The state of Michigan has gone through legislative changes in the liquor industry since the 1900s culminating in the setting up of the Michigan Liquor Control Committee (MLCC) that controlled the distribution of distilled spirits from manufacturer to the retailers in the 1930s. The trigger for state intervention was economic and political considerations to control the trade, revenue from a monopoly business a well as the tax revenues for the state from sale of liquor.
The predicament of MLCC is nothing unique. States all over the world are confronted with policy issues on regulating sectors such as tobacco, liquor, entertainment and gambling, that are socially considered undesirable while surreptitiously promoted to satiate private desires of those who can afford. These sectors are sources of huge tax revenue due to their non essential nature and limited support against taxes. States use these sectors as hunting grounds for cronyism and nepotism and tend to promote unwanted employment. Low operational efficiency, mismatch between resource needs and deployment, high employee rewards, nepotism, and attempts to raise public funds to feed the incompetent, irresponsible and greedy elements are signs of such conduct. MLCC is playing multiple and possibly conflicting roles of a regulator, wholesaler, licensing authority, and revenue generator for the state, which are incongruent, needing a review.
- Problem statement
MLCC is confronted with increasing cost of its wholesale liquor distribution and citizen resistance to raise taxes to fill the gap in running the business. There is a felt need to focus on efficiency improvement in the wholesale distribution of liquor, in a non disruptive manner.
The state is caught in a dilemma of having to balance conflicting stakeholder needs: politically correct and socially desirable stance of discouraging liquor consumption, arresting bootlegging from 100% control, consumer interest to check on excessive pricing by entrepreneurs, anti liquor lobbyists wanting a dry
state and traders wanting to keep the business on, and the state using liquor as a tool for raising revenue for the state. There are concerns of increasing distribution costs (121% in recent 11 years), falling levels of efficiency in inventory turnover (6.7 to 5.5), mismatch between (manpower) resource allocation and business needs in the three geographic regions, corruption, nepotism, and union issues. Other issues are mandated state delivery contracts that cannot be terminated, lack of perceived incentives for higher productivity, small retailers’ expectation for MLCC to continue to enjoy a level playing field with large ones, consumers’ expectation of an equitable price.
Organization and policy
Data analysis - Observations and discrepancies at MLCC level
- Role of government: One government entity performing multiple roles of regulator, operator and supporting revenue generation, leads to issues of collusive conduct, low transparency, lack of accountability, poor oversight and governance. This is a key reason for MLCC’s low operational efficiency despite being in a monopoly business and poor accountability, as it violates the fundamental principle of arms length relationships and role segregation for good governance and effective control.
- Poor internal control, data management (MIS), operational flexibility and accountability, has resulted in discrepancies in operational performance parameters such as contribution, variation in costs across district warehouses and leakage of tax revenue.
- Organizational and operational structure poorly aligned with business needs compounded by accountability problems
(refer sheet MLCC operations in Excel file)
District level analysis
- MLCC level data shows a shipment of 6970000 cases while the aggregate of district level shipments indicates 6981065, the MLCC data falling short by 11065 cases
- Tax collected based on declared revenue and actual collected, shows an under collection of taxes of $ 23527108, amounting to about 32% of taxes due, but not collected or reported
- Computation of total variable cost comprising district level costs, annual cost of distribution operation, inventory carrying costs, and shipment costs of producers to state warehouses (to be incurred by state warehouses) indicates an over estimation of contribution of $24703063 that is 67% overestimation to the real contribution
(refer sheet district level operations of excel file)
District 3 is found to be lagging in terms of operational efficiency compared to districts 1 &2, reflecting performance variation in similar contexts. These include
- Fixed costs per case shipped 50% more than the average for districts 1 &2
- Variable costs per case about 4 times the average of districts 1 &2
- Warehousing costs per case more than 4 times the average of districts 1 &2
- Variable costs per case per state store about 2.6 times the average of districts 1 &2
- No. of cases shipped per state store less than 10% of the average of districts 1 &2
- Total costs per case shipped about 4 times the average of districts 1 &2
- District1 being the lowest cost operation and district 3 being the highest
- Revenue is taken as value after 17% discount to retailers as amount accruing to MLCC
- Contribution is taken to mean contribution to fixed cost (Revenue – variable cost)
- Cost of distribution operation does not include inventory carrying cost
- Cost of distribution does not include estimated total cost of shipment from producers to state warehouses @ $1 per case to be borne by MLCC
- Cost of distribution operation does not include cost of district level operations
- Transfer freight and freight are included in cost of distribution operation o variable costs
- Answers to review questions
- What alternative designs for distilled liquor distribution in Michigan might be considered
