House of Commons - Pub Companies - Business and Enterprise Committee

Pub Companies - Business and Enterprise Committee Contents

3 Ties

76. The nature of the 'tie' for a pub will be determined by its lease; there are a number of ties for different products such as wine; soft drinks, beer or spirits. The beer tie, the commonest, is sometimes referred to as 'wet rent'. As the Trade and Industry Committee said, the notion of 'wet rent' is misleading as it is in reality just an additional income stream for pubcos.[121] Nonetheless, pubcos, lessees and campaigners clearly see it as a form of rental, and its effects are complex.

77. The tie is an issue of particular contention for the lessees who submitted to the inquiry. Opponents of the tie believe the price lessees are charged for beer through their pubco is causing them financial difficulties and is putting them at a competitive disadvantage to the freehouses and managed pubs. Moreover they argued that rents for tied pubs do not adequately take account of the higher beer costs imposed on lessees by contractually obliging them to buy from pubcos rather than from cheaper sources.

78. Pubcos claim that any extra cost to the licensee is compensated for by lower rents and by the extra support the companies provide for their lessees. We examine these benefits in more detail later in the report.

BEER PRICES AND DISCOUNTS

79. Although breweries have published 'list' prices for their beer, few buyers actually pay this price. Instead, it is commonplace for both pubcos and free houses to negotiate discounts, which can be substantial. Like supermarkets, pubcos can negotiate large discounts from brewers when buying beer because of their large purchasing power. In principle, the greater market power of the pubcos could mean they are able to negotiate such significant discounts from brewers that they can make a profit while supplying beer to their lessees at the same or lower price than a freehouse could buy it. In practice this does not appear to be the case.

80. ALMR have created the following table for us to demonstrate the discounting system:

Table 4: Barrelage Discounts

ALMR estimates (per barrel)

List Price £450 - £480

Pubco discount £210 - £250

Individual free of tie discount £140 - £150

Source: Ev 91

81. The pubcos pass some of the discounts on to customers, Giles Thorley told us that Punch has three broad lease agreements involving: high discounts of £95 a barrel; medium-sized discounts of £45 a barrel; and pubs with no discounts at all.[122] Enterprise said that approximately 60% of their licensees get some discount.[123] A lessee provided us with details of Enterprise's sliding scale of discounts — there were no discounts for pubs selling under 150 barrels a year, but discounts could be achieved of up to £42.12 a barrel if over 500 barrels a year were sold.[124] We note the difference between the highest Enterprise discount of £42.12 and ALMR's estimate of a free of tie discount of between £140 and £150.

IS THE BEER TIE ACCOUNTED FOR IN THE 'DRY RENT' CALCULATION?

82. The pubcos argued that the higher beer prices paid by lessees in tied houses were compensated for in the dry rent calculations. Punch explained that:

What is important is the actual beer price paid by the Licensee, not the discount or tie. This determines the level of gross profit realised by the Licensee, which then determines the level of rent, being a reflection of the fair maintainable profit for the business. This ensures that the Licensee is not disadvantaged in the market place against free trade operators. If the beer price is higher then the GP is lower, and consequently the level of rent is lower.[125]

This argument was also put forward by Mr Willis of RICS

the gross profit, […]will clearly take into account any elements of the lease which bring in a tie. It will take into account discounts that are given[126]

83. There is a great deal of confusion about this point. Rent calculations simply take into account the cost of beer as an input. They do not take account of the additional income stream the pubco gains through profit on the tie. The RICS valuation guidance states:

There has been some suggestion that the reward available to the supplier of tied products should be reflected in some way in the rent assessment. This is not correct. Estimated rental values for each particular business arise only from market evidence and analysis relating to the maintainable income stream derived from the operation of the business in the hands of a reasonably efficient operator.[127]

