Memorandum submitted by the Progressive
Pub Company (PPCL)
PPCL is a small pub owning company based in
Huddersfield, West Yorks. We purchase pubs within two hours drive
of our base, principally in the conurbations of the North West.
The majority of our estate is wet led community
pubs.
All our pubs are let to self employed tenants.
We impose a limited tie on draught beer and
cider and take no money from the machines
SUMMARY OF
POINTS MADE
— The tie is beneficial to both sides.
— Unilateral alteration of the fundamentals
will have unexpected deleterious consequences.
— Increased regulation will not improve
the workings of the pub letting market.
I am aware the Committee has all the evidence
from the previous enquiry and therefore apologise if I restate
things already covered but I feel it necessary to put some markers
down as to how we have arrived at the current situation, these
are:
— The pub industry is probably undergoing
its worst recession since the Second World War.
— Since the tied estate beer orders
the majority of pubs are now owned by stand alone pubcos rather
than vertically integrated pub owning breweries.
— Over the last 10 to 15 years there
has been a massive increase in pub capacity with 10s of 1,000s
of square feet of pubs being added, principally in town centres,
each one of which is equivalent to five to 10 ordinary community
locals.
— There has been a huge shift in drinking
habits from controlled "on sales" to home consumption
of "off sales", this driven by an ever widening gap
between the retail price "on" as against "off",
and also by a social demographic shift away from heavy male dominated
industry where leisure was principally football and pub to a far
more diverse situation now.
— Government has recently adopted two
measures which are highly damaging to the "on" trade:
The smoking ban has had a huge effect on alcohol sales in pubs;
the deliberately high duty increase has disproportionately affected
the pub trade.
— The vast majority of pubs are not
capable of introducing food profitably.
Against this background the important thing
is to ensure that no inadvertent harm is done to the industry
by drawing false conclusions.
Firstly can I address the contention that it
is the pubco model that is principally to blame for the current
crisis; this is demonstrably not so.
Many of these companies are formed out of the
tenanted divisions of older breweries. Their operational staff
in many cases are from that background, the agreements they operate
are based on brewery style ones from before the Tied Estates Beer
Order (TEBO), Brewery tied tenants are not noticeably better off
than pubco ones (indeed given the further restrictions on what
they can stock they may well be in a worse position) The dynamics
of the arrangement are such that it is in the pub owning companies
interests (probably more so if it is a pubco than a brewery) to
ensure the viability of their customers. Breweries were little
if any better thought of than pubcos (hence the TEBO).
There have been suggestions of limiting the
number of pubs a pubco can own. This strange way of thinking that
size is a determinant of quality and big is bad, whilst quite
seductive in many ways, we know personally is not always true
and where there is a need for substantial backup for struggling
businesses clearly the reverse is true. In any case how do you
determine what figure is good and what bad, it would be completely
arbitrary and would have unintended consequences (witness the
TEBO).
Why then do pubcos have such a poor reputation?
There is undoubtedly a way in which we all blame the nearest target
for our ills. The crunch brought about by the rising supply of
pub space the steady decline in demand, suddenly accelerated by
government action, coupled to a economic slowdown has undoubtedly
produced a crisis in the industry. Have the pubcos contributed
to this? In as much as there is another entity sharing the economic
risk of operating the business they are undoubtedly shouldering
part of the burden: The principle asset of a freehouse is the
capital value of the property. This has taken a huge knock in
the last 12 months, leaving anyone in a freehold freehouse many
tens of thousands of pounds worse off. If they are in the lucky
position of having low borrowings they can probably survive. Though
as they are much more dependent on "wet" profit, as
they make much more on a barrel than a tenant, it may be the case
that many are barely surviving. With the credit crunch they will
be unlikely to borrow their way out of trouble against the reduced
capital value, evidence for this can been seen in the increased
number of freehouses up for sale or shut for conversion.
Why then the uproar against pubcos? It is certainly
the case that over the last five or six years there has been a
considerable concentration in the pubco market. Most now adopt
similar tied policies and similar management techniques with their
customers. I would contend that the problem with them is largely
due to their inefficiency not with the basic model.
Take the tie; for beer and cider the pubcos
are much more capable of extracting discounts from producers than
individuals are, so by using their buying power the pub as a unit
is more profitable, they create value. Removal of the tie on beer
and cider would destroy value in the pub and transfer it to the
producer. How much of this increased profit if any should accrue
to the tenant is a moot point which I will return to. Where the
tie is extended to wines and spirits these large companies can
hardly buy bottles at the prices supermarkets retail at, add on
the necessity to deliver it and administration and the net result
is an overall diminution in the profit of the pub, thereby destroying
value.
The tie on machines in the way it is presented
(a share of profit after rent) is also beneficial; maximising
income is a statistical exercise which an individual cannot do.
Unfortunately the practice of inflating the rent to the benefit
of the pub owner has gone from an administrative charge to cover
their fixed overhead, to now a major source of income, and neatly
demonstrates the disincentivising effect of swapping a variable
cost (part share) for a fixed one (rent).
If the current malaise is part due to government
legislation; part due to economic circumstances largely beyond
the control of either government, tenants or pub owners; and partly
due to inefficiencies in the pubcos: to attempt to cure those
ills by focusing on only one part of the problem is very unlikely
to produce a cure, indeed given the track record so far intervention
in this market is likely to produce unintended results.
I would certainly predict that any change in
the regulatory framework is most likely to accelerate the rate
of pub closure. Of particular concern would be the removal of
the tie. If the pub owner can no longer directly benefit from
any increased trade the pub may generate from improved performance,
as the rent will have already been set, there is a huge disincentive
to them to invest any further resources into the building. This
will leave anyone on a free of tie lease essentially to their
own resources, the community of interest between landlord and
tenant is broken and the situation many licensees castigate their
landlords for adopting will be forced upon them namely they will
solely be interested in collecting the rent, not in ensuring the
long term welfare of the business. Any opportunity to realise
the capital value for alternative uses will be taken, as there
is no prospect for enhanced income from the property as a pub.
There are suggestions that if the tie is removed
rents will not raise by the same value as the discounts the tenant
receives from a wholesaler as the current formula for deciding
rents (50% of net profit before rent) would only allow a raise
of 50% of the tenants increase in profit.
Leaving aside the iniquity and possible illegality
of the government depriving a business of its legally acquired
profit; this whole system is predicated on the landlords having
a clear knowledge of; not only how much that individual pub is
doing but also of how much similar pubs are capable of. This whole
structure breaks down without the tie, and eventually pubs would
have to be let in a similar manner to other commercial property,
generally speaking on comparable rents.
There would be no assessment of sustainability.
For evidence of what the likely outcome would be we need to look
at the only substantial body of pubs let on such commercial leases,
which are in town centres, predominantly to managed house operators.
These are also largely comprised of the companies responsible
for the huge rise in capacity I mentioned earlier. These companies
run the largest units, in centre of the city centre circuit trade,
they have very large turnovers and command top discounts from
suppliers, particularly as their venues are seen as opinion formers
for brand consumption.
Surprisingly a number of these are in severe
financial trouble and several have gone to the wall. The commonest
reason being the unsustainable nature of the many of the rents
they face and the unwillingness of their landlords to negotiate.
These are generally speaking the most at risk pub operators, and
their experience of free of tie leasing is not encouraging.
There are of course individual cases of free
of tie lease being highly beneficial to the tenant, but these
are usually special cases of non-commercial landlords, or where
there may be special circumstances. Generally speaking these pubs
are in extremely poor state of physical repair as neither the
landlord or the tenant has an incentive to look after the building.
Having demonstrated that the tie is beneficial
to both parties, there is then the question of the pricing of
the tied products.
