Friday, 5 July 2013

Storm In A Beer Mug?

The trade press and the multitude of online fora (or is it forums) have been quite exercised this past week with the findings of an investment analyst's research and opinions on the just closed government consultation into the pubco/tenant relationship.

I wasn't sure why this piece of research and analysis has caused quite so much furore even though it's authored by one of the architects of the current pubco business model, one Nigel Parson, who now earns a living under the banner of Dryburgh Research. I say "wasn't sure" about all the fuss until I began to dissect the analysis and concomitant opinions expressed.

It didn't take me long to realise why Parson has so upset the cyber-sphere of the pub trade as the first sentence of the report goes like this:

"We  are  astonished  at  the  government’s  intervention  in  business-to-business  negotiations that  are  freely  entered  into, with  no  overt  consumer  angle"

I think thousands of tied pubco tenants, their customers and CAMRA might disagree with this astonishment and Parson's premise of "no overt consumer angle" ... even thought the latter's super-complaint to the OFT failed, common sense dictates if a tied tenant is paying on average 1.6% more in turnover for their dry rent (property only rent) than their free of tie counterpart whilst paying often twice or more for their beer under the tie then the consumer drinking in a tied pub might just be disadvantaged by the pricing a tied tenant has to achieve to make a profit compared to the bar prices of a free of tie operator.

The report goes on to claim the government intends to "shift up to £234millions of profit from landlords to tenants" with a range in benefit for tenants of nil to the average of £4,250 and in some cases up to £9,750. This would be great news for the 80% of tenants who earn less than £10,000 a year from their pubs (according to the recent CAMRA survey carried out by respected pub industry research company CGA Strategy). My guess, from the dozens of calculations I have undertaken for pub clients using the government's sample Rent Assessment format in the pubco consultation is this may yet still prove to be a conservative estimate.

The report bemoans the potential drop in profits before tax for companies most likely to be affected by a 500 pub estate floor.... 65% for Punch, 41% for Enterprise, 18% Marstons, 9% Spirit, 8% Greene King. Surely these profit warnings alone, especially for the first two companies is just proof of their rampant profiteering and another justification for government intervention into the pub trade.

As the consultation does not call for the abolition of the beer tie, rather a guest beer provision, free of tie option (emphasis on the option) and open market rent assessments I am somewhat bemused at Parson's assertion of these consequences:

"we would expect them to go completely free-of-tie, trigger rent review clauses, remove all SCORFA benefits, sell hundreds of smaller pubs and convert to REITs"

Ignoring the issue of REITs (Real Estate Investment Trusts), which bigger brains than mine understand or care about, would a renewed equilibrium of risk and reward hoped for by hard-pressed tied tenants really push the likes of Punch or Enterprise to go completely free-of-tie? Would tied tenants really miss the benefits of the pubcos so-called "SCORFAs" if they were withdrawn? Would hundreds of smaller pubs be sold off? 

(See bottom of article for a note on SCORFAs if you don't know what they are)

If the pubcos had only moved somewhat on a "fair divisible profit" by passing some of their gargantuan beer discounts on to tenants and set more realistic Fair Maintainable Trade(FMT)/Rent Assessments then perhaps this whole consultation would have never taken place. However, the pubcos continued to gouge their respective tenants, relying on the transfer of tenant assets to the pubcos through the mechanism of "churn" whilst claiming any protest was from a minority of failed (read bad) publicans or vociferous malcontents. Their corporate greed has undone them, the buying spree resulting from the exit of brewers from the pub-owning property market as a result of the original Beer Orders and the speculative bubble this fuelled has resulted in billions of pounds of unsustainable debt, which, if applied to an SME such as pubs would result in insolvency, but due to the vagaries of accounting has meant these behemoths have continued to trade in their current "zombie" state. (See graphic below courtesy of LifeLongLandLady) 

More likely is the increase of tenant discount to compensate for high rents, thus redressing the balance of risk/reward giving the pubco the best of both worlds, high fixed dry rents and lower variable wet rents (read the opposite for tenants). Not perfect but it would be a step in the right direction and would go some way to justifying the pubco mantra of "low cost entry" for their business model. 

I believe the most contentious of issues is the SCORFAs using the BIS impact assessment figures for the consultation these are valued in the range of £1,500 per pub per annum, to the mid-point of £7,500 and in some cases as much as £10,000. I think what scares the pubcos so much isn't the issue of high rents and high beer prices being put under the microscope by the pubco consultation, after all the figures relating to these tenant costs are well within the public domain, it's the possibility they will have to clearly identify and accurately quantify the benefit of SCORFA in the setting of rents. Perhaps Tuppen and other gravy-train drivers have suddenly realised they cannot justify the "added value" they bring to their respective "partnerships". After all, I would say the average tenant (and I daresay investor) would like to know exactly what benefit these handsomely rewarded pubco executives and managers bring to the table.