84. Although the cost of inputs is taken into account, lessees' profits are still lower than they would be if they were free of tie. We use a very crude set of figures for ease of understanding; we stress that this is schematic, and that none of the prices are intended to be anything other than notional. Assume two lessees; Mr A's pub is free of tie, and Ms X operates a tied pub. The brewer's list price is £450 a barrel. Mr A buys his beer at a discount of £150 per barrel. The pubco has the same £150 discount as Mr A, but sells to Ms X at a discount of £40, i.e. £410 per barrel. The pubco keeps £110 of the discount. The effect of the inputs on the FMT calculations is as follows:

Table 5

Mr A: Pub without beer tie:

Turnover £720

Cost of barrel £300

Divisible balance £420

If divisible balance is split 50/50

The pubco takes - Dry rent £210

The lessee makes - Profit £210

Table 6

Ms X: Pub with Beer tie

Turnover £720

Cost of barrel £410

Divisible balance £310

If divisible balance is split 50/50

The pubco takes - Dry rent £155

The lessee makes - Profit £155

Note - These tables work on the assumption that there are 36 gallons in a barrel. This is the equivalent of 288 pints. Each pint sells for £2.50 net

As this demonstrates, the effect of the beer tie on basic rent is that both pubco and lessee take a lower income. However, while the decrease in the lessee's income is absolute, the pubco has £110 from that part of the discount on its barrelage it has not passed on to the lessee. The reduction in rent is accompanied by a reduction in the lessee's profit but an increase in the pubco's overall revenue. Given this, it is hardly surprising that 82% of lessees from our survey did not believe their rent adequately took account of the beer tie.[128]

85. We have also not been presented with any substantial evidence that rents for tied pubs are significantly less than that for equivalent free of tie pubs other than a small comparative selection submitted by Enterprise.[129] Indeed Paul Daly informed us that the rent he paid for his tied Enterprise pub was actually more than for his free of tie pub and they were only round the corner from each other.[130] Our survey does not allow us to compare like for like; we note it shows that leases for the Wellington pub company, which operates free of tie, were higher than for tied estates: however they also show that a significantly greater proportion of these leases were assigned from the previous lessee rather than being purchased direct from the pubco, suggesting that the likelihood of being able profitably to assign a lease is higher for these free of tie pubs. Moreover, most free of tie pubs are freehold; while they may cost more to acquire, the purchaser gets a tangible asset, rather than a lease which cannot be guaranteed to be assignable.

86. A tied lessee can try to maintain their income by selling beer at a higher price, and there is evidence that this happens.

Table 7: Comparison of beer prices

Industry Punch Taverns Price Difference Enterprise Inns Price Difference

Draught Standard bitter 2.18 2.29 + 11p 2.25 + 7p

Draught Premium Bitter 2.40 2.58 + 18p 2.43 + 3p

Draughtflow Standard Bitter 2.17 2.21 + 14p 2.28 + 11p

Draughtflow Premium Bitter 2.43 2.40 - 3p 2.46 + 3p

Draught Standard Lager 2.43 2.49 + 6p 2.57 + 14p

Draught Premium Lager 2.78 2.86 + 8p 2.85 + 7p

Draught Stout 2.62 2.69 + 7p 2.70 + 8p

Draught Cider 2.50 2.55 + 5p 2.56 + 6p

Source: Numis Securities Travel and Leisure Report 4 December 2008

However this then puts them at a competitive disadvantage to their competitors. If they keep their prices at the industry average their margins are reduced and they are given little room to manoeuvre in an economic downturn — as Morgan Stanley said:

Arguably, [the tie] is exacerbating the volume declines in tied pubs, who are unable to reduce price without taking a significant hit to their cash margins.[131]

The 2008 Good Pub Guide noted "compared with the average, we found Punch and Enterprise pubs were charging 5% more for beer."[132]

87. If the interests of the pubcos operating a tied system and their lessees were truly aligned, one would expect that pubcos would want a system in which the combination of rental costs and beer costs enabled their lessees to supply beer at a price which was competitive with other pubs. This does not seem to be the case.

Distribution benefits and purchasing power

88. Giles Thorley, Chief Executive of Punch, told us a lessee could buy all the products needed from a single point of contact, rather than having to deal with multiple brewers.

