Select Committee on Trade and Industry Written Evidence

APPENDIX 23

Memorandum by Punch Taverns

  Submission of our written evidence in Memorandum form comprising three sections with annexes.

  1.  Executive Summary

  2.  Supporting Documentation

  3.  Independent Report Produced by Messrs Maitland Walker

  4.  Annexes

PART 1—EXECUTIVE SUMMARY

SUMMARY

1.  Introduction

  2.  Punch Taverns welcomes the interest of the Trade & Industry Select Committee ("TISC") in the relationship between pub companies and their tenants. In responding to your review we have summarised our position below. Given the fundamental changes that have occurred in the industry over the last few years we have sought to provide a thorough understanding of our business model in Section 2. In addition Punch has commissioned an independent report by Messrs Maitland Walker, a firm of solicitors that has unparalleled experience in looking after the interests of pub lessees, to provide a tenants-eye perspective on the market. This can be found in Section 3.

  3.  The British pub is one of the most enduring and successful retail businesses and remains one of the few that is predominantly operated by individuals or small businesses. Its survival is due to tremendous innovation by pub retailers to ensure the business constantly evolves to cater for their local customers. The independent pub companies ("Pubcos") play a critical role in this industry, providing a package of resources, finance, investment, training and support to develop the pub sector and protect its long term future. Moreover, the commercial benefit of attracting the best pub retailers has ensured that the industry is highly competitive and one of the most innovative property leasing sectors in the UK.

  4.  Punch Taverns was formed in 1997 and is now a UK listed company and one of the leading leased/tenanted pub companies in this market. Our business and our long term prosperity is entirely dependent upon the success of our retailers and the promotion of the industry and is based on a profit sharing model with Punch and its retailers sharing the benefits of the success of our pubs. We estimate that the average income of our retailers is approximately £35,000 pa (inc accommodation), whilst Punch earns a pre tax profit of approximately £25,000 per pub. The company only operates leased and tenanted pubs, does not manage any of its premises directly and has no brewery interests.

  5.  The pub leasing model is successful because it brings significant benefits to potential retailers by providing a low risk and low cost entry route to the pub market. The retailer benefits from considerable operational freedom and can choose from a range of flexible agreements, many of which allow the retailer to generate a real capital asset as well as draw a good income. The benefits to the consumer are equally significant with pubs now offering a greater choice of operational styles, product range and prices than ever before. Much of this can be attributed to the arrival of the pub companies in the last few years, including Punch.

  6.  Running a pub is one of the last businesses that still include accommodation in the package. The vast majority of our estate includes rent-free residential accommodation for the retailer and family or staff. As a result the pub is also the retailer's home. The model has supported tens of thousands of licensees and should continue to do so.

  7.  The pubcos protect this model by deriving scale benefits such as purchasing, financing and expertise, which are passed on to retailers by way of an increased range and price certainty of product, lower rent, focused investment, training, expert business advice, and a "one stop shop" arrangement with all products available on one order, one delivery and one standard set of credit terms.

  8.  At Punch, our key priority is to attract the best retailers and help them build better businesses. Our relationship with our retailers is enshrined in a comprehensive Retailer Charter (see Annex D of Section 4) and we hold regular forums with our retailers to debate issues affecting the business. More recently, we have revised the entirety of our lease agreements, introducing a plain English flexible lease agreement which is available to all new and existing operators.

  9.  In addition:

—  we are attracting in excess of 450 applicants a month wishing to run our pubs;

—  we invest considerably more in our pub estate than the previous brewery owners, £19 million in the first half of this year alone and over £85 million in the last three years;

—  we are training more retailers than ever before, more than 1,100 in the first half of the year with over 3,700 training days;

—  we measure retailer satisfaction as a key element of the way we reward our staff; and

—  we are the current holders of the Pub Company of the Year Award for large leased pub companies, having been identified as a "service-led, customer-focused organisation".

  10.  Historically, each brewer incorporated a prescriptive obligation in their pub leases to require the tenant to sell that brewer's products alone (the "tie"). Not only did this restrict consumer choice, it also materially limited operational freedom for the tenant.

  11.  Pubcos on the other hand have used the tie to negotiate supply contracts with a wide selection of beer and other drink suppliers, providing both the retailer and the consumer with a more extensive choice than has ever been available in the past. Moreover, since none of our agreements include any "must stock" or "minimum purchase obligations", our retailers are free to operate their business in whatever way they see fit, even if this results in no beer sales whatsoever.

  12.  The rent charged for a tied pub is considerably lower than that of a pub without any purchasing tie. Our retailers thereby benefit from a lower fixed cost and, in the case of the beer purchased, are only buying what they sell. Our standard credit terms provide up to 24 days credit for their purchases so the beer delivered will often have been sold before payment is sought.

  13.  It may also be a surprise to note that despite the considerable merger activity in the pub sector, the industry is more fragmented and significantly more diverse today than it was at the time of the Beer Orders (the "Orders"). At the time of the Orders the Big 6 "National Brewers" owned over 34,000 pubs. Today, the top 10 pub companies own just over 28,000 pubs (see Figure 1 para 58). The Punch pub estate comprises approximately 7,300 traditional pubs. This amounts to approximately 5% of all licensed outlets and 12% of the pubs in the British Isles. In beer sales terms our total draught beer volumes account for approximately 7% of total on-trade beer sales.

  14.  By negotiating on an arms-length basis with all major suppliers, pubcos have dramatically increased the choice of brewers' products available in pubs and to the consumer. By separating distribution from the supply of beer, we have been able to provide smaller brewers with a huge benefit in terms of an efficient route to a national market beyond their own distribution arrangements. Currently we source beer from 46 national and regional brewers, plus some 35 small brewers. This includes 180 draught beers. In fact, at Punch, we are in a position to offer any brewer access to our estate on a distributed basis.

  15.  The structure of the market is highly pro-competitive and this has been endorsed by the competition authorities in the EU and the UK on a number of occasions. The issues raised by the TISC are very similar to the issues considered by the OFT in response to a letter from the Federation of Small Businesses ("FSB") as recently as March 2003. Following its own investigation, the OFT concluded that the FSB's complaint did not raise any concerns and that the on-trade market was very competitive.

16.  THE BASIS OF INQUIRY AND THE ISSUES RAISED

  17.  Certain specific issues have been raised and we summarise below our responses. These answers are supported in significant detail throughout Section 2 of our submission.

18.  The Committee's Issues

  19.  The exclusive purchasing obligations (beer tie) enforced by pubcos on their tenants.

  20.  Most lease arrangements contain a drinks tie whereby the retailer is required to buy his beer and some other drink products from Punch. This tie enables Punch to negotiate with a wide range of suppliers substantial volume discounts which are significantly higher than those available to individual retailers. Only in this way is Punch then able to offer retailers certainty of product range, price and distribution; to afford services and investment to benefit the retailer; and to agree rents based on an equitable division of the available retail profit.

  21.  It should be noted that whilst retailers are tied to buy beer from Punch, we can source a very wide range of drinks from any supplier—in this way our modern tie is quite different from that used by brewery landlords in the past, who restricted choice. Also, our leases contain no "must-stock" or minimum purchase obligations, and in most cases allow extensive freedom to buy non-beer drinks (eg soft drinks, wines and spirits) and all food products from any source.

  22.  The link between the wholesale beer prices charged by pubcos and the rents they charge their tenants;

  23.  Punch assesses potential rents in accordance with RICS guidelines on a profits method and share of "divisible balance". This approach ensures that the beer price paid by the retailer has a direct link into the rent agreed. If a retailer pays the standard price for his beer, this produces a lower profit assessment than if the retailer's agreement offers a secure discounted price, which increases their potential profit and consequently results in a higher rent. Either way it will always represent a fair proportion of the retailer's divisible profit.

  24.  In the Punch estate approximately two thirds of the pubs buy their beer from a standard price list which is based upon the brewers' national wholesale price. The balance buy their beer subject to discounts of approximately 15% or an average of over £40 per barrel, with a small number (currently 78) receiving a discount of an average £80 per barrel. The level of discount received is dependant on the agreement reached at the outset and not reflective of the volume of beer sold.

  25.  Pubcos margins with regard to the prices paid by pubcos to breweries and those they charge to their tenants;

  26.  When calculating the price to charge our retailers for their beer purchases we use a benchmark based upon the national wholesale price set by the brewers. To the extent that any discounts are provided they are calculated by reference to the brewers' national wholesale price. This is a consistent methodology used throughout the industry for assessing market price, and is a good way to maintain brand and supplier differentials.

  27.  As mentioned above, the price paid by retailers for their beer is fully reflected in the rent assessment. As pubcos have got larger so their purchasing power has improved. This has manifested itself in a number of ways—larger scale purchasing has meant that pubcos are now able to deal with many more suppliers, more products are being offered on a discounted basis, and the pubcos have begun to provide long term certainty on pricing or discounts for the length of the lease agreements, sometimes as long as 30 years. Arrangements such as this simply do not exist in the free house market.

  28.  Pubcos do not have any involvement in the setting of the retail selling price of the products sold. Although advice can be provided on margins and market statistics, no guidelines are set.

  29.  Table 1 below sets out the breakdown of the share of price on a pint of beer. The average price of a pint of beer in a leased or tenanted pub in the UK is £2.14 (Source: A C Neilsen).

  30.

  31.  The difference in the beer price that pubcos charge their tenants and the free market price;

  32.  Pubcos offer a package of a property lease and goods supply together with a support service which is primarily focused at growing the business for both landlord and retailer. As a result the beer price we charge is an integral part of the package that we offer. However, we also believe that the price we charge is comparable with the free market price, if not a little lower than available in the free trade if considered on an equivalent basis.

  33.  To give a sense of this, it is important to consider the number of factors that will affect the price of the beer to a free-trader. Below is a table of the variables that will be considered by a free trade supplier when negotiating a deal with a free trade customer. In addition we have provided a summary of the package we provide by way of comparison.

  34.  Table 2

FACTORS THAT WILL AFFECT THE PRICE OF BEER

Package	Free-trade	Punch
Length of contract being offered	Negotiable—rarely longer than one year unless the retailer signs a more restrictive tied purchasing agreement with the brewer or wholesaler.	Punch retailers are guaranteed their package for the life of their agreement—up to 30 years. Punch's supply contracts last no more than seven years but we believe we can negotiate terms to provide this package.
Price	Negotiable usually by way of discount from the national wholesale price.	Choice based on agreement: Fixed in line with national wholesale price, Discount of approx £40 off national wholesale price, Discount of approx £80 off national wholesale price.
Amount of beer purchased	Very different pricing dependent on the size and volume sales of pub.	No impact—price fixed based on discount package above. Most of our pubs not on guaranteed discounts have some form of volume purchase incentive.
Minimum Purchase Obligation	Negotiable—the higher proportion of sales the better the price.	None
Must stock	Negotiable—the more must stocks the better the price.	None
Solus—fixed requirement to sell only a specific brand	Negotiable—a solus brands deal will result in a much better price.	None
Range	Negotiable—brewer supplier will not normally make available large competitors products. The more limited a range sought the better the price.	Top selling beer in every category available to all of our retailers.
Location	Increasingly extra cost of delivery to difficult locations or for small deliveries.	No charge to retailer irrespective of size or location
Loan	Negotiable—high interest rate and cheaper beer price, low interest rate and higher beer price.	No loan arrangements linked to beer supply.
Rent	No longer the landlord so retailer will pay free of tie rent to third party property owner, or will own the property.	Bespoke based upon agreement type and specific outlet allowing us to fully reflect the circumstances of different pubs.
Credit terms	Negotiable	Standard terms covering all purchases and rent.

  35.  Pubcos tend to set their beer prices to be consistent for all of their retailers, reflecting the diverse mix of products on different margins offered and sold throughout the estates.

  36.  In order for a direct comparison to be made between the price paid by tied retailers and similar free house operations it is important to note that should a retailer wish to stock the top selling drinks brand in each category they would probably need to source products from at least eight different suppliers. (See Figure 20 para 225). Although the national brewers have the necessary infrastructure to serve the outlet, they tend not to be prepared to offer competitive terms on competitor's products. The free of tie retailer would then be left with an unattractive choice of buying through a wholesaler at a lower margin or purchasing a less attractive range of products from one of the brewers. The pubcos offer all of these products at certain pricing and on a composite basis.

  37.  Given the number of variables, notably range, distribution and operational freedom, we believe that it is right to differentiate our pubs by way of the total package with the rent and discount being the key variables. Both of these are negotiated openly, up-front and are bespoke to the specific outlet and the supply and demand for pubs in that location. This is much the best way to provide a small operator certainty upon which to build a successful business.

  38.  The basis on which pubcos' tenants rents are set and increased and their impact on struggling tenants.

  39.  Every effort is made at the outset to agree the rent on a transparent and consistent basis and this starts well before a prospective retailer is even considering a specific outlet. Guidance is provided in our Welcome Pack and Retailer Charter. When a pub is identified we request a business plan to be produced by the prospective retailer analysing the performance of the property based upon the rent proposed. In addition, we provide a copy of our analysis of the rent calculation. (An example of which is provided in Annex C).[47]We would also refer you to www.punchpubs.co.uk where we provide a thorough analysis of the pros and cons of running a pub, the alternatives and the pitfalls. We also provide an outline to assist retailers in providing their business plan.

  40.  Ultimately Punch can propose a rent, but the actual rent is negotiated between Punch and the retailer and reflects the open market. This will be influenced by recognised economics of supply and demand for particular pubs in an area.

  41.  Once a rent has been agreed at the start of an agreement the majority have an annual RPI increase. This is seen as being beneficial to the retailer as it evens out any spikes in the rent that might occur during a longer rent review cycle.

  42.  The process of rent reviews is clearly set out in our agreements and our Retailer Charter. This protects any retailer by allowing an independent arbitrator to settle any dispute at review. In the overwhelming majority of cases agreement is reached without external intervention. We do however offer a free mediation service as a facility to avoid incurring the retailer in unnecessary arbitration costs.

  43.  Since 2001 we have completed 648 rent reviews, mostly covering a five-year period, with just three mediations and nine arbitrations. Since the year 2000 all new leases granted have a mechanic to allow the rent to go down as well as up. With the majority of our retailers having enjoyed prosperous businesses with our support the average uplift in our rent reviews since August 2001 has been 15%, some 20 pubs have however seen their rent fall on review.

  44.  At any time during the life of an agreement the retailer can seek assistance from our area managers, called Business Relationship Managers ("BRMs") who have delegated authority to agree short-term rent concessions for a term up to six months while a longer term solution to the retailer's difficulty is considered. We currently have 167 active concessions in the total estate.

  45.  Struggling retailers get into financial difficulties for many reasons and it is not always because the rent no longer represents a fair share of the available profit. It is also worth noting that, on average, rents as a proportion of turnover seem to be coming down. The latest trade survey in the Morning Advertiser highlighted a reported average rent at 13.35% of turnover, down from 14.18% in the prior year (source Morning Advertiser/Morgan Stanley industry report May 2004).

46.  CONCLUSION

  47.  Pubcos rely on developing and retaining a vibrant pub community. To achieve this, we must offer a package of quality outlets, investment, training, goods and services that attract the best retailers. A failed pub is a failure for both pubco and retailer. However, the numbers of applicants, the improved profitability of our retailers and the innovation of all provide ample evidence of a healthy, competitive and well balanced market. We await the outcome of your review with interest.

PART 2—SUPPORTING DOCUMENTATION

CONTENTS

Paragraph

  INTRODUCTION  48

INDUSTRY BACKGROUND  55

    Pub Ownership  56

    The Beer Market  65

    Pub Operating Structures  74

    Operating a Pub as a Business Opportunity  86

    Buying or Leasing a Pub  90

    Benefit of the Tied Lease  99

    Retailer Profitability    102

PUNCH TAVERNS BUSINESS MODEL  109

      Origins of the Company  110

    Financial Structure and Performance  115

    Lease Agreements  121

        The Agreements in Punch  122

        Recruitment of Retailers  127

        Calculation of Rent  140

        Rent Review Process  162

        Lease Renewal Process  170

        Lease Assignments  175

      Sale of Product  183

          Product Range within Punch  184

          Pricing, Discount and Incentive Schemes  204

          The "One-Stop-Shop"  221

        Retailer Terms of Credit  232

    Support Services  235

        Operational Structure  236

        Communication and Dialogue  244

        Retailer Training  272

        Business Planning and Support  278

        Investment Facility and Process  281

        Growing the Business  292

    Corporate Governance  315

POSITION OF PUBCO LEASES UNDER COMPETITION LAW  327

CONCLUSION  341 48.  INTRODUCTION

49.  Punch Taverns ("Punch") owns 7,371 pubs, which represents approximately 12% of all pubs or 5% of all licensed premises in the UK.

