Sunday 2 January 2011

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.


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.


Curmudgeon said...

Actually, having read the Adnams article, it could be argued that the current PBD system tends to encourage a proliferation of very small breweries that aren't really viable in the long run. In a sense, it actively discriminates against growth. A stronger small brewery sector might result from reducing the maximum relief but providing more of a taper at the top end.

Also, to grow your brewery, I would suggest it is important to get permanent, regular accounts and not to place too much reliance on the rotating guest beer market. That might also help in establishing a price premium and not being at the mercy of lowest common denominator pricing.

Cooking Lager said...

maybe a nice bland fizzy cold cooking lager would get a large enough market to be viable? I'm not paying more than 40p a can, mind.

Mark Dredge said...

Very interesting read, Dave. The whole scale of economics with brewing is something I've entirely overlooked until recently and so this makes things a little clearer. It's not an easy business, that brewing lark, is it?!

Unknown said...

Mudgie, I shall be returning to PBD in time and will respond to your very valid point then.

As for permanent accounts I agree they are ideal for many reasons. We have two at the moment, not enough, but it's a start.

I think any business that depends on a single route to market is bound to have problems. We have a diverse strategy which includes increasing the number of accounts both permeant and guest.

Cookie, lager is part of the plan, however, I suspect it'll be more than 40p a pint. Mind you, I could consider asking Molson Coors to contract brew it I guess.....

Mark, no business is easy, but to be fair, it can be very rewarding.

Ed said...

Dave, you seriously need a bigger brewery.

And adding an extra kg of hops per hl sounds like a massive increase to me.

Unknown said...

Ed, agree on the bigger brewery thing.

1kg extra on my hopping would be approximately doubling my current usage. I shall again quote BrewDog;

"We use 35 times more hops than an industrial brewer and over 15 times the hops of an average small UK brewer to make one barrel of BrewDog beer."

I bet Thornbridge, Marble et al use similar amounts. My beer isn't as good as these guys yet, and although matching the hopping rates isn't the be all and end all of good beer, it's a big part of it.

Reuben Gray - TaleOfAle said...

Very interesting read Dave. It puts things into perspective when considering starting up a brewery. I suppose it goes to show that running a brewpub might be a little easier since you already have a base market and don't need to advertise.

You would of course know all about that where as I am just guessing.
In the US, brewpubs often brew over capacity for their needs and sell kegs and even bottle their beer to sell at liquor stores. Is that sort of thing viable in the UK? Use the pub business as your main source of income and sink profits in to expanding the brewery? If it works out you, could then move the brewery to a larger premises and brew full time.

I guess that is what the Porterhouse in Dublin did and they are on a slow march to global domination these days without the Brewdog fanfare.

Ed said...

"We use 35 times more hops than an industrial brewer and over 15 times the hops of an average small UK brewer to make one barrel of BrewDog beer." they indeed. [Scratches chin in the style of Jimmy Hill.] From the day I spent at brew dog I remember they used a lot of hops...but not that much.

Unknown said...

TaleOf Ale, I think that the BrewPub model has loads of benefits, at least having a guaranteed outlet is very useful.

Ed, as far as I can remember from what they told me a kg per hl dry hops is not unusual for BrewDog. However, I think I'd best find out for sure. I'll let you know.

Brewers Union Local 180 said...

FIrst of all, the UK duty thing, tied to ABV and scale, is goofy. Maybe you need some effective lobbyists like the equivalent of the Oregon Brewers Guild or the Brewers Association.

I still don't understand whether there is a wholesale/retail dichotomy over there. You'd hafta be big like a Ninkasi or Oakshire (to name a few local production breweries) to even make a nickel off a pint. Wouldn't it be better to stay reasonably small, buy yourself an inn, and skip the middleman by selling over your own bar? Maybe I need a cogent explanation of whether there really is a middleman like in our three tier system.

Unknown said...

BUL180, there isn't the same middleman system as there is in USA. We can sell to absolutely anyone we choose, providing they want to buy our stuff. We need a licence to sell to the general public, and for off-sales this is work in progress.

Buying a suitable pub, in a suitable location is, as I have explained before, part of the grand plan.

