House of Commons - Trade and Industry

Select Committee on Trade and Industry Second Report

9 BALANCING THE COSTS AND BENEFITS OF THE TIE

178. It has been claimed that the cost of the tie to tenants, the wet rent (wholesale price differential) plus AWP income paid by tenants to their pubcos, is exactly counterbalanced by the benefit of the tie to tenants, lower rent plus special commercial or financial advantages (SCORFA).[241] This 'value equation' suggests the countervailing benefits tenants receive should leave them in the same position as if they were not tied at all.[242]

179. We did not receive sufficient data for any one pubco or pubcos in aggregate to judge with any degree of accuracy whether the wholesale price differential on tied products plus AWP income were exactly counterbalanced by the countervailing benefits of a rent subsidy and other special commercial or financial advantages. With this in mind, our analysis is an approximate guide arrived at using established methods and the best estimates of the 'true' data available to us. These are backed by many assumptions, some of which we believe are unrealistic.

The cost of the tie to tenants

180. The wholesale price differential has been calculated by the European Commission as the average discount to a free house operator minus any discount granted to tied tenants.[243] Data on the actual level of discount received by free house operators or pubcos' tenants are not readily available. We received estimates of the discounts available to free house operators which ranged from £40 to £140 a barrel.[244] Taking the middle of these estimates suggests free house operators' discounts, the discounts pubcos' tenants forgo because of the tie, are in the region of £70 per barrel.[245]

181. 30 percent of Punch's estate received an average discount of £45 a barrel.[246] A further 60% received an average discount of £8 to £9 per barrel.[247] Across their whole estate this averages out to a discount in the region of £20 a barrel.[248] With free house operators receiving discounts of £70 per barrel, this suggests the wholesale price differential is around £50 a barrel for a large pubco's tenant.

182. These estimates may be too high, especially as free house operators cannot be certain of discounts from order to order, unlike pubco tenants whose discounts are guaranteed for the term of their agreements. The wholesale price differential also varies from pubco to pubco and from agreement to agreement. For example, for tenants on Punch's preferred 'Growth Lease' the wholesale price differential would be closer to £35 a barrel.[249]

183. The value of pubcos' AWP income from each tenant is also not readily available. Deutsche Bank have estimated it is in the region of £4,000 per annum or £20 a barrel for an average public house.[250] Together with the estimated wholesale price differential above, this suggests the total cost of the tie to tenants is in the region of £70 a barrel.

The benefit of the tie to tenants

184. The level of rent subsidy (the difference between the rent pubcos charge tied tenants and the rent for free house operators) has been calculated by the European Commission by subtracting the actual rental income from pubcos' tied estates from 15 percent of the turnover of the estate.[251] Information on the individual rents for each of the 30,000 tenanted public houses that pubcos own is not readily available. Data on the total rental income from the accounts of pubcos is available, from which estimates of the rent of an average tied public house can be made. The data suggests the rent for a large pubco's public house is in the region of £22,000 per annum.[252] Deutsche Bank have estimated that an average tied public house, with a throughput of 210 barrels and a rent of £24,000, has a turnover in the region of £200,000,[253] of which 15 percent equates to £30,000. This suggests the value of the rent subsidy is in the region of £6,000 to £8,000 per annum or £30 to £40 a barrel for a large pubco's tenant.

185. Many of the SCORFA benefits offered by pubcos are intangible, such as business support, professional and legal advice, centralised complaint and ordering procedures. Some SCORFA benefits such as investment and purchasing scale benefits are tangible.[254] Punch invests around £23 million pounds a year in development projects.[255] This suggests an average spend across their estate of just over £5,200 per public house. Enterprise estimated the annual benefit to their tenants of purchasing non-tied, non-drinks goods from them at around £800 per public house across their estate.[256] Pubcos' public houses often include free accommodation and other cost of living benefits for tenants, which the FSB[257] and Deutsche Bank[258] have estimated to be worth £5,000 and £10,000 per annum respectively.

186. We believe these benefits are over estimated. We were unable to confirm the investment or purchasing scale benefits by pubcos across the whole of their estates. We also believe the cost of living benefits achieved are overstated. Although in many cases tenants do get free accommodation, these estimates take little account of the benefits accruing to pubcos from having tenants living 'on site', such as buildings security.

187. Our analysis suggests the cost of the tie to tenants is in the region of £70 a barrel. This is 'balanced' by a rent subsidy and quantifiable SCORFA benefits in the region of £50-£75 a barrel plus an indeterminable amount of unquantifiable SCORFA benefits.

188. It should be remembered that this Inquiry stemmed from complaints about inequalities in the contractual relationship between pubcos and their tenants. On the basis of the evidence presented to us we feel that the immediately quantifiable cost of the tie is usually balanced by the benefits available to tenants. However, this does not mean that for every tenant the costs equal the benefits, leading to some tenants getting into financial difficulties. In such cases pubcos could do more to redress the imbalance. Indeed, it became clear as the Inquiry progressed, that some pubcos demonstrated greater sensitivity to tenants problems than others.

The consequences of ending the beer tie

189. Tenants and their representatives suggested to us that the problems tenants had complained to us about would be resolved if the beer tie were removed, enabling tenants to purchase their beer on the free market.[259]

190. We asked our witnesses what they believed the outcome of removing the tie would be for the industry. The FLVA expressed concern that if the tie was removed, pubcos could and would increase the rent tenants paid: "in all tenancy and lease agreements it is pointed out that the rent takes into consideration the tie and is therefore less than what [tenants] would be expected to pay if they were not under an obligation to purchase specified drinks from the landlord or their nominated supplier. It then goes on to say that if they are released from the tie the company reserves the right to review the rent taking into consideration the release from the tie".[260]

191. Mr Salussolia, the Chairman of the ALMR told us that pubcos as mere property owners would not be interested in the business being carried out in the premises but only in maximising the rental income of the property: "there is a relationship with the pubco, because when you look at a site and you bid for a site with a pubco, they take into account what you are going to do with that site. You may not give the biggest rent bid, you may be chosen because you are going to give the biggest volume of return out of that business".[261]

192. The Chief Executive of Enterprise told us that removing the tie would split their business into wholesaling and property companies which would be "completely at-odds with what we believe and what we have sought to describe to you as the most important principle of the tenanted and leased business model that we operate, and that is the principle of partnership".[262] Enterprise saw the tie as essential to their partnership with tenants, ensuring that both were committed to sales growth and they shared risk. If pubcos were to operate under a rent only relationship, Enterprise believed, "it is difficult to see how those interests could be aligned with such assurance as we believe they are now".[263]

193. Pubcos also argued that tenants would lose the special commercial or financial advantages pubcos provided because of the tie as pubcos would have no reason to offer these if they had no interest in building tenants' businesses. Mr Findlay, Chief Executive of the W&DB told us that "the idea that a pubco could be split into a wholesaling operation and a property company would be bad news for the public house sector as a whole because what pub companies do is invest a lot of resource in managing what is actually legally a very complicated business. We provide a lot of advice to tenants that a property company just simply would not be able to do".[264] An example of the additional support given by W&DB was the £1 million they had invested in helping tenants through the process of the new licensing reforms. They suggested this was: "the sort of thing we do because we have a relationship with them based on knowledge of the business, knowledge of the trade, and the fact that we sell beer to them as well".[265]

194. The Chief Executive of Punch told us that the only people who would benefit from the tie being removed and pubcos becoming pure wholesalers would be the international brewers: "the biggest wholesaler in the UK is owned by the biggest brewer. The second biggest wholesaler in the UK happens to be owned by the second biggest cider maker. The reality of the situation is that the brewers will cut out the wholesalers".[266] Independent wholesalers were unlikely to cope with a sudden increase in business from 30,000 pubco tenants.[267]Through international brewers' specialised distribution networks, by way of which they already deliver beer to the majority of public houses, they would become the dominant wholesalers: "that is what the competition authorities have investigated many times and sought to avoid. We [pubcos] act as a counterbalance to that. We are not as big a counterbalance as the supermarket chains who have 70 per cent of the off-trade but we are a counterbalance to that and at all stages we seek to use that counterbalance to subsidise the package".[268]

195. Other areas of concern to our witnesses about ending the tie included the impact on small brewers, prospective tenants and smaller public houses' tenants. The Campaign for Real Ale (CAMRA) suggested the tie was important for smaller brewers as it guaranteed them an outlet for their products: "these brewers currently own 5,800 tenanted public houses and are reliant on these tied outlets to showcase their products and provide access to market".[269] The tie guaranteed distribution for the output of these brewers, without which they could not otherwise compete with the larger brewers.