  50.  All of our pubs are leased to retailers (individuals or small companies) who manage the pubs themselves, subject to the terms of the lease. Lease agreements may be short term tenancies (typically three years, non-assignable, non-repairing), or longer term leases (typically 10 to 25 years, assignable, fully repairing). There are many variations of lease agreement, but in all cases the retailer will pay a rent and is required to source most beer products through Punch.

  51.  The main aim of Punch is to help our retailers to build better businesses, and our support services are focused to this objective. Our relationship with the retailer is vitally important—we are very clear that, in the longer term, if the pub and the retailer are not successful, then we will not be either. That said, it is also inevitable that, on occasions, there will be tensions between landlord and retailer, and that, in common with other retail ventures, there will sometimes be business failures. We try hard to minimise these.

  52.  The pub industry has evolved dramatically in the last 15 years, and Punch has been near the forefront of that evolution since its formation in 1997. Pubs in the UK now offer the consumer a very wide choice of drinks and other amenities, especially food, and are no longer the retail distribution point of an owning brewery. The advent of longer term leasing has seen a sea change in the type of entrepreneur who is attracted by the opportunity to lease a pub, and has created a culturally rich mix of diverse retail outlets.

  53.  Punch is a successful company, achieving pre-tax profits in our last full financial year of £113 million, or £25,000 per pub. We believe in investing in our business and last year £44 million capital was reinvested, £33 million of this directly into enhancement of our pubs. Our underlying growth in pub profitability is circa 4%. We are pleased to note that the average income of our pub retailer is estimated to be circa £35,000 per annum, including an allowance for accommodation, and we believe that most retailers are enjoying a growing income.

54.  Information Note:

  In December 2003 Punch Taverns completed the acquisition of Pubmaster, increasing our estate by circa 3,100 to the current 7,371. Pubmaster operates a very similar business model to Punch and, over time, the two businesses will be fully integrated. For the purpose of this note however, it should be recognised that some information relates to the pre-Pubmaster estate of Punch only, as less history of the Pubmaster business is available at present.

55.  INDUSTRY BACKGROUND

56.  Pub Ownership

  57.  Before 1990 the large brewers, with the exception of Guinness, all owned substantial tied estates comprising both managed pubs and tenanted pubs. Their estates represented about 57% of the c 60,000 pubs in the UK and a still greater share of pub sales and beer volumes.

  58.  Figure 1

BREWERS' PUB OWNERSHIp (1989)

Brewer	Number of Pubs (managed and tenanted)
Bass	7,190
Allied	6,678
Whitbread	6,483
Grand Metropolitan	6,419
Courage	5,002
Scottish and Newcastle	2,287
Total	34,059

  Source: The Supply of Beer (Tied Estate) Order 1989.

  59.  Since implementation of the Beer Orders during the early 90s, the model has changed radically. None of the major brewers now own any pubs, as they have focused on developing international beer brands in place of controlling access to the retail market.

  60.  Figure 2 below highlights that during this period of change in the industry, the overall size of the market has changed very little, at around 60,000 pubs. However, there has been a dramatic reduction in national brewer ownership, and growth in pubcos. Meanwhile the regional brewers have reduced slightly, and the number of independent individual outlets has remained very similar.

  61.  Figure 2

  Source: Publican Pub Industry Handbook 2004.

  62.  Despite the emergence of pubcos, after 10 years of re-consolidation the top 10 pubcos account for nearly 6,000 fewer pubs than were owned and operated by the six national brewers at the time of the Beer Orders, as shown in Figure 3.

  63.  Figure 3

PUB OWNERSHIP (1989 vs 2004)

1989				2004
Bass	Mixed (Brewer)	7,190	Enterprise	Leased	9,093
Allied	Mixed (Brewer)	6,678	Punch	Leased	7,400
Whitbread	Mixed (Brewer)	6,483	Spirit	Managed	2,470
Grand Met	Mixed (Brewer)	6,419	M&B	Managed	2,077
Courage	Mixed (Brewer)	5,002	Greene King	Mixed (Brewer)	1,684
S&N	Mixed (Brewer)	2,287	W&D	Mixed (Brewer)	1,605
			S&N Pub	Leased	1,119
			Innspired	Leased	1,066
			Wellington	Leased	835
			Avebury	Leased	750
TOTAL		34,059			28,099

  Source: Beer Orders, Publican Pub Industry Handbook 2004.

  64.  It should be noted that pubs form part of the "on-trade" market, which includes all premises with a license to consume alcohol on the premises. There are c140,000 on-trade outlets in the UK, of which pubs comprise just over 40%.

65.  The Beer Market

  66.  None of the pre-1990 brewers remain intact and some company names, such as Bass, have disappeared as the larger brewers have restructured, merged and grown their market shares in response to the new industry structure. All of the remaining big UK brewers are now multinational, and seek to expand their brands globally. Figure 4 compares the major brewers of 1993 with those of only 10 years later.

  67.  Figure 4

BREWERS MARKET SHARE OF BEER VOLUME (UK ON-TRADE)

	1993		2003
Bass	23.0%	Scottish & Newcastle	26.2%
Courage	16.1%	Coors	20.5%
Carlsberg-Tetley	15.8%	Interbrew	16.7%
Whitbread	11.4%	Carlsberg UK	14.0%
Scottish & Newcastle	10.2%	Diageo	6.0%
Guinness	5.5%
All other brewers	18.0%	All other brewers	16.6%

  Source: A C Neilsen.

  68.  Changing consumer leisure patterns, the growth of in-home entertainment, and aggressive price promotions by the multiple grocers have combined over the last two decades to a progressive growth in beer volumes sold in the off-trade (ie not consumed on licensed premises). Figure 5 sets out the extent of this growth, compared with the on-trade.

  69.  Figure 5

  Source: BBPA 2003.

  70.  The number of off-licensed premises in the UK has actually declined by 5% since 1993 to around 43,000 in 2003 (Figure 6), but the significant change has been the increasing dominance of the multiple grocers, where volume has almost doubled in the last 10 years. Some 68% of beer sales in the off-trade sector are sold through less than 16% of outlets.

  71.  Figure 6

OFF-TRADE VOLUME BY OUTLET

	Multiple grocers	Multiple specialists	Co-ops	Independents
1993 Volume ('000 bris)	2,966	1,118	353	1,355
2003 Volume ('000 brls)	5,654	644	378	1,643
1993 Outlets	3,856	5,081	2,173	33,950
2003 Outlets	6,707	3,870	2,322	30,096

  Source: A C Neilsen.

  72.  The beer supply and off-trade markets are now much more concentrated than the on-trade retailing market (see Figure 7). Consequently the more fragmented on-trade sector is still more profitable for the brewers than the off-trade, given the huge purchasing power held by the multiple grocers in the off-trade.

  73.  Figure 7

CONCENTRATION OF BEER VOLUME IN THE ON-TRADE, OFF-TRADE AND SUPPLY MARKETS 2003

On-Trade	Volume Share	Off-Trade	Volume Share	Beer Supply	Volume Share
Leased/tenanted pubs	29%	Multiple grocers	68%	4 national brewers	77%
Managed pubs	17%	Multiple specialists	8%	Others	23%
Independent pubs/clubs	43%	Independents	20%
Other	11%	Other	4%

  Source: A C Neilsen.

  74.  Pub Operating Structures

  75.  A retailer wishing to run a pub has a very wide choice of operating format to choose from.

  76.  The main operating structures for pubs are as follows:

—  Managed, owned and operated by a company,

—  Tied Lease or Tenancy, owned by a landlord but operated on a commercial lease by an independent retailer,

—  Franchised, owned by a landlord but operated under franchise agreement by an independent operator,

—  Free of tie lease, owned by a landlord but operated on a commercial property lease by an independent operator,

—  Independently owned and operated.

  77.  Further detail of these formats is provided in Annex A. In general, managed pubs are larger in size, often branded and in High Street or busy locations. Other formats are more suited to smaller pubs, usually serving a local community, where the independent operator is able to tailor the consumer offer in the pub to meet local demand. Punch Taverns operates pubs in the tied lease or tenancy format. Figure 8 shows a breakdown of current numbers of each format.

  78.  Figure 8

PUB NUMBERS BY KEY FORMAT

Leased/Tenancy	29,829
Managed	12,885
Free independent	16,850
Total	59,564

  Source: Publican Pub Industry Handbook, 2001-04.

  79.  Following the Beer Orders in 1989 the tied lease agreement has emerged and offers significant alternative to the brewery tied tenancy agreements which prevailed previously.

  80.  Prior to the Beer Orders the main form of occupation was an insecure tenancy agreement with no protection from the 1954 Landlord and Tenant Act ( the "LTA"). This enabled the brewery landlord to dictate stocking policy and rents, and to obtain possession without significant justification or paying any compensation.

  81.  The Beer Orders extended the protection of the LTA to licensed premises in England and Wales. This caused brewery landlords to reconsider their property strategies as the relationship changed from that of quasi employer to property landlord and product supplier. Many brewers chose to adopt a standard form of commercial lease that offered the retailer a greater interest in the business. This was embraced by the market and has become the preferred model for pub companies and entrepreneurial retailers alike.

  82.  Retailers now enjoy two main types of tenure, known within the industry as the lease model or a tenancy model.

  83.  Today the lease and tenancy terms have the following generally accepted meanings:

  84.  The Lease is a long term (typically 10-25 years) secure and assignable agreement with full repairing obligation, generally with some form of discount offered on products purchased. This agreement is attractive to entrepreneurial retailers who realise the opportunity to develop the business and capitalise on the goodwill created.

  85.  The Tenancy is a short term non-assignable, internal repairing agreement with only limited target based discount incentives offered. Agreements are typically three years but with the opportunity for the tenant to terminate at any time. This type of agreement is attractive to the retailer who is risk averse, and requires greater levels of business support from the pub company, and the opportunity to leave the business at any time.

  86.  Operating a Pub as a Business Opportunity

  87.  Whilst for some individuals running a pub is a lifestyle, many of the retailer operators in the Punch estate are entrepreneurs or small companies who will consider a number of business opportunities as an alternative to running a pub.

  88.  Compared with other retail opportunities, running a tied pub has three distinguishing features:

1.  Almost uniquely, the vast majority of leased pubs include accommodation.

2.  Leased pubs have a very low cost of entry. In particular, the value of stock is low compared to other businesses, and the overall cost of entry can generally be as low as £10,000-£20,000.

3.  Margins earned by leased pub operators are generally higher than other retail opportunities, as measured by earnings before interest and tax compared to sales income, as shown in Figure 9.

  88.  Figure 9

EBIT MARGIN AS A PERCENTAGE OF SALES

Jewellery	14%
Leased pub	12%	Clothing	10%
Health and beauty	9%	DIY	8%
Electrical	(5%)	Food	5%

  Source: Deutsche Bank estimates.

  89.  Buying or Leasing a Pub

  90.  Punch considers that the leased pub model offers a very attractive and low cost means of entering the on-trade market.

  91.  There are circa 17,000 independently owned pubs in the UK. However, in many cases, leasing presents a cheaper and more attractive option. The retailer wishing to buy rather than rent will need considerably more capital outlay. The other costs of entry will be similar to leasing but the economic cost of the property during the life of ownership will also be cheaper on average for a lessee.

  92.  Figures 10 and 11 consider the cost of buying a pub compared with letting a pub on a tied lease. To illustrate the economics we have used indicative values based on Punch experience. Consider a pub worth £450,000, with a rent of £26,000 pa and barrelage of 210 barrels pa

  94.  Figure 10

CAPITAL IN-GOING COSTS—PURCHASE vs TIED LEASE

Capital In-going Costs		Buy			Lease
Purchase price		£450,000
Loan70% LTV		£315,000
Balance		£135,000	Deposit	¼ rent	£6,500
Stamp Duty	3%	£13,500	Stamp Duty		£3,600
Fixtures & Fittings		£10,000	Fixtures & Fittings		£10,000
Stock & Glassware		£3,000	Stock & Glassware		£3,000
Total Cash Required		£161,500	Total Cash Required		£23,100

  Source: Punch estimates.

  95.  Figure 11

ANNUAL COSTS—PURCHASE vs TIED LEASE

Capital In-going
Costs		Owner			Lessee
Interest	7%	£22,050	Rent		£26,000
Min required return on capital invested	20%	£32,300	Min required return on capital invested	30%	£6,930
Free Trade Barrelage	£70		(£14,700)
Discount	per barrel
Total Annual Costs		£39,650	Total Annual Costs		£32,950

  Source: Punch estimates.

  96.  In the assessment, we have assumed that in addition to interest or rent, a retailer should be seeking a reasonable return on the money invested in the business at the outset. We have suggested a return required of 20% on a freehold purchase and 30% on a long lease. We have used a free trade discount of £70/brl, but made no allowance for the much greater product range and support services available under the tied lease model. A more detailed version of this analysis has been adopted by Deutsche Bank in their analysis of the pub sector ("The Bear Pit", 31 October 2003).

  97.  Even with the extra return criteria, in the current market a retailer who leases rather than purchases would save some £6,700 per annum and make capital cost savings of over £138,000. Although the lessee would not gain on the capital appreciation of the freehold, the lessee has an asset which is assignable. It is worth noting that the average assignment premium paid by in-going lessees on an assignment is £66,750 in the Punch estate.

  98.  A further major issue is risk. Should the value of the property fall for some reason, the whole of this value loss would be felt by the owner, generally in the form of "negative equity", whereas the lessee is largely protected. The purchaser is also highly susceptible to an interest rate increase. If borrowing rates rise, every 1% rise in interest rates in the example above would cost a pub purchaser £3,150 pa.

99.  Benefit of the Tied Lease

  100.  The analysis above highlights the significant cost benefits and risk mitigation to a retailer operating a tied lease pub rather than buying an equivalent outlet. These benefits are a direct consequence of the structure of the business model and the value enhancement that the pub company landlord can provide to the retailer. They can be identified in three main areas:

—  the purchase of goods for resale through pubs at prices which reflect the aggregation of purchasing power;

—  cheaper finance costs at fixed rates on a long term basis; and

—  ability to recruit and retain expertise in all fields relevant to the development of a support service for our pubs.

  101.  These benefits allow Punch to tailor our economic model to support our retailers at the same time as giving a fair return to our shareholders. Compared to retailers on free of tie leases, or those running a free house, tied lease retailers benefit in particular from:

—  range of products available;

—  discounts, incentive schemes, special offers;

—  fair market rents reflecting the economic model and business opportunity; and

—  support services.

102.  Retailer Profitability

  103.  As set out above, Punch considers that the tied lease model can present a significant profit opportunity for retailers. However, the profitability of each retailer can vary, depending on the type of pub, its location and the performance of the retailer.

  104.  The precise profitability of each retailer is not known by pub owners such as Punch. There is no requirement in the agreement to share information and retailers generally keep such detail confidential.

  105.  However, sufficient information is known at the point of business assessment, for example when calculating a rent, to make a good estimate of retailer profitability. As a general rule, rent is agreed at approximately 50% of the available retail profit from the pub (see para 129 for rent assessment), meaning the retailer net income is broadly equivalent to the rent. In addition, the retailer benefits from the value of accommodation and living on the premises, which is not taken into account in the rent assessment.

  106.  On this basis, Punch is able to estimate an average retailer profitability of circa £35,000 pa in the Punch estate, one of the highest in the industry. This estimate is supported by independent research conducted by Deutsche Bank in a review of companies in the pub industry (The Bear Pit, 31 October 2003), which found the average lessee package as varying between £22,482 pa and £37,112 pa, depending on the type of estate, with Punch at £36,327 pa.

  107.  Inevitably there will be a degree of volatility in performance and profitability of individual retailers, however in general it would appear that most retailers are seeing an improvement in their results. A survey conducted by the Publican newspaper in 2003 found over 70% of tenants and lessees seeing both turnover and profitability in line with or ahead of prior year, as reproduced in Figure 12:

  108.  Figure 12

RETAILER'S TURNOVER AND PROFIT GROWTH, 2003

	Up a lot	Up slightly	No change	Down slightly	Down a lot
Tenants turnover	19%	43%	7%	18%	10%
Lessees turnover	28%	44%	8%	15%	3%
Tenants profit	15%	42%	7%	20%	12%
Lessees profit	23%	41%	15%	12%	5%

  Source: Publican Newspaper 18 August 2003.

