Game Theory and the Hop Industry

The craft beer industry everybody praises as being responsible for a renaissance in hop flavors and craft production during the past decade, is transforming the hop industry. I’m not talking about insatiable demand for new hop flavors or the ever-increasing number of hop varieties on the market. The business of the hop industry itself is changing. That change is cannibalizing the hop industry that contributed to its success.

Very seldom does anybody say nice things about anybody else in the hop industry so let me break with tradition for a bit to make an important point about the industry. It would be an understatement to say the Barth-Haas Group has been around a while. George Washington was President of the United States and the American Declaration of Independence was only 18 years old when the company started. For a German company steeped in the tradition and romance of an industry whose recorded history dates back nearly 1,000 years, the last couple hundred years probably seems like a great beginning. To an American, like myself, 200+ years in the same business is an unfathomable amount of time. It’s an amazing accomplishment! Kudos to them! Even after all that time, the Barth-Haas Group has an excellent reputation within the hop and brewing industries. That’s really no surprise to anybody who knows the people who work there. They have an amazing team of people across the globe that sincerely care about hops and love what they do. They’ve invested time, money and effort to make the hop and brewing industries better in more ways than many of us will ever know. At times, they have led the industry in research. They have contributed to setting standards by which the industry operates, and they have improved the way brewers use hops today. Those are just a few of the things I can remember during the past 19 years I’ve been in the business. I think it’s fair to say that every member of the hop and brewing industries has benefited from their contributions over the years. Props to all the people over at the Barth-Haas Group for caring about what they do and doing it so well!

If you’re reading this, scratching your head and wondering why all this love for Barth-Haas and you’re waiting for the hammer to drop … sorry to disappoint. No hammer. In fact, I’ll go even deeper. I could have substituted Steiner, YCH, HVG or a handful of other merchant companies to illustrate that same point although the details of their contributions would have varied slightly. My point is simply that there are amazing people working at merchant companies around the world to make the hop and brewing industries better. These are the very merchant companies whose efforts many brewers discount and disrespect today. The game is changing quickly.

The landscape of the hop industry changed dramatically during the past decade with the surge of craft. The entrance of thousands of craft brewers, hundreds of growers and dozens of merchants means there are new and different philosophies in play. Some of the new players don’t have the experience or baggage of dealing in the market. They charge bravely forward into a market they don’t completely understand. The new blood and passion that comes along with them can be a great thing for the industry. One thing is certain, all the attention has created much greater competition at every level. Many of the new players don’t know how markets have played out during previous cycles and don’t understand the lengths to which some players will go to keep what they believe is “their” market share.

Back to the premise … which, if you’re still distracted by all that love for hop merchants, was simply that the craft revolution is a dream come true for everybody associated with hops. At the same time, the craft industry threatens the fabric of the very hop industry upon which it depends. Blasphemy, you say! Craft beer has been nothing but good for the hop industry. Thou shalt not speaketh evil against the almighty craft brewer.

Ok, calm down … In many ways, increased popularity of hops has been great for the hop industry. On the surface, it certainly seems to be a net benefit to everybody involved in the industry. It’s only when you dig a little deeper that you find the problem. The lack of tradition and brewing experience combined with a reckless willingness to explore new brewing practices led to the creation of the plethora of new flavors of beer flooding our supermarket shelves today. That willingness to experiment is probably the root cause for much of the success of craft beer. It’s new. It’s fresh. It’s real. It’s different. It’s pushing the boundaries farther with each passing day. For those reasons, a lot of people who never enjoyed beer before now do. We are truly living through a beer renaissance.

The problem is when those same renegade tactics are applied to the long-established practices of buying and selling hops. Bankers require farmers and merchants to have contracts to finance the enormous capital investments needed. Expanding hop acreage, building cold storage facilities and installing processing facilities is not for those with shallow pockets. Granted, contracting is not a perfect system, but it has worked in the past. Just because something has worked in the past, however, is no reason it should continue working in the future. Contracting does not fit well into the craft beer industry where taste preferences change with the weather and where brewers, in a battle for market share in an increasingly crowded market, need to respond accordingly. I’ve heard time and time again how brewers find it hard to compete when they’re locked into contracts for hops. That makes sense to me, but still … given the constraints of the bankers what alternatives are there. Another problem many brewers had with contracts was projecting sales during a booming market with constantly changing preferences which suddenly slowed. I don’t want to beat a dead horse too long here. I think you get the idea. Nobody really enjoys the system of contracting. Nevertheless, there have always been ways to handle the problems that arise so long as everybody played by the same rules.