Table 8: Top six products in the UK

—  Product —  Brand —  Supplier

—  Ale —  Tetley's —  Carlsberg

—  Lager —  Carling —  Coors

—  Cask Ale —  Greene King IPA —  Greene King

—  Cider —  Bulmer's Strongbow —  Heineken

—  Premium Lager —  Stella —  InBev

—  Stout —  Guinness —  Diageo

Source: Punch evidence Q293

He stated that an individual pub would have to "deal with six different suppliers" or "sub-optimise and deal with a wholesaler" to obtain the top six products in the UK (see table above). In comparison he said Punch supplied those six as well as 250 different beers and a whole range of cask ales.[133] However we have been told by lessees:

Times have changed since the Beer Orders and there are a number of 'Brewery-free' Wholesalers operating in the market place as well as organisations such as the SIBA Direct Delivery scheme which did not exist before. Conversely, at present most of the large pubcos, if not all, outsource their distribution to the Breweries anyway.[134]

89. Mr Thorley also argued that a further benefit of the pubco model was that lessees were offered "certainty of credit, certainty of terms, no minimum purchase obligations and guaranteed delivery on a 24-hour basis, six days a week". He concluded that Punch "do provide a very significant service" as they have put in the infrastructure to do so.[135] However, the lessees who contacted us did not have such a high opinion of pubcos' 'infrastructure' system.[136] A lessee told us:

Deliveries can be out of the declared time slot, they refuse to take all the 'empties' and the crew changes week by week. The same draymen rarely deliver twice to the same pub. Hence we get calls asking for directions, they need explanation of the position of the drop, and need baby-sitting in order to do their job.[137]

In addition lessees were unhappy about additional delivery charges they had to pay if their beer supplies ran out at inopportune moments from a sudden increase in trade.[138]

90. Punch has extolled the benefit of its purchasing power to us and to lessees.[139] The lessees of the Three Compasses Pub said that they were told of Punch's 'greater buying power' when Punch bought out the pubco from which they originally leased their pub, but in the same letter they were informed their prices were going up by 10% — even though Punch had ten times more outlets than their previous landlords.[140]

91. Lessees felt that the pubcos were not acting fairly in passing on discounts. Paul Daly, who operated both free of tie and tied pubs showed us that what he paid for his drinks through Enterprise for his tied pub was far higher than what he paid for his free of tie pub a few streets away, in spite of Enterprise's greater market power.[141]

Table 9: Enterprise price comparison

—   —   —  Coors —  Enterprise —  Variance —  Variance

—  Product —  Size —  Net Price £ —  Net Price £ —  £ —  %

—  Guinness —  11g —  90.28 —  110.75 —  20.47 —  23

—  Carling —  11g —  64.33 —  103.46 —  39.13 —  61

—  Grolsch —  11g —  77.32 —  119.51 —  42.19 —  55

—  Sol —  24 —  18.04 —  23.65 —  5.61 —  31

—  Budvar —  24 —  15.99 —  24.44 —  8.45 —  53

—  330ml coke —  24 —  8.49 —  9.71 —  1.22 —  14

—  330ml diet coke —  24 —  8.49 —  12.45 —  3.96 —  47

—  Baby Bitter Lemon schweppes 125ml —  24 —  4.98 —  6.05 —  1.07 —  21

—  Baby Ginger Ale Can Dry 125ml —  24 —  4.38 —  6.05 —  1.67 —  38

—  Baby ginger beer schweppes 125ml —  24 —  6.21 —  7.28 —  1.07 —  17

—  Baby slim line tonic schweppes 125ml —  24 —  4.38 —  7.28 —  2.90 —  66

—  Blackcurrant Cordial Schweppes —  12x1tr —  10.80 —  14.55 —  3.75 —  35

—  Lime Cordial Schweppes —  12x1tr —  10.80 —  14.55 —  3.75 —  35

—  Total —   —  324.49 —  459.73 —  135.24 —  42

Source: Ev 259

92. We believe it is seriously misleading for any pubco to promote to potential lessees that a pubco has benefits from 'purchasing power' when that benefit is not passed on to lessees.