  109.  PUNCH TAVERNS BUSINESS MODEL

  110.  Origins of the Company

  111.  Punch Taverns was formed in 1997 with the acquisition of the c.1,400 remaining leased and tenanted pubs owned by Bass plc. The Group then expanded its pub estate through acquisition, buying the leased and tenanted estate of Allied Domecq (c.1,800 pubs) and Inn Business plc (c.650 pubs) in 1999, and Pubmaster (c.3,100 pubs) in 2003, plus sundry other individual or small company acquisitions. The estate has now grown to 7,371 pubs (at 6 March 2004), almost all owned outright on a freehold or long lease, and let to retailers on a leased or tenanted agreement. All pubs are located in the British Isles.

  112.  Punch Taverns was originally a private company backed by a consortium of venture capital investors. In early 2002 the company became a plc then floated on the London Stock Exchange. We now have a market capital of around £1.2 billion, and are members of the FTSE 250 index, with a full range of private and institutional shareholders.

  113.  We welcome the corporate governance requirements that are associated with being a public company. We have adopted a policy of open disclosure of financial performance to all stakeholders through our annual report and accounts, and through a variety of presentation and information material, all of which are published on the corporate website. This approach brings clear visibility of company behaviour and performance, to the benefit of all of our stakeholders.

  114.  The transparency of our company and the nature of our capital structure make it very easy for retailers to invest in Punch and we encourage this. On flotation in 2002 we established a single company ISA for retailers and those who participated have seen significant gains on their investment.

  115.  Financial Structure and Performance

  116.  Punch Taverns plc is funded through a mixture of equity and debt.

  117.  Our equity is in straightforward ordinary shares traded on the London Stock Exchange. The current dividend yield we pay on our shares is circa 1.7%.

  118.  Our debt is predominantly in the form of tradable investment grade securitised mortgage bonds. These securitised bonds provide long term finance, at fixed rates of interest (averaging 7.1%), repayable over a 30 year period on a known payment schedule, and carry no exposure to interest rate fluctuations. This is an extremely effective way to finance our business—long term steady finance affordable from stable income streams. The capital structure brings significant economies to the company that are not available to the individual operator and were not utilised by the former brewing owners of our pubs. The key benefits are:

—  low cost of funding;

—  no interest rate exposure;

—  long term repayment mechanic; and

—  secure finance for the long term.

  119.  Punch is a successful business and has achieved good growth and financial returns in recent years. The main drivers of growth are:

—  Steady organic growth in sales and profit. In our "like for like" estate (all owned pubs excluding recent acquisitions), sales growth in our most recently reported results was 2.4% (previous year 2.6%) whilst underlying pub profit growth was 3.9% (previous year 4.3%).

—  Acquisitions of new pubs, to which we can add value, and which generate synergy benefits across the estate

—  Our capital structure, with fixed interest costs, which provides an acceleration of earnings.

  120.  For the last full financial year, prior to the Pubmaster acquisition, Punch Taverns earned profit before tax of £113 million, or just over £25,000 per pub. Our operating profit of £227 million was earned on a capital employed of £2,161 million, a pre-tax return of 10.5% (or 7.4% post tax). During the year we invested £44 million in capital expenditure, £33 million of which was invested directly in pub enhancement schemes, and £11 million in company infrastructure to improve our support services and efficiency.

  121.  Lease Agreements

  122.  The Agreements in Punch

  123.  When Punch constructed its estate through acquisition of existing brewers' pubs we inherited a wide range of legacy agreements which had limited product choice. Over time we have negotiated better supply agreements that have opened up product availability to our retailers. At the same time, because of the discounts obtained through our purchasing power we have been able to offer our retailers products at a reduced price, significantly below the national wholesale price, through the introduction of the Punch Growth Lease ("PGL") in 2000. The PGL guarantees off-invoice discounts for the life of the retailer's lease, a commitment which is not available to free of tie publicans who rely on the free market price at a particular time, and significantly improves upon the range of products needed by the pub to meet local demand.

  124.  We now have over 1,500 PGL agreements in place (ie one third of the pre-Pubmaster estate) with minimum guaranteed off-invoice discounts of £40 per barrel. A further 78 retailers enjoy terms with minimum guaranteed off-invoice discount of £80 per barrel. Agreements with guaranteed discounts are now available to our extended estate and we are negotiating approximately 400 new PGL's each year.

  125.  As the market has matured retailers are more familiar with the various modes of occupation and expect greater choice of agreement. We believe it is vitally important in this competitive arena for new retailers to provide the best agreements, and we have therefore responded by offering a more flexible form of agreement to meet this demand. This is known as the "Retailer Agreement" (the "RA"). To ensure that our retailers fully understand the commitment we make to each other as business partners the RA has been written in consultation with the Plain English Campaign and has received their accreditation. We are also corporate members of the Plain English Campaign and are working with them to make all of our communications more accessible to our retailers.

  126.  Our Retailer Charter incorporates a section which details the process a retailer should follow to select the appropriate agreement for them and their business needs.

  127.  Recruitment of Retailers

  128.  The best determinant of the health of the industry is the number of applicants wishing to enter it. We believe that the demand for pubs is more buoyant today than at any time in the past. At present we have over 1,600 prospective retailers going through the process of finding a pub with us.

  129.  In terms of how our retailers are recruited, we have three broad categories, as shown in Figure 14:

  130.  Figure 14

SOURCES FOR RECRUITMENT

Source	% of Punch applicants
Advertising	19%
Word of mouth	43%
Web	38%

  131.  Within the word of mouth category, 35% come directly from our retailers, either as recommendations or friends that they have in the licensed trade.

  132.  When recruiting we are extremely thorough in our vetting process. Whichever route applicants come by, they are steered towards our recruitment website, www.punchpubs.co.uk. This gives an extremely detailed introduction to the trade in general, to leasing, and to Punch in particular. It fully explains the free house, managed and leased models ensuring all applicants think carefully about which area to enter. If that choice remains leasing, it then takes the applicant through what the commitments are to both parties, particularly early cost. It explains the following:

—  the agreements we have and how they work;

—  how we invest in the business;

—  how to apply, including writing a business plan;

—  business set up including the money needed;

—  legal and financial considerations;

—  operational administration;

—  equipment;

—  staff;

—  licensing;

—  training to be received; and

—  countdown to entering the pub and the first six months on site.

  133.  A copy of the website materials is reproduced in Annex B.[48]

  134.  If having read this, the applicant wants to proceed, they fill in an application form. From then on, a detailed recruitment process is followed, which involves:

—  an initial screening telephone interview looking for key characteristics in that individual;

—  first interview by a Business Relationship Manager on a generic basis, looking to understand the applicants' motivations and abilities;

—  credit check to ensure that the applicant has the requisite finance to enter the trade;

—  second interview, which will be pub specific and involve a detailed business plan of how the applicant will operate the pub; and

—  follow up interviews with business plans for a number of pubs until the correct match is found.

  135.  The process is extremely rigorous and from those who progress from initial interest to actual application, we get an average 26% dropout rate, due to our rejecting them or their withdrawal once they fully understand the implications of running a pub.

  136.  Web applications have been running at c 450 per month since July 2002. Recently, when we went live in April 2004 with a joint Punch/Pubmaster site, this jumped to over 700 applications. Those who successfully pass the initial interview and cannot be placed in a suitable outlet according to their skills and requirements are placed in our talent bank and at present, the average number of applicants that are moving through our recruitment process post screening and credit checks is 1,600. These applicants will either be at interview 1, interview 2 or included in our talent bank.

  137.  Interest is not only driven via the website. The recruitment department receives an average of 300 telephone enquires per week.

  138.  Applicants come from a wide variety of backgrounds and age groups. At present, the split in age groups is fairly even at one third in the 18-30 group, one third in the 31-40 group and one third in the 41-50 group. Backgrounds range from existing licensees to people from the forces/police to young entrepreneurs to qualified chefs. Two of the big attractions are seeing this as a retail site, that is to say, an alternative to running a shop, restaurant or franchise and secondly, that it is one of the few business that comes with accommodation.

  139.  Calculation of Rent

  140.  Method of Assessment

  141.  The principal method appropriate to the vast majority of Punch's pubs is on the basis of a profits assessment. This is the market accepted method for the valuation of non-High Street pubs and is supported by the Royal Institution of Chartered Surveyors.

  142.  This requires a projection of the fair maintainable turnover ("FMT") a good/average hypothetical retailer could be expected to achieve from the licensed premises involved. Similar projections are made relating to the likely overheads and costs of the business in the hands of the same hypothetical retailer, but excluding his own salary. The rental to be paid is also excluded from the calculation. The rental valuation is then assessed on the basis of a percentage of the resultant profit before rental (known as the "divisible balance"). The share of profit that is used to decide the rent reflects the market demand and specific agreement terms for that pub, but is typically around 50%.

  143.  This system is the historically acknowledged method of valuation and has the advantage of ensuring a pub is rented in accordance with its profit earning potential in the hands of an average retailer. Retailers who are above average in capability are not penalised by way of being charged an excessive rent and similarly retailers who are performing below the standards which could reasonably be expected of them are not subsidised by the way of the rental for their shortcomings. The support and training we offer aims to identify development needs to ensure that our retailers' skills are at least as good as those of the hypothetical retailer.

  144.  An alternative method of valuation adopts a rental figure per square foot of the gross internal area of the licensed premises. This method is favoured in the cases of night clubs or city centre bars which compete with standard retail outlets or offices for prime space within a commercial area. A major disadvantage of such system relates to the fact that larger licensed properties do not necessarily produce correspondingly larger profits—indeed the reverse can often be the case. This method is rarely used in our estate.

  145.  In judging whether the rent assessed is appropriate in the circumstances we make a check by comparing the proposed rent with the rentals for other comparables, their desirability and the demand for pubs of this type. However, the rentals of the other comparable pubs have to be adjusted for any differences from the pub being assessed; this might include differences in the agreement terms which include the discount available and repairing obligations as as well as the date the rent was assessed.

  146.  When we make a rental assessment we have regard to the views of the retailer and our knowledge of the past performance of the outlet concerned, as well as the quality of the retailers who have been attracted to run that pub in the past. The retailer is invited to prepare his own business plan and guidance is provided on our website which explains the costs and commitments made when running a pub business. Prospective retailers are also advised to take all necessary independent advice before entering into a legally binding commitment.

  147.  Once we have made our assessment we share how we have arrived at the proposal with the retailer and give them a summary of our assessment (copy provided in Annex C attached).[49] We then seek to reach agreement over the appropriate assessment of FMT and the level of rent. It is important that both parties are happy with the proposal if we are to make a success of developing the business together.

  148.  If we are marketing a vacancy, potential retailers are interviewed and asked to explain their business plan and justify their rent bid. With a new talent bank of circa 1,600 retailers waiting to take a pub from the company we do not necessarily select the highest bidder. We seek to ensure from our knowledge of the pub and the business plan supplied that the retailer best suited for the outlet is recruited and a sustainable business is created.

  149.  Pub turnovers have increased as consumers' tastes have changed so that a greater proportion of pub trade is now represented by the sale of food rather than liquor. The profits assessment, based upon the fair maintainable turnover from all sources, inherently adjusts so that it fairly reflects these continuing trends which other methods of valuation would fail to recognise.

  150.  In the recent case of Gregor Robertson v Punch Taverns Properties Limited, Judge Barker QC commented:

". . . I should note that this landlord, Punch, does take care to ensure that prospective tenants are aware of the risks, obligations and commitments involved in taking on a lease of licensed premises. From the hard copy of various Punch website pages added to the trial bundle shortly before the resumed hearing, it is evident that Punch wishes to operate as a responsible landlord enjoying a mutually beneficial commercial relationship with prudent and responsible tenants."

  151.  Who is involved in the rent assessment?

  152.  The retailer's principal point of contact within Punch is their Business Relationship Manager ("BRM"), who is in regular contact with the business, reviews the current actual trade and assesses the FMT from his knowledge of the business potential of the pub. The BRM is also responsible for seeking agreement to the rental by negotiation with the retailer.

  153.  The Regional Operations Director ("ROD") who has knowledge of a geographic region is able to support the BRM in developing his business assessment skills and is available to the retailer where there is any point of disagreement.

  154.  The Regional Estates Executive ("REE") is a property expert who reviews the rentals proposed in their market context and provides advice to the BRM and ROD as necessary.

  155.  Whilst the rent is generally fixed for between three and five years to provide our retailers with certainty, part of the BRM's role is to continually review the business profitability throughout the course of a retailer's occupation.

  156.  Rent Concessions

  157.  Unlike earlier brewery agreements, Punch's agreements allow rents to be reduced as well as increased. This may be through a temporary rent concession, or through a formal rent review.

  158.  It is in our absolute interest to have profitable retailers and therefore, if the rent is untenable through no fault of the retailer, we will consider a rent reduction. We always support a struggling retailer with business advice; this is only effective where they are open with us and apply our recommendations. An example where we may reduce the rent would be when demographic changes have adversely affected consumer demand at a particular pub.

  159.  From the Punch estate, we currently have 167 active concessions which amount to a total annual rent subsidy of £2 million. In addition, we have 140 stepped rents in place to allow retailers to build their business to the agreed level of trade.

  160.  However we don't just give the concession, we then work with the retailer to retarget their business (sometimes with investment) to return it to a more sustainable level.

  161.  Rent Review Process

  162.  Although the process of rent reviews is set out in the agreement between us and the retailer, we have recognised that this can be daunting and expensive for our retailers. Therefore we have introduced a charter where we commit to an open and consultative process to achieve agreement on rent review with the opportunity of an independent mediation at no cost to the retailer. We have found that, provided our retailers are prepared to be open and honest about their business, we have always been able to reach agreement through the mediation service where a case is referred.

  163.  It is now rarely necessary for either us or the retailer to embark upon the costly and time. consuming formal arbitration process provided for in the contract, although this remains available as a fair method of last resort. A copy of our Retailer Charter (Annex D)50 and Mediation Information Sheet (Annex E)[50] are attached for reference.

  164.  We fully encourage our retailers to obtain their own professional advice and we allow their representative to be present throughout all discussions during a review and where desired to negotiate on behalf of the retailer.

  165.  The majority of our agreements provide for the rental to increase each year in line with the rate of inflation. This is incorporated so that when a full review of the rent takes place after three or five years (depending upon the agreement) the increase does not create a sudden unexpected burden on the cash-flow of the business: We have found that cash-flow difficulties are one of the main causes of early failure of small businesses. However, our agreements also provide that the rent may reduce at the time of the review where the increase in retail prices has raised the level of rent above the market rent assessed under the review provisions.

  166.  Since August 2001 we have agreed 648 rent reviews, with an average increase of 15%, including 20 instances where the rent was reduced.

  167.  So far this year we have amicably agreed 128 rent reviews and a further 62 retailers have taken the opportunity at the time of their rent review to transfer to one of our leases with guaranteed discount.

  168.  Since its launch in September 2003, three cases have been mediated with a further four cases pending. The feedback from all concerned has been very positive and in line with our Retailer Charter, we are now publicising this opportunity at an earlier stage in negotiations and extending the service for lease renewals, as well as throughout the recently acquired Pubmaster estate where no such opportunity previously existed.

  169.  Lease Renewal Process

  170.  The process of lease renewal in England and Wales is statutorily regulated by the Landlord and Tenant Act 1954 (subject to amendment from 1 June 2004) and the majority of our retailers therefore enjoy the protection afforded by the right to continue in occupation. We adhere to the strict timescales and processes set out in the Act. The formal statutory notice required advises the retailer to take independent advice and we are precluded from giving advice as the landlord. However, we have set out in our Retailer Charter a clear guide to help our retailers through the process and again highlight that they should seek professional advice throughout. As in the case of a rent review we also intend to offer mediation, in addition to and as an alternative to statutory renewal requiring attendance at court.

  171.  At the end of a lease, provided a retailer has adhered to the terms of their existing agreement, they are offered the opportunity to renew and are invited to transfer to our new agreement with guaranteed discounts. In such cases we also discuss the opportunity of an investment to develop their business to higher levels of trade or react to demographic changes that impact demand at the pub.

  172.  Since August 2001, we have renewed over 600 leases and it has only been necessary to obtain a court determination of rent in two cases. The most recent, Gregor Robertson v Punch Taverns Properties Limited referred to earlier, lent significant support to our approach to the valuation and interaction with our retailers.

  173.  During the renewal process, the majority of our retailers choose to convert to our new lease with guaranteed discounts even though they have the right to continue on their existing agreement terms.

  174.  Lease Assignments

  175.  All of our long term agreements offer the opportunity for our retailers to sell their business and realise the capital value of their goodwill and any improvements they have carried out with our consent. This sale process is known as assignment.

  176.  We have a special assignment team dedicated to supporting our retailers through the process of selling their business. Although we do not act as an agent or advise on the value of a business, we do give retailers access to our web site where, at no cost, they can advertise their pub business for sale and have access to our talent bank of applicants.