But this time someone else is going to run it and I'll only go there to drink my beer and bollock people.

Our duty per volume of pure alcohol is unlikely to change. I expect eventually all alcohol will be taxed irrespective of it's production method. I need to do research on this, but the gap between beer and spirit duty appears to be closing.

Erlangernick said...

Am brewing today (well at home, only 5 gallons, but still) so no time to digest all of that yet, but how do you think your Infra Red really compares to a Cascennial IPA from Orygun? I'm considering ordering a mixed case from Ales by Mail once I find out about their continental shipping rates.

Unknown said...

Nick, I'd like to think it matches quite well to the West Coast IPA thing. It's been compared to Stone for instance. However, you'd have to try it to see for yourself.

Unknown said...

As a side note, I've been criticised here and elsewhere for suggesting that 1kg per hl is not significant.

One comment was "Some of the figures in that article and the comments that follow it are pulled straight from his arse" a little harsh I feel.

Anyway, I've put together some true figures from my brew records that I have looked at today. I've also corrected the post as the reader can see.

Infra Red uses 0.88kg per hl in the copper and 0.1kg per hl dry hops. A total of 0.98kg per hl.

Queboid uses 1.1kg in the boil and 0.2kg dry hopping per kg. A total of 1.3kg per hl.

Of course these amounts might be varied to take into account variations of alpha acid.

My comments about BrewDog are a guess and I'm sorry that people think that equates to pulling figures from my arse. I do think it comes from a reasonably informed viewpoint, but I accept I could be wrong.

Also, I guessed at the amount BrewDog use for dry hops, not their total hop usage as some seem to think I was trying to say.

Unknown said...

My previous comment seemed to disappear; let's try again.

The extra kilo of hop per hl, would that be all dry-hopping?

And out of interest, what's you maximum annual production? You intimate it through the turnover figure but I don't want to trust an extrapolation.

It's just that, although I understand your love of hoppy beer, wouldn't sustained growth be better achieved by increasing stainless capacity rather than upping the hops??

Unknown said...

Simon, well the cost of an extra kg per hl isn't really any different for dry hopped or in the boil, so for the purposes of brewery viability makes no difference.

However, my experience is that hops used for dry hopping give much more "zing" to a beer than if they are used in the copper.

The down side is that to maximise that effect the beer needs to stay in contact with dry hops for about 6 weeks. That ties up stainless in some form or other. I suspect most brewers up the rates of dry hopping and leave the beer on dry hops for less time.

You are correct, stainless is the best investment for improving capacity and turnover, but it does depend on achieving sales.

My own view is that the market for traditional ales that use moderate amounts of hops is at best stagnant and saturated, but possibly in reality declining.

I hope the market for hoppier beers is increasing. I include the approachable beers in this category. Perhaps it's just a case that there is always a market for superb beer. Dry hopping seems to be a sure way of making superb beer.

As for my own capacity, I can brew about 850 hl per year. More FV's would increase that as I can easily brew 850/52=16.3hl in one shift with parti-gyle brewing.

My turnover figures are based on 4% beer. I can, and probably will improve my turnover by making some, or perhaps a lot, of strong dry hopped beer. I can charge more for that, providing I can get it to market. This should take my turnover up a little.

I think the term is "premiumisation" or some such nonsense.

I hope that answered you question....

StringersBeer said...

Dave's right here of course - the margins in the brewing business are very low - I've read 2.5% net for the beer industry overall. The smaller brewers have to maintain higher margins than this to keep their small operations viable while producing great beer with lower efficiency.

For all the pain we hear of in the retail sector, their margins are still much better than the poor bloody brewer. Which is why (a) many micros like to get their own pubs asap and (b) the tied model is so fiercely defended.

If we can't get or grow a reasonable margin, then we look to growing our volume. But if we're not seeing the market (sector) grow overall then we'll be looking at grabbing sales from competitors - if we think we can do this without hitting margins then good, but otherwise it turns in to a stupid game of beggar-thy-neighbour, which can work out badly for any or all concerned.

Rob Sterowski said...

