Friday, 21 November 2014

PubCo Reform - A Great Victory or Just Plain Stupidity?

They say it's about time the "other side" got to throw a Punch or two - the way that PubCo's have been running their lease agreements just isn't in the Spirit of ensuring the success and sustainability of Britain's pubs. But have we gone about it the right way, or is our knee-jerk reaction just as slapdash as the running of the PubCos we are trying to break free from? I have deliberately refrained from openly speaking about this issue until now, simply because I feel that it would put my professional relationship with our PubCo at The Wingerworth [Punch Taverns] in a difficult position, but there really isn't any avoiding the matter now.

I met with my own Business Development Manager from Punch Taverns on Wednesday lunchtime and one of the first things he asked me was what my thoughts were on the recent vote in the House of Commons. I honestly told him that I hadn't really kept tabs on it because even if the changes were passed, it probably wouldn't benefit us in the short-term. The stark reality is that only a minor progression has been made in the grand scheme - it will realistically take at least another 3 years for any "benefits" of a free of tie, market rent only option on leases to be seen in the real world. That is, if the decision isn't overturned in the meantime before it becomes law. I do of course have an opinion on the matter and my stance may come as a surprise from a tied pub owner. The future of pubs in Britain is on a knife-edge and we must consider the bigger picture, rather than just the short-term saving that this bill will offer for landlords.

CAMRA have been one of driving forces behind this campaign for over a decade now and believe this vote is a huge victory for British beer and British pubs, but it seems to me that they can't see beyond the end of their own pint glass [and how much it will cost them to refill it]. It must be said that when CAMRA began the campaign, the relationship between PubCo and landlord was very different. The system was certainly abused with [among other things] obscene rent increases through rent reviews and liability orders for costly repairs that weren't mentioned before signing the lease. Since then these practices have ceased, to the degree that the only party able to ask for a review of the rent is the tenant. That isn't to say that the system is fair, it's just more fair than it was. The CAMRA campaign simply hasn't adapted with the times and those organising it were so focused and hell-bent on achieving their goals that they hadn't noticed that the world changed around them.

In order to understand the complex relationship between a PubCo and its tennants, we need to understand one key fact - although the original PubCos were owned and operated by a single brewery, the modern-day PubCo is more akin to a property company so the "cost price" for the product that they sell onto us is much higher than the raw ingredients, had they been brewing it themselves. They have no obligation to a single brewery and before the recession they were simply interested in acquiring as many properties [on credit] as they possibly could. When the recession hit, this left them in a position of mind-boggling debt just at a time where Britain's social habits changed and we began to do most of our drinking at home.

So what does the vote mean for the PubCos, who quite frankly are already on their knees? It was only in August that I was reading about the latest "last-ditch" attempt from Punch Taverns to restructure £2.3bn of their debt, leaving 85% of the company in the hands of bondholders. The big plan from the bondholders is of course to sell assets [pubs] to recoup the losses, probably to large [more] successful companies such as Tesco or even someone like The Restaurant Group, who own Frankie & Benny's, Chiquitos and so on. Or worse, housing developers... Either way, our pubs won't be pubs anymore and this week's "victory" will only compound the issue. Today, Punch's shares are worth about 0.023% of their highest value in June 2007, losing a further 10.9% of their value immediately following the vote this week. So who is going to pay for this dramatic decline in the long-run?

The Daily Mail was quick to announce its opinion that the scrapping of the beer tie is a good thing for the customer because landlords will be able to shop around for the best deals, which ultimately means greater profit for the pub and hopefully a saving for the customer too. But I cannot understand how in reality this will result in a saving for the customer. If pubs are apparently struggling because they aren't making enough profit, surely they would ensure their own financial security before passing on the benefits to the end consumer. Similarly microbreweries will be quick to act in increasing their wholesale prices - the fact of the matter is that there are now more breweries in the UK than ever before and less pubs than ever before. Simple math, simple economics. What it might mean is a better standard of beer - if wholesale beer prices go up, pub owners will be more selective in the beers that they buy so only the best breweries will survive. That said, with higher quality come less choice.