Pubcos are charged with grossly overcharging
their tenants, and it is undoubtedly the case that they could
purchase the products much more cheaply elsewhere. However is
it really in the tenant's interest to swop produce profit for
rent. I would suggest it clearly is not. The cost of products
is the only truly variable input into a pub and to decrease it
in favour of fixed overhead such as rent is to court disaster,
particularly in a declining market. Making themselves ever more
reliant on a diminishing market is bound to come unstuck eventually,
even if consumption returned it still would not be sensible, as
trade is never consistent and high fixed overheads play havoc
with cash flow.
How then are current prices arrived at? Quite
extraordinarily they are determined by the brewers. They announce
the wholesale prices and when they are going to increase. Do they
do so in collusion with the pubcos? I do not know. I presume to
do so would be illegal. It is however a very strange way of pricing.
When they announce the increase they cannot pass it onto all their
customers. The big pubcos just like the big supermarkets have
annual pricing contracts with the brewers and so they do not suffer
the increase straight away. Many of the pubcos have contracts
with their tenants that oblige them to pass such increases on
directly, so the pubco pockets the rise. It is very hard to tell
who is paying for these increases but they certainly fall hardest
on the smallest customers, just the people many tenants are asking
you to turn them into.
Should pubcos discount the beer to their customers?
Given that very few people actual pay a brewer their wholesale
price there is a fair case for suggesting a realistic price is
lower than full wholesale but how much lower can only be left
to the commercial judgment of the company involved. I have to
say I have found it strange that the biggest two pubcos offered
the worst discounts until recently, when they could have been
using their size to give their customers an edge in the market
place, but the effects of that sort of poor decision making are
clear to see in their share price.
This last point clearly shows that the most
effective method of regulation is the market place. Investors
will punish poor performance; if the current arrangements are
detrimental to the industry then they will disappear as companies
that use different ones prosper at the expense of the current
incumbents. Or more likely those current incumbents alter their
business practices to bring about a more optimal position. One
thing I am pretty sure of is that, that will not involve removing
the tie from beer and cider, and another thing is that it would
be disastrous for the industry if it did.
Turning to the more specific issues the committee
are considering namely the effect of the new licensing arrangements
and of the last TISC report.
Commercially I have not found the new licensing
arrangements have made any great difference. The freedoms allowed
have not led to any great alteration in drinking patterns, local
councils can, as always, vary in their interpretation of rules,
but as one of the objectives was to allow more local input into
licensing decisions, then variety was seen as positive good.
There is always a potential conflict between
a pub and the population surrounding it, as by there very nature
they encourage people to enjoy themselves at times when others
are wishing to be quiet, particularly if they do not wish to use
the pub. So far I have not encountered any unreasonable requests
and the situation is not noticeably different from the magistrates
system.
Administratively it is both better and worse.
The system for changing the licensee is much better. The system
for becoming a licensee is more difficult, and does lead to a
certain inflexibility of operation. The process for changing licensing
conditions is very time consuming and prohibits flexibility to
changing circumstances.
The last TISC report did not directly affect
our company, bit I am concerned that too rigid implementation
of its recommendations would be detrimental.
Banning machine income sharing (though I do
not take a share myself) would I believe once again work to the
detriment of the trade, by depriving the overall pub unit of profit,
the practice of increasing machine rents to enhance pubco profits
could well do with some light shedding on it, but this was not
a point the committee originally investigated. It could be recommended
that any such pubco machine rent should be clearly stated.
Full disclosure of relevant information including
how rents are calculated will definitely benefit the current major
pubcos. I am sure they will all provide you with copious documentary
evidence that that is exactly what they do. Indeed this sort of
tick box culture serving central office needs is another of the
traits that differentiate the current incumbents from their predecessors
and has not in my experience led to either improved corporate
performance or customer relations. For small operators such as
us it will be yet another regulatory burden we could do without.
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