  177.  We offer an efficient service to our existing retailers and also interview the person buying the business to ensure he is fully aware of the obligations of the agreement. However, clause 19 of the Landlord and Tenant Act 1927 as amended by section 1 of the Landlord and Tenant Act 1988 provides that we cannot unreasonably withhold consent to an assignment, although we do advise both parties to instruct solicitors and take professional advice. This does mean we can only offer guidance and cannot be prescriptive where a prospective retailer who has failed to take advice is determined to proceed and has agreed to pay an excessive purchase price to the outgoing retailer.

  178.  Where permitted by the agreement and appropriate due to lack of experience, we do insist upon a new retailer attending the Punch Modern Licensed Retailer training course which we offer at a subsidised cost.

  179.  The evidence indicates that there is a healthy demand for our leases on assignment and that our retailers are successful in both building their business and realising its value.

  180.  In the year to April 2003 there were 303 assignments achieving an average sale price for the retailer of £56,000. In the year to April 2004 there were 402 assignments and the average sale price rose to £66,750. This realised value to our retailers of in excess of £26 million.

  181.  When we grant a lease for the first time no premium is charged. This is because we are not in occupation and are not therefore able to sell goodwill for having operated the business. This means that on assignment the sale price realised by a retailer recognises his success in running that pub and we do not share in any part of that profit.

  182.  Sale of Product

  183.  Product Range within Punch

  184.  Historically, the brewers tie was used by the brewer to protect the prescribed sale of that brewer's brands in its pub estate.

  185.  This is totally different to the pubco tie where the primary focus is on providing the retailer with a package of products that allows him to choose the range that best meets the demands of his consumers. In particular Punch's agreements and those of other pub companies are characterised by multi-sourcing and periodic tendering. In addition the structure allows us to obtain competitive advantage by sourcing new and different products to appeal to changing consumer preference.

  186.  This model is backed up by a series of relatively short-term independent brand supply contracts direct with each brand owner. These contracts are not co-terminus so there is a regular process of re-tendered upon expiry.

  187.  In 1998, when Punch first acquired pubs from the Bass Lease Company, 87% of the beer sold in those pubs was brewed by one supplier (Bass). Today, Punch buys beer brands under contract from 46 different suppliers, and the largest brewery supplier to our estate (Coors) brews only 34% of beer sold.

  188.  Since the distribution of beer to our outlets is separate from the brand supply, the size of our estate is no impediment to a small supplier who wishes to sell their product to our retailers. In fact, we can minimise the supplier impact by taking responsibility for all aspects of the marketing and pub distribution to give them the best chance of getting access to the largest possible number of our outlets with minimal capital outlay. It would otherwise be impractical for a small supplier to put in place the infrastructure required to service our estate.

  189.  For the very small supplier who is unwilling or unable to get his product into our depots, we have an alternative arrangement with Beer Seller, a national wholesaler, to assist in delivering small local brands. Smaller niche brands, often with limited production cycles are made available to support specific outlets through the Punch Finest Cask scheme which offers a further range of ales from a variety of smaller or micro brewers. Partly through this scheme, we have listed products from 52 SIBA (Small Independent Brewers Association) members over the last three years. This enables those outlets where cask is important to the retailer's consumer offer to market their business to a wider audience.

  190.  Punch retailers now have direct access to a very wide range of drinks as shown below in Figure 15:

  191.  Figure 15

DRINK PRODUCTS SOLD TO PUNCH RETAILERS AS AT MAY 2004

Draught Beer	180	Including 93 cask ales, 63 keg ales, 24 lagers
Packaged Beer	45
Soft Drinks	155
Ciders	27
Wines	525
Spirits	233
Total	1,165

  

  Source: Punch internal statistics.

  192.  A full schedule is provided in Annex F attached.[51] A small minority of these products are not available to all retailers at all times—some only regionally available and others only for a limited period, such as Christmas ales.

  193.  The widening of our supply base has been particularly beneficial in the traditional or "cask" ale market. Regional and smaller brewers have taken an increasingly large share of the sector since they have been able to exploit their commitment to their brands by accessing Punch's distribution infrastructure and sales support which operate nationally whereas their own infrastructures are only regional or local in scope. As a result, regional and smaller brewers have enjoyed a 28% increase in cask ale volumes within the Punch Taverns estate in the three years to April 2004, despite the continued decline in the UK ale market, and increased their share of cask ale to 51% as shown in Figure 16. In addition to this we have listed products from 57 SIBA (Small Independent Brewers Association) members over the last three years, giving access to some of the many micro brewers. We expect these trends to continue.

  194.

  195.  Other Drinks Supply

  The sale of non-beer products, which include wines, spirits, soft drinks, ciders and premium packaged spirits, many of which are non-tied products in the context of our retailer agreements, are driven through two channels, namely:

—  Within Punch Taverns, products are sourced in most instances direct from the brand owners, and sold in to our retailers through telesales and our own field based sales support team.

—  Within Pubmaster, a wholesaling agreement with Carlsberg UK covers the supply of a range of such products, ie wines, spirits, soft drinks, packaged beers and cider.

  197.  In the Punch estate, we sell some 940 non-beer products from 46 other drinks suppliers in addition to the brewers, providing a comprehensive beverage range. Due to our competitive offer and one stop shop approach, with composite delivery, c 80% of our estate purchase non-tied products from us.

  198.  Contracts Structure

  199.  In general the contract will set out the trading relationship between the parties, including the following:

—  Term of the agreement.

—  Range of products covered by the agreement.

—  Price to Punch and the supplier's wholesale price.

—  Supply price review mechanic—usually on an annual basis and as a result of duty changes.

—  Obligations of both parties during the term of the contract.

—  Promotional support for the brands.

—  Termination circumstances.

—  Technical Services support and service standards.

—  Terms of trading with the appointed distributor.

  200.  Following the acquisition of Pubmaster, we are in the process of combining and renegotiating existing supply contracts.

  201.  Whilst some of the brand supply agreements currently oblige the company to meet certain distribution and/or volume commitments, the company does not impose any brand stocking or volume sale commitments on its retailers. The focus is on the availability to the retailer of the leading drinks brands where possible, with the more regionally important products being available in that locality to offer choice for the retailer and their customers.

  202.  Historically, the brewers sought to commit the pubcos to their supply through onerous brand supply contracts with volume commitments equal to or in excess of the volume then being sold. At Punch there are a small number of legacy contracts of this type. However, all new contracts are focused on distribution and brand development rather than volume of sales.

  203.  Pricing, Discount and Incentive Schemes

  204.  Punch bases the price of beer sold to retailers on the brewer's own national wholesale price for each product, which is a benchmark used throughout the industry, including the brewer's own sales to the independent free trade. This allows differentials between suppliers or individual products to be maintained, and is a fair reflection of the relative market price of each product.

  205.  In Punch, discounts are provided against this base list price depending upon the lease agreement.

  206.  In 2000, Punch introduced the Growth Lease Agreement, which is now our preferred lease agreement and covers one third of the Punch estate (excluding Pubmaster). Retailers on the Punch Growth Lease are guaranteed discounts averaging at least £40 per barrel on a list of key products, on which the average discount is now £45.77 per barrel. The discounts recognise discounts we earn from our suppliers, and offer the retailer more flexibility in managing his retail price over the bar. These products and discounts are shown in Figure 17:

  207.  Figure 17

GROWTH LEASE DISCOUNTS

	Std Price £/brl	Discount £/brl	Discount %
Draught Bass	306.98	42.06	14%
Tetley Bitter cask	278.80	45.80	16%
Tetley Bitter smoothflow	282.15	46.36	16%
Worthington Bitter cask	276.96	36.76	13%
Worthington Bitter smoothflow	277.00	36.73	13%
Carlsberg Export	358.24	58.07	16%
Stella Artois	367.49	52.39	14%
Carling Lager	316.14	43.35	14%
Carlsberg Lager	312.28	52.62	17%
Guinness	344.29	24.33	7%
Castlemaine XXXX	296.97	44.18	15%
Budweiser NRB	499.86	66.60	13%

  Note: Prices and discounts exclude VAT. There are 288 pints in one barrel.

  208.  These key products have been selected to guarantee discounts on all major brands, but in fact all beer products sold under the Growth Lease earn a discount of up to 17% on list price.

  209.  Some 78 retailers are on enhanced terms, which allow them to earn discounts at approximately twice the above level.

  210.  Discounts guaranteed by the growth lease agreement are paid off-invoice, across every barrel sold. The amounts are agreed by reference to the retailer agreement, irrespective of the level of volume, and beneficial terms are therefore reflected in the rent.

  211.  In addition to discounts, Punch runs various volume incentive schemes, intended to encourage and reward retailers who increase their beer sales. These schemes are target based, and, depending on the scheme, can pay up to £55 for each incremental barrel. Payments are made retrospectively, after targets have been exceeded. Over 1,600 Punch retailers are currently benefiting from these schemes, with a total value of around £3 million.

  212.  Non beer products are sold from a variety of net price bands, depending on the lease agreement, the type of product, and the volumes concerned.

  213.  Retail Pricing

  214.  Punch retailers are free to set their own retail prices in response to their local market, and are not subject to any minimum purchase obligations to distort this freedom.

  215.  The average price of beer in leased pubs is slightly higher than in managed house pub chains (which are severely affected by cost cutting in the High Street), and slightly lower than the independent free trade. See Figure 18 below.

  216.  Figure 18

AVERAGE RETAIL PRICE

£/pint	Ale	Lager
Leased/tenanted pubs	£1.97	£2.26
Managed pub chains	£1.93	£2.23
Independent pubs	£2.04	£2.26

  Source: A C Neilsen, March 2004.

  217.  Taking an average price of £2.14, the relevant costs and gross margins are made up as shown on Figure 19:

  218.  Figure 19

VALUE CHAIN ON A PINT OF BEER

Pence per pint	With PGL Discount	No Discount
VAT	32	32
Retailer	87	73
Pubco	43	57
Distribution, technical	4	4
Brewery	48	48
Total	214	214

  Source: Punch estimates.

  219.  As can be seen, retailers earn the largest share of the available gross margin, with a gross margin of 48% on a growth lease agreement, and 40% on a standard agreement.

  220.  The "One Stop Shop"

  221.  Within the free trade market, the independent operator has difficulty in obtaining all top brands to give him the best opportunity to compete and attract the consumer. Because the majority of beer sold is still draught, specialist distribution has to be used, and this distribution is almost exclusively owned by the major brewers. Given the control that this provides, the brewers have always been unwilling to supply their competitor's products.

  222.  As a result, a free house operator is left with the compromise of receiving a limited range of products from one supplier, or getting a range of key beer brands from a wholesaler or multiple sources at inferior prices. It is worth noting that the largest wholesaler in the UK has recently been purchased by the largest national brewer (Beer Seller by Scottish & Newcastle). It also means that there is little price certainty and the need to move suppliers is a common occurrence in the free trade, in an effort to optimise the level of discount and product mix available.

  223.  Through our multiple supply contracts, Punch is able to offer retailers a choice of all of the top brands by key category, as listed in Figure 20, on consistent terms and on one composite delivery. In the case of retailers on a Growth Lease agreement, these will be at discounted prices.

  224.  Figure 20

THE TOP BRANDS BY BEER CATEGORY—ON-TRADE BY VOLUME

Category	Brand	Supplier
Standard Lager	Carling	Coors
Premium Lager	Stella Artois	Interbrew
Standard Cask Ale	Tetley Bitter	Carlsberg
Premium Cask Ale	Draught Bass	Interbrew
Regional Cask Ale	Various: London Pride IPA Pedigree	Fullers Greene King W&D
Packaged Lager	Budweiser	Anheuser Busch
Stout	Guinness	Diageo
Cider	Strongbow	S&N

  Source: A C Neilsen.

  225.  Originally pubs were sold to pub companies under a structure whereby the brewer would retain credit control, ordering and distribution. Over the last five years, a number of the pub companies have become concerned with the ability of these large brewers to unduly influence the choice of the retailers through the order and delivery process. As a result most of the major pub companies, including Punch, have now set up their own infrastructure to handle the ordering and credit management process.

  226.  Unlike order management and credit control, the distribution operations are still owned by the major brewers. However, to create a more efficient business model and to sever the link between brand supply and distribution, several years ago Punch contracted out the entirety of our distribution business. The structure means that any brewer wishing to sell beer in our estate merely has to deliver a pre-agreed quantity to the depot/s of our distributor and they will handle the delivery to outlet. This is particularly advantageous to smaller suppliers who have insufficient or regionalised infrastructure that is unable to service the entirety of our estate. Instead they simply have to deliver a primary load of product to our designated depot.

  227.  Following our most recent distribution tender in 2002, Carlsberg UK was appointed sole service provider for retail distribution to the Punch business operating under two contracts expiring in 2005 for the original Punch estate and 2006 for the former Pubmaster estate. Under these contracts, Carlsberg stocks and distributes on behalf of Punch/Pubmaster those products required by our retailers, whether or not they are brands from rival drinks suppliers which Carlsberg does not otherwise offer to its other customers. This service provides a composite delivery of the full order to the retailer and also includes extra deliveries in addition to the regular pre-planned delivery if required.

  228.  The near complete separation of delivery and supply within Punch has enabled the broadening of the range and choice of products across all the drinks categories that can be supplied to support the retailer. It enables speed of access for new products to the retailer from suppliers, and our structure means that any supplier can access the entire estate irrespective of the infrastructure they have themselves, thereby removing a key impediment to the growth of emerging and successful smaller or niche brands.

  229.  The "One-stop-shop" service also allows the company to manage its suppliers against specified service criteria and we ensure that a higher level of service is provided to our retailers than they might achieve on their own. For example:

—  Distribution.

—  Technical services (cellar and dispense).

—  Brand support.

—  Sales support.

—  Training.

—  Merchandising.

  230.  Specific examples include arranging replacement products for the retailer should there be a delivery or product quality failure, organising without charge an emergency delivery for a retailer who did not order enough stock, arranging an emergency repair to drinks dispense equipment, and the provision of brand promotions to attract potential consumers. The scale of Punch is important in being able to raise individual service issues as a priority with the major national service providers.

  231.  Retailers Terms of Credit

  232.  The "One-stop-shop" distribution model means that terms of credit are provided on a consistent basis across all products purchased from Punch. The majority of our retailers are on our standard credit terms. Statements are issued every two weeks detailing rent and deliveries invoiced during the two week period. Payment of the full value of the statement is due 10 days after the date of the statement, providing for between 10 and 24 days credit, and usually meaning that cash has been received over the bar before payment is due. Most retailers pay by direct debit.

  233.  The company maintains a particularly active debt management process and there are a number of ways in which we assist retailers who have been unable to make their payments. Overall we collect around 99.5% of what we bill during the year.

  234.  Support Services

  235.  Operational Structure

  236.  Punch Taverns employs approximately 530 people in its business. One third are based in the company's head office in Burton on Trent, with the remainder field based proximate to our national pub estate.

  237.  Punch continues to lead the pub sector in its efforts to develop and enhance the business model for our retailers. We have enshrined this into our objectives and our mission statement, which is:

"Helping our retailers build better businesses"

  238.  Our structure is a direct reflection of that mission statement, and our business model puts the development of a positive relationship with our retailers at the forefront of everything we do. Figure 21 below illustrates how we are set up to do this:

  239.  Figure 21

RELATIONSHIP PYRAMID FROM CONSUMER TO THE BOARD OF PUNCH

  240.  Each of our employees who have direct contact with our retailers has a clear remit on what they deliver and how that adds value. Our remuneration package is designed to reward and recognise those in the organisation who deliver fully on our mission and objectives. The key determinant of remuneration is our performance management or bonus structure, which has a major element relating to the Retailer Satisfaction Survey. Our employees' potential bonus is thereby directly linked to the service and support they provide.

  241.  The package of support and resources we offer is growing all the time. The focus of these is set out in Figure 22 and described in more detail below:

  242.

243.  Communication and Dialogue

  244.  To deliver on our commitment to help retailers build better businesses, it is essential that retailers have full access to our support packages in a number of formats, ready acess to a support team that can address any issues, and also have the ability to give us feedback on how we are performing.

  245.  The starting point for our support package is two documents—the Welcome Pack and the Retailer Charter.

  246.  The Welcome Pack (see Appendix G) is sent to all new retailers and clearly explains the structure of the company and how each department supports the retailer. This is accompanied by the Retailer Charter (Appendix D) which sets out a series of commitment levels to our retailers for key aspects of the relationship. The areas it covers are:

—  applying for a pub;

—  selecting the right agreement;

—  Business Relationship Manager support;

—  credit service support;

—  machine management;

—  investing with Punch;

—  rent reviews;

—  agreement renewals;

—  transferring the agreement; and

—  query resolution and service standards.