Enforcing the tie

93. Whether or not the beer tie has the advantages claimed for it, pubco lessees have entered into an agreement with the company, and must abide by its terms. We agree that buying out of the tie (that is buying beer or other tied items from a supplier other than the pubco) is a breach of contract. Pubcos are entitled to take action if they find their contract has been breached. However it is only reasonable that if lessees are obliged to buy through their pubco systems should be in place to ensure supplementary orders can be supplied quickly and without extra costs when necessary. This is not the case.[142]

94. Moreover the method used to monitor the lessees' compliance with the tie must be fair and accurate. Some pubcos rely on a company called Brulines; our evidence suggested that the information derived from its monitoring can be used to enforce large penalties against the lessee.[143] The Brulines system measures how much beer is flowing through a pub's pipes to ensure that more is not being sold than was bought through the pubco — that the lessee is not buying outside the tie. However a number of lessees told us that the system is inaccurate, and claimed that they were being fined for buying out when they had not in fact done so. David Law from The Eagle Ale House in Battersea explained that the system could not differentiate between beer and the water used to clean the pipes.[144] In the Eagle's case the Brulines data was used by the pubco in accusations of 'buying out' of the tie but after further analysis it was discovered that the extra volume which had flowed through the pipes was not 'unaccounted beer' but water.

95. When questioned on this issue, Giles Thorley, the Chief Executive of Punch told us:

The simple answer, as hopefully most of us will be aware, is that beer is a different density from water, so it actually measures the difference in the density of the products, so, therefore, as you are well aware, when you are cleaning a line, that is already factored into the volume that goes through the flow meter.[145]

Our Chairman visited The Eagle to witness a demonstration of Brulines. It was clear that the essence of the mechanism used by Brulines is a simple wheel which cannot differentiate between densities. Punch have since admitted in a letter two months after the evidence session that "the system does not measure the difference in density of beer versus water."[146] We are disappointed that Punch misled us in oral evidence and that they have not apologised for doing so. In fact Brulines examines records of flows sent to them remotely and make informed value judgements as to which volumes are beer and which water. This is unsatisfactory but is a particular problem for cask beers where more cleaning is required.

96. Leaving aside the question of specific density of beer and water, we have doubts about the basic accuracy of the equipment. Brulines said that it uses the "highly reliable Titan Pelton Wheel flow meter" and that the flow meters "undergo an in-situ calibration process traceable to national standards".[147] Our visit to The Eagle Ale House found that their Brulines 'account' bizarrely showed that they had almost 2,000 gallons (around 220 barrels) of beer in stock that had been delivered and not sold over a 12 month period. As Simon Clarke told us: "the implication being we are 'stockpiling' beer or possibly selling it wholesale at a mark up on pubco price!".[148]

97. It is possible that Brulines equipment is as reliable as the company claims. The difficulty is that there is no independent verification of this. As Brulines itself says "Weights and Measures legislation does not apply to the provision of data by Brulines because the service it provides arises out of business to business transaction and do not impact on the product sold to the end user. In addition, Brulines has always believed that its equipment does not require to be stamped by Trading Standards."[149] Section 7 of the Weights and Measures Act 1985 states that "use for trade" does not include transactions where the sale "is not a sale by retail". There is no meaning given for "sale by retail".

98. It is entirely legitimate for a company to seek to ensure that the other party to a contract respects its terms. However, we believe that where a measurement device is used to police this, it should be properly calibrated, and subject to external verification. If necessary, the Weights and Measures Act 1985 should be amended to ensure this. Furthermore, given the impossibility of distinguishing between beer dispensed and sold, beer run off and disposed of preparatory to serving, and water used to clean the lines, we believe pubcos should not be allowed to rely on data from Brulines equipment to enforce claims against lessees accused of buying outside the tie.