196. CAMRA[270] and Enterprise also believed the removal of the tie would mean prospective tenants would no longer have the option of a low cost entry into the industry in terms of capital outlay: "the tied system […] offers a fantastic opportunity for people with relatively small resources. You do not need to spend half a million or a million to buy a pub; with £25,000/£30,000 you have the chance to take on and make money from a business".[271]

197. The FLVA were concerned that tenants who would lose out the most from the removal of the tie would be the tenants of smaller public houses. Once pubcos reassessed the rent of public houses, tenants would be able to purchase beer on the free market. However, they would not obtain the same discounts that pubcos did. Smaller public houses' tenants would be 'squeezed' by higher rents and higher beer prices, which would lead them to go out of business.[272]

198. It is not clear that removing the beer tie would make tenants better off. In practice, pubcos, as property companies, would offset their loss of income from the wholesale price differential (wet rent) they charge by charging higher rents. The pubcos have the right to do this through clauses in their leases and would undoubtedly do so. Pubcos would maximise the rent for their properties as they would have no interest in expanding tenants' businesses.

199. There is a danger that splitting the wholesaling and property functions of the pubcos would only benefit the international brewers who currently control the national distribution of beer. In the main, distribution companies owned by certain international brewers already deliver to the majority of tenanted public houses for the pubcos. Removing the tie would enable them to supply free from tie tenants with wholesale products directly. The national brewers would then have a virtual monopoly on the wholesaling of beer, as they did in the days before the Beer Orders.

Code of conduct

200. There have been calls for a legally binding industry code of conduct to ensure that pubcos fulfil the terms of their agreements with their tenants.[273] The British Beer & Pub Association (BBPA) already recommends its members, who include Punch, Enterprise and the other large pubcos, to adopt codes of practice setting out guidelines on the granting and operation of leases as well as dispute settlement.[274]

201. The Chief Executive of Enterprise told us that Enterprise have had a code of practice since 1996.[275] Punch's code of practice, their 'Retailer Charter', includes sections on how their tenants could expect Punch to behave in their relationship at all stages, including applying for a public house, developing the business, agreeing rent reviews and renewing and transferring agreements. Adherence to their charter is measured by Punch through their customer services team.[276]

202. When questioned about whether such codes should be legally binding, the Chief Executive of Enterprise told us that: "if there were to be a legally binding industry wide code of conduct I would imagine with confidence that we would comply with all aspects of it. So it presents no risk to us. I simply caution that I fear you may be harming the market place by introducing such a thing because, as always, if you are trying to make something standard across the industry there is a risk that it finds its level at the lowest common denominator".[277]

203. Since the British Beer & Pub Association (BBPA) code of practice was updated in 1997 the industry has changed and we suggest that this code of practice should be revised as a matter of urgency. This should involve consultation with the widest range of interested parties including tenants, their representatives and public house owners. The areas we believe a code should cover have been highlighted elsewhere in this Report but should include: rent reviews; the role of BDMs; complaint and dispute procedures; disclosure and the availability of information; and the taking of legal and professional advice by prospective tenants.

204. At this stage we do not think a legally binding code of practice necessary, but if the industry does not show signs of accepting and complying with an adequate voluntary code then the Government should not hesitate to impose a statutory code on it.

205. We hope that our successor Committee in the next Parliament will review the situation in the public house industry, in particular whether the code of practice is working.

241 For example see Q 202; Q228; and Appendix 17, para 3.8 Back

242 Appendix 17, para 3.8 Back

243 See European Commission Decision, Case IV/35.992/F3 - Scottish & Newcastle, 16 June 1999 (OJEC (L) 1999 186/28 paras 50-57) Back

244 See for example Appendix 17, para 2.2; Appendix 23, para 420; and Appendix 12, para 5.1 Back

245 Deutsche Bank have also estimated the discounts forgone by pubcos' tenants as £70 per barrel. Source: Deutsche Bank, UK Pubs Sector Report - The bear pit, 31 October 2003, pages 32-33 Back

246 Appendix 23, para 24 Back

247 Deutsche Bank, UK Pubs Sector Report - The bear pit, 31 October 2003, pages 32-33 Back

248 Assumes Punch estate of 4,430 public houses as at 31 October 2003. Source: Deutsche Bank, UK Pubs Sector Report - The bear pit, 31 October 2003, Figure 7 Back

249 Appendix 23, para 24 Back

250 Deutsche Bank, UK Pubs Sector Report - The bear pit, 31 October 2003, Figure 5 Back

251 15 percent of the turnover is the working assumption used by the European Commission to represent the 'rent' of a free house operator. For example see European Commission Decision 1999/474/EC, Case IV/35.992/F3, Scottish & Newcastle, 16 June 1999 (OJEC (L) 1999 186/28, paras 59-60) Back

252 Estimated from: Deutsche Bank, UK Pubs Sector Report - The bear pit, 31 October 2003, Figure 7 Back