MPs voted to introduce the New Clause 2 (NC2) amendment, which outlines that companies with more than 500 pubs and at least one tenanted/leased site will have to offer a market rent-only option. The Government has since accepted the vote and said it will not seek to challenge it in Parliament.
The Publican’s Morning Advertiser contacted tenant representative groups after the vote and asked them to comment on the implications of an MRO option being available to tied tenants.
The Fair Pint campaign — which has been pushing for reform for years — said the move was “fantastic news” and would lead to a boost in profits. “This potentially im-proves a pub’s profitability by 7%. Given the average pub turnover is about £300,000, then it’s a cash injection of about £20,000 per pub,” the group said.
“MRO is a negotiating chip — no longer will tenants have ‘here’s your rent and here’s your price for tied products — like it or lump it’. Either the tie survives on its merits or it will be abandoned.”
Access
Licensees Supporting Licensees said MRO would return profit back to tied tenants enabling them to invest in their pub and expand their product range. “They will be able to sell what their customers want at a price that is good for both licensee and customer. They will be able to negotiate prices rather than be dictated to and will have full access to the amazing number of breweries in this country.”
The Federation of Licensed Victuallers Associations (FLVA) adopted a more cautionary tone. “The initial response will be one of perceived benefit but any decision will need to be carefully considered. The problem may come when the rollout creates a distorted marketplace within an area, which could have severe consequences for outlets and may result in some pub closures.”
The FLVA also warned about reduced investment from pubcos and reduced access to market for microbrewers as tenants most likely commit to one company for their drinks. “MRO will expose tenants to higher fixed costs and in a declining market for beer that is not a good place to be,” it added.
Challenge
Greg Mulholland MP, chair of the Save the Pub Group, who tabled the NC2 amendment, has written to the three big brewing pubcos affected by the clause — Marston’s, Greene King and Star Pubs & Bars — inviting them to meet him to discuss how it will work in practice.
It is understood affected pubcos are weighing up the possibility of a legal challenge, with both Punch and Enterprise warning the MRO option will have the effect of reducing investment in the sector, and increasing pub closures and job losses. Analysts suggest the Government might delay its introduction by four years to allow pubcos to prepare.
Full responses below:
How do you assess the impact the market rent only option will have on tied tenants?
LSL: MRO will return profit back to tied tenants enabling them to invest in pub premises, innovate their business offer, increase product range, respond flexibly to customer demand and provide better value to their customers. Quite simply they will be able to sell what their customers want at a price that is good for both licensee and customer.
Fair Pint: Fantastic news - still has to come to fruition (at best 18 months) it will mean that tenants who are aware of its existence may see a significant improvement in profits regardless of whether they choose to stay tied or take the MRO option.
FLVA: There will be a mixed bag of reactions. There is confusion in the market at the moment with people not knowing what the position is now or will be in the future. In an already turbulent market this is not good for business. The initial response will be one of perceived benefit but any decision will need to be carefully considered, because the position will be different in each and every case. This highlights the need for sound advice to be taken at the onset and at any review point within an agreement. The problem may come when the roll out creates a distorted market place within an area which could have severe consequences for individual outlets which may even result in the closure of some pubs.
There may well be a legal challenge by the pubcos who currently have a block exemption from Europe which allows them to operate a tied agreement, they will not just roll over so any introduction or impact of MRO may well be some time away. For some it will be good news but as I stress again each case is different and must be considered carefully for each and every occasion.
How will tenants approach the new right to buy beer on the open market?
LSL: Tenants will be able to be responsive to customer demands; they will be able to negotiate prices rather than be dictated to and will for the first time have full access to the amazing amount of breweries in this country and take full advantage of this, the biggest growth market in the drinks industry.
Fair Pint: It is a negotiating chip - no longer will they have “here's your rent and here’s your price for tied products - like it or lump it”. Either the tie survives on its merits - fairly - or it will be abandoned. It can no longer rely on a captive market.
FLVA: They will obviously contact the major players, and this may well include their current landlord who may wish to operate a “price match” option and retain the tie. It will be very interesting to see what the response will be from those suppliers towards the smaller outlets. To maximise their profit potential a tenant will more than likely commit to one company for their supply. This may have the effect of stifling the availability of brands made available for public choice on the bar. “Guest beers” may suffer and the access to market for many of the micro brewers may become more difficult as the big supply routes dry up.
There may be an initial rush to reduce pricing to the public but care must be taken as a fully-costed exercise must be undertaken which takes into consideration all other factors, not least of which will be the new fixed overhead of an MRO. Unless the offer across the bar results in a higher level of gross profit, in cash terms, to the tenant then any price reduction is a risky strategy, without a resultant lift in volumes, which will require the public to physically drink more in the on trade, the net result is one of reduced profitability. As the old saying goes you can’t spend or bank percentages.
After the initial surge by the suppliers to maintain their market share their emphasis will move to profitability and the current levels of discount enjoyed in the market place by current FOT outlets may well be pared back especially for the lower volume outlets. Again, highlighting the need for a fully-costed and considered decision as it will remain with the tenant for the duration of their agreement.
How much of a concern is there that pubcos reduce their investment programmes in pubs as a result of this?