Amusement with prizes income

99. In addition to their income from the beer tie, pubcos can obtain income from other ties, notably that from amusement with prizes machines — the AWP tie. The Trade and Industry Committee recommended that the AWP tie be removed.[150] This has not happened.

100. The pubcos argued that the AWP tie was advantageous for their lessees because of their companies' purchasing power. Giles Thorley of Punch told us that

What we try to do is maximise the number of our pubs that have the betting machines at the best rates and that is the benefit of being able to lease 13,000 machines compared to two for an individual pub.[151]

However lessees complained that in fact they paid more for their machines through the tie than if they rented them independently. ALMR told us that one of their members was being charged £70 per week rent for a machine in an outlet on an Enterprise lease. The rent for exactly the same machine, provided by the same supplier at the same time in another outlet in his estate operating on a Fuller tenancy was just £53.50.[152] Whatever their claims about purchasing power, it is clear that pubco prices are higher than is standard in the industry as the price lists supplied to us from the British Association of Pool Table Operators (BAPTO) demonstrated:

Table 10: AWP machine price comparison

Punch Enterprise AWP Directory (taken from WHAT Amusement Machine?)

Casino Crazy (A1) £77.98 (Band 1) £79.94 £56-£59

Star Wars - A New Hope (A2) £77.98 (Band 2) £77.63 £56-£59

Rob Da Bank (B3) £70.21 (Band 3) £73.36 £52-£55

Source: Figures taken from evidence supplied by BAPTO which included rent lists from Punch Taverns, Enterprise Inns and AWP showing prices as they stood at December 2008/January 2009^.

In addition lessees considered pubcos took too much through the AWP tie. ALMR argued that pubcos not only took half the machine earnings but the machine income was often included within the pub's net profit in the 'dry rent' calculation and so the lessee was being charged twice — effectively only receiving 25% of the machine profit.[153]

101. The pubcos argued that the AWP tie benefited the lessees because of the support they gave to lessees. Marston's argued:

We believe that this tie adds value to its tenants' business due to the provision of better machines that are more appealing to customers, have better service and, therefore, generate higher revenue for the tenant. MPC continues to supply extra support to tenants, to ensure that they make the most out of the AWP machines. Our service covers all the legal, licensing and other legislative requirements with operating AWPs. […] Where appropriate, we also give advice on the best location for AWPs and relevant laws.[154]

However BAPTO[155] and Kossway, a supplier of gaming and amusement machines, argued that lessees can quite easily decide for themselves which the best machines for their pubs are and where they should be situated. Kossway said:

If a tenant is deemed fit and proper to run a pub and promote the sale of beers, wines and spirits to the best of his ability, to maintain and keep that pub and pay the rent, then surely he must be deemed as capable of making a simple decision as to whom he wishes to supply his gaming and amusement machines and at what terms. The pubcos' claim that they provide assistance to the tenant is nonsense. Their real objective is to gain as much income as they can get away with from the gaming and amusement machines sited throughout their tenant's estates.[156]

102. The pubcos have suggested that if the tie had been removed, following the Trade and Industry Committee 2004 recommendation, their lessees would have suffered more by the economic downturn and the resulting fall in machine earning. They argued that they have shared the loss of earnings which would not have happened with fixed rent. Enterprise said

Had ETI accepted the 2004 Committee's recommendation, removed the machine tie and replaced the company's "lost" income with a supplemental fixed charge, it is clear that ETI licensees would now be worse-off, having exchanged a declining source of income for a fixed cost. No mechanism currently exists by which any such supplemental fixed charge might be reviewed to reflect changing circumstances.[157]

This rests on the assumption that pubcos would have been compensated by an ongoing fixed charge. Pubcos already have income from dry rent and wet rent. We do not believe that it would be appropriate to impose a fixed charge in return for removing a tie from which lessees received no benefit.

103. In 2004 the Trade and Industry Committee concluded that "In our opinion, pubcos do not add sufficient extra value from their deals to justify their claims to 50% of the takings from AWP machines. We remain unconvinced that the benefits of the AWP machine tie outweigh the income tenants forgo and we recommend that the AWP machine tie be removed." That conclusion remains valid.