That’s what is different in today’s market. Many of today’s craft brewers have applied the same wanton recklessness that gained them fame and success in the brewing world towards purchasing hops. Some purposely delay buying contracted hops at prices higher than the current spot market to take advantage of lower prices from other merchants or in some cases directly from growers. I can think of several words to describe these guys, but today at least I’m in a G-rated mood so I’ll leave the more colorful language to your own imagination. To be fair, not all brewers are behaving that way, but it only takes one domino to start the chain reaction. Thankfully, there are more than a few brewers who wish to honor their contracts, but who simply can’t buy their contracted hops. Poor cash flow due to slower than projected sales, or the latest brewery expansion, built for a level of sales they have painfully realized they may never achieve is making it difficult to pay. Brewers are nothing if not creative though and, as they say, necessity is the mother of invention. What do you do when you can’t afford your contracted hops and there are cheaper hops on the market? It seems for some brewers the answer was obvious.

For better or worse, technology today enables farmers and brewers to work directly. Many are eager to do just that. Some growers have the infrastructure to support those deals. For those who don’t, it’s still possible, in some cases, to utilize the existing merchant infrastructure to accomplish this, sometimes at no cost. The hop industry is about relationships after all. The existing infrastructure then subsidizes these cheap deals. At the same time, however, these deals outside the traditional system slowly erode that very equity. Those sales also undermine the very contracts that led to the excess production in the first place. Why would a merchant or a grower do that? Because they think it‘s better to be involved than to watch the game from the bench. Unfortunately, due to the secrecy in the industry it is not possible for a grower to know there are contracts in place with a brewer when they sell hops directly at lower prices unless the brewers mention it. If the brewer is trying to escape what they perceive to be an expensive contract with another supplier, the chances of that happening are slim to none. There’s no way to differentiate a sale for demand that has previously been contracted from a new opportunity. Who wouldn’t jump at that chance?

Furthermore, when a brewer sources product directly from a grower, they have the perception that they are doing good. As the reasoning goes … more money goes directly to the farmer. They get to be the hero. Many believe that the product must be better simply because it was purchased directly from the person who produced it. Of course, that’s not always true. One more perception among some brewers and farmers is that merchants make too much money for the services they offer. I can’t tell you how many times I’ve heard the question, “Are you only a dealer or do you grow the hops?”  Those brewers apparently see another point between A and B and don’t recognize the value of everything that happens between those two points. Millions of dollars worth of cold storage facilities to maintain hops at temperatures below freezing until the customer is ready to take delivery, state of the art processing facilities, and a sales and logistics team available year-round seem to be completely discounted in this equation.

Prices fluctuate in the hop industry from year to year as they do with any commodity. The key word in that sentence, unfortunately, is commodity. Most brewers act like hops are a crucial ingredient to their success that must be carefully chosen during an extensive selection process by them by hand personally immediately during harvest. When it comes time to pay for those well-screened hops, however, some of those same brewers see hops only as a commodity to be purchased at the lowest price. When hops are treated like a commodity and not as a perishable product with a fragile market that should be respected, it erodes the stability of the market. When brewers continue to shop for and find lower prices on hops they already have purchased with contracts, they feel like they paid too much. I often wonder if they get mad when the grocery store has a sale on potato chips a couple days after they just stocked up. I wonder if they would ever consider calling up a potato farmer or Lays directly to see if they get a better deal.

Supply increases in response to the contracts brewers sign along with other sales for a variety until supply reaches a saturation point. At that point, prices decrease. When brewers decide to forego taking delivery of their relatively expensive contracted hops to buy the same variety cheaper on the spot market, it undermines the hop industry and is the beginning of the end. That is where we are today, but the end of what?

This is probably the point at which you are thinking to yourself that you’ve figured out which direction this blog is going … Doug is just a hop merchant who is upset about some brewers not paying on time and others abandoning their contracts altogether. If that’s what you think, keep reading, because that’s not the point at all … not even close. Sure, some brewers abandoning contracts or even paying a year or two late hasn’t been very fun. It has caused a lot of grief, but, as they say, it is what it is. That’s the beginning of a lot of adaptation the industry will experience in the coming years.