  247.  The Retailer Charter has been designed so that each section is a separate sheet within the main folder. This enables the individual sections to be mailed to the retailer as they are updated. All new retailers automatically receive a copy of the whole Charter.

  248.  Adherence to the Charter is measured through frontline, our Customer Services team. If the service provided by Punch, or one of our nominated service suppliers, does not meet the published or expected service standards, the retailer contacts frontline. All queries logged through frontline are tracked to resolution within agreed timescales.

  249.  For other issues, the primary point of contact and support is the BRM.

  250.  This support is supplemented by our integrated web strategy. On the web there are three areas supporting our retailers and other stakeholders:

Corporate website www.punchtaverns.com

Extranet site www.punchpages.co.uk

available exclusively to our retailers

Recruitment site www.punchpubs.co.uk available for potential and existing retailers.

  251.  The corporate website clearly sets out the company mission "to help retailers build better businesses" and supplements this with information on strategy. It gives retailers free access to all City presentations and allows them the opportunity to ask questions directly to the Board through a feedback and enquiries mechanism.

  252.  The extranet was developed following extensive research via our retailers, both by telephone survey and through forums. The aim of the site is to give retailers access to key information which will support them in the running of the business. The site provides access to:

—  Brulines (flow monitoring) information which can be used to manage beer dispense, sales demand, promotional activity and stock management.

—  Investments via fact files on recent refurbishments and guidance on how the process will work.

—  News via a daily news stream plus articles on legislation and law.

—  Online publications including Inspiration (retailer monthly magazine), Connect (retailer monthly promotion brochure), Buying Power (retailer access to Punch discounted deals) and Wines of the World (retailer guide to wines).

—  Additional information including the benefits from ATM's, up to date information of top performing machines, machine legislation, links to other websites, catering information, marketing information etc.

  253.  The extranet site also provides the ability for retailers to give feedback or ask questions. Since its inception, there has been a steady growth in usage and, at present, 1,049 retailers are registered users. It is also about to be rolled out to the Pubmaster estate.

  254.  The recruitment site is used by both potential and existing retailers. It clearly sets out the leased model, how it compares to the free trade and managed model and then, in detail, takes the retailer through the process of applying for a pub, costs, legal work, and what actually happens over the first six months.

  255.  Further support comes from Inspiration, our monthly retailer newsletter. Inspiration keeps retailers up to date on the latest Punch initiatives, the industry, and news from other Punch retailers. The newsletter frequently contains free giveaways and competitions to encourage readership. Examples of these giveaways include Profit from Wine videos, Pepsi upsizing kits, branded glassware and CAMRA's National Pubs Week posters.

  256.  Inspiration was first developed in the summer of 2000 as a quarterly 20 page magazine. Feedback through our retailer forums identified that retailers would like to receive communications from Punch on a more frequent basis, in a shorter, sharper format. As a result we evolved the Inspiration magazine into a four page monthly newsletter. Our latest marketing survey in July 2003 identified that 67% of Punch retailers read Inspiration.

  257.  All of our literature refers to frontline as the first port of call for query resolution. Frontline has been developed with full retailer input as a telephone based query helpline and resolution centre. Via one phone number, all of our retailers have access to anyone in the company to resolve ongoing issues, queries and complaints. All calls are logged and assigned commitment levels, ranging from four hours to 100 hours. Frontline then assumes full responsibility for the resolution of the issue raised within those commitment levels and has an escalation process in place to ensure the highest degree of service ensues.

  258.  In addition to this, three further feedback mechanisms exist which are:

—  Retailer Forums.

—  Retailer satisfaction survey.

—  General complaints process.

  259.  Retailer Forums

  260.  Two years ago, Punch introduced a series of retailer forums for the senior management and our retailers to debate key issues relating to company strategy or affecting the industry as a whole. These meetings are now held every quarter and are an integral part of our retailer relationship strategy. Regional forums are held in all 15 of our regions, hosted by the regional Director, and open to all. From the regional forums up to 20 retailers are invited to a national forum hosted by the CEO and senior management.

  261.  These forums give retailers the opportunity to question management and debate particular topics. The forums have been instrumental in developing key parts of the business strategy notably the Retailer Charter and Punch's new plain English lease agreement, the Retailer Agreement.

  262.  Since our forums programme commenced we have conducted 57 forums attended by over 500 retailers.

  263.  Retailer Satisfaction Survey

  264.  The first Retailer Satisfaction Survey was conducted in November 2003. The survey was a major piece of quantitative research conducted by an external research specialist, Heawood Research. Heawood telephoned the entire Punch estate and achieved an excellent 80% response rate.

  265.  Significant points highlighted in the survey were the overall relationship with Punch, the relationship with the BRM and key processes such as rent reviews, lease renewals and investments.

  266.  The results of the survey provided us with a benchmark with which to compare the results of future surveys. The survey will be repeated in August 2004.

  267.  The results of the survey have been communicated to all Punch staff through briefing sessions and regional workshops. The results from the Retailer Satisfaction survey are used to drive continual improvement to the overall relationship with our retailers and are used as a measure within our employee bonus scheme. The results have also been communicated to our retailers through a letter (see Appendix H: Retailer Satisfaction Survey letter).

  268.  We also receive feedback from an independent survey undertaken by the Morning Advertiser. They have now undertaken two surveys, an initial benchmark survey and a follow up survey one year later. The response rate to this survey is very low, below 5% from a target audience of some 13,000 retailers, covering at least 19 companies. We were pleased to find improvement in some of the key measures for Punch, but the low response makes it difficult to draw major conclusions.

  269.  General Complaints Process

  270.  The complaints procedure has now been in place three years and is referenced in the Retailer Charter. Complaints covered by the process are from all sources, including retailers and members of the public. All complaints are acknowledged within three working days and a reply sent out or discussed by phone within 10 working days. A full log of all complaints, status and confirmation of closure is monitored by senior management to ensure that each complaint is dealt with. The average number of complaints has dropped from 23 to 15 per month as an average over the last two years and the last three months has seen a further drop to below 10 a month.

  271.  Retailer Training

  272.  Punch offers a comprehensive training package to both existing retailers and applicants, whether they take a pub with us or not. We are the only pub company that has, as a key part of its lease agreement, a compulsory introductory training course. This is because we firmly believe that all retailers need full and comprehensive induction training whether they are totally new to the industry or "old hands".

  273.  Our training is split into three main programmes, plus a number of supplementary modules. The main programmes are:

—  MLR (Modern Licensed Retailer)—our compulsory introductory course for all new retailers.

—  Investment Support Programme—another compulsory course run for all investment projects.

—  Ex! Factor programme—an advanced marketing course aimed at developing new income streams.

  274.  Within the Punch estate, from August 2001 until May 2004, 1,662 retailers have attended one of these three courses, accounting for 11,432 training days. Combining with Pubmaster we have trained over 1,100 retailers in the first half of this year, covering over 3,700 training days.

  275.  All of our courses are accredited by the British Institute of Innkeeping and we are the present holders of three National Innkeeping Training Awards, including the Supreme Award for overall training.

  276.  We also have our training reviewed externally by Professor Conrad Lashley of Nottingham University. He has undertaken two independent pieces of research one in 2002 looking at our Modern Licensed Retailing course and Investment Support programmes and one in 2004 looking at the Ex!Factor course, with very favourable findings in both cases.

  277.  Business Planning and Support

  278.  Our Business Relationship Managers ("BRM"s) are equipped and trained to undertake a detailed assessment of an individual pub business and to establish a shared business plan with the retailer. The triggers for business plan development are when establishing a new lease, at retailer request, or when a business needs particular support. Under normal circumstances a new retailer will work with a BRM to establish a shared plan ahead of "going in" to the pub. It is with this business plan and the actions therein, that the partners work together.

  279.  All the principal aspects of the business relationship are caught within the plan, including rent. Should the current level of trade be materially short of a fair maintainable level then a set of actions will be established to energise the business. This may include among others, promotional activity, introduction of new offers such as food, alteration to trading hours/format and retailer training. On these occasions Punch Taverns may offer a rent concession for a period of time up to six months whilst this takes effect.

  280.  Investment Facility and Process

  281.  The company recognises the importance of helping retailers grow their business and compete within their specific market place. This is supported by our proactive approach to joint investment with our retailers. Access to this support is available and communicated to all retailers through the Retailer Charter and Inspiration magazine.

  282.  In the last three years we have invested some £85 million in development projects, including £19 million in the first half of this year. In this way we cover 10%-12% of the estate each year. The company's average spend is £60k per site with additional retailer's investment at £12k. The financial return varies project by project, but in general the company earns a payback on this investment after 3-4 years, and we estimate that the return earned by the retailer is significantly faster.

  283.  The company invests primarily in the building and landlords, fixtures and fittings, such as the bar. The retailer is responsible for the cost of trade fixture and fittings, such as tables, chairs and bric a brac.

  284.  Our philosophy is to provide a quality holistic approach, based around the following key stages;

Step 1:        Business feasibility for the retailer.

Step 2:        Agreement of clear retail objectives and brief.

Step 3:        Design stage and budget costing.

Step 4:        Confirmation of investment proposal and any variations to their current agreement with the company.

Step 5:        Delivery of scheme and completion.

Step 6:        Post investment retailer satisfaction survey.

  285.  Again this process and our commitments on investment are set out in the Retailer Charter.

  286.  All investments are evaluated in the first place from the retailer's perspective through a robust business planning template. This ensures that any consequential rental uplift is calculated through a profits test method (as outlined in the rent review section).

  287.  The type and range of investment varies significantly across the estate. This is because each scheme is tailored to the individual retailer to meet their retail business objectives, for example, to attract more female customers at lunchtime. In this example the scheme could involve improving visibility into the pub, provision of a catering kitchen or an extension to provide additional space for eating. This objective led investment process helps tailor the level of spend to the retail opportunity, minimising the risk and improving the return to both parties.

  288.  Post investment a specific retailer satisfaction survey is carried out to record our success, or otherwise, ensuring any issues are resolved promptly. This covers the performance of all the key players including the development team, designer and contractor.

  289.  Retailers continue to get marketing and BRM support post investment, enabling us to monitor the retailer's profitability in the early stages. This minimises the risk to the retailer and allows the company to review the rent via a concession in extreme circumstances where the investment may not have delivered the projected retail uplift. This option of course would not be available to an individual free house operator who may choose to invest their own money, possibly involving a bank loan.

  290.  One significant benefit of our business model is that the retailer can grow their retail profit, and hence the capital value of their lease, using the company's cash. Again this minimises their risk and improves their ability to achieve high returns on low capital expenditure.

  291.  Growing the Business

  292.  In order to commercially support the Punch retailer there are a wide range of promotional support systems.

  293.  Branded Goods

  294.  Each pub has access to a Point of Sale hotline where they can access free materials like branded glassware, drip mats, bar towels, T-shirts and posters. Point of sale material worth £320k has been distributed in this way in the last 12 months.

  295.  Connect Magazine

  296.  Connect magazine is produced each month and combines telesales promotions with other marketing support opportunities. A typical month's content would include promotions on both tied and non-tied goods eg consumer kits to support beer brands, volume offers such as buy three cases of a bottled beer brand and get one free, new product launches, or price reduction offers on products such as RTDs, soft drinks, wines and spirits etc.

  297.  Each edition will also feature non drink offers such as savings on wholesale food bought from Woodwards or snacks bought from Walkers.

  298.  Finally, each edition will also feature at least one heavily subsidised "retail" offer that would allow retailers to grow their business by attracting new customers. Examples would be appearances from darts or pool professionals, sports talk-ins, day trip to horse racing, Christmas "special offer" cards, live entertainment etc.

  299.  In every monthly edition we would expect around 50% of our pubs to take advantage of at least one offer. In a recent sample based telephone survey 97% of retailers agreed that they regularly read Connect and felt it was beneficial to them.

  300.  Other Marketing Support

  301.  Some of this comes through the Business Relationship Managers and is targeted towards pubs which will benefit from the service. Examples of this would be the free production of food or wine menus. 250 of these were produced in the last 12 months.

  302.  Also, high profile promotional activity designed specifically by Punch (in 2003 it was the "Football Classics" video collection). From August 2004 Punch will extend the promotional support system used in Pubmaster to all pubs. This will enable virtually all pubs to agree marketing support specifically for them with their Business Relationship Manager.

  303.  In conjunction with a number of other pub companies we created National Pub Football Week in 2003. This year, over 3,500 kits have been distributed to nearly 2,000 pubs for this event at the end of May.

  304.  Also in the field helping the retailers to build their businesses are Sales and Marketing Executives in each region. They help build marketing opportunities for retailers whilst selling our superb range of non tied goods at extremely competitive prices.

  305.  Finally in this area is branded kit activity (T-shirt collector etc) which is allocated based upon who stocks particular brands and who feels has customers that would appreciate the activity. Pre-identification of these pubs often take place using the Marketing Survey.

  306.  Marketing Survey

  307.  Each year the Marketing department undertake a complete outlet marketing survey which involves asking each pub what promotional support their pub would benefit from. The answers are used in two ways. Firstly, they help Punch identify which pubs would be most likely to be interested in a particular activity (eg football activity is addressed to those pubs who regularly show live football on TV). Secondly they help Punch understand which opportunities are worth developing support for (eg in 2004 Burns Night and Halloween support is being made available for the first time). This is in response to the number of pubs who wanted to promote around these events.

  308.  This survey also throws up genuine opportunities for both parties. For example if a surveyed pub declares itself to be "family friendly" then Punch can help provide them with food menus, wholesale food, snacks and soft drinks specifically aimed at children.

  309.  Amusement Machine Management

  310.  Income from amusement machines can make a significant difference to the retail profit of a pub.

  311.  At Punch, we are able to use our significant buying power to extract best terms from our suppliers and to make sure we have access to the best machines. On the basis that machine profit after all costs is shared with our retailers 50:50 any reduction in actual rentals paid to suppliers is beneficial to our retailers.

  312.  The Punch Taverns average rental is some 10%-20% lower than our competitors reflecting our shared commitment with the retailer to help him grow his business.

  313.  Whilst cost of supply is important, absolute performance of machines has a greater impact on profitability than the cost. We therefore provide a centralised machine management service whose responsibility to optimise the performance of all the machines in the area.

  314.  Corporate Governance

  315.  One of the important functions that the company has been able to contribute to has been the significant number of pieces of legislative and regulatory changes that have been proposed over the last few years. We take our corporate responsibility very seriously and seek wherever possible to represent the interests of our retailers in the best possible way.

  316.  To best achieve these aims we are active members of the various trade organisations. The Chief Executive is Chairman of the Pub and Leisure Group of the British Beer and Pub Association ("BBPA") and a member of the Council of the Association of Licensed Multiple Retailers ("ALMR"). Other directors represent the company with Cask Marque, the British Institute of Innkeeping ("BII") and the Society of Licensed Victuallers ("SLV"). We are signatories of the Portman Group charter on alcoholic drinks.

  317.  It is important to understand that the industry fosters a thorough level of debate on its own. In September 2003, the ALMR held a debate on the leasing model, at which we set out the case for the tied lease model together with the views of retailers and advisers to the industry. It is the openness of the industry today which we feel is one of the most important improvements since the Beer Orders. The industry has learnt to resolve its own difficulties and the competitive nature of the industry is such that customer service excellence is a necessary strategy to attract better retailers to run our pubs.

  318.  The industry is currently facing considerable challenge from a variety of sources, which is often based upon the poor standards of few to the detriment of the industry as a whole. At present we are directly involved in the debates on smoking in pubs, the Government's alcohol harm reduction strategy and the discussions on the proposed gaming legislation. A recent example of the impact of our efforts saw the threshold on the imposition on stamp duty on new leases increased following co-ordinated lobbying by the BBPA and ALMR on behalf of our licensees. The result will be of significant benefit to many retailers minimising the cost of entry into a pub.

  319.  This year has also seen the introduction of the new licensing legislation. Whilst we see this as a huge opportunity for the industry, we have sought to mitigate the concerns of our retailers and the perceived additional cost by offering a package service to assist them in the new licensing process. This will include surveys of all the properties in our estate and pre-production of key core elements of the required business plan. To that end we have written to all retailers confirming:

—  Punch will pay for and provide property plans/layout for all premises and trading areas as per the guidelines outlined by Government.

—  Punch will provide a formatted Business Plan and give assistance in filling it in to all licensees.

—  Punch will provide copies of applications for personal licences and solicitors advice/support in the application process.

—  Punch will chase each licensee to ensure that everything is in place for transfer.

  320.  In addition, Punch is working with the Publican newspaper with a commitment to fund production of a guide to the new Licensing Act once it is finalised and the Publican is in a position to print it.

  321.  The Disability Discrimination Act (the "DDA") will apply to all pubs on 1 October 2004. We worked through the BBPA on the interpretation of this legislation and we were among the first to implement the principles of the legislation. All pub investments made for the last two years now go through a DDA checklist to ensure compliance with the legislation.

  322.  Punch is fully committed to working with the industry and its retailers in the important area of binge drinking. To that end we have put in place a number of key steps to help supervise that responsibility, which are:

—  All retailers are trained as part of their induction training on quality of drink and dispense, on the laws governing the serving of alcohol to under age drinkers and people who are drunk, on how to deal with awkward/drunken customers.

—  Clear guidelines on outlet marketing and activity are given encouraging the responsible promotion of alcohol and use of public houses.

—  BRM's and field staff work with the police and local authorities in managing, regulating and potentially removing errant licensees.

—  We work with all our current drink suppliers in developing both training and marketing activity which fits in with the code of practice on responsible drinking.

  323.  Also, as a company whose outlets are predominantly local community pubs we cannot stress enough the importance of involvement by both ourselves and our retailers in the local community. We actively encourage our retailers to get involved in community activity, to run local clubs, and become engaged at grass roots levels with all activity that builds responsibility in the fabric of the community.

  324.  This includes promotions such as National Pub Football week, darts teams, pool teams, teams and clubs of any sort. We also encourage our licensees to become members in local neighbourhood watch schemes, door management schemes and identity card schemes. We actively support and develop this through membership of key organisations such as Business in the Community, Pub is the Hub and the Duke of Edinburgh Awards.

  325.  We feel that it is these, together with the many more initiatives which the company has been developing over the last few years that were recognised in the recent Publican trade awards where Punch Taverns was voted Leased Pub Company of the Year.

Quote from Judges: "Punch is a worthy Publican Awards winner. It has transformed itself into a service-led customer-focused organisation, putting the licensee at the heart of everything it does. Punch is now a perfect partner for the most driven, dynamic and entrepreneurial licensees the industry has to offer"

  326.  POSITION OF PUBCO LEASES UNDER COMPETITION LAW

  327.  The Government's stated goal is to make markets work well for consumers. Punch considers that markets work well when there is vigorous competition between businesses and that when markets work well, good businesses flourish. As set out in the Office of Fair Trading's mission statement:

"Strong competition provides the best guarantee to consumers of choice and value."

  328.  The role of competition law is to ensure that markets function effectively. Where a market is competitive, however, Punch do not consider that it is appropriate or in the interests of consumers for the Government to intervene to support uncompetitive businesses. Any such intervention is likely to reduce competition and encourage inefficiencies to the detriment of consumers and other businesses.

  329.  Over the last few years the UK Pub industry has faced regular competition scrutiny in the UK and in Europe. In particular, the arrangements between brewers and pub companies on the one hand and their respective tied tenants on the other have recently been reviewed by the Office of Fair Trading, the High Court and the Court of Appeal in the UK and the European Commission and the Court of First Instance in Europe. Time and again these authorities have concluded that the on-trade sector in the UK is highly competitive. Punch considers that the advent of pub companies has promoted competition and delivered real benefits to consumers in the form of greater choice and lower prices. In its December 2000 report into the supply of beer (the "Beer Report"), the Office of Fair Trading agreed noting that:

"The changes in the structure and behaviour of the industry appear to have led to an improvement in competition. In particular, the concerns which Sir Gordon Borrie had in 1986 about high prices and lack of consumer choice of beer appear to have been diminished".

  330.  It is in Punch's interest and in the interest of our retailers to ensure that our pubs compete with other pubs in their area be they tenanted, managed or free houses. The vast majority of our pubs do so successfully. Inevitably, however, in the competitive environment in which our pubs operate a small minority of businesses will fail. Punch together with its retailers, actively seeks to minimise these business failures. For the reasons set out below, however, Punch does not consider that any government intervention is necessary or appropriate.

  331.  As set out above, the arrangements between brewers and pub companies and their tenants have faced regular competition scrutiny. In particular, over the last few years the European Commission and the Court of First Instance have given lengthy consideration to the arrangements for the supply of beer between all the national brewers and retail pub chains on one hand and their respective tied tenants on the other under Article 81 of the EC Treaty. Although some of the "old" tenancy agreements between brewers and their tied tenants were found to breach Article 81, none of the agreements which currently underwrite brewers and pub companies' tied pub tenancies have been found to be anti-competitive.

  332.  In the recent case of Crehan v Inntrepreneur, the Court of Appeal, following an earlier European Commission decision, found that the standard form tenancy agreement used by Inntrepreneur before 28 March 1998, which included a requirement that the tenant purchase all of its beer requirements from Courage, served to foreclose the on-trade beer market and fell within Article 81(1) of the EC Treaty which prohibits anti-competitive agreements. The court of appeal awarded the publican in question damages of £131,336 plus interest.

  333.  However, the decision does not apply to the standard form tenancy agreements currently used by Inntrepreneur or other pub companies. In June 2000, the European Commission found that Inntrepreneur's "new" agreements, which do not require the tenant to purchase all of its beer requirements from a single brewer but allow for multi-sourcing and periodic tendering, fell outside the scope of Article 81(1)[52] and were not anti-competitive. In particular the Commission concluded that:

"rather than significantly contributing to the foreclosure (of the on trade beer market), the tied leases of a "non-tied" pub company are more likely to enhance the competitive structure of the market."

  334.  In addition the Commission found that tied agreements with pub companies offered a gateway for a substantial number of brewers to the UK on-trade market as it was easier for another brewer, to conclude an agreement with one wholesale player and thereby obtain access to all the outlets tied to such a player, than to conclude agreements with each individual retail outlet.

  335.  In March last year, the Office of Fair Trading, acting on a complaint from the Federation of Small Businesses, considered whether the arrangements between pub companies and their respective tied tenants were in breach of either Chapter 1 (anti-competitive agreements) or Chapter 2 (abuse of market power) the Competition Act 1998 or whether there were any grounds for making a market investigation reference to the Competition Commission under the Enterprise Act 2002.

  336.  Following a detailed investigation, the OFT concluded that the tenancy agreements benefited from the exclusion of land and vertical agreements from Chapter 1 of the Competition Act 1998 and that none of the pub companies could be considered either individually or jointly dominant. In particular, it considered that there was evidence that competition in the on-trade sector was intense with tied pubs competing actively with managed pubs and free houses. There was, therefore, no detriment to consumers and no grounds for withdrawing the benefit of the land and vertical agreements exclusion or launching a market investigation under the Enterprise Act 2002.

  337.  As set out above, Punch consider that the growth of pub companies over the last few years has significantly increased competition in the UK Pub industry. As a result of this competition, pub companies compete actively with managed pub companies, brewers and the free trade to attract high quality individuals to run their pubs. As set out in Section 4 above, the need to attract good mangers/tenants has led to tenants being offered far greater choice and flexibility in their arrangements with pub companies as compared with the restrictive agreements historically offered by the large national brewers. Key changes have, in particular, included the removal of upwards only rent review clauses, multi-sourcing and periodic tendering of beer supplies and the removal of minimum purchasing requirements. These have resulted in significantly more flexible agreements which have been reviewed under both UK and European competition law and expressly validated.

  338.  Punch now offers a variety of different tenancy agreements to suit different individuals and locations. As set out above, Punch consider that these options offer a highly attractive low risk business model to tenants. The number of applicants wishing to operate Punch pubs is testament to this.

  339.  Punch and other pub companies already operate within a strictly regulated marketplace. As demonstrated in the Crehan v Inntrepreneur case legislation is already in place to protect competition and tackle market failure. In particular, individual publicans are now able to take pub companies or brewers to court and sue for damages if they consider that their tenancy agreements restrict competition and fall foul of UK or European competition law. Punch considers that any further attempt to regulate tenancy agreements is likely to be counter productive and result in successful pub company tenants subsidising a small minority of unsuccessful businesses. The net effect of this would be to make the pub companies less competitive vis a vis managed pubs and free houses reducing competition in the on-trade market as a whole to the detriment of consumers.

340.  CONCLUSION

  341.  The British pub is one of the most enduring business models in the world. Most of our pubs were built during the growth of the country, notably at the end of Victorian times, and in the early 20th Century. Our business is to protect and develop this industry for decades to come. The business is vibrant attracting huge levels of interest, competitive, both at the local outlet level but also at the pubco level in our efforts to attract the best retailers.

  342.  No model can cater for all skills and by the nature of the diverse market, some of those who choose to operate pubs are unsuccessful. However, we believe that the level of failure would compare favourably with virtually any other business sector.

  343.  Punch is enhancing this business model with a financial structure that provides certainty for the future, higher levels of investment than anyone else, more training and a package of goods and services that would not otherwise be available to the individual operator.

  344.  Running a pub remains one of the cheapest occupations to start and we pride ourselves with the openness with which we conduct our business, debate the issues of the day and grow our business in conjunction with our retailers.

  345.  We are grateful to the TISC for their interest in the industry and hope that you find, as we do, that market forces are such in the industry that it is probably one of the most progressive open and competitive sectors in the British economy.

PART 3—A PERSPECTIVE FROM SOLICITORS FOR TENANTS

346.  INTRODUCTION

  347.  At Punch, we feel strongly that the competitive nature of the market is such that the pub leasing sector is developing into one of the most transparent and innovative in the property sector. However, given the points raised by the TISC, Punch Taverns decided to commission an independent report from Messrs Maitland Walker ("MW"), a solicitors firm that has unparalleled experience in looking after the interests of pub lessees and the impact of the tie on their business, to provide a tenants-eye perspective on the market.

  348.  To protect the verity of the document, rules of engagement were agreed with MW in advance and verified by David Vaughan CBE QC, MW's lead counsel in a number of key legal actions on the validity of the tie.

  349.  The attached report by MW is an insight into the differing views within the industry. Whilst Punch does not share the views of MW in every respect, we welcome open dialogue on the issues facing our industry and find the contribution very useful. Punch believes strongly that its long term success depends ultimately on the success of its retailers and their pubs, and that the best way forward lies in understanding the views of all concerned.

  350.  We are pleased to note the view of MW that relationships between pubcos and their tenant retailers have improved in recent years and this is evidenced by the considerably lower levels of responses, when compared to last year, to recent tenant satisfaction surveys produced by the Morning Advertiser/Morgan Stanley. Of those who responded 58% remain as or more confident about business prospects than a year ago. Although improving, we remain disappointed about the levels of satisfaction and share the belief of MW that further progress to improve relations can be made.

  351.  MW has, as part of its review, made certain specific proposals for improvement to the transparency of the industry set out in their executive summary and in further detail in the main document. Whilst these recommendations are for the industry as a whole and we cannot talk for our competitors, we agree with the majority of these recommendations in principle and are indeed already acting on many of them within our business.

  352.  Our specific comments on the recommendations raised are as follows:

  353.  Action to improve the training of aspiring pub tenants and to encourage them to seek professional advice when taking leases

  354.  We support this recommendation and have adopted a proactive approach to advice and communication highlighted on our websites, welcome pack and acknowledged by Judge Barker in Gregor Robertson v Punch Taverns earlier this year.

  355.  Punch has developed one of the most extensive training programmes in the industry. In addition to our training being award winning, the programmes offered are accredited by the British Institute of Innkeeping. All inexperienced retailers are required to go on our introductory training course, the Modern Licensed Retailer Course, prior to leasing a pub. In the first half of our financial year, we trained over 1,100 retailers, completing in excess of 3,700 training days.

  356.  Pubcos to give full disclosure of pub trading history on letting

  357.  We support this recommendation to the extent that retailers recognise the limitations of the information that we have. Since we are not the operators of the pub, information may be limited to the levels of beer purchases made by the former retailer from us in the past. This can create particular difficulties in the case of disclosure where a prospective retailer is considering taking possession of a pub on an assignment. In these cases we are only able to withhold consent to an assignment on reasonable grounds. Often we are not party to the information provided to the assignee by the existing operator and are therefore unable to determine whether the information provided is accurate or otherwise.

  358.  Establish industry guidelines for tied and free of tie rent calculations

  359.  It is our objective to ensure that the rent set is fair and Punch already operate within recognised industry guidelines supported by the RICS for pubs using the "profits" method of valuation. This requires the assessment of a Fair Maintainable Turnover with the proposed rent then being a percentage of the resultant net profit. This "divisible balance" method is recognised as being a far more equitable approach than merely calculating rent as a percentage of turnover, as divisible profit takes account of the individual circumstances of the business such as retail pricing and operating expenses incurred by a tenant. We support moves to make rent assessment processes more transparent.

  360.  Abolish upward only rent reviews

  361.  Irrespective of the legal regulations, Punch believes that a rent should be fair and maintainable. It is for this reason that whilst the vast majority of our rent reviews have seen the rent rise, we have also agreed 20 rent reductions in the last 24 months.

  362.  We endorse the RICS Code of Practice on Commercial Leases and our most modern agreements in the form of the Punch Growth Lease (introduced three years ago) and our recently launched Retailer Agreement were designed to comply with the recommendations of the code, which also offers greater flexibility for our retailers.

  363.  Concessions

  364.  In addition, and well before a rent review, the company can and regularly does grant a concession on the rent for a set period to tide a retailer over trading difficulties. The total number of these rent concessions currently in place in Punch is 167 with a concession value totalling £2 million.

  365.  Streamline rent review procedures through setting uniform rules for conduct and disclosure in arbitration/expert determination

  366.  The rent review process in Punch is clearly set out in plain English in our Retailer Charter. In addition, we have recently introduced a more consultative and free "mediation" service to retailers as a means of resolving rent reviews outside of the more formal arbitration process, details of which are provided in Appendix E. Punch would support any recommendations that cut down the cost and associated time involved in the independent resolution of rent reviews and lease renewals.

  367.  Establish national database of rent reviews to facilitate access to comparable data

  368.  Punch supports this recommendation. Moreover, recent provisions under the Land Registration Act 2002, gives new powers of access to the land registry for individuals to see copies of leases, including rental information, which may be of interest to prospective tenants or as comparable information for rent reviews.

  369.  Ban tie on non-drink products

  370.  We would not contemplate any form of tie which is potentially illegal under competition law. However, we strongly believe that as the industry develops, there will be scope for Pubcos and retailers to develop a partnership in the negotiation of supply deals with key suppliers of goods and services to the trade to ensure that our retailers get better prices, more choice and/or better standards than would otherwise be available to an individual retailer. Any extension of this type would have to be agreed with each retailer and could not be introduced unilaterally.

  371.  Restore guest ale provisions

  372.  We would not support the re-introduction of a guest ale provision since we make every effort to supply any cask ale that our retailers require to meet the tastes of their customers. In so doing we currently supply products from 46 national and regional brewers plus numerous micro brewers.

  373.  The guest ale provision that was historically introduced in the Beer Orders gave little or no additional benefit to the consumer in terms of choice price benefit because it was used by the vast majority or retailers to buy a national ale brand at the expense of many regional products.

  374.  It is worth noting that in the Punch estate there are still in excess of 500 lease agreements where the retailer retains a guest ale right. In a recent survey of these retailers approximately 17% use the arrangement to purchase a cask ale from a source other than Punch and of these, 77% purchase brands which are already available from Punch.

  375.  Where a retailer does wish to source a product which we are unable to supply and where sufficient demand exists, we are willing to give a dispensation for this to take place. For example, we have several brewery pubs in the estate where the retailer is able to serve any beer produced on the premises.

  376.  Reintroduction of a guest ale facility may alter the balance of profit earned in favour of the national brewer. To the extent that any financial advantage is available to the retailer, this would be reflected in a rent review.

CONTENTS

  Executive Summary  

  Introduction  

  The History of the Beer Tie since the early 1990's    

  The Relationship between Pubcos and their Tenants    

  Rents  

  Product Pricing  

  Tenants' Income Levels

  Demand for Pubco Leases  

  The current health of the Pubco Tied Estates

  Ties for non-drink Products

  Conclusions and Recommendations

A Perspective from Maitland Walkers Solicitors for Tenants—31 May 2004

  Maitland Walker, 22 The Parks, Minehead, Somerset TA24 8BT.

377.  EXECUTIVE SUMMARY

  378.  Although the level of conflict between pubcos and their tied tenants has fallen considerably since the early 1990s as a result of the introduction of trade discounts for tied tenants and "fair dealing" measures introduced by many pubcos, the relationship between pubcos and their tenants generally remains poor.

  379.  There continues to be a small but significant number of tenants in serious financial difficulty, squeezed between high rents and high beer prices.

  380.  The tied lease business model remains valid for the industry but only works effectively where the balance between rent and tied prices is appropriate to enable tied tenants to compete with free of tie competitors.

