Memorandum submitted by Enterprise Inns
plc
EXECUTIVE SUMMARY
Enterprise Inns plc ("ETI") broadly
supported the recommendations of the Trade and Industry Select
Committee (2004) report into the relationship between pub companies
and their tenants, not least because ETI either had already met,
or was on track to meet the standard to which the vast majority
of recommendations aspired. However, ETI did not and does not
accept the rationale behind the Committee's recommendation to
remove the tie for Amusement With Prize (AWP) machines and the
reasons for this are explained in paragraphs 19 & 20 below.
Current market conditions are challenging for
all consumer-facing businesses and the ETI leased and tenanted
model is well-placed to respond to these trading challenges and
to provide valuable assistance to licensees in appropriate circumstances.
ETI believes that current market mechanisms
ensure that there is vibrant competition across the pub sector,
that existing custom and practice, as demonstrated by ETI, is
both fair and flexible and that existing regulation is more than
adequate.
BACKGROUND
ETI was established in September 1991, was listed
on the London Stock Exchange in 1995 and has grown its estate,
through acquisition, to the current level of 7,782 pubs, located
throughout England and Wales. 98% of the pubs in the ETI estate
are owned freehold by the company and all ETI pubs are operated
exclusively under tenancy or lease agreements.
ETI remains steadfastly committed to the leased
and tenanted business model which provides a low entry cost, low
risk opportunity for an entrepreneurial, independent business
person to develop a successful business supported by the organisational
capabilities and financial stability of a large company.
ETI has sought continually to improve the quality
of its pub estate, through churn and investment. In the last 4
years, the company has invested over £250 million, alongside
substantial investment by licensees, in additional facilities,
refurbishments and new retail propositions to help them grow their
businesses in an increasingly competitive marketplace. The value
of the ETI pub estate now stands at £5.8 billion.
CURRENT TRADING
ENVIRONMENT
The leisure market has changed significantly
over recent years, as a consequence of changing economic conditions,
demographics, lifestyles and consumer habits. In addition, the
number and range of choices for consumer discretionary expenditure
has expanded massively. Furthermore, staying at home has become
an increasingly attractive option, with huge improvements in at-home
entertainment, the massive expansion of internet usage and the
impact of supermarket pricing, particularly on alcohol consumption.
Pubs and licensees have had to evolve and improve in order to
compete effectively and in some cases to survive in this testing
marketplace.
In the last 12-18 months, pubs have been further
affected by the worsening economic climate, compounded by the
smoking ban and the burden of regulation and taxation. Exposed
to rising input prices, the crisis of confidence amongst financial
institutions and the current decline in consumer confidence, the
pub industry is inevitably facing severe trading challenges.
Pubs are closing, permanently, at an unprecedented
rate, as the accumulation of external influences causes them to
become unviable as businesses. The majority of such closures are
occurring within the independent free trade pub and club sector
(Source: CGA Strategy). However, current economic conditions are
undoubtedly contributing to the increase in business failures
of all types, including in leased and tenanted pubs.
In ETI's experience, there is a strong correlation
between business failure and licensee quality, regardless of the
economic circumstances. Where pubs in which licensees "failed"
have been re-let, the sales performance of these pubs, under new
management, has typically improved by 12-15% in the 12 months
following re-opening, when compared with the 12 months prior to
business failure.
THE STRENGTHS
OF THE
TIE AND
THE ETI LEASED
AND TENANTED
BUSINESS MODEL
The evidence presented by ETI to the 2004 inquiry
sought to demonstrate that the ETI leased and tenanted business
model, openly negotiated and fairly managed, closely aligns the
profit objectives and the business risks of both parties.
The supply tie ensures that ETI has a vested
interest in sales of drinks products, which are inextricably linked
to pub traffic. Increased pub turnover, as a consequence of increased
footfall, leads directly to increased wholesale margin for both
ETI and its licensee, whilst rent levels remain constant, at least
until the next scheduled rent review. Conversely, declining sales
of tied drinks products lead directly to a fall in income for
ETI.
In simple terms, a drop in beer sales introduces
an immediate reduction in the "wet rent" paid by the
licensee. If circumstances are such that further help is needed,
the leased and tenanted model provides a real incentive for ETI
to offer additional assistance. Never has this been more obviously
and demonstrably evident than in the current trading climate,
where ETI is working harder than ever, for less profit, supporting
licensees with substantial financial help.