Of course, everybody does what they believe is best for their business in the end. Sometimes they consider the effects on others, but mostly not. If you want to read some fascinating analysis of how that works you can search for “game theory” and “John Nash“. The things described by Nash, for which he won the Nobel Memorial Prize, non-cooperative game theory, apply directly to the hop industry. Brewers who undermine contracts by focusing only on price and those growers who sell to them discount the cost of long-term consequences in exchange for the goal of maximizing short-term profits. The irony it is the very system those deals undermine enables many of them to enjoy the success they have today. That system and its infrastructure will change or disappear for everybody as a result of the current trend of commoditization of hops and the dilution of the hop sales process.

The infrastructure of the hop industry is eroding more quickly than it is being built. The effect will be that many of the things brewers have come to take for granted may not be available under whatever new alliances emerge under the new system. The result will probably be a hybrid of what has existed for centuries and some new commoditized system, the characteristics of which are only now forming.

The reason I bring this up is not to complain about a few sneaky brewers or broken contracts. That’s just the game I suppose. There’s so much more to it than just the buying and selling of hops. That is the part of the picture being ignored. Money to develop new varieties that literally every brewer says they want more of must come from somewhere. Money for hop research that enables growers to fight pests and diseases also must come from somewhere. Money for new innovations in handling, storage and product development that enable brewers to use fewer hops more efficiently must come from somewhere.

It’s a travesty that some brewers don’t appreciate the true value of the infrastructure in place. It’s the foundation on which everything is built. All those things can be paid for in other ways if they are not funded privately through merchants and growers, but who will pay for them? At the time of this writing, there are a few craft beer billionaires out there and many aspiring to be. Will they pay?

Unfortunately, craft brewers are not rushing to become members of and donate to the Hop Research Council. On the other side of the fence, few hop growers want to pay more money per bale of hops to fund industry research programs. Some growers in newer production areas don’t pay anything despite the fact that they reap the benefits of years of industry investment. Ouch!

The lack of sufficient donations and assessments combined with the demand for innovation created the system that existed for years. Maybe it’s time for the old system to change. Will the future spawn a new sense of philanthropy that will create a different model? That would be nice. Who will fund the work done in the future, Hop Growers of America? Ha! Ann George is an amazing lady who does some incredible work, but Hop Growers of America is chronically underfunded and always on the verge of extinction. Without a LOT of government grant money, which is constantly in short supply, the organization would strain to keep its current programs going.

Don’t be fooled into thinking the same people who save money on hop purchases will give it back in other ways. That doesn’t happen. All that investment by companies like Barth-Haas, Steiner and others over decades enabled the success so many brewers have today. Without their continued investment into things that don’t provide immediate gratification, like R&D, where will the hop and brewing industry be 10 or 15 years down the road? If everybody decides, “Live for the moment. Carpe Diem.” If that becomes the dominant way of thinking, then we may be heading toward a pay-to-play industry where breweries and growers invest millions of dollars each year on R&D, proprietary varieties and work more closely with farms to guarantee production. Then, perhaps, more brewers will appreciate and value the risk inherent in agriculture.

The path down which the hop industry is headed is certainly unknown, but we are headed there quickly. There is no going back. On the surface, the change afoot today is about the price of hops and Johnny from the Woohoo brewery saving two cents per pound. The real change taking place is about who sets the rules of the game. That will begin a new era in the hop industry.


2 thoughts on “Game Theory and the Hop Industry

  1. Tom says:

    The Hop Research Council is better funded and has more small brewery members than in the last 20 years. The Craft Brewer’s Hop Quality Group is nearly 30 members strong and contributes significant dollars to breeding and research each year. The BA has provided a sizable long-term investment into public hop breeding. There appears to be no decrease of research funding into hops from the large multinational brewers. And lastly, for the first time, a coalition of hop growers, researchers, brewers, and industry representatives organized and lobbied DC for increased public funds into hop research. In my 15 year involvement with the hop industry, I have not seen a stronger infrastructure in place to help drive and evolve the industry. That’s the snapshot today. There is no lack of support of the hop industry from the brewing industry compared to anytime in the recent past. Sorry Doug, but these are the facts. This scenario may change in the next few years, but I would bet against it.

  2. Bryan says:

    Doug, Thanks for your continued insight and work to bring issues like this to light for more experienced and less experienced hop growers. We have started a small internet radio show that focuses mainly on the hop industry but all beer ingredients as well. We would love to have you on to talk about some of your experience and predictions for the future. If you would be willing email me. Thanks, Bryan

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