As for selling off hundreds of smaller pubs I'll keep it simple for you, the pubcos, the estate agents and the government... BRING IT ON! Without the ever-expanding belly of corporate pubco greed to feed I reckon many of these smaller pubs would suddenly become viable. There are plenty of examples of ex-pubco pubs (large and small) who have made a go of it once relinquished of the burden of pubco "management" and debt servicing. Unfortunately, some of these smaller pubs will not be viable, for instance land-locked, wet-led pubs which have suffered so disproportionately since the introduction of the smoking ban and having to endure what is still the second highest level of alcohol duty in the EU. Whilst I decry their conversion to other retail or residential or demolition this may be a small price to pay for bringing fairness to the tied pub sector.

One thing I have noticed is the increasing reliance of pubcos, their agents and spokespersons on what is becoming their new mantra of "unintended consequences" and the Dryburgh Research report is littered with "examples". Now, I don't know it Parsons is in the pay of pubcos but it strikes me some of his analysis is scare-mongering of the worst kind. "If the pubcos go under this will mean the end of pubs and brewing in the UK" seems to be a developing theme, just witness the chief pubco stooge Brigid Simmonds and her various utterances on the subject.

The Dryburgh report " would  expect  higher  business  failures  among  tenants  as  the  higher  fixed  rent increased  the  operational  leverage  on  their  businesses.  The  tie  is  a  ‘safety-valve’ where  profit  and  risk  are  shared.  If  a  licensee  sells more  beer,  they  pay more  ‘wet rent’, whereas in hard times they pay less."  I would argue the only time the "safety-valve" works is when the initial 'dry rent' is based on reasonable FMTs and when beer pricing is not designed to punish the tenant whether their respective beer sales are in decline or growth.

Parsons goes on to say he would expect "most of  the  profit pool  released by pubcos going to free-of-tie to flow to the major brewers, and not to tenants. We would expect brewers to increase wholesale  prices  to  reflect  the  higher  costs  of  servicing  small  customers  with  little purchasing  power,  and  consolidate  their  efforts  behind  fewer  brands  to  extract further economies of scale." This bears special attention as it flies in the face of evidence. So going free-of-tie would result in major brewers gaining the benefit? So no chance of smaller brewers actually picking up volume from pubs who are crying out for locally brewed beers? No chance the margin smaller brewers might generate from their brewing would increase without the pubco mouth to feed? And absolutely no benefit to the tenant in having to pay significantly less for their beer or from their respective customers being able to afford even one pint a week more in the pub?

How silly of me, of course it will go the way Parsons predicts, as ordinary tenants (who let's face it are no good at business or the pub trade wouldn't be in the mess it's in if they were even half-decent entrepreneurs) don't have the wit or expertise to either join one of the many buying groups or set one of their own up? Parsons brings a new understanding to the word "patronising" with this drivel. If one can have an economic "fact" it's that pricing is determined by demand and if the demand for globally brewed beer diminishes as consumers and their hosts turn to craft, cask or locally brewed keg then I'll bet you'll see some quite aggressive discounting by the big brewers.

The same can be said for his assertion "some of the weaker, mid-scale family brewers to exit and close their breweries as a consequence of loss of protected route to market. The micro-brewers are flourishing, helped by tax breaks and consumer demands but the major brewers seeking to foreclose the market could squeeze them hard." One can almost imagine Jonathon Neame hovering over Parson's shoulder as he typed this gem. With an ever-more sophisticated consumer base, especially the "Gen X/Y" and "Millenials" influencing many market places including the hospitality sector does Parsons really think the current mood of localism, artisanship, sustainability is just a flash in the pan and we're all going  back to drinking Double Diamond? I would posit the smaller brewers (whether pub-owing or not) will more than take care of themselves if they provide their tenants with a reasonable balance of risk and reward as envisaged under a regulatory regime. 

I'll even go one step further and say that the likes of the SIBA direct delivery service will blossom if the market is freed up from pubco domination... who knows they might even buy their own logistics company to service the demand for over 6,000 brews from over 1,000 brewers who have restricted access to some 24,000 tied pubs.

There's precious little I agree with in the opinions expressed by Parsons, however, I can agree with this:

"Unlike the ‘Guest Ale’ provision that was abolished with the recall of the Beer Orders in 2003, there is no definition of type of draught product. Hence, it is fair to assume that the tenants would  opt  for  their  most  profitable  line.  A  standard  lager  (Carling,  Carlsberg,  Foster’s, Heineken,) could amount to as much as 30% of draught sales. The international brewers would not care if this option were to be endorsed by government."