In the year to September 2008, some 1,600 ETI
pubs received direct, non-contractual financial assistance from
the company, comprising a combination of non-repayable rent concessions
and tied drinks product discounts, on each occasion for an average
of four months. Approximately 70% of businesses which receive
such support regain financial stability and continue to trade.
The balance are either assigned (sold) by the incumbent lessee,
or surrendered by mutual agreement to the company, in order to
be re-let to new operators.
Current economic conditions are exposing the
relative weakness and fragility of some small business operators,
whilst at the same time reinforcing the positive attributes of
the tied lease and tenancy model. In difficult trading times,
it is inevitable that some licensees will not be good enough and
some businesses will fail. However, far more than with any lending
bank or other financial institution, ETI has a vested interest
in helping good quality, committed and honest licensees to survive,
offering not only valuable business advice but real financial
concessions where appropriate.
Finally, it must be understood that every individual
contract between ETI and a tenant or lessee is initially negotiated
and agreed by both parties, with complete transparency of every
obligation that each party is undertaking. This includes full
details of drinks product pricing, amusement machine pricing and
share of income and a valuation of the rent payable having due
regard for the terms of the lease.
80% of all ETI pubs are let on long term, assignable
agreements in which subsequent operators (assignees) pay a capital
sum (premium) to the original lessee (assignor) in order to acquire
and enjoy the rights (and obligations) of such agreements.
In ETI's experience, the vast majority of all
tenants and lessees accept and abide by the terms of the contractual
agreement they have made, regardless of the trading conditions
they face and at ETI we remain convinced that the leased and tenanted
business model continues to represent an unparalleled opportunity
for entrepreneurial licensees to create a business generating
real profit and long term value.
ETI'S RESPONSES
TO THE
CONCLUSIONS AND
RECOMMENDATIONS OF
THE TRADE
AND INDUSTRY
SELECT COMMITTEE,
PUBLISHED ON
21 DECEMBER 2004
6. TISC observations and recommendation regarding
the detrimental impact of listing and marketing fees. (Para 53
)
— ETI has never levied listing or marketing
fees on any supplier of any products offered for sale to licensees.
The extensive portfolio of drinks available for sale is selected
according to customer demand, product quality and logistical considerations.
7. TISC observations and recommendation regarding
product range and consumer choice. (Para 61)
— ETI recognises the benefits of providing
choice to our licensees, who are able to select from a vast range
of drinks products, sourced from local, regional, national and
international producers.
— Since acquiring former brewery-owned
estates, ETI has massively increased the range of drinks available
to all pubs, from all brewers, now comprising 11 standard lagers,
18 premium lagers, 59 keg ales, three stouts, 98 premium and standard
cask ales, plus 1,391 cask ales from small independent brewers
(SIBA), 22 keg ciders and 106 different packaged beers and ciders.
8. TISC observations and recommendation regarding
access to market from small, independent brewers. (Para 66)
— ETI recognises the contribution that
small, independent brewers can make to the range of beers on offer
in local, regional and national markets.
— Cask ale continues to represent almost
13% of all beer and lager volumes sold in ETI pubs, almost double
the national average and by working closely with the Society of
Independent Brewers (SIBA) through their direct delivery scheme,
312 local breweries have supplied almost 1,400 different beers
to ETI pubs in the last 12 months.
11. TISC observations and recommendation
regarding repairing obligations and dispute resolution. (Para
90)
— ETI has a dedicated resource in place
to manage the company's repairing obligations and to conduct a
formal programme of property repair inspections to ensure that
both parties' obligations are effectively discharged.
— ETI has also introduced mechanisms
(dilapidations bond and repairs fund) by which outgoing assignors
and incoming licensees can ensure that their repairing responsibilities
are discharged in full without fear of recourse.
— Our existing Code of Practice provides
a straightforward escalation mechanism by which tenants may seek
to resolve disputes arising from any aspect of their agreement
with the company.
— In the event that we fail to agree
on the important matter of rent, our practice is to refer the
dispute to independent experts or arbiters.
— In the 24 months to September 2008,
out of 2,687 rent reviews completed, just 15 have been referred
to independent determination for settlement, of which nine have
now been settled.
— Arbitration should remain an instrument
of "last resort" and we are encouraged that its infrequent
occurrence would indicate that our existing escalation mechanisms
operate effectively. In the event that arbitration is necessary,
we try to ensure that the burden of costs reflects the outcome.
— ETI has worked extensively with the
British Institute of Innkeeping during 2008 with the objective
of producing a low risk, low cost, fast track solution to the
independent expert determination of rent and expects to launch
this over the coming months.
