Growing a Brewery to be viable

The beer market is incredibly sensitive to price. It might well be possible to sell a very limited amount of beer at an increased price, but basically, the vast majority of beer can only command a price that falls within fairly tight limits. The off-sales market seems to show significantly greater variation as a rule, than the on-sales market, but even so, these limits are in my view quite tight. For the purpose of this discussion I'm not intending to criticise that position. It is a fact, and one that has an influence over the economics of businesses that make beer; the breweries.

I guess beer is a bit like bread, they are both made from grain and yeast is an inherently important part of the processes. But they also share other traits on an economic level; bread is a staple food and as such its price has upper limits beyond which demand drops to zero. Of course the same could be said of potatoes, carrots, onions, rice, milk.....

Beer has one great benefit, much the same as bread; it can be made at industrial scales. Massive plants, with massive tanks, in huge buildings can ensure highly efficient processes. This has always put micro-brewers at a disadvantage. We have small brewers beer duty to help us out in that respect. The key reason for the proliferation of micro-brewers is as a result of the small brewery beer duty. Without it a brewery of the size of Hardknott would just not be economically viable.

Actually, as we currently stand, our brewery isn't really viable anyway. To make enough beer to earn an honest living we need to make more beer. We don't actually need to do very much to what we already have, but we still need to make and sell more beer if we are to make any profit. It's all to do with overheads.

Progressive beer duty starts to reduce rapidly when a brewery starts to sell more than 5000hl of beer. That's about 3000 barrels a year or about 230 firkins a week. Putting it into context that's an exclusive VAT turnover for the brewery of around £700k per year. About 24% of the turnover goes out in beer duty - £170k, and an equal or greater amount goes on raw materials. There are then some variable overheads in the form of energy, costs of ownership of the building and plant¹, rates, transport and for a brewery of the size indicated there would have to be employees and so a wage bill. To achieve and maintain the level of beer sales there would be essential cost of marketing the products. It is highly likely that net profit would be less than 10% of turnover. Perhaps a £50k per annum profit is reasonably achievable, and is an above average salary, although conversely it is unlikely that a business of this size is owned by a sole individual. By today's standards this is in no way a large business. Indeed, many successful town centre pubs turn over much more and probably make much more profit than a brewery under 5000hl production.

This probably represents a sweet-spot of operating size. Above this there is a steep drop off as Progressive Beer Duty is increased steeply. Below this size overall margins can shrink due to dropping efficiencies of scale and simply because percentage net profit for any brewery is unlikely to increase above the 10% mentioned above. Reduced turnover represents reduced profit.

With the stainless steel I have in my brew house I probably have a maximum achievable turnover of around £100k. At an overall net profit of 10%, the maximum we can reasonably expect to achieve, we might earn £10k a year between us. I don't know about the reader, but I think this is insufficient for a reasonable standard of living in the 21st century. This is dependant on us successfully and efficiently brewing to capacity and selling every last drop. Bearing in mind the fact that any business person is risking financial ruin should it all go very wrong, the fact that actual disposable income available is achieved due to a determined and consistent dedication to the operation rather than just turning up 9 to 5 and doing a bit.

I don't want to appear to be complaining too much; running a business has many rewards beyond financial recompense. Some of us do it because we have tried the working-for-someone-else game and don't get on with the concept. Additionally, brewing beer is extremely rewarding. Positive comments from people who drink my beer almost, and note I say "almost", compensates for the poor rewards that today's modern competitive market creates.

It does baffle me, as a result of the key financial issues above, why there is an inherent misunderstanding of the need for breweries to grow. When I have discussed the BrewDog growth or our own plans for growth there seems to be objection to the plans.

I'm aiming for the 5000hl sweet-spot. Going above that would require world-domination plans of BrewDog proportions. However, at that level there are key problems that could reduce the overall profitability. I want to use more hops. If I increase my hopping rate by 1kg per hl, which is not overall a great increase which may seem a lot to the reader, but is what I need to do to compete with the best breweries, at current prices it would represent an increased cost of £40k per annum at this proposed level of trading. That would eat away at my profitability. The only way to negate this would be to increase production and sales, by quite some quantity, overcome the initial disadvantage of the hump caused by the onset of variable beer duty.

My chart here has a logarithmic scale for production. It makes it easier to show the full range of sizes of brewery from nano to regional breweries. It does however mean that the effect of the variable duty rate across the range 500hl - about 2000hl looks less steep than if shown on a linear scale. Either way it can be seen that any increase of capacity above 500hl is going to be incredibly significant for any expanding brewery.

BrewDog are now in this range. In a recent document, sent to me by James Watt, they state that their prices are going to have to increase to account for this increase of beer duty.

"In 2010 our production increased from 8700 HL to 14500 HL meaning the beer duty we have to pay increased by, for example, £5.50 on a 50L keg of Punk IPA."²

As the company gets bigger the increases of beer duty will become less significant therefore I would expect further economies of scale to cut in and help to counter the effects of the duty. From a business point of view, having broken the 5000hl barrier it makes sense to carry on growing.

When talking about specfic problems with the operation over the last year; things that I've also heard customers complain about, BrewDog state:

"The positive thing is that all of these is caused by the demand for our beers."

Again, more reason to carry on growing their enterprise.

So, I hope the reader might now see why the most successful breweries have to grow.

In fact, if Adnam's have their way, those that don't grow will fall foul of proposed changes to progressive beer duty anyway. However, that particular issue is another blog subject.

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¹I don't owe any money on the stainless steel I currently own, however, it represents capital tied up. If I had not bought the plant and put money in an ISA instead then I'd earn some interest. We rent the building and so there is a cost there. We are likely to have to borrow money if we are to grow, this will have a cost implication.

²If my readership is as clever as I expect you all are you will realise that BrewDog turnover for that level of brewing doesn't match my earlier figures. At 14500hl, from my model, they should be turning over less than £2m rather than the £3.7m. I expect the main reason for this is that a large volume of their beer is stronger and bottled, both putting an acceptable increased price on the product.

Additionally the company also now has retail outlets, further increasing gross margins.