Just to briefly look into a price comparison on a few of our own core lines becomes a complex calculation because of the way in which the rent structure is intertwined with the product purchase price. We are currently on Punch's "PA2" agreement, which entitles us to a [I suppose purely hypothetical] £160 per barrel discount on our draught purchases. This was the option that we chose over their "PA3" agreement, which offers a £100 per barrel discount. In addition, if we were to achieve the [unachievable] annual barrelage target set by Punch, we would see the benefit of a further £20 per barrel discount on any purchase above the target. Sounds good so far, BUT... the "PA2" agreement of course comes with a higher rental valuation, which happens to be just shy of £83,000p.a. at The Wingerworth. The reason we chose this option was because it was more of a known entity - although we made countless projections prior to taking on the lease, in reality we had no idea how much beer we would sell, so the safer bet seemed to be to take a lower beer purchase price, with a higher known weekly rent that we could manage. Once you add in our weekly draught purchases [forget any bottled or soft drinks...] of over £1000, it takes Punch's 10-year income on the site to around £1.4m. Considering that the [one assumes circa £600k] property is mortgaged, and that they spent almost that again on the refurbishment, I don't think it is that unreasonable.

However, it must be noted that Punch have coined the phrase "fair maintainable rent" rather than "market rent" when negotiating the rent that they charge for their sites. What they suggest this means, is "the level of rent that a competent operator could maintain whilst still retaining good profits". Here lies the gaping chasm in the PubCo's side of the argument on this reform - if their rent calculations are fair and they really do work on a balanced sliding scale, why are they so upset about this vote? If the calculations really are fair, there aren't very many competent operators out there at all, because over 60% of landlords tied to a PubCo earn less than £10,000 per annum, which equates to about £3.21 per hour, based on an extremely modest 60 hour week.

what pub owners earn

Nevertheless, apart from tied landlords largely living on the poverty line, incorporating inflated beer prices into the deal does look great on paper because it means that someone with not much capitol to invest can operate a site on an [allegedly] lower rent. The PubCo makes its money back if the site is successful through inflated product sales. The key phrase here is if the site is successful. The risk is being taken by the PubCo and it is greatly in their interest to make it a success, wherein comes the plethora of "additional services" offered to tied publicans; marketing teams, trade shows, trade "experts" and so on. I use ironic air quotes deliberately but a handful of people we've worked with have genuinely been hugely helpful - our BDMs through regular meetings and constant email contact, the Catering Development Manager who works closely with and offers guidance to our Head Chef and the Property Manager when the refurbishment was taking place. One of the big worries that our BDM expressed on Wednesday was that something would have to give if this reform was passed and in his opinion one of the first things to go would be these additional services. The Telegraph supports his views, suggesting that PubCos will slash their central expenditure by 25%. My opinion is honestly, don't wait for it to happen. Do it now. Most of the services are a waste of time to a competent operator and most of the people carrying out those services are in fact grossly incompetent...

So how much does the beer cost us from Punch? And what would it cost us if we were free of tie?

Well real ale is an easy comparison, because we sell our own exclusive ale LokeAle 1643 on a free-of-tie basis from North Star Brewery and we also sell tied ales from Punch Taverns:

Wholesale Price
Per Pint
Punch Price
Per Pint
Sale Price
Our GP%
LokeAle 1643
£61.00 +VAT
Farmer’s Blonde

£103.46 +VAT

From the figures above, one would assume that Punch make approximately £40 (net) per cask on the higher £160 per barrel discount just for being the "middle-man". But of course not, because they sting the brewer aswell. Rather than the brewer setting a price for his/her product, Punch tell them what they will pay. This value is often 20-25% under market wholesale rate, leaving the poor brewer with only £20 cash margin on each cask that they produce and Punch with a whopping £50-55 (>50%), just for delivering the beer to me, which the local brewer would happily have done for £60-65 instead of the £103 that I pay to Punch.