Other ties

104. Pubcos also receive income through a variety of other ties. Some insist that insurance is arranged through them. Others arrange for licenses, electricity or other services. Ideally, these ties should benefit both the lessee and the pubco; lessees should benefit from having services provided without trouble, possibly at a lower price than they themselves could arrange; whether or not pubcos get a profit stream from these ties, they can be confident that lessees have suitable arrangements in place for matters such as insurance. However, here too there is insufficient transparency, and there can be no certainty that the arrangements benefit both parties in every case.

INSURANCE

105. Pubcos have put forward their provision of insurance as a form of support for lessees. Enterprise said:

There are two key commitments that we make to every ETI licensee:

We guarantee to provide insurance for every single licensee, including those who would simply not get insurance in the market. This includes those pubs which have recently suffered repeated, and sometimes devastating, flood damage.

We ensure that every pub pays a premium which is appropriate and we guarantee to match the best rate available in the market for cover of equal quality.[158]

In addition Ted Tuppen told us:

If any licensee can demonstrate that he can get the same cover at a cheaper price, we give him his money back, so we could not make a greater commitment than that. [159]

106. Yet the insurance was one of the subjects regularly raised with us in evidence from discontented lessees. A lessee informed us:

we are paying £1054.68 per annum. In the last week I have tried to make a claim for damage due to a burst pipe. […] Admiral now inform me that there is an excess of £1000 on this policy. The damage is not more than £1000 , so I am now that amount out of pocket, from a policy I have no control over, and has never been sighted[160]

Moreover Mr Morgan has since written to the Committee stating that:

Enterprise Inns flatly refuse and have refused in every instance of which I am aware, to issue a copy of their insurance policy. We thus have the ultimate Catch 22 which shows the strength of honesty of Mr Tuppen's reply to your Question 297. As far as I am aware, no tenant has been able to obtain a competitive quote, specifically because they are unable to obtain a copy of the Enterprise Inns insurance policy[161]

From the evidence we have been shown, it appears in some cases insurance covers the entire pubco estate, rather than being associated with individual premises. This obviously has advantages for the pubco. Indeed, some lessees in higher risk premises may also benefit. However, lessees lose control over an important part of their business operations.

107. Lessees particularly resented the fact that some insurance covered the pubco's losses for up to two years if a pub ceased trading.[162] The Fair Pint Campaign told us this extended to cases where a lessee defaulted. This is not quite the case. We have consulted the ABI who confirmed that the leases which have been presented by the Fair Pint Campaign only offer pubco insurance if the lessee is unable to operate due to damage to the building[163]. They also informed us that to the best of their knowledge no policy insured against a lessee's default. Nonetheless, the lessee's insurance appears to confer benefit on the pubco.

108. Pubcos have a right to require that each of their pubs is fully and properly insured. It may well be that the insurance offered through pubcos is as good as or better than any that lessees could arrange directly. Nonetheless, since lessees are frequently not allowed sight of the policy, it is impossible to establish whether this is the case. Moreover, it is also clear that some insurance policies require the lessees to pay for a benefit to the pubco. We do not see why pubcos should not themselves take out insurance against the risks they face directly.

121 HC (2004-05) 128-I, para 81, 118 Back

122 Q 293 Back

123 Ev 101 Back

124 Ev 73 Back

125 Ev 165 Back

126 Q 84 Back

127 RICS Valuation Information Paper No. 2: The Capital and Rental Valuation of Restaurants, Bars, Public Houses and Nightclubs in England, Wales and Scotland, para 7.8 Back

128 Ev 302 Back

129 Ev 107 Back

130 Q 30 Back

131 Leisure and Hotels, Leased Pubcos: Avoid, Morgan Stanley Research, September 2008 Back

132 Fiona Stapley and Alisdair Aird, Good Pub Guide 2008, (London, 2008), Introduction Back