12, 13 and 14. TISC observations and recommendations
regarding information disclosure upon initial let or assignment
(Paras 103, 104, 105 and 106)
— ETI provides, and draws to the attention
of prospective licensees, extensive information relating to individual
outlets before any decision to proceed with a lease is required.
We do recognise our responsibility to ensure that tenants take
proper notice of all the information provided, including professional
advice where appropriate.
— A high standard of due diligence
is required in respect of the information provided and received
during a lease assignment and best practice indicates that the
assignor's profit and loss account and a full property survey,
should be the minimum requirement for disclosure purposes.
— The ETI Retailer Pack and the ETI
Guide to Assignment, (for both assignors and assignees), clearly
detail the actions that all parties (including the Company) should
take and the conditions that we expect to be met if we are to
grant an initial lease or give our consent to assign.
— ETI regularly refuses consent to
assign until such time as the incumbent licensee (assignor) has
fully complied with the defined repairing responsibilities under
their lease agreement, thereby ensuring that a new licensee (assignee)
commences occupation in a building which is fit for purpose.
— Since 2004, all new ETI agreements
include an express clause which enables the Company to refuse
consent to assign unless the assignor provides prospective purchasers
with a minimum of two years accounts. In all cases on assignment
(even of a lease which predates 2004) we interview prospective
assignees and, acting reasonably, would withhold our consent to
assign if we have any doubts about the ability, preparedness or
standard of due diligence of the assignee.
15 and 16. TISC observations and recommendation
regarding the use of independent professional advice. (Paras 110
and 111)
— ETI strongly advocates that prospective
licensees should seek independent professional advice (financial
and legal) before entering into an agreement and we provide new
entrants with a list of independent solicitors who are familiar
with our agreements.
— During 2004, ETI introduced measures
to make the requirement to take such advice an enforceable condition
of purchasing an ETI agreement through assignment, such that all
new licensees at assignment must prove that their business plans
have been reviewed and signed off by an independent financial
advisor. Since the introduction of this mandatory condition, almost
2,700 assignments have occurred.
— ETI will also contribute £250
towards the costs of financial advice, for prospective licensees
who progress to completion of an agreement, utilising one of a
list of independent firms of accountants.
— ETI has developed a new tenancy agreement,
in which the continuing utilisation of a qualified trade accountant,
to provide effective management information and financial controls,
is a mandatory requirement of the agreement.
17 and 18. TISC observations and recommendation
regarding prices paid for drinks supplies. (Paras 124 and 125)
— Discounts available in the market
are broadly understood across the industry. However, the specific
prices paid by ETI to its suppliers should have no bearing on
the decision-making process for a tenant or lessee. The critical
information required to enable a tenant to produce a business
plan is the price, net of discounts, that the tenant is to pay
for supplies.
— ETI operates a variety of permanent
discount schemes on beers purchased from the company and approximately
60% of licensees currently derive some benefit from these schemes,
which are contractually protected under their agreement. (This
excludes temporary discount concessions granted during a period
of financial assistance.)
— The proportion of an ETI licensee's
turnover accounted for by drinks purchased under the tie has reduced
from approximately 61% (2005) to 55% of turnover in 2008. During
this period, food sales, as a proportion of total sales, have
grown from 17% to 21%. Profit from sales of food, as a proportion
of total profit, has increased from 22% to 26%.
19 and 20. TISC observations and recommendations
regarding the tie for amusement with prizes (AWP) machines and
the allocation of machines share between tenant and landlord.
(Paras 129 and 132)
— The Select Committee concluded, correctly
in our view, that "the machine tie improves tenants' takings
from AWPs" and industry research clearly demonstrates that
there are benefits in terms of absolute and shared income, security
and transparency, derived from ETI's involvement in the management
and administration of machines. (Average takings in free-of-tie
machines are 26% lower than in tied machines—source: National
AWP supplier)
— However the Select Committee subsequently
made its recommendation to remove the tie for amusement machines
based on the statement that "free-of-tie tenants make more
money... from machines than tied tenants do...". As free-of-tie
tenants receive 100% of takings, whilst ETI tied tenants receive,
on average, 50% of takings under their contract, this finding
is self-evident, but does not provide a valid rationale for the
removal of the machine tie, nor does it consider the consequences
of doing so.
— ETI operates a variety of machine
tie agreements, ranging from entirely free-of-tie to sharing approximately
50% of the net takings. These alternatives are made clear to prospective
licensees and can therefore be fully accounted for in their evaluation
of the earnings potential from machines, its contribution to house
business profit and its relationship to the total rent charged
for the business.
