Wednesday, January 15, 2014

I'm not an Economist, but...

Professor Morten Hviid is. He wrote (in his reponse to the BIS consultation on proposed intervention between tenants and pub companies:

"If the market really is competitive as claimed, then increasing the fixed costs of the industry will lead to exit until the price has increