Monday 20 July 2009

Tie Economics

Yes, sorry, I'm going to comment on the tie again. For the free marketeers who support the tie, I am going to take your side for the purpose of this discussion. The agreement between a lessee and his building owner are a business agreement that is freely entered into. This is true; The details of the lease are there to see when a prospective lessee is considering entering into the agreement.

From early in my drinking career1 many of the people I drank with had the same view of brewery owned pubs as myself. Perhaps they were OK to drink in but whenever talking to landlords on the subject the overriding view was that they paid too much for the beer and then if the pub started to do OK, due to the efforts of the publican, the brewery put the rent up negating any reward for the effort. This opinion is the basis of my objection to the tie.

If every publican who starts out understands the terms then they have little to complain about when taking on a tied house. I have no argument in this respect. My problem is that I'm not sure that every publican really understands the effect this might have on the profitability of their business before they start out. One of the motivations behind this blog is to tell it how it is from behind the bar. If that stops one person from making a poor life choice, then all my efforts here have been worthwhile.

Recently I have visited two very nice tied houses. One was buying outside the tie, without the pub companies knowledge. In conversation the licensee told me he was able to get away with it because the landlord had not put a meter on the line. The difference between the tied beer wholesale price and the untied price was £25 per firkin.

A day or so later I visited the other pub on a trip out. A regular in my pub had recommended this house to me and I was delighted to see a wide range of beers on sale when I got there. This could not be a tied house on the grounds that the choice was too great and too diverse for that. It turned out I was wrong. It was in fact owned by one of the biggest two offenders. So how did the victualler manage to achieve the vast range of wares?

"We pay for it" came the response. I can only assume this means corkage2 charges. I didn't feel comfortable getting into a full scale discussion about the situation but there came a second comment along the lines that if they didn't keep the range of beers they might as well "shut up shop". It is certainly a good pub and the management are doing a good job despite their tie.

Now, whether it be corkage or the premium charged by the brewery or pub company, it seems to me, without gaining more empirical evidence, that the going rate on a firkin is around the £25 previously mentioned. That's £100 per brewery barrel3. Consider a mediocre pub of a barrellage4 of around 200 barrels5 a year. This equates to £20,000 per year extra that the publican is paying. That's a similar amount I pay for my mortgage, but I don't pay rent.

So, are we really sure that if a prospective publican can't afford to buy a free house he can afford to lease a tied house? I'd argue he can do neither6.

I am very interested in the economics of the free trade verses the tied trade. I believe that in general the tied trade is being ripped off, but then I've always believed that. If any reader has empirical data I can use I would be happy to receive this. In return, discretion would naturally be assured.

1Definition of career: To hurtle uncontrollably. To move rapidly straight ahead, especially in an uncontrolled way.

2Corkage is a charge levied by a premises for consumption of a customers own drink. Not uncommon in a restaurant and for a bottle of wine for instance can easily be £5 and often more. The same can be applied to a lessee who wishes to sell beer legally outside the tie.

3A brewery barrel is a unit of measure, NOT the container that beer is delivered in. A barrel is 36 gallons or 288 pints. About 164 litres.

4Barrelage is a good measure of a pubs wet trade. It normally includes wines spirits and often soft drinks. Most tied houses are tied for the majority of this volume of sales.

5I would consider a 200 barrel a year wet led pub not to be viable. Match this with at least the same again of other revenue and things might look a bit better. Either that or double the barrelage, which for a tied house would double the cost of the tie to £40,000 per year. Are your eyes watering yet?

6I admit that in a town centre the volumes of trade can make for significantly different slant. Many large town centre properties enjoy a comfortable relationship between the business operator and the property owner.


John Q. Publican said...

Hi :)

I know you've read at least one of the posts I made recently deconstructing the economics of the tie. I'd be interested in seeing if you can relate your experience to it: also, there are some further details on tied/free economics in the comments thread here that you might be interested in.

My blog is primarily political rather than about the beer, but I do occasionally mix the two, as do my customers...

Cooking Lager said...

The way I look at this is would we accept this in other industries? Many other franchise systems operate, some effectively and with long term success and some less so. The successful ones tend to have the feature of effective business partnership and the less successful ones tend to be in some way about making a profit by stiffing the little man running the shop.

With financial products there are numerous mis-selling scandals which ultimately boil down to financially illiterate consumers being conned into buying inappropriate investments. The law takes measures to protect consumers by creating legal requirements for disclosure of information as well as a grace period to back out. Ultimately though there remains an expectation that the investor has a duty to himself to be informed about investments he makes.

In terms of selling whole businesses to folk, I suspect many are naive and trusting and are effectively scammed of their modest life savings by paying for the privilege of renting a pub and buying overpriced beer through a restricted supply chain. Sadly it will be people of modest means as I suspect people with greater means would buy a freehold. Also I think it is the failing pubs that are advertised to the public. The signs outside pubs inviting me to run the gaff are all failing pubs. You don’t see them outside successful pubs. Thus the adverts are arguably immoral, inviting the naive to part with cash for a business they have little chance of succeeding with.

How to regulate this? I’m not sure you can and still expect an “enterprise culture” that encourages business start ups. Market efficiency is as much about letting failing businesses die as it is success, and letting free people make investments some of which will succeed and some of which will fail.

If you were to write more on this subject I’d be interested to know about the disclosure given to new licensees in the tied model. Do they get to read the books of the business for the last 3 years and know what the true state of the business is? Are they fully informed about the deal they are signing? If so then you have to accept buyer beware. If not, regulation to ensure full disclosure would assist market efficiency and not harm it. Perfect competition requires perfect information.

Andy said...

I think you have hit the nail on the head when you suggest not every publican understands the ramifications of taking on a tied pub.
Essentially the tie is simply a contract. The essence of that contract is supposed to be that in return for buying beer from the pub company the tennant will get charged cheaper rent and some element of business assistance from the pub company. In reality from the stories I hear I am not sure if that trade off actually applies. Of course there are a whole minefield of other clauses such as upward only rent clauses etc that may also apply.

The problem is a lot of tennants walk into this without getting proper advice from both a solicitor and surveyor and ideally an accountant, partly because that advice is not cheap, after all people are initially attracted to a tied pub because it is likely to be seen as a cheaper alternative to a freehold. I suspect a lot of people get attracted to the whole idea of running a pub without first doing a lot of research to make sure they have the best possible chance of making the particular pub work financially. No doubt some people spend more time researching the car they will buy than a contract which will lock them into a major commerical obligation for 3 years.

The tie should be capable of working and indeed with some breweries and smaller pub companys I understand it does work well, because they are interested in the long term development of their commerical business. The problem with some of the big pub companies is that they are really leveraged property funds, with little commitment to the actual day to day business of running pubs or developing long term mutually beneficial relationships with their tennants.

Unknown said...

John P, I like your writing and will read more of it, when I have time.

Mr Lager, the more I think about it the more I think that regulation rarely fixes much.

I do however think that publicans of tied houses are poorly represented generally.

Andy, you focus on the key point really. Most, including me possibly, enter the trade after research through rose coloured spectacles.

Thanks for the comments, all good stuff.

In summary "BUYER BEWARE" - If you are thinking about taking on a pub then do some more thinking. Oh, and read the contract 3 times.