Time for a new model?

The pub industry's prospects appear bleak and things are likely to get much worse if the UK economy goes well and truly into recession.

Moreover, the ownership of large numbers of pubs by companies such as Punch Taverns and Enterprise Inns is unlikely to improve the industry's vigour.

This is because pubcos are less inclined to take a vertically integrated view of the pub trade in the same way that pub-owning brewers would do.In tough economic conditions, brewers are in a position to evaluate whether they should financially support their retail operations, for example by reducing retail prices, implementing aggressive marketing campaigns or accepting lower returns until the economy picks up.

There appears to be no similar mechanisms within the marketing strategies of the large pubcos. Ted Tuppen, Enterprise Inns' chief executive, recently told The Publican​ that pubs had to be even better to perform well. He went on to say that "we are working harder than ever to support licensees", citing the £70m of capital expenditure the group had spent during 2007.

But what does all this "support" for licensees amount to in reality? The pubcos will not, for example, be offering to match the price levels of independent wholesalers as a tool for keeping consumer prices attractive.

Let's be honest, the millions of capital expenditure unveiled grandly at press gatherings is largely used for acquiring more real estate or for repairing the bricks and mortar of the existing pub estate. Any remaining funds that are spent on improving trading performance are re-charged to leaseholders through higher rents.

Coming from a catering industry background where food franchising is common, I'm staggered that the government allows pubcos to control the leaseholders' cost base without being made to take any responsibility for ensuring that they can achieve an industry-standard retail gross profit.

A more equal relationship

If we were to compare pubcos with food franchises (for example Subway, KFC, Burger King), we would see that there is a much more transparent and equal financial relationship between the franchisors and franchisee than there is between pubcos and licensees.

Franchise operations succeed because they offer:

• tried and tested retail brands

• industry-standard product margins

• marketing support

• fair and reasonable franchise fees.

Without happy franchisors and franchisees you don't have a viable business model.

This brings us to the pubcos, which are part-property company and part-monopolistic wholesaler. Having evolved rather ironically as a by-product of government legislation aimed at restricting the power and influence of large brewers, as a business model for investors, pubcos have delivered excellent trading results through cheaply funded acquisitions, rocketing pub valuations and leveraging better purchasing deals with suppliers.

However, as tougher economic conditions take hold and higher interest rates and declining property values impact on profitability, a fundamental weakness of the model will be exposed - and it is this: pubcos are too distant from the consumer.

Apart from the directly managed pubs they have acquired - rather by accident than by design - they have not built businesses based on consumer awareness or loyalty. They have not developed the true potential of their licensees and they do not have any coherent retail strategy for fighting for consumer market share in a recession.

Only the best customer organisations perform well in an economic downturn and in comparison to the well-known food and drink brands, the large pubcos' leasehold estates come across as rather a rag-bag operation.

Admittedly, some of their outlets are very good - but how will the average leaseholder respond to a recession? In a nutshell, they will try to muddle through. Some will attempt to be price competitive but their operating margins will be a lot slimmer than other operators. Cashflow will tighten and a considerable number could go out of business.

How the pubcos respond to the plight of their leaseholders will prove to be a defining moment for the pub industry.

Mike Smith is licensee of the Three Compasses in Hornsey, North London - ​The Publican's 2008 Community Pub of the Year - and a non-executive director of The Great American Bagel Factory​