- MLCC should have centralized inventory management, order placing & stock delivery, and retailer order accepting & dispatch system. In place of geographically linking manufacturers, warehouses and retailers, it should be dynamic based on demand and availability of stock to optimize inventory & operational costs, to balance resource deployment and utilization. MLCC should do real time tracking of operational performance & make credible information available to all, to eliminate multiple versions of data and problems of data integrity
- MLCC should redistribute the work to load district 3 more and do more marketing to increase volume so that district 1’s low cost is taken advantage of, and district 3 volume also picks up and per unit costs reduce. Along with this, staff should also be redeployed to match business volumes in the three districts
- The third option is wind up district 3 to save fixed cost of $7.5 million, if feasible. This should be followed by either outsourcing operations of district 3 at average unit costs of districts 1 &2, or licensees serviced by district 3 to be assigned to district 2 (till the dynamic allocation and distribution policy is implemented) with only a 10% increase in its load, to reduce fixed cost per case shipped, as district 2 is relatively closer to district 3. Also district 3 is not currently serviced for customer freight and they have to take delivery on their own. Therefore this reassigning is unlikely to cause any inconvenience or objection from customers
- Discuss the benefits and risks of alternative designs for distilled liquor distribution
- Most efficient in the long run
- An integrated system for complete end to end transactions, tracking performance, enabling transparency, scalable with reduced manpower
- Long gestation time for reorganization, organizational transformation process
- Training needed for staff
- May not be accepted by employees, resistance
- Risk of low success rate due to the organizational context
- Middle of the road approach
- Less resistance
- Low gestation period
- Low risk and low cost
- Only marginal improvement to be expected as the basic structure is retained, a luke- warm approach
- May meet with resistance from retailers as service levels may be marginally affected
- May hamper long term transformation for maximum benefit, after the mid way path
- May not fully benefit from IT
- A transition phase before going fully dynamic
- Immediate benefit of avoiding cost on district 3 warehouse operations
- Outsourcing will help fix costs and improve efficiency
- May meet with resistance for closing down district 3 operations, reassigning staff, outsourcing or redistribution of work
- May also meet with resistance from retailers to go through the risks of transition
- Are the historical conditions which the current distilled liquor distribution is based upon still relevant today? What if any other factors exist that require consideration?
Historical conditions of the existence of multiple stakeholders with diverse interests and the government having to do a balancing act does exist today. However some other relevant factors for consideration are
- Technology has advanced considerably, that it is easy to benefit from low costs, high volumes, data access, data integrity and real time information by using IT and MIS, to operate efficiently from central locations. Induction of IT will transform the whole process of procurement and wholesaling in such a manner that, the state’s stores need not even handle the physical cases, buy will only carry out control and monitoring functions.
- The knowledge that systems exist for tracking performance, efficiency and processes will itself motivate earlier reluctant staff to be open for change and likely bring in discipline
- When staff need not have to handle physical goods and the role is more of a monitoring agent, possibilities of inefficiency creeping in and mismanagement for own benefit, can be expected to reduce
- Does an inherent social conflict exist if state governments rely upon tax contribution from liquor sales to fund educational programs?
Yes. An inherent social conflict does exist, as, to promote one desirable activity (education) the state has to promote another socially undesirable activity (liquor promotion) to generate revenue for the promotion of the former. Over time, this will expose the state’s lack of clarity in its priorities and lead to dilution of the educational programs taking cover under the need to check the undesirable activity that funds it. The one to one association is definitely undesirable and patently unsustainable. The other possibility, is under the cover of promoting education, there could be over enthusiasm for promotion of liquor business, with its losing control gradually
- How would organize the final report on distilled liquor distribution in Michigan if you were Joseph Duncan
Following is the way I would present may case
- Historical background of MLCC and liquor control in Michigan
- MLCC’s performance over time and concerns of the recent past and the present
- Transitions that have taken place since the MLCC came into being in 1930s to the first decade of the 21st century (focusing on need for removing conflict of interests, need for segregation of tasks for good governances, redraw the mission and vision of MLCC with a set of well aligned objectives, KRAs, measures and reward system) and need for review
- What is the central objective of MLCC and what options exist to achieve that?
- Should MLCC necessarily be physically handling liquor to achieve its objective for control of liquor trade and tax revenue
- Redefine operational role and time bound objectives for MLCC and how to induct IT for efficient operations to achieve the same
- Benefits that will accrue through the redefined approach for MLCC’s role and operations
- Costs (real financial and all social) of transition to the new system and how to address those, including staff redeployment
- An opportunity for a public debate to get the buy in of stakeholders for the transition
- Prerequisites for transition
- Time lines or schedule for transition and monitoring mechanism for its implementation