I hate to play armchair entrepreneur, but I think the market for moderately hopped (or even barely hopped) beer is still capable of growth, if it is seen as part of a shift to better beer in general. Look at all the people supping Erdinger and Innis & Gunn. They are (in their own estimation) trading up, and happy to pay through the nose to do so.

Unknown said...

Comprehensive as ever, Dave.

Beer style, strength and dispense are shaped by the marketplace you're in. Brewdog (IIRC) export the majority of their beer, majority of that is bottled, much of that is higher abv/hop profile I'm guessing.

With my work-day hat on, nearly all of the brewers we work with their expansion plans produce <6% ABV cask beer for a tied house, their own pub (through 'Project William' style schemes) or for SIBA DDS.

There is indeed a market for moderately hopped cask beer in volume. On the back of which, there's a premium market for stronger, fuller-flavoured beer as an adjunct to the core offering. It's just that it helps measurably to have access to the market. Your own pub, regular accounts and DDS are all tried-and-trusted ways of gaining access.

Unknown said...

Barm, Simon,

I think we could continue to discus what we see as growth markets or declining markets - it depends on what we see as moderately hopped, or barely hopped. What is true is that the beer market is shrinking, and I suspect will continue to do so. It looses out to wine, whisky, gin, vodka, ready-to-drink and all that nonsense.

The good news is that there is some growth in quality markets.

Simon and Stringers are both right of course, and Mudgie in his first comment; some form of ensured route to market is invaluable.

Unknown said...

Barm, that, by the way, means I probably agree with you. Good beer does not have to be hopped to hell. Good beer is good beer and will sell better than beer that is not so good. Big brewers have managed to get away with selling not so good beer by marketing. Small brewers who make not so good cask sell it because of provenance.

I think the market for good beer, whether it be barely, moderately or hopped to bits, has a future.

Erlangernick said...

Back to drinking your beer. Would you be at all interested in doing a trade? I could ship you a few bottles of exceedingly rare Franconian treats (not the famous Rauchbier...unless that's your thing!) in exchange for a couple bottles of your Infra Red and maybe that 3% Cascade. Treats like pale, bitter, hoppy Winterbockbier and dark, malty Winterfestbier.

It costs me 22 € to ship 10 kg your way, and I'd be willing to paypal you some dosh if it costs you substantially more to ship this way. If you'd fancy such a deal.

Tandleman can vouch for me, and he's got my contact info.

Steve Wright said...

Interesting - as a homebrewer I don't have to worry about the overheads or costs - chuck in more hops and get new yeast is order of the day.

I'm with you on the view that the micro cask-ale market is saturated and it's interesting that you seem to refer most to BrewDog as a comparator.

The comments on PBT were echoed on a recent tour round Copper Dragon at the Craft Brewers Assoc National Comp - seems a divisive issue.

As you note BrewDog have managed to craft some very different (for the UK) and distinctive beers and beer lovers will pay for them as you at least know you'll get something different - reflected in their packaging, marketing etc. The other micros in the UK seem content to plough the same narrow furrow of middle-of-the-road undifferentiated ales and often use stunningly dull yeasts like Nottingham or Saf-04 to further make their beers the same as everyone elses, a saturated and undifferentiated market.

Perhaps a comparison worth thinking about is Belgian craft breweries who literally craft different beers and while beer is cheap there they also export for substantial markups and command higher prices for these. Is there not a message in this for a UK micro to start chasing the niche connoisseur market (BrewDog but with subtlety?) 'premiumising' or whatever it is. The back-catalogue of lost or hard-to-find styles with an export potential seems huge: Imperial Russian Stouts, Traditional IPA's a real aged and blended porter, an Elizabethan Doble Doble barley wine etc.? Then perhaps the idea that there is a top limit to prices is no longer true - I paid £5.50 for a 330ml bottle of BrewDog's whisky-barrel aged imperial stout and don't regret it and would buy it again if I ever see it but no-one else seems to be after that market. Where are the stock ales of yore with their brettanomyces character from ageing? Perhaps small and specialist could work?

Of course stronger needs longer ageing and storage and concomittant costs but if the trad ale market is saturated this must be the place for growth and niche working surely?