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The Wrong Type of Income

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We have been thinking a lot about pub companies recently, not least because of the Fair Deal for Your Local campaign. We still don’t understand enough about the details of the business model to have a strong opinion on its rights and wrongs, but one thing has been puzzling us: why do pubcos bother selling beer?

Why do they bother maintaining a buying-sales-distribution network when they could just make money from renting at market rates to people who want to run a genuine freehouse?

We wonder if the answer is tax.

At present, our tax system distinguishes between trading income and letting income, with the former qualifying for many more ‘reliefs’ (tax breaks). This is because trading is seen to be generating ‘economic activity’ while letting and passively holding investments is not. So, from the pubcos’ perspective, rental is probably ‘the wrong type’ of income.

Can anyone who works in the industry, or at Her Majesty’s Revenue & Customs, confirm our deny our hunch?

19 replies on “The Wrong Type of Income”

A lot of people who go into the pub trade don’t want to be free traders with all the responsibility that goes with that, and actually welcome the more structured business model and level of support that comes from being a pub company (or brewery) tenant. Having said that, as opposed to being a McDonalds or Subway franchisee, it’s questionable whether belonging to Punch as such does anything to bring trade to your pub.

Interesting theory. I’ve been wondering about this myself recently, what with it being on the grown-ups’ news and everything. I would suggest (and apologies if this is daftly obvious) that profit sharing is part of it — rental income has little to do with how much work the tenant does to run a good profitable pub. Renting to Tony The Perfect Landlord, Beloved Of Deep-Pocketed Regulars will mean you’ll miss out if you don’t have your fingers in his till. Other industries with similar models tend to just split the profits; pubcos seem have gone about the same thing in a slightly different way by having a tie, with more expensive beer, guaranteeing some profits, even if the beer rots in the cellar because Jeremy The Twat Landlord can’t be arsed cleaning his lines.

Yes – agree with all that’s been said above. Selling beer to a manager (who can’t shop around) is another very valuable source of profit for the pubco’s. They make quite a margin, buying cheap (because they’re big) and selling dear (because the manager has no choice).
If they stopped selling beer they’d be cutting their business in half.
At least, that’s how it seems to me.

What I find a bit weird is that the British beer commentariat get outraged that tied wholesale beer is more expensive than free market, as though it’s some sort of sneaky scam rather than an intrinsic part of the business model. It’s like being outraged that a bottle of wine is more expensive in the pub than the supermarket.

I don’t think many people are outraged by the principle in itself. They are outraged by the effects of pushing the pubco’s profit margin on beer to such an extent that the pub business stops being viable. There is quite a difference. If a pub charges £18 for a bottle of wine that I can buy retail for £7, fair dos. If they expect me to pay £50 for it, yes, that is outrageous. You see?

You can accept the principle of the tie and still find it disproportionate and exploitative for a pub to have to pay £130 for a container of beer that the free trade can get for £75.

Is this a new thing, Barm? Was there a time when the gap between tie and non-tie wholesale beer prices was reasonable? I don’t recall a time when it wasn’t being complained about, but I’ve only been paying attention for the last six or so years.

The most worrying part of many emotive accounts given by pubco tenants is the sense that they only saw the numbers once they’d signed the contract: they feel they were lied to about the pub’s turnover, they didn’t realise just how much beer bought through the tie would cost, etc..

It always used to be called “wet rent”.

In a sense it reduces the exposure of the tenant to market fluctuations – compared with a higher rent, lower beer price model, he gains less if he does well, but is also less vulnerable to a downturn in trade. To expect free-trade beer prices but no increase in rent is pie in the sky.

There must be a concern that statutory pubco reform could turn into another Beer Orders – well-meant, but fraught with unintended consequences. It could lead to a further damaging upheaval and shake-out of the pub trade.

There are a number of factors at play here. Firstly the PubCos sprang out of the former Big Six brewers and their business model was set roughly on the same tied house basis, but of course, as they had borrowed lots of loot, with the tilt much more in the favour of themselves (70/30 according to evidence to the OFT by the Federation of Small Businesses), particularly as the Beer Orders didn’t apply to them. So there is a historical factor which then influences everything else.