He's absolutely right about that, global drinks companies, for all their PR spin,  don't give a toss where their product is sold, hence their complicity in the scandal of deep-discounting and "pocket-money pricing" in the off-trade. To borrow the pubco mantra of "unintended consequences" perhaps a shift from off to on-sales brought about by tied tenants being able to make a living whilst still reducing the price they have to charge their respective customers wouldn't be a bad thing.

I sense, dear reader, your interest may be waning at this point, so off you go and make a cuppa/crack open a beer... but I promise we're nearly done and it's about to get interesting.

Parsons next talks about "abolishing the machine tie proposal" as he vainly tries to defend the SCORFA of the machine tie

"A pubco can vet an operator to ensure they are reliable operators and ensure better quality of service than a tenant might be able to procure.

Governments originally supported the machine tie as a means of protecting individual operators  from  criminal  elements. Machines  can  also  be  used  in money  laundering scams. 

Pubcos  can  use  estate  trends  to  influence  the  introduction  of  new models  and  the rotation of machines positively with the aim of optimising income. "

I will refer Parsons and the pubcos to the Independent Operators Association who number some 14 machine operating companies who list as their customers (yes you guessed it) the likes of Greene King,  Wetherspoon, Marston's, Punch, Star to name but a few. So all the "expertise" the pubcos offer can be found elsewhere. And without the "rebates" and "discounts" the pubcos demand from operators in addition to the split they take from tenants, I would hazard a guess that tied tenants freed from pubco "management" would make a little more from their machines than they do now and certainly enough to allow pubcos to increase the dry rent to compensate for some of their lost income. How about this for an "unintended consequence"? It might even allow the pubcos to slim down a bit as their "machine controllers" move out of their offices and into the likes of the IOA.

And finally the issue of beer flow monitoring equipment, one which has vexed tied tenants for a long time not least of all because the major player in the market, Vianet (formerly Brulines), has come under the scrutiny of the not only tenants but the government in its investigations into the pub trade. For a long time Vianet has resisted the call for its equipment to be subject to testing and calibration by Weights & Measures and the National Measurement Office whose raison d'etre is:

"Confidence in trade" - The National Measurement Office (NMO) ensures the UK’s system of weights and measures is fair, accurate and legal so that consumers and businesses have confidence whenever they buy and sell by quantity. Each year in the UK, £622 billion worth of goods and utilities are sold on the basis of the measurement of their quantity."

They've resisted as there is plenty of other independent evidence that proves their equipment is not fit for purpose in the way it is used to quantify "buying out" and were it not for a Tomlin Order preventing me from discussing the testimony of representatives of Vianet in a court case I was involved in I would be able to share some startling admissions... suffice it to say perhaps if it was written into any proposed regulations that pubcos could not use information derived from beer flow monitoring equipment to "prosecute the tie" or within rent assessments then, perhaps the albeit flawed information a tenant can derive from these iniquitous systems might be seen to be of benefit. After all, it's the tenant that pays for these wretched machines and the least they can expect is the equipment can do even the basics, such as differentiating between water and beer flowing over through its meters.

So there you have it out of 13 major points in the Dryburgh Research report only one has any merit, if this were a school report then 1/13 would deserve a resounding F and the admonition "Nigel has a vivid imagination, but he really needs to try harder, if he is to successfully master the interpretation of facts"

But as with opinion I'll daresay there are many who would say the same of me... in any case the sun is shining and I must away to the nearest beer garden as the weekend starts here... cheers!



The  SCORFA principle  says  that  there  must  be  compensating  benefits  to  lessees  (or  free  trade customers) who accept ties or exclusive trading agreements.

‘SCORFA’  is  an  acronym  for  ‘Special  Commercial  or  Financial Advantages’.  The  acronym was first used in EU Regulation 1984/83, the block exemption applied to brewers and pubco ties. Pubcos do not deny  that  their  tied  tenants pay higher wholesale beer prices  than  free-of-tie operators,  but  the  tenant  receives  a  lower  dry  rent  and  special  or  financial  advantages (SCORFA)  to  offset  the  higher  beer  prices. 

Examples  include:  accounting  services,  code  of practice,  design  and  financial  support,  gaming  machine  management,  management  and marketing support, product service support and discounts, rating services and training. 

(I'll leave it to others to explain whether SCORFAs are of benefit to tied tenants, especially as many SCORFAs attract a charge from the pubcos to the tenant for the provision of these "services".)

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