  381.  Pubcos and their tenants need one another and good relations and mutual confidence must be restored. Some pubcos have already started on this process by developing "fair dealing" initiatives with their pub estate. This process should be encouraged and systems introduced to increase efficiency and fairness into the system.

  382.  To achieve these objectives Maitland Walker recommend the following:

—  Action to improve the training of aspiring pub tenants and to encourage them to seek professional advice when taking leases.

—  Pubcos to give full disclosure of pub trading history on letting.

—  Establish industry guidelines for tied and free of tie rent calculations.

—  Abolish upward only rent reviews.

—  Streamline rent review procedures through setting uniform rules for conduct and disclosure in arbitration/expert determination.

—  Establish national database of rent reviews to facilitate access to comparable data.

—  Ban tie on non-drink products.

—  Restore guest ale provisions.

383.  INTRODUCTION

  384.  We have been appointed by Punch Taverns plc ("Punch") to prepare, from the tenants' perspective, an independent Memorandum with respect to the Select Committee inquiry. This Memorandum falls into 10 sections:

—  Introduction.

—  The history of the beer tie since the early 1990s.

—  The relationship between pubcos and their tied tenants/lessees.

—  Rent.

—  Product pricing.

—  Tenants' income levels.

—  Demand for pubco tied pub leases.

—  The current health of the pubcos' tied estates.

—  Ties for non-drink products.

—  Conclusions and recommendations.

  385.  The firm Maitland Walker has extensive experience within the licensed trade sector. Partners of the firm have acted on behalf of pub tenants/lessees since 1982. Details of our experience are contained in Appendix I. Two matters regarding our experience are perhaps of particular relevance in relation to this Memorandum. The first is that Rupert Croft, a partner in the firm, represents the Claimant, Mr Crehan, in the beer tie test case of Crehan v Inntrepreneur, in which on 21 May 2004[53] the Court of Appeal awarded damages to Mr Crehan resulting from the beer tie in the original Inntrepreneur lease, which was held to infringe European competition law (Article 81 of the EC Treaty). The firm also acts for about 350 other Inntrepreneur tenants who have claims stayed behind the Crehan test case. The second point to note regarding our experience is that the firm acted for Whitbread tenants in relation to their dispute concerning the beer tie in the Whitbread lease, which culminated in the Court of First Instance's decision in 2002 in the case of Shaw v Commission.[54] Both cases concerned the beer tie, which in our view is the central issue regarding both the relationship between pubcos and their tied tenants and, as we understand it, the Select Committee's inquiry.

  386.  We concentrate in this Memorandum on the position of the tied tenant. We do not consider macroeconomic issues such as the current extent of foreclosure of the UK beer market. Similarly, we have not considered the position of the consumer of services provided by pubs. The analysis of empirical evidence regarding pub tenancies/leases has been abbreviated in view of the short time allowed for submission of written evidence to the Select Committee.

  387.  The views expressed in this Memorandum are based on the personal experience of the partners of this firm. We have circulated requests for information to approximately 400 past and present pub tenants who have instructed us in the past. We have also invited comments from pub tenants through the trade press and on The Publican website. So far we have received comments from about 35 tenants. The response rate has been low. This may reflect the fact that tenants are generally satisfied with their leases, but we believe it is partly because there has been insufficient time within which to obtain reactions from the trade.

  388.  Although we have been appointed by Punch to prepare this Memorandum, our main experience in the pub sector lies in representing the interests of tenants. Punch fully recognise this and indeed have asked us to prepare this Memorandum precisely because of our experience in acting for tenants. We have accepted the instructions from Punch on the basis that the Memorandum will be independent and will express our views seen from the perspective of solicitors for tenants. We have informed Mr Crehan of our instructions, issued a joint press release with Punch, and circulated a newsletter to pub tenants for whom we act explaining the nature of our appointment. Punch understand and accept that, so far as the Company is concerned, accepting instructions to prepare this Memorandum does not in anyway compromise our ability to act for pub tenants of Punch or any other pubco either now or in the future. "Rules of engagement" have been agreed with Punch confirming the position (see Appendix J). At our request, these rules have been approved by David Vaughan CBE QC, our lead counsel in the Crehan case, on the basis described above.

  389.  We hold a substantial amount of information and documentation regarding the licensed trade sector. Where we have gaps in our knowledge and/or documentation, we have requested further documentation and information from Punch. The documents regarding pubcos and their relationship with their tied tenants supplied to us by Punch are listed in Appendix K.

  390.  We have also sought the view of industry expert Martin Shepherd and valuers Howard Day FRICS, MAE and David Morgan FRICS, MAE, MRPAS. Mr Day and Mr Morgan have both at different times acted as expert witnesses in the Crehan case.

  391.  Whilst we have taken into account representations received from tenants and the views of other professionals with experience of the pub trade, the opinions and recommendations in this Memorandum are those of the partners of this firm.

  392.  The History of the Beer Tie since the early 1990's

  393.  It has never been the case of any pub tenant/lessee for whom we have acted that beer ties are intrinsically objectionable. The first section of the submissions made to the European Commission on behalf of the Inntrepreneur tenants in May 1994 stated as follows:

"The tenants do not object to beer ties as such. They recognise that in the ordinary event beer ties produce benefits which outweigh the negative nature of the tie. This has been accepted by the Commission in Regulation 1984/83 and by [the European Court of Justice]."

  394.  The main flaw in the Inntrepreneur lease, which caused so many problems in the early 1990s, was summarised in the submissions thus:

"The Inntrepreneur lease . . . is not the normal bipartite arrangement between a brewer/landlord and purchaser/tenant. This is a tri-partite arrangement between (1) a property company, Inntrepreneur and (2) Courage, a brewer and (3) the lessees. This means that, unlike the ordinary event where the brewer landlord makes his profit by balancing a higher than normal price for his beer and a lower than normal price on rent, here the property company maximises its profit on the rent and the brewer maximises its profit on the beer, thereby imposing an intolerable squeeze upon the viability of the tenant. This is particularly true given the fact that the major outgoings of such a tenant are the price he pays for his beer and the rent he pays . . . As a result of this squeeze lnntrepreneur has the highest rate of tenants going out of business."

  395.  Current pubcos are both landlords and suppliers of beers to their tied tenants. There is therefore a bi-partite arrangement. This means that, unlike the flawed Inntrepreneur business model, the pubcos are in a position to ensure that there is not "an intolerable squeeze upon the viability of the tenant". The pubcos can control both the rent and the price of the beer they sell to their tenants/lessees albeit often through nominated suppliers. In our view, this is a much improved model for beer tie arrangements. It should mean that the interest of the pubco in securing the highest rent should be restrained to some extent by the pubco's interest in ensuring that the tenant succeeds since this will secure the maximum level of return by way of "wet" rent through the beer tie. Therefore the success of a tied lease is predicated on striking the right balance between the rent discounted from market rent and the premium which the tenant is required to pay for tied products over and above the free trade price.

  396.  The UK on-trade beer market has recently seen significant consolidation. Last year, Scottish & Newcastle sold its pub business to Spirit Group, thereby creating the UK's largest managed pub operator with about 2,500 pubs. In November 2003, Punch purchased Pubmaster. The deal increased Punch's pub estate to around 7,400 outlets. In March 2004, Enterprise Inns exercised its option to buy the remaining 83% of Unique Pubs which it did not already own. This added 4,000 pubs, giving it an estate of about 9,000 pubs.

  397.  Three pubcos—Spirit, Punch and Enterprise—now control about 19,000 pubs, which is nearly one in three of UK pubs. As stated in a recent market report[55], this concentration is reminiscent of the days when national brewers dominated the UK beer market before the Beer Orders forced them to reduce their pub estates. The difference now is that there is a separation between brewing and retailing since all the major brewers have sold their retail interests.

  398.  We find that many of our pub tenant clients tend to look back favourably to the period prior to implementation of the Beer Orders when pub tenants paid comparatively low rents (and volumes of on-trade beer sales were higher). However, there were two significant disadvantages to pre-Beer Order tenancies, namely:

  399.  There was no opportunity for the tenant to invest in the long-term development of the business since most tenancy agreements were for three years and there was no security of tenure under the Landlord & Tenant Act 1954. Most tenancies were terminable on short notice, usually one month and were non-assignable.

  400.  The beers and other product portfolio available to the tenants was extremely limited. It would usually be confined to the products produced by the relevant brewer landlord.

  401.  In contrast with the period prior to the operation of the Beer Orders, pubco leases provide their lessees with the prospect of investing in their pubs and developing their business over the long term. The leases are usually assignable after two years, which will, in appropriate circumstances, provide an opportunity for lessees to sell on the goodwill they have generated in the business. This, combined with the relatively low cost of entry and (usually) the provision of accommodation at the pub, make the tied lease attractive to tenants.

  402.  The tenants/lessees of pubcos are now offered a wider range of products from their pubco beer supplier. By way of example, in 1992, Inntrepreneur tenants were offered 24 brands of draught beer; Punch now offer over 100 brands of draught beer to their lessees. Copies of the respective price lists are at Appendix L.

  403.  In 1992, tied tenants did not receive any discount for beer from the nominated supplier's list prices. Free of tie tenants were able to obtain discounts of an average of about £50 per barrel. Tied tenants do now receive discounts averaging £30 to £40 per barrel but the discounts available for free of tie tenants have increased to an average of £80 to £90 per barrel. Therefore, although tied tenants do now receive some discounts, the difference between the price paid for beer by a tied tenant and a free trade tenant appears to be similar to what it was in 1992. There is still evidence that some tied tenants are being squeezed between a high rent which has not been discounted to reflect the tie and high wholesale beer prices which make them uncompetitive with free of tie competition.

  404.  CURRENT RELATIONSHIP BETWEEN PUBCOS AND THEIR TIED TENANTS/LESSEES

  405.  We consider in this section of the Memorandum how the tied tenancy business model is currently operating in practice.

  406.  The major pubcos have over recent years expressed an intention to adopt a partnership approach with their tenants/lessees. This is to be welcomed. It is in the interests of pubcos that tenants should succeed since such success generates greater income for the pubcos through the tie while at the same time increasing the underlying asset value of the pub through enhanced goodwill.

  407.  One indication of this improvement is the fact that we have received instructions from relatively few dissatisfied tenants/lessees of pubcos over recent years, probably approximately 30 to 40 per year. This is in contrast to the period 1991 to 1998 when we were inundated with instructions from tenants/lessees of various pubcos and brewers, who were either defending proceedings or wished to bring their own claims. The relationship between landlords and tenants of public houses was then at an all-time low. Tenants, faced with substantial rent increases, were unable to compete with free trade competitors who had the benefit of ever higher discounts from breweries. As a result many tenants fell into arrears and started buying outside the tie. The brewers and pubcos claimed possession and arrears of rent. Tenants countered by challenging the beer tie and taking legal action on the basis that the trading performance of the business had been misrepresented to them before they signed their leases. There was also considerable litigation over repairs. At its height, we were dealing with four or five new claims a week.

  408.  Since 2000, we have found that there has been a decline in the number of disputes between pubcos and their tenants/lessees. We consider that the main reason for this was the introduction of discounts to tied tenants which started in 1997 and the "fair dealing" measures taken by the more responsible pubcos to ensure that prospective tenants were better informed before taking on a lease and better equipped for the business.

  409.  However, we believe that there are still too many examples of cases in which pubcos have failed to provide adequate information to tenants, have adopted what we consider to be an unreasonable stance in negotiations with tenants or have failed to recognise uneconomic and unfair trading terms which arise in individual cases and to take action to deal with them. By way of illustration, we set out in Appendix M examples of some cases which have been drawn to our attention by tenants in the context of preparing this Memorandum. We have not had an opportunity to verify the facts but they may be of anecdotal interest reflecting tenants' perceptions of the types of problems which they experience in their relations with pubcos.

  410.  CURRENT RENT LEVELS

  411.  The major grievance of tenants in the early 1990s was the substantial increase in rent which took place on the conversion from the traditional short term tenancy agreements to the long term leases. In some cases rents increased by as much as 300% at a time when the economy was in recession and beer sales on the decline. Since then rent levels in the pub trade have settled down somewhat but still remain high in comparison with many other commercial leases, at least expressed as a percentage of turnover.

  412.  The Morgan Stanley investment report of May 2004 entitled "Tenanted Pubs—More Sweet than Bitter" ("the MS Report") indicates that the total rental costs to pubco tenants/lessees as a proportion of pub freehold values amounts to about 7%. In other words, the tenants/lessees pay 7% of the asset value of their pub to operate it. According to Morgan Stanley, this comprises a combination of the "dry" rent (ie the contractual rent under the lease), the "wet" rent (ie the discounts earned by the pubco on the tenants' tied sales), and a share of machine income. The accommodation benefit which most pubs offer is then deducted. The calculations and estimates for Enterprise Inns and Punch made by the MS Report are reproduced with the permission of Morgan Stanley at Appendix N. The "yield" of 7%, which Morgan Stanley say has been static over the past three years, is apparently in line with yields in the commercial market.

  413.  We consider that the expression of rent in terms of yield on the asset value of the pub is unreliable as a basis for rental calculation. It depends heavily on the freehold value attributable to the pub, which, as an investment property, will be based on rental value making the valuation exercise somewhat circular.

  414.  In any event, return on asset value is not the measure by which rent is in practice calculated. The modern trend in valuations is to determine rents by reference to the "divisible balance" of profit as between landlord and tenant after expenses, which is then checked against the appropriate percentage of fair maintainable trade ("FMT"). Morgan Stanley calculate that, after deducting accommodation benefit, free of tie tenants/lessees are paying about 14% to 16% of their turnover as rent. This is based on a turnover of about £180-250,000 for an average tenanted pub. The European Commission expressed the view in its Bass decision of 19 June 1999 (Case IV/36.081/F3 -Bass) that the UK industry average for the rent of a tied house was 10% of turnover and, for a free of tie house, 14 to 15% of turnover.

  415.  Morgan Stanley and the Commission both refer to "turnover", ie the actual turnover of the individual tenant. FMT is the normal measure applied in pub rent valuations, ie the turnover which would be achieved by the average tenant. Assuming Morgan Stanley's analysis is correct and that the turnover figure given approximates to FMT, it would appear that free of tie rents have not increased as a proportion of FMT since the Bass decision. However, the FMT of any particular pub is very much a matter of opinion and where FMT has been set too high it can lead to serious problems of over renting. For that reason, we will be recommending some objective standard of FMT to be introduced into the market.[56]

  416.  The absence of adequately discounted rents leaves the tied tenant at a considerable disadvantage to the free of tie competition. Given that out of more than 60,000 public houses in the UK over 40,000 are subject to a tie this inevitably leads to higher consumer prices since tied tenants will need to pass their high purchase costs through to their customers setting a bench price up to which the free of tie operators can compete.[57]

  417.  Product Pricing

  418.  As stated above, in the early 1990s tied tenants received no discounts from suppliers' published price lists. Free of tie purchasers on the other hand received discounts in the region of £50 to £100 per barrel depending on volume.

  419.  In or about 1997 tied tenants began receiving discounts, mainly as a consequence of the Inntrepreneur litigation.

  420.  From the inquiries which we have made in the preparation of this Memorandum it appears that a tied tenant now receives an average discount of £30 to £40 per barrel. Tenants of larger pubcos appear to receive higher discounts than those of smaller pubcos, which probably reflects the higher volume discounts available to the larger groups.

  421.  Free of tie tenants obtain discounts averaging £80 to £90 per barrel so that the average wholesale price differential between the tied and free of tie retailers is £50 per barrel, which is approximately the same as it was a decade ago. A difference of £50 per barrel represents 17 pence per pint.

  422.  Tenants' Income Levels

  423.  The MS Report calculates that the average income of tenants/lessees of pubcos currently appears to be about £35,000 per annum per pub including accommodation benefit (for which they allow £8,000 per annum). Enterprise Inns have estimated that the current average income of their tenants/lessees ranges from £37,000 to £40,000. Punch and Wolverhampton & Dudley Brewery both estimate £35,000. It is important to bear in mind, however, that this income is usually based on a husband and wife team, each often working 70-hour weeks.[58] On that basis, the average hourly rate of tenants/lessees is likely to be well below the national minimum wage.

  424.  It must also be borne in mind that the MS Report is based on the average tenant. Some tenants will in fact be achieving lower levels of turnover so that their income will be less even than the low average given in paragraph 401 above.

