Private Equity Will Ruin Everything, Including Your Favorite Liquor Store

A few years ago, I read a long article in the New Yorker about private equity acquisitions of mom and pop HVAC companies in small towns across America. The point of the strategy was simple: keep the established family name, just change the service. Instead of helping local homeowners maintain and repair their air conditioning units, they instructed their workers to recommend upgrades, even when no upgrade was needed.

There’s not much money in fixing HVAC units, but there’s plenty of money to be made in selling someone a new one (then charging extra for the installation). By keeping the trusted family name on the branding, these new PE shells tricked loyal customers into purchasing HVAC systems they didn’t need, sending profits through the roof until the market was tapped out. At that point, they planned to sell the company to someone else and move on. Like parasites.

Last year, when I started noticing changes around my mom’s assisted living center in Burbank, the hairs on the back of my neck went up. Indeed, the company that maintained her care had been sold to private equity. Two things happened quickly: the quality of service went down and the cost went up. The building had an essential elevator that was out of service for nearly a month. The dishwasher in the kitchen broke and it took five weeks to fix it (the residents were eating off paper plates with plastic cutlery the entire time). Keep in mind we were paying five figures a month for this top-tier environment.

I didn’t need to wait around much longer to know where all this was headed. Within two weeks, I had a moving truck pick up my mom’s furniture and she was settled at a (legitimate) family-owned assisted living community back in Modesto near her friends. Last I heard from one of the employees I kept up with, at least a dozen residents followed my mom’s lead and half of the staff quit soon after.

It’s all so reminiscent of what’s happening to family-run wine and spirits shops at the moment. An entire generation of small business owners is aging out of the industry and private equity groups are jumping at the chance to run the same HVAC strategy within the booze business. So far, they’re doing a great job of shedding longtime employees, ruining their reputations with customers, and dumbing down the facets that made them successful in the first place, but I don’t think the profiting is going as planned. Here’s why.

Because of all the costs surrounding licensing and logistics, profitability with alcohol requires serious scale. Costco and Total Wine, for example, are the two most profitable liquor stores in America because they’re able to operate their sales models at a national level. In addition, their private labels (where the real profit is) sell at an enormous clip because customers have faith in both institutions—and for good reason! As someone who helps behind the scenes with a few of their private labels, I can vouch for the quality.

Mom and pop retail stores do not scale nationally, however; especially given all the different regulations between states. What makes them special—knowledgable employees who care about quality, impeccable customer service, niche products, a friendly face who knows your name—is not valuable to private equity. All they care about is the name and the reputation, which they will use to bait and switch consumers into a different experience from the one they’re expecting. And that’s the issue. The entire reason consumers make the effort—yes, the effort!—to shop at a local mom and pop liquor store is because of the aforementioned attributes. Take those away, there’s no reason to go there. You might as well just go to Total Wine or Costco.

In addition, the previously-mentioned HVAC buyouts were specifically selected by private equity groups due to the monopoly they held over a particular regional market. Customers would have no choice but to use their service or fix their air conditioning units themselves. That’s what made the strategy so devious. Wine and spirits retail, however, is like the wild west. There’s no chance at a monopoly for the boutique side of the business. Retailers are shipping everywhere these days despite what the laws say. No one has a monopoly over anything. You can order wine from New York or California and have it shipped just about anywhere (except Utah and Michigan).

At the end of the day, all you have is your reputation and your ability to deliver value for the dollar. Like I said already, those two things are very, very difficult to scale.

Nevertheless, I see more and more shops thinking they can follow Total Wine’s lead by copying their blueprint, but there’s one different gigantic difference between Total Wine and everyone else (HINT: it’s a number followed by eight or nine zeroes). That model scales because those stores have the money to stock literally everything, regardless of whether it sells. Good luck trying that strategy with a smaller budget. In the meantime, your favorite local shop might not be what it used to.

-David Driscoll