— Under existing tied machine sharing
arrangements, the impact of the decline in income from amusement
machines in pubs over recent years, exacerbated by the proliferation
of other forms of accessible gaming (notably in betting offices,
on TV and via the internet) has been shared equally between ETI
and its licensees.
— 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.
— During 2007, ETI introduced new share
terms on AWPs, whereby the company carries all of the costs associated
with the provision and operation AWP machines. These terms have
proved to be very effective in removing the risk of high-cost,
low income machines to licensees and there are already 1,696 pubs
with machines operating on these terms.
21. TISC observations and recommendation
regarding rent valuation (Paras 144 and 145)
— ETI is obliged to assess the value
of rent having due regard to the terms of the lease. This is not
an accountancy exercise, but a valuation of Fair Maintainable
Trade, constructed according to guidelines laid down by the Royal
Institution of Chartered Surveyors and taking account of local
market conditions and prospects.
— The assumptions used in the construction
of rent calculations are disclosed to licensees, together with
an estimated and summarized profit and loss account which supports
the rent assessment. This should never remove the responsibility
for tenants to produce their own detailed assessment and business
plan and ETI's Code of Practice clearly details the rights and
responsibilities of both the company and licensees in relation
to the provision of information.
— However ETI disagrees with the recommendation
that a detailed profit assessment should form an addendum to a
lease (on the basis that it would supposedly improve transparency).
It is those assumptions which support the assessment of rent at
the date of review which are pertinent, not those used at the
time of an earlier assessment, whether such review is contractual
or as a result of a Code of Practice request. It is also common
business sense that any prospective licensee should take responsibility
for the proper preparation of a meaningful business plan supporting
the rent that he is agreeing to pay for the pub that he has chosen.
— ETI believes that its approach to
the assessment and negotiation of rent is open, transparent and
fair, as reflected by the extremely small number of rent reviews
that are referred to independent experts for determination, or
remain overdue for settlement. Unsustainable rents are completely
counter-productive, resulting only in dissatisfaction, instability,
increasing the risk of business failure and greater cost to ETI.
22. TISC observations and recommendation
regarding upwards only rent review (UORR) clauses. (Para 151)
— ETI confirmed to the 2004 inquiry
that it does not enforce any upwards only rent review clauses
in any agreements in which such clauses were present and had not
done so since 1997.
— Furthermore, all ETI agreements developed
since 1997 do not contain an UORR clause, but provide that the
rent will be assessed at market value upon review, whether that
is above or below the passing rent.
— Since 2004, ETI has conducted 4,690
rent reviews 3,718 of which contained an express UORR clause which
was completely disregarded. The average annual growth in rent
arising from rent reviews throughout this period was below inflation
at approximately 2.5%, including 162 reviews which resulted in
a permanent rent reduction.
23 and 24. TISC observations and recommendation
regarding sustainable rents and concessions. (Paras 158 and 162)
— Through its fair rent policy and
Code of Practice, ETI always seeks to ensure that rents are reasonable
and sustainable, that its assessment of Fair Maintainable Trade
is balanced and that tenants are treated fairly.
— ETI acknowledges the subjectivity
of both parties in the determination of Fair Maintainable Trade
and a consequential assessment of rent, but would contend that
the wealth of competition and comparable evidence available to
the market ensures that ETI's approach to rent is fair and sustainable.
— ETI's Code of Practice entitles any
tenant, at any time, to request a review of rent should circumstances
materially change. In the 12 months to September 2008, ETI has
received and completed its evaluation of 37 requests for a Code
of Practice review. Eight of these were declined and 29 have resulted
in a permanent reduction in rent.
— In appropriate circumstances, ETI
will offer non-refundable rent concessions or temporary trading
discounts to support licensees who are experiencing short-term
financial difficulty. Unsurprisingly, ETI will only provide such
support where a licensee can demonstrate full compliance with
all the terms of their agreement, the maintenance of excellent
retail standards and the preparation and disclosure of detailed
financial information which demonstrates sound business controls.
— In the 18 months to September 2008,
approximately 1,800 pubs have received direct, non-refundable
financial assistance in the form of discounts and/or rent concessions,
at a cost to the company of approximately £12 million to
help them during current trading circumstances.
25. TISC observations and recommendation
regarding licensee training. (Para 165)
— ETI strongly advocates the importance
of training to prospective and existing licensees and, recognising
that cost is a potential barrier, provides a wide range of flexible,
low-cost and accessible training solutions, together with a money-back
guarantee in the event that delegates believe that the course
has failed to deliver its value-adding objectives.
