The pubcos' beer escalator
The tenanted pub companies can't carry on passing through inflationary wholesale price rises, says Peter Linacre.
Following the release of the update to the Business Innovations & Skills Committee (BISC) report into the pub sector, I'd like to highlight an issue that was not particularly covered in this report or previous reports, but I believe should gain an increasing amount
of attention.
BISC, in paragraphs 155 and 156, requests that the Office of Fair Trading keeps an eye on the setting of arbitrary price increases by the pubcos. I'd suggest that they also voluntarily amend an aspect of their agreements that has been an enormous benefit to them, but caused an enormous amount of damage to lessees.
This benefit is obscured because the numbers each year are relatively small, but over the period of a lease are simply enormous; it all relates to the fact that the discount to the lessee is fixed, but because the wholesale price of beer is increased every year there is a gain for the pubcos.
Some might say it is odd that an industry, such as brewing, which is in a state of substantial over-supply of its product and is seeing declines in demand of anywhere up to 10% per annum, manages wholesale price increases at all!
As we all know, the discounts received by lessees are fixed. Each year the wholesale price of beer rises and, indeed, some products cost more from the pubcos than they do at full WSP from the brewers.
As everyone knows this is not the price or the price reference by which the pubcos actually pay for beer — but it is the price that pubcos pass on to lessees. If wholesale prices rise by 3% per annum, but the price that pubcos pay rises by only 1% then each year they are able to "take" 2% from the beer margin that is available.
This might seem like a trivial sum. The following illustration, however, shows the effect on a lessee.
Let's assume that the discount paid to a lessee is set at £45 per barrel at the start of a lease taken out in 2010 and that at the time the cost of a barrel of beer is £400. This discount to the lessee represents 11% of the price of a barrel of beer. By the end of a 25-year lease that 3% rise in the annual wholesale price means the price of the barrel has increased to £922.
The lessee's share has fallen to 5% of the value of the barrel and the pubco's share has increased to 45% or £415 (after giving the lessee the £45). Putting it into sums of money, while the £45 remains fixed, your share has grown and by the time 25 years come around that will amount across 17,000 pubs to £2.8bn! Yes, £2.8bn.
The numbers
Conversely, put this into the context of a single 300 brewer's barrel pub. At the start of the lease the discount to the tenant is worth £13,500 per annum and to the pubco £46,500 per annum. At the end of 25 years the pubco's discount will rise to £73,000 and the tenant's will remain at £13,500.
Go back to the start of the new style of leases in the early to mid 1990s and look at what has happened since then — there is a dramatic picture.
This was the period in which pubcos exerted maximum power over brewers and the differential between wholesale price increases and what they paid to lessees meant that the discount the pubcos enjoyed actually grew from £55 per barrel to £162 per barrel after the £45 has been passed to the lessee, or roughly 8% per annum.
The cash numbers are terrifying — the pubcos benefitted to the tune of £102m in 1996 and £155m in the current year. Over this period of 15 years pubcos have "taken" £1.8bn out of the beer margin of 17,000 pubs.
There might be a useful conversation as to where all the cash has gone — but that might be for another time. However, in the spirit of the BISC update, I am sure everyone would want the industry to move forward with fairness and strength.
I suggest that along with the other areas of transparency called for by BISC, an immediate commitment to indexing all discounts to the wholesale price of a barrel of beer to all lessees would be a great start.