  425.  Demand for Pubco Tied Pub Leases

  426.  It would appear that there are substantial numbers of applicants for each available lease of the major pubcos. In October 2003, Enterprise Inns, Punch Taverns and Greene King had 899, 1,400 and 690 applicants comprising 17%, 31% and 61% of their respective pub estates.[59]

  427.  Our experience is that there has always been a good demand for pub tenancies. For many the notion of running a pub is a very attractive career and typically candidates for pub tenancies will be those disaffected by the monotony of employment looking for an opportunity to be their own boss in what seems to be an attractive leisure based activity. If anything, the demand for pub leases possibly increases in times of recession. In the early 1990s, many Inntrepreneur lessees had been made redundant and looked to taking on a pub as alternative employment using their redundancy money to provide funding for the new business.

  428.  THE CURRENT HEALTH OF THE PUBCOS' TIED ESTATES

  429.  Bad Debts

  430.  We understand that bad debts are running at between 0.25% and 0.5% of sales for the tenanted and leased estates of the four largest pubcos[60]. These are relatively low levels of bad debts and indicate that the number of tied tenants defaulting on their trade debts is low. However, this does not necessarily indicate that tenants are prospering. An alternative explanation is that the pubcos' credit control has greatly improved. For example, tenants falling into arrears with their trade debt are now as a matter of course put on to cash with order so that significant trade debts cannot arise.

  431.  Moreover, the bad debt figures do not include rent arrears which would better reflect the number of tenants in financial difficulty. We suggest that the pubcos are asked to provide data on the level of tenant rent arrears and the tenant failure rate.

432.  Rent Concessions

  433.  Pubcos occasionally offer tenants/lessees rent concessions where they are struggling to pay rent or more usually during the early months of a full repairing lease where the tenant has substantial works to carry out. The current level of rent concessions by pubcos are low. The amount to less than 0.5% of Enterprise's rent roll and 1.6% of Punch's[61]. We do not think that this suggests any reduction in the need for concessions. In our experience the offering of rent concessions is very rare in response to a tenant in trading difficulty and this seems to be confirmed by the tenants who have contacted us in connection with this Memorandum. Whilst their attitude has improved in comparison with the stance adopted by brewers/pubcos in the early 1990s, we believe that the pubcos could do more to assist tenants in such circumstances.

  434.  One of the valuers we have consulted, David Morgan, has provided us with details of contested applications in which he has been instructed over the past 18 months for (a) the grant of new tenancies and (b) rent reviews. These involved six different pubcos.

  435.  Examples of rents on renewal of lease and on rent review

Pubco opening offer	Passing rent	Settled at
£45,000 (renewal)	£35,000	£31,000
£38,000 (renewal)	£30,000	£24,000
£37,000	£30,250	£34,250
£36,700	£31,134	£24,500
£60,000	£32,000	£30,500
£62,500	£55,000	£57,000
£35,000 (renewal)	£25,000	£21,500
£44,500	£37,500	£40,000
£31,250	£22,500	£21,500
£57,000	£42,000	£47,975
£45,000 (renewal)	£36,000	£32,000
£26,000	£18,000	£21,250
£90,000	£42,000	£56,000
£90,000	£44,000	£74,000
£45,000	£30,500	£37,200

  436.

  437.  It will be apparent from this table that in all of these cases the settled rent was substantially below the pubcos' opening offers. It is also important to note that in each of the four renewals where the Court has to set a market rent, the rent was reduced. The average reduction across the four cases was £4,375 or 14%. Since rent reviews have to date always been upwards only, lease renewals represent a better opportunity to check the passing rent against the market rent. Whilst clearly a small sample, these figures appear to confirm our experience that current pubco leases are often over rented.

  438.  Although the level of pubco/tenant litigation is currently low, we do not think that this suggests that the tied tenancy model is currently operating perfectly. It seems to us that many tenants are surviving but probably only just and if there were to be an economic downturn many pubs might cease to be viable based on the current levels of rent. Even today we are aware of instances where tenants/lessees of pubcos have entered into leases on unsustainably high rents or have accepted or had imposed upon them inappropriate rent increases on review. The pubcos may argue that, if a tenant or lessee does not agree with the rent, they should not have entered into the lease or accepted the review. We do not share this view. In the commercial relationship between pubco landlord and tenants, the tenant is in the weaker bargaining position and this is particularly true of the many tenants who come into the industry perhaps following redundancy with little or no experience of pubs. We consider that the pubcos have a responsibility to ensure that they do not exploit their position of economic strength, that tenants are treated fairly and that lease terms are reasonable and rents sustainable.

  439.  Morgan Stanley and The Morning Advertiser have recently conducted a survey of 13,000 pub lessees and tenants, receiving 624 completed surveys. Around half of those replying rated as poor or very poor their landlord's help in developing their business, their commitment to investing in the pub, and their fairness as a business partner. 53% of respondents thought that their rent was too high (interestingly, when asked what reduction would make their rent "fair", the average was under 10%).

  440.  Morgan Stanley's explanation of the discrepancy between their quantitative assessment of the data and the responses to their survey was that the survey picked up a disproportionate number of weak pubs. We suspect that their view that the survey was not truly representative may be correct. Nevertheless, average rent levels do appear to be high as is illustrated by the reductions being obtained on renewal (see paragraph 415 above) and, although there may be a silent majority for whom the current tied tenancy model appears to be working satisfactorily, a significant minority are in difficulty.

  441.  Ties for Non-Drink Products

  442.  Most tied leases tie for beers (including lagers) only or for beers plus other drinks such as ciders, wines and spirits, NAB/LABs and mixers. It is comparatively rare at present for the tie to be extended to other products such as cigarettes, matches, food etc.

  443.  Section 2(2) of the Competition Act 1998 ("the Act") gives as an example of a restriction prohibited by the Chapter 1 Prohibition of the Act the imposition of a tie in respect of products or services which "by their nature or according to commercial usage, have no connection with the subject matter of the contract". Accordingly, we consider that pubco leases should not extend the scope of the tie beyond drink products or other products directly connected with the operation of licensed premises.

  444.  Conclusions and Recommendations

  445.  We see no objection in principle to tied tenancies as a business model which, properly applied, provides relatively low cost entry into the industry for tenants, particularly through the discounted rents, while giving the freeholder a stake in the performance of the outlet through the tie which in practice operates as a turnover rent.

  446.  However, trade surveys and the comments made to us suggest that there is a significant level of tenant/lessee dissatisfaction. Whilst we have some doubts as to the representative nature of these surveys and comments, there are undoubtedly instances where tenants/lessees have genuine grievances, most notably where the combined "wet" and "dry" rent payable is unsustainably high.

  447.  It is in the interest of neither landlord nor tenant for a pub to be over rented. If the "wet" and "dry" rent combined is too high, the tenant soon falls into financial difficulty and investment in the pub and its services suffer. This results in a fall in trade leading inexorably to a spiral of failure which ultimately will put the tenant out of business. We recommend that the Select Committee take the following action in order to minimise the risk of failure:

  448.  Professional Advice

  449.  Prospective tenants/lessees should be required to take professional advice before entering into a lease. The survey carried out by the Morning Advertiser in April 2004 revealed that a staggering 41% of publicans who responded admitted to not seeking legal advice before signing their lease. This accords with our experience. In most cases the tenants we see who become involved in business failure or disputes with their landlord not only have failed to obtain proper legal advice when taking their lease but have also failed to obtain adequate accountancy or valuation advice or commissioned a survey report even though they have usually taken a full repairing lease. This is of particular concern where the tenants are new to the pub trade. We have come across cases where pubcos have failed to draw to prospective tenants' attention the importance of getting proper professional advice. Tenants who take on pub leases are committing themselves to very substantial financial obligations. When taking a loan involving a similar commitment a UK lender will not only be required to advise the borrower of the need to obtain advice but will often insist as a condition of the loan that such advice has been obtained. We are aware that the major pubcos recommend in their sales literature that prospective tenants/lessees should take professional advice. This is a step in the right direction but, in our view, does not go far enough. We believe that many of the disputes which arise between pubcos and their tenants would be eliminated if pubcos insisted as a condition of acceptance that tenants obtained all necessary professional advice and perhaps also contributed to its cost. It is also important that tenants receive appropriate advice from professionals with expertise in the licensed trade. A key element to taking on a pub lease is the preparation of a detailed business plan which helps to indicate the viability of the pub on the basis of the terms offered. Prospective tenants require the assistance of independent professional advice in preparing a business plan. All too often they rely upon what they are told by their business development manager ("BDM") and produce their own.

  450.  Financial Information

  451.  In our experience, pubcos provide very little information as to the historical performance of a pub to prospective tenants. Frequently a tenant is given only a vague statement of average weekly takings and barrelage coupled with a comprehensive disclaimer of liability should that information prove to be incorrect. The pubcos often claim that this information is not available to them or that they are reluctant to make representations as to performance which might subsequently prove to be incorrect. In the purchase of any other type of business it is standard practice for at least three years accounts to be produced to a prospective purchaser to enable a proper judgment to be made as to the viability of the business. Pubcos have available to them a considerable amount of information concerning pubs within their estate. They will have precise details of barrelage from purchasing records and beer monitoring equipment. They obtain information concerning the level of trade from rent reviews and from the BDMs' reports on individual pubs and tenants for whom they are responsible. We believe that pubcos should provide prospective tenants with all information available to them as to the pub's historical trading performance to ensure that the prospective tenant is able to prepare an accurate business plan and make an informed decision on whether to proceed. In circumstances where the pubco is unable to provide reliable information or it proves to be incorrect, the tenant should be entitled to seek a downward rent review.

  452.  Training for Tenants

  453.  Pubcos should encourage proper business training for prospective tenants to improve knowledge and performance through courses such as those run by the British Institute of Innkeepers.

  454.  Industry Standard for Rent Levels

  455.  We believe that an industry standard for tied and free of tie lease rents should be developed. In the Bass Decision[62] the EC Commission suggested that the average free of tie rent was 15% of turnover and 10% of turnover for a tied lease so that the idea of an industry standard is not new. We believe that the industry could and should establish clear guidelines for this valuation process as well as guidelines as to the level to be applied as between tied and free of tie leases. From our discussions with valuers we understand that the rent on mid-range barrelage leases in and around London might be in the region of 13-17% of FMT free of tie. For a tied lease the rent might be 12-16% with reasonable discounts. Our valuers consider that a rent of 10% FMT should only be applicable to tied houses receiving no discounts or with very low discounts in the provinces. An industry standard must reflect the type and location of a pub, but all other things being equal, the margin between a free of tie and a tied rent should reflect the discounts foregone.

  456.  Option for Tied or Free of Tie Lease

  457.  We believe that pubcos should offer tenants a lease on either a free of tie basis or a tied basis with the appropriate rent in each case so that the tenant can make the choice. Punch seems to have gone some way towards this by offering its "Growth" lease and "Super-Growth" lease with different levels of rent and discounts.

  458.  Complaints Procedure

  459.  We believe that all pubcos should introduce effective complaints procedures for tenants/lessees. We are aware of Punch's Retail Charter containing its Frontline Customers Queries & Complaints Procedure. This procedure provides that if the service provided by Punch or its nominees fails to meet the published service standards contained in the Retail Charter the issue can be raised with Punch by telephone, e-mail or in writing to Frontline. The Charter maintains that all queries will be logged and tracked and that complainants will be given a log number and estimated time for resolution of the problem. Written queries will be acknowledged within 72 hours of receipt and if the query is not resolved within an agreed timescale they will be passed to the appropriate senior manager who will get directly involved in the process. The query will be escalated within the business until it becomes the responsibility of the Chief Executive. We suggest that all pubcos adopt similar complaints procedures and ensure they are fully implemented in practice.

  460.  Constructive Dialogue

  461.  It is important that pubcos do more than simply establish complaints handling procedures. In a significant number of cases in which we have been involved, tenants facing financial difficulty are treated unsympathetically by their pubco and do not receive constructive advice as to how best to deal with the trading difficulties that they have. Furthermore, there is often a general unwillingness on the part of the line managers within the pubcos to accept that pubs are over rented and that a reduction to a commercial rent should be made. Again in a significant number of cases, we have seen pubcos insist on payment of the full contractual rent forcing a tenant out of his pub only to offer the pub for reletting at a lower rent thereafter. Having regard to the fact that many tenants will have invested substantial sums in the repair and management of their pubs, and that the pubs represent not merely their business but often home for themselves and their family, we consider pubcos should adopt a more positive approach.

  462.  BDMs to Focus on Proper Role

  463.  We believe that the relationship between pubcos and their tenants would be improved if a BDM's role was limited to providing advice and reports to tenants in the development of their businesses, rather than extending their involvement to the issue of rent negotiation and reviews. In our view, this would restore tenant/lessee trust in their BDM.

  464.  ADR to Resolve Dispute on Repairs

  465.  Where pubcos are responsible for external and structural repairs, disputes will frequently arise due to the failure to carry out necessary repairs. We have received representations from lessees to the effect that there are delays in effecting repairs by the pubcos. The external repair of a public house is often crucial to its trading success because passing trade will be discouraged by premises which do not appear to be well maintained. Litigating these issues is an expensive and time-consuming business which is not in the interests of either the landlord or the tenant. We would recommend that such leases should contain an inexpensive and efficient system of arbitration or alternative dispute resolution ("ADR") with fully independent arbitrators or experts to resolve such disputes without imposing legal costs on either side.

  466.  Abolish Upward Only Rent Reviews

  467.  "Upward only" rent reviews should be removed from tenancies and leases. The rents referred to above in paragraph 413 appear to us to demonstrate the prevalence of over renting in the tied pub sector. The larger pubcos are already taking steps to allow downward rent review. The other pubcos should follow.

  468.  Streamlined Rent Reviews

  469.  Many tenants have expressed to us concern about the system of rent reviews. Arbitration is expensive and unaffordable for many tenants. Some pubcos offer expert determination as a cheaper alternative but tenants perceive that expert determination is weighted in favour of pubcos since the experts available for nomination seem to be drawn from professionals who act regularly for the large pubcos. Pubcos will usually have available to them a great deal more information about comparables in the trade than is available to the tenant's representative and it is often difficult to obtain disclosure of rent comparables from pubcos on grounds of confidentiality. Furthermore, there appears to be no uniform guidance as to the method of valuation to be applied so that currently arbitrators and experts carrying out rent reviews have too wide a discretion. This leads to uncertainty and mitigates against early settlement. We recommend that the rent review process should be streamlined, national guidance for rent calculation introduced and that the disclosure rules and rules of evidence clarified. We suggest that it would be a good idea to develop a nationwide register of rent reviews which would be accessible by professional valuers representing both sides of the industry. Such a register would increase transparency and reduce contested reviews.

  470.  Limit the tie to drinks products

  471.  We consider ties for products not connected with the supply of beer and other drinks which are not directly ancillary to the operation of a pub should be removed on the basis that they are likely to infringe competition law in any event.

  472.  Restore guest beer right

  473.  We suggest that consideration might be given to broadening the use of guest beer (ie draught cask conditioned ales) provisions in leases. The guest beer provision was introduced by the Beer Orders and applied to brewery owned pub estates. Pubcos are not required to grant tenants a guest beer right and it is falling into disuse. We believe that the guest beer right has many benefits, not only to the tenant but also for the industry as a whole, and should be maintained. The benefits include the following:

—  allows access to pubco estate by micro brewers;

—  widens choice for consumers;

—  acts as a pricing constraint on tied beers; and

—  gives the tenants greater degree of independence.

  474.  However, we do not consider that the guest beer right should be used as a means of acquiring beers within the tied portfolios at lower prices. To achieve the benefits described above, the guest beer right should be exercisable only in relation to a true guest beer ie one which is not included in the list of tied products.

  475.  We believe that the changes recommended above would improve the efficiency and transparency of tied lease negotiations and substantially reduce both the scope for misunderstandings between pubcos and tenants and the risk of tenant failure for the benefit of all in the industry.

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47   Not printed. Back

48   Not printed. Back

49   Not printed. Back

50   Not printed. Back

51   Not printed. Back

52   Cases IV/36.456/F3-Inntrepreneur and IV/36.492/F3-Spring. Back

53   The Times 28 May 2004. Back

54   2002 ECR 2020. Back

55   Interbrew UK Market Report 2004, Seeing Beer in a New Light. Back

56   See paragraph 432 below. Back

57   The Pricing Analysis prepared by AC Neilsen shows that briefly between mid 2002 and the end of 2003 retail prices in independent pubs were higher than those for managed and leased pubs. We cannot explain this anomaly which goes against the trend of uniform retail price increases since 1995. Back

58   A recent survey by insurers PremierLine found that 46% of publicans say that they work more than 70 hours per week. The Publican 2003 Market Report found that publicans work on average 75 hours per week. Back

59   Source: Deutsche Bank estimates and company data (UK Pubs Sector Report-The bear pit, 31 October 2003). Back

60   Source: Deutsche Bank estimates and company data. Back

61   Source: Company data, Morgan Stanley research. Back

62   See paragraph 392. Back

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Prepared 14 March 2005