— The range of accessible training
solutions available through ETI continues to grow and attendance
levels are stable. Our money-back guarantee applies to every training
course and to date there have been no applications for the reimbursement
of course fees.
— In 2006, ETI introduced the mandatory
condition that all applicants for ETI pubs who do not have existing
qualifications or a track record of successful operation in licensed
premises, must attend the 5 day Business Foundation Programme,
covering health and hygiene, employment law, basic financial management,
marketing, merchandising and cellar management. In the last 12
months, over 600 delegates have attended the programme.
26. TISC observations and recommendation
regarding the role and performance of business development managers
(BDMs). (Para 171)
— ETI believes it has been able to
attract, train and retain a highly professional and experienced
team of managers, who seek to uphold the values and standards
expected of them, whatever situation they face.
— ETI has invested significant sums
in the training and development of its operational management
teams and continues to do so. This includes the National Industry
Training Awards (NITA) award-winning Associate Regional Manager
programme, where candidates undertake a rigorous six month (minimum)
training schedule before the prospect of taking up an operational
role arises. Furthermore, the Association of Licensed Multiple
Retailers (ALMR) has recently named an ETI Regional Manager as
its 2008 Operations Manager of the Year. Five other ETI Regional
Managers had also been considered in the final evaluation stages
of the competition.
27. TISC observations and recommendations
regarding tenant support and complaints procedures. (Para 177)
— The provision of high levels of service
represents good business practice and is an important differentiator
for ETI versus its competitors. Unlike many business franchise
agreements, ETI does not force licensees to utilise any specific
services and does not charge additional franchise fees for any
of the services provided.
— The efficient and effective handling
of complaints also represents good business practice and the company
operates an escalation procedure which helps to ensure that complaints
can be resolved to the satisfaction of both parties. These principles
are detailed and enshrined within our existing Code of Practice.
— Howsoever received by the company,
all written complaints and the company's responses to them are
reviewed by a Board Director.
28, 29 and 30. TISC observations on the balance
between the costs and the benefits of the tie. (Paras 188, 198
and 199)
— ETI concurs with the Select Committee's
assessment that the tie usually balances the costs and benefits
available to tenants and that the existence of the tie provides
demonstrable benefits to both tenants and customers alike. In
drawing this conclusion, the Select Committee's observations are
consistent with those of each of the 8 previous reviews conducted
by various regulatory bodies since 1969.
— ETI acknowledges and has to contend
with, the main argument it faces from detractors of the tie, who
may selectively highlight the difference in prices charged for
tied products (when compared with those available in the free
market) whilst taking little or no account of the many other tangible
and intangible benefits which the Company offers.
— ETI also has to contend with the
disingenuous interpretation, by campaigners such as Fair Pint,
of elements of the TISC (2004) inquiry in relation to the tie.
This includes the promotion of the entirely false notion that
TISC (2004) concluded that "the tied tenant should be financially
no worse off than the free of tie tenant", thereby completely
ignoring the many other benefits which the TISC (2004) review
recognised were provided by the pub companies.
— ETI is continually developing the
range of services and support mechanisms available to licensees,
but does not expect every licensee to place equivalent (or even
any) value on every individual element of support offered.
— As described in the introductory
paragraphs to this submission, the strength of the tenanted and
leasehold model and the positive contribution of the tie towards
the alignment of interests between ETI and its licensees has never
been more obviously and demonstrably evident than during the current
period of weak consumer demand and challenging trading conditions.
31. TISC observations and recommendation
regarding Codes of Practice. (Paras 203 and 204)
— ETI supported the recommendation
that a comprehensive industry-wide code of conduct should be developed
by the industry's trade associations, drawing on all the best
practices of landlords and licensees and is aware that such an
exercise was completed by the British Beer and Pub Association
(BBPA) on behalf of its members. However, it is important to note
that approximately 12% of UK tenanted and leased pubs are owned
by companies and individuals who are not members of BBPA and therefore
not subject to its framework code.
— The ETI Code of Practice is an essential
part of the proposition we make to prospective licensees and is
regularly reviewed and updated to ensure that the Company is competitive
and remains at the forefront of best practice.
— ETI was a prime mover in the establishment
of the British Institute of Innkeeping Benchmarking and Accreditation
Service (BIIBAS) and was the first company to submit its Code
of Practice for accreditation, which was subsequently received.
BIIBAS has confirmed that, since its accreditation, there has
been no occasion on which there has been cause to contact ETI
regarding a complaint that a breach has occurred.
29 September 2008
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