirits sales business and turning it over to private enterprise.

Now, some 19 months later, more than 60 percent of those who bought former state stores are out of business, and most of the remainder are headed in that direction, according to the Washington Liquor Store Association. The WLSA represents former state liquor store and state contract store owners.

“It’s just been a nightmare,” said Michelle Tate, a former state liquor store employee and ex-grocery store manager who, along with her dad, Teddy Rayford, bought the rights to the state’s former liquor store on Tacoma’s Sixth Avenue.

Her father, who bankrolled the venture, says he has invested more than $500,000 in the store. That investment involves countless hours of work offering a hard lesson in the reality of competitive business, a partially mothballed store and a stack of unpaid bills.

Tate and “Pop” — she named the store Pop’s Liquor after her dad — are among the few battered survivors in a business that never lived up to the hopes that small entrepreneurs had for it.

They plan to open a sports bar in much of the building that formerly housed their liquor store.

Widespread wipeout

Dozens of owners of the 167 former state stores the state auctioned off in the spring of 2012 and the more than 150 former state contract stores are already gone from the liquor business, their savings and that of friends and relatives wiped out. Many still owe money to the state and suppliers.

Nearly two dozen remaining stores are in danger of losing their licenses because they owe the state fees on liquor already sold.

While early-stage failures are common in startup small businesses — the Small Business Administration says 15 percent of small businesses fail in the first year and nearly double that don’t survive until their second birthday — the 60 percent failure rate of former state liquor stores after a little more than a year and a half is extraordinarily high.

A number of things contributed to the business disaster that has ensued: Too-high prices for state store rights, a rushed effort to privatize the state’s liquor business, competition from big-box stores and liquor superstores, unclear rules and regulations about how the new system would work and a privatization initiative written by and for big liquor retailers, not the state’s neighborhood liquor stores.

The state’s auction of the rights to its former stores, which had a monopoly on liquor sales for 78 years, had been greeted with great exuberance — some would say an irrational exuberance — by would-be business people who saw a once-in-a-lifetime chance to buy into a long-established and profitable business.

The auctions garnered the state a total of $31.9 million in payments for the rights to open stores under 10,000 square feet in the same area where the state itself had stores. On average, the new owners paid nearly $200,000 per store for the former state store rights.

Winning the auction rights supposedly gave the new state store owners a niche that under law couldn’t be entered by any of the other 1,100 new retailers selling liquor in Washington. That niche was stores under 10,000 square feet.

New liquor retailers, stores such as Costco, Safeway, Fred Meyer, Walgreens, and out-of-state-based liquor super stores such as BevMo and Total Wine and More, could sell spirits but only in stores larger than 10,000 square feet.

For most, that meant opening the former state stores under new ownership. Or, if they couldn’t reach a deal with the state’s former landlord, opening a new store within a mile radius of the former state store.

In theory, that left the neighborhood market to the former state stores and contract sellers. No convenience stores would be selling booze, and the former state stores would have a wider selection than the supermarkets and drug stores that carried only a few dozen best-selling brands.

The new owners of the former state stores knew they would lose business to the big retailers, but they hoped that their bigger selection, more personal service and neighborhood convenience would allow them to retain a significant share of the state’s former volume.

That was the theory. The reality was something else. Sales fell dramatically.

In Chelan, where Julian Mart and his business partner bought the sole liquor store, sales fell from $2.5 million under the state’s monopoly to $260,000 in the first year of business.

In Tacoma’s Westgate area, David Cho’s Liquor Liquor store saw sales drop 85 percent.

In DuPont, Nyong Pang’s store’s volume dropped from a few thousand dollars a day to a few hundred.

“We knew we’d lose a lot of volume to Safeway and Thriftway and the big-box stores,” said Tate of Pop’s Liquor. “We figured that even with a big drop, we could make money,” she said.

But the sales decline was even steeper than they had predicted.

Bars, restaurants, distributors play role

Some of that decline came because the bar and restaurant business nearly evaporated for most of the former state stores.

Under the old state monopoly, bars and restaurants bought all their liquor through state stores. Under the new system, they were free to buy booze anywhere, even directly from the big wholesale distributors who had come to the state to win new business.

The new owners of former state stores figured — wrongly as it turned out — that even if the distributors were able to service the so-called “on premises” business, the local former state stores could meet or beat their prices and provide better service.

The working theory was that because the stores could order in larger volume, cases at a time, from the distributors, they’d get lower prices than the bars and restaurants, which might only order a bottle or two at a time.

Small-store owners say the distributors, particularly the state’s two largest, Southern and Youngs, which control more than 93 percent of the liquor distribution in Washington under the new privatized system, are employing aggressive pricing to win business from the bar and restaurant trade.

In some instances, that means a restaurant can order as little as one bottle from a distributor and pay less for that bottle than the former state stores do per bottle for 50 cases of the same beverage.

In a recent legislative hearing, the liquor store association contended such practice is illegal. The association contends that the distributors, which have exclusive sales arrangements with many distillers, can offer discounts based on the lower costs of handling large quantities of liquor but must charge all customers the same amounts for equal quantities.

The distributors won’t disclose to the small-store owners their prices to bars and restaurants, but some restaurant owners have shared their distributor invoices with the store owners.

Here is what the store owners say they discovered in those admittedly anecdotal examples:

In the instance where one restaurant bought a single liter of Tanqueray gin from Southern, the distributor charged the restaurant a basic price of $19.67 not including taxes. A former state store ordered 10 cases (240 bottles) of the same gin from Southern and was charged a per bottle price of $23.11.