Supply agreements at very advantageous prices (not passed on to the tenants or lessees) are a considerable source of income, as is AWP income (games and fruit machines) and other supply agreements to which a premium can be applied – or if you like, a screw can be made. Giving up such advantages on a wide scale, while servicing huge debt, would be problematical to say the least.

Add to that the need to service overwhelming debt and you can see the cash equation (freeing from the tie) would only work if the rental income could be increased to the same level that overall income is now with the tie. That would require the tenants to take a considerable leap in the dark in be able to increase trade.

That’s unlikely. In a few cases it is possible that freeing from the tie for an increased rent will work for both – and there are cases where that happens – but in the vast majority it wouldn’t.

Basically, the PubCos have painted themselves into a corner. They have no good options really.

As an aside I’ll bet the big brewers would have stayed in business as vertically integrated businesses if they knew then what they know now. Bass for example could have retained the tie on 4,738 pubs and ran the other 2738 free of tie. Sounds fairly attractive now doesn’t it?

“Giving up such advantages on a wide scale, while servicing huge debt, would be problematical to say the least.

Add to that the need to service overwhelming debt and you can see the cash equation (freeing from the tie) would only work if the rental income could be increased to the same level that overall income is now with the tie.”

So basically they have an asset which isn’t as valuable as the debt held against that asset. The only hope they have is changing the asset so it is more valuable (i.e. selling for development into flats/shops) or conning their tenants with ‘projected profits’. It’s not surprising what they are doing really.

Given that mis-selling has become more under focus (PPI etc), I wonder whether tenants who’ve lost a chunk of their savings to get these projected profits will be able to sue.

“Add to that the need to service overwhelming debt and you can see the cash equation (freeing from the tie) would only work if the rental income could be increased to the same level that overall income is now with the tie.”

Which would also need to take account of any lost tax breaks from the move from ‘trading’ to ‘letting’.

Short answer: massive great non-rental income streams. ‘Renting at market rates’ is less attractive than selling through at above-market rates.

The exact means by which the pub co extracts profits out of the tenants is inconsequential really. They’re always going to squeeze as much money out of the tenants as they can.
The underlying problem is that it is a very one-sided relationship, purely because if the relationship breaks down, its far easier for the pub co to find another mug to run their pub for a pittance, than it is for the tenant to find a better deal elsewhere.

Furthermore, this is currently being exacerbated by the economic environment where the alterate employment options for the tenants are limited, whereas the option for the pub co of simply selling up to developers and cashing in are increasingly attractive.

What prompted this was wondering why there aren’t more relationships developing such as the Craft Beer Co and Greene King’s. There clearly is scope for the right tenant to convince a landlord to rent them a premises and not tie them on beer, and given there are both plenty of failing pubs and keen pub tenants, why do the pubcos stick to the business model as long as possible?

We’re not convinced it’s because they’re holding out for a greater share of the profit. Profit sharing sounds great when there are profits, but wouldn’t most people prefer a steady return rather than something that went up and down, particularly when you replace “people” with “shareholders”? Yes, flogging beer at crazy margins will generate short term profits but is also volatile if it bankrupts your tenants.

I don’t think anyone’s looking at the long term. I mean that literally, not rhetorically – I don’t think anyone’s got the kind of figures, for a ten- or fifteen-year period, that would quantify the effects of pubs closing & tenants going to the wall in a way that might make it possible to compare with a hypothetical rent-based model. Absent that kind of information, they’re going to stick with what works, sort of, mostly.

but the Craft Beer + Greene King setup ultimately lost us a place like the Spotted Dog in Brighton,so that doesnt seem a much better solution, and GK bought out Capital pubs, and whilst those pubs retain a non GK flavour to the point theyll still sell Adnams rather than any GK brand, Id want to see the rent deals these pubs were on before I thought they were any better off as I doubt its as straightforward as GK just letting the property and allowing the leasees do what they like without someform of increased financial compensation as a result

I’d have though that with the exception of London, buying a pub on a mortgage would be a damn sight cheaper than leasing it long term from a PubCo. Free of tie leases are available though, but clearly since it doesn’t happen often, the maths don’t work out for either party.

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