It is evident that we do make a healthier margin on the free-of tie products, which we have to do in order to recoup some of the deficit left by tied products, but we do also pass on a substantial saving to the customer. Because of this, we sell almost three times as much LokeAle as any other ale - which Punch are (of course...) not happy about!

Let's also briefly consider flip-side of the interaction between Pubco and microbrewery - the fact that the 'tie' is actually keeping the wholesale price of beer under control. Without the weight of these huge companies determining what they are prepared to pay, brewers could effectively charge what they wanted. Particularly with limited production capacity and supply/demand coming into play, we could easily find ourselves in a situation where the cost to the pub actually goes up, not down. Take two local success-stories for example - Castle Rock and Blue Monkey, whose 'free of tie' ale prices are £20+ per cask (25%) more expensive than their local competitors. Why? Because they can.

Contrary to popular belief, pub beer prices aren't actually expensive in comparison to the "good old days". In 1970, the average salary was £1,664 and the average cost of a pint 20p (0.012% of the annual salary). Today, the average salary is £26,500 and the cost of a pint of ale £3.10 (again, 0.012% of annual salary!). So why do campaigners believe that cheaper beer is the solution?

Real ale is not the only affected product - let's take a look at San Miguel, which I sold at The Embankment in Nottingham through Marston's on a free of tie basis:

Marstons Price
Per Pint
Punch Price
Per Pint
Sale Price
Our GP%
San Miguel FOT
£96.00 +VAT
San Miguel Tied

£146.61 +VAT

It's the exact same stuff remember! If we were to sell the San Miguel at the same price that I could afford to at The Embankment, the margins would be catastrophic. Don't even get me started on Peroni...

So yes, pubs tied to PubCos have to pay more for their beer and make a lower margin. In turn they have to charge the customer more, which undoubtedly impacts levels of sales, particularly when competing with large chains such as Wetherspoons and indeed supermarkets. Yes, many tied landlords are struggling to survive because they can't make their margins work or their sales are impacted by the high prices that they have to charge. But what of the alternative?

Make no mistake, I do believe that the leases that "us landlords" have agreed to are fundamentally unfair. But we have agreed to them. For one, there is absolutely no way that we would have been able to afford the in-excess-of £550k refurbishment that Punch stumped up for us at The Wingerworth in August last year. We live in a privileged time, where as a customer we expect a perfect pint, in lovely surroundings at minimal cost. Can anyone remember drinking anything other than local beers before PubCos came along? Can anyone remember the state of their local pub before a PubCo took it over and refurbished?

Enterprise Inns alone spends £70m per year on renovating and maintaining its pubs - operators would never be able to afford anywhere near this level of expenditure. The reality is that if PubCos such as Punch didn't charge us more, The Wingerworth would still be a dingy pub struggling to turn over what we pay out to Punch in a week. In fact, PubCos themselves would have folded long ago because of their lack of ability to service their debts and the majority of pubs would most likely no longer still be pubs.

Yes, PubCos have displayed ineptitude at every level, comparable only to the banks that keep lending them money to buy and refurbish. Yes, PubCos have brought pubs, one of the finest elements of British heritage, to its knees but let's not be hasty - let's make sure that we're making the correct decisions to sustain pubs for the future. After all, PubCos are not the only reason for the decline of our pubs. A recent survey by the Department for Business, Innovation and Skills suggested that only 42% of tenanted pub owners felt that their struggles were a result of mistreatment by PubCos, in comparison to 61% stating supermarket prices, 60% taxation, 32% the recession and 16% the smoking ban as one of the three biggest challenges they were facing.

Spare a thought - what will happen to your local when [not if...] the major PubCos go bust following this reform and the administrators take over? Without a recession, would we have any qualms about the prices that PubCos are charging? And finally, are supermarket prices not the real threat to our pubs?

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