Robert Sayles: Is the price of beer being 'manipulated'?

In 1890, English economist Alfred Marshall published his work, 'Principles of Economics' which outlined how the principles of supply and demand interact to determine price.

Marshall determined that the price level of a good is determined by the point at which quantity supplied equals quantity demanded.

During the most recent economic downturn, gold has provided a perfect illustration of that concept.

Demand has soared as more and more investors come to see the precious metal as a 'safe haven' investment; the result being a surge in the price. (It currently stands at more than $1,400 an ounce).

Many economists would argue that Marshall's law is universal, a cornerstone of economic theory.

However, perhaps that is something of a generalisation. After all, there is one commodity at least which continually defies this fundamental rule of economics.

Demand for beer, particularly in the off-trade, is falling at unprecedented levels. Yet, guess what? The price continues to rise.

Don't you find that a little odd?

Now I'm sure that various bodies will come up with all manner of reasons to explain this particular anomaly. However, a look at the way the market currently operates suggests that perhaps all is not as it should be.

Let's look at the brewer's situation first of all. It's clear that a changing market has left them with two major problems.

Falling volume - it is a well publicised fact that we as a nation are drinking a lot less.

Plummeting volumes in the off-trade bear testimony to the fact that people are turning away from alcohol in increasing numbers.

Falling margin - the problem has been exacerbated by a significant change in drinking habits; a fact evidenced by the growing ascendancy of the off-trade.

The buying power of supermarkets has given them a great deal of leverage to negotiate substantial discounts; a policy they have pursued with ruthless efficiency. This in turn has impacted negatively upon brewer's margins.

The emergence of the pubco has only helped exacerbate this problem. The big pubcos in particular have been just as effective in utilising their buying power to drive down costs.

This has put further pressure on already stretched margins and left the independent free trade sector as a disproportionate contributor of brewery profits.

So how do the brewers resolve these issues? With regard to supermarkets, the brewers appear to have little scope for manoeuvre.

The strategy of 'stack it high, sell it cheap' appears to be sanctioned at the highest level. Consequently, there appears little prospect of breweries negotiating more favourable terms any time soon. (Of course it should not be forgotten that the brewers oppose minimum pricing, hence a dilemma for the BBPA).

What about the pubcos? Well, this is where it gets a little more interesting.

Many suspect that brewers are offsetting depleted margin in the off-trade by foisting annual increases upon the on trade; a policy sanctioned by a mutual beneficiary, namely the pubco.

This notion gains added credence once you dismiss the idea that rising wholesale beer prices are bad for pubcos. In fact, nothing could be further from the truth.

Consider the following hypothetical conversation:

Brewers:​ 'Look, you're screwing us on margin and our volumes are going through the floor. The current arrangement is unsustainable.'

Pubco:​ 'OK. Why don't we come up with an arrangement that is mutually beneficial to both of us? You implement an annual increase to help improve margin, we'll negotiate a percentage increase with you and pass the rest on to our tenants.'

It seems like the perfect arrangement; a bit of mutual back scratching if you will.

So the big question. Is it possible that brewers and pubcos have colluded to come up with a strategy that is beneficial to both sides?

Of course one would need access to the smoky boardrooms to find the answer to that one. It should not be forgotten however that in 2009 the BISC acknowledged the possibility of such an 'arrangement'.

They concluded that "there is little pressure from pubcos to resist increases in beer list prices (upon which the consumer retail price is based) because pubcos discounts actually increase pro rata with brewery list price increases".

They went on to highlight an extract from a Morgan Stanley report which stated the following; "It is not in the pubcos' interest to push back too hard on list price increases, because they get a proportion of the price increase as additional discount. Some even argue that pubcos like it when brewers put up prices."

Similarly ALMR observed that pubcos have "forced retail prices up in a difficult market and contributed to the widening gap between the pub and the supermarket where maximum discounts are passed on to customers."

What is patently clear is that pubcos NEED escalating pre-discount wholesale beer prices to secure additional profits.

After all, how else are they able to grow wet rent? (Dry rent of course takes care of itself through the link to RPI, currently running at 5.1 per cent).

Pubco's priorities, particularly those saddled with large debts, lie in driving wholesale price lists up whilst obtaining increased discounts from the supplying brewers to secure greater margin. (The suspicion remains that the brewer's increase to the pubcos is somewhat less than that passed on to tenants and lessees).

It is also worth bearing in mind that, for a number of tenants at least, any initial discounts offered at the start of their agreement are fixed. Over time the benefit of any such discount is eroded through further price increases, the result being in an ongoing depletion in tenant's margin. The same cannot be said of pubcos.

If a true 'partnership' existed of course, then ALL tenant's barrel discounts would be index linked to cushion the tenant against the impact of future rises.

But then again, when was it ever a 'partnership' in the true sense of the word?

The escalating price of a pint has undoubtedly had an impact. The BISC concluded that the "retail price divergence has in turn contributed to the rate of pub closure as consumers choose to drink at home rather than accept the artificially inflated beer prices which tied lessees are forced to charge."

The inclusion of the wording "artificially inflated beer prices" is quite telling, isn't it? It suggests in no uncertain terms that pubcos are manipulating the price. What I suspect the BISC want to see is an investigation that will answer the following question.

Is the privilege of the tie being abused to shore up brewers margins whilst enabling pubcos to line their pockets?

If proven, it would lead us to one further unpalatable conclusion. The heavy discounting witnessed in the off-trade is being subsidised by the price hikes imposed upon the on-trade. How ironic would that be?

The recent OFT investigation clearly didn't think there was a problem with the current arrangement. However, the BISC anticipated such an outcome as early as 2009, concluding that "given its clearly stated position, we do not believe an OFT investigation would be satisfactory".

They went on to state that "since the OFT is unwilling to initiate an appropriate investigation, we recommend that the Secretary of State uses powers set out in section 159 of the Enterprise Act 2002 to refer supply ties in the public house industry to the Competition Commission for a market investigation."

I would suggest that the time for such a referral has well and truly arrived. If nothing else, it might finally help answer one very important question.

Why does beer continue to defy Marshall's fundamental laws of economics?