In another example, a restaurant ordered two, one-liter bottles of Cazadores tequila from Youngs. A liquor store bought two cases or 24 bottles. The price per bottle to the restaurateur was $23.35, not including taxes.  The store paid $27.38 each for the two dozen bottles of tequila.

The small-store owners want the Legislature to halt what they say is an unfair practice.

John Guadnola, executive director of the Washington Liquor and Wine Distributors, said prices do differ between stores and bars and restaurants.

That practice, which the industry calls “channel pricing,” is a well-established practice in many states throughout the country.  Courts, he said, have upheld the practice as legal.

Lower pricing to bars and restaurants is a benefit to those business people because their costs are less and they can pass on the savings to customers.

The distributors paid a heavy price to the state, too — $150 million in fees to the state — to enter the business here, Guadnola said. And they too were burdened by a truncated timetable — just seven months from the initiative’s passage until full privatization — to build new facilities, hire new people and get their distribution systems up and running.

Owners take issue with Liquor Board

While the distributors’ practices attract criticism from the store owners, the liquor board’s handling of the transition from public to private ownership likewise comes in for bad reviews from those who bought the rights to the former state stores.

Besides the wholesale price differential, the stores say they lost bar and restaurant business because the liquor board required them to pay the same 17 percent fee on sales to bars and restaurants as they do on over-the-counter retail sales.

The Legislature earlier this year eliminated that fee but not before the stores had lost much of their bar and restaurant business, said the association’s president, Jas Sangha.

The small-store owners say the liquor board has also put them at a competitive disadvantage by prohibiting the stores from pooling their orders to gain volume discounts from the distributors.

Even in the case where one person owns multiple stores, the board requires that owner to enter his orders store by store, not for the whole group.

Tate said the board even prohibits small stores from trading stock.

“If I had a few cases of an expensive product that was moving slowly in my store, I couldn’t trade it or sell it to another store across town where there was a high demand,” she said.

The board’s rules apply unevenly to the former state stores and larger retail stores, the association said claims.

If one of the former state stores was looking for a new location, they’re limited to a one-mile radius of the former state store site. Larger stores aren’t so restricted.

When the state sold the rights to the former state stores to their new owners, the state often sold the new owners depleted stocks of slow-selling merchandise.

And the accelerated timetable for getting licensing paperwork done and locations secured put some new owners in untenable positions, they say. However, that timetable was set by Initiative 1183.

Liquor board spokesman Mikhail Carpenter noted that the small-store owners were given the option not to buy the remaining stock in the stores. They could have ordered a completely new inventory of spirits to their own specifications from the liquor distributors.

Leasing issues

Many owners bought liquor store rights they couldn’t afford to exercise. Others signed high-priced leases for former state stores because they were under pressure to open by the June 1, 2012, changeover date.

WLSA’s Sangha, for instance, paid $75,000 for the right to operate a liquor store in Belfair. He has yet to open.

The former state store was in a strip mall with a large grocery tenant who exercised a clause in his lease that allowed him to block the landlord from leasing space to a liquor sales competitor. The state had previously leased its stores, and new owners couldn’t simply assume that lease from the state but had to negotiate a new lease, sometimes with just a week to do so.

No other available space within a mile of the former state store was suitable for a liquor store, said Sangha.

In some instances, landlords, knowing the time crunch that new owners were in, insisted on much higher rents, larger spaces than the new owners required and five-year leases backed by personal guarantees.

Testifying before a legislative committee last month, a Renton liquor store owner who sold his trucking business to buy the rights to two state stores, said he fears that creditors will seize his personal assets to satisfy his debts because he can’t make a go of the stores.

Byron Roselli, a real estate consultant who helped two dozen private store owners negotiate their leases, said the compressed time line from the auction to the opening dates gave landlords huge leverage in setting the terms of the leases.

Some refused to lease to the owners of store rights because of noncompete clauses in other tenants’ leases or simply because they were waiting for a bigger, better tenant.

In one Bellevue-area shopping center, the landlord reportedly wouldn’t rent to the new owner of the former state store. A few months later he signed liquor superstore BevMo for that former state space and adjacent stores.

Owners want resolution

Roselli said the fate of the small owners is a tragedy. Of the two dozen he helped with leases, 23 are now out of business, and the last has told him he’s closing at year’s end.

Now most of those who bought those rights consider them virtually worthless.

“Who would buy the rights to a business that’s not profitable?” asked Mart, the co-owner of the former state liquor store in Chelan.

Rep. Liz Pike of Camas was so concerned about the way the small-store owners were treated that she sponsored legislation to refund the money they paid for the rights to the stores. That bill, filed late in the session, didn’t advance. Pike said she’s unsure whether the bill has the force behind it to move forward in the coming session.

“This was a perfect storm for these people. There is plenty of blame to go around,” she said. “I’m trying to be a champion for the little guy.”

Some critics of the small-store owners say they simply failed to do their homework, and the state shouldn’t interfere in the natural selection process among the retailers who sell spirits.

It was a lesson in survival of the financially fittest, and small liquor retailers simply weren’t among them, they say.

But the small liquor retailers say the state owes them something, a more level price structure, a tax break, or more flexibility to join together to win volume discounts.

“We paid the state more than $31 million, and all we got was grief,” said Tate.

john.gillie@thenewstribune.com

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