Pub Companies - Business and Enterprise Committee Contents

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


    —  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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