LSL: It’s obvious by the amount of tied houses in a state of disrepair that the reality of ‘Investment Programmes’ is very different to how the pubcos portray them. Pubcos do not invest in pubs without tenants paying back the capital through overinflated increases in rent or through the tenant paying into a maintenance fund. MRO would allow profit to remain in the pub and tenants will be able invest in their premises.
Fair Pint: None - its hogwash! This potentially improves a pub’s profitability by around 7%, given the average pub turnover is estimated to be about £300k then it’s a cash injection of about £20k per pub. There are 20,000 tied pubs so a possible £400m released investment in the hands of publicans not the pubcos (I believe that is twice what they claim - spuriously - to deliver).
FLVA: I think this will be an inevitable consequence of the MRO option. A soft landing may be achieved by the pubcos if they adopt a price match strategy in terms of volumes but capital available for investment will be less and any subsequent return on investments made will be lower, thereby reducing both the number of investments undertaken and the scale of each of them.
Could the MRO option leave tenants exposed to higher fixed rents and reduced levels of support?
LSL: There is little real evidence that rents will increase as long as they are assessed by independent valuers in the open market following RICS guidelines. Again, the support that pubcos purport to offer seems totally at odds with the support actually received by tenants. Tied tenants are even expected to pay for branded glassware which free of tie licensees receive at no charge whatsoever from the breweries!
Fair Pint: Yes - rent possibly higher in some instances. An example, a tied pub doing 350 barrels is paying about £150 a barrel over the odds (150 x 350 = £52,500, this is wet rent) the commercial dry rent might be £35,000 so in total that tied pub is paying an equivalent total rent of £87,500.The tenant earns about £24,000 so total net profit before rent is say £111,500. The pubco is getting about 78% of the net profit. With MRO, assuming no SCORFA, the net profit is the same but would be split roughly 50:50 so the tenant would expect to earn about £56k and pay about £56k in rent (i'm rounding numbers). So yes rent has gone up, but so too has tenant earning.
FLVA: The introduction of MRO will expose them to higher fixed costs and in a declining market for beer this is not a good place to be. Don’t forget as well, this fixed overhead is probably linked to an annual RPI/CPI increase which in effect will be a double whammy for the tenant being squeezed between higher, and rising, fixed costs and lower and declining benefits from discount as volumes drop.
The relationship between the tenant and the landlord will change dramatically. Where the only landlord interest is that of rent, and there is no shared benefit of beer sales, then decisions become much more black and white. If the rent isn’t paid then proceedings are started to regain possession, ask any current FOT leaseholder, or check out what the bank manager would do if his loan isn’t paid on time. Look back at the support given, or perhaps more accurately, not given by the FOT lease companies during the last few years.
Some have argued that pubcos might be more inclined to dispose of pubs or transfer to alternative operating models – do you agree?
LSL: Pubcos are already inclined to dispose of pubs! They may look at managed estates but they are unlikely to make the same return as they would from a tenant. It is for them to decide the best course of action to sustain their fundamentally unsustainable business plan.
Fair Pint: Those that have been operating an unfair model will no doubt seek to extract themselves from the sector - would we really miss them? If a pub owning company has been operating its tied model fairly, to the mutual benefit of both themselves and their tenants, then they should have no objections to what is being proposed. The scallywags will seek to continue to circumvent the legislation. My prediction is development of their managed estates, in order to block lease renewals, which conveniently for them are all coming up in the next couple of years, they will run them for a year or possibly less and then promptly seek to flog them for redevelopment and/or change of use. This is why the planning reforms are so necessary to tighten the loopholes left so blatantly open by Brandon Lewis; it does not look like Kris Hopkins has grasped the importance of this.
FLVA: This has to be a possibility with the tax breaks that can be achieved for property investment trusts, large and complicated sums will be undertaken by the companies to maintain the best return for their shareholders. It may also result in a new breed of agreement. When is a “franchise” not a franchise or is it a tie by another name? And what is the market rate for a franchise Fee? As I said, at the moment confusion reigns.
GMV response
“As a member of The Fair Deal for Your Local, the Guild of Master Victuallers congratulates Greg Mulholland MP in getting the cross-party amendment adopted. The Fair Deal Committee is clearly of the view that the market rent only option is the only sure way to the problem of unregulated prices and high rent.
In its submission to the business minister, Jo Swinson, the Guild stated that self-regulation was not the way forward and we were pleased when the minister set down that there would be a statutory Code to set down the rules which pub companies would have to conform to, with an independent Adjudicator to ensure that licensees are being treated fairly.
The Guild's policy over the years has been for the abolition of the tie. The proposed basis of the tie and how it used to operate is that licensees pay more for beer and other products but pay a lower than market rent - but this stopped being the case and leases became unfair based on hugely inflated beer prices and high rents.
The Guild's representatives visited Europe and made its policy known. We were aware that the European Competition Law sought to regulate tied agreements with undertakings and block exemptions, the principal being that the disadvantage of being tied (high product prices) would be counter veiled by lower rent. Essentially a principle that ‘the tied tenant should not be worse off than if they were free of the tie’. But that is not clearly the case.
There is no doubt that the changes will have their effect on the industry but the trade will deal with the change. It will not happen overnight; the change will be gradual and will likely happen as contracts expire and are renegotiated. As always The Guild will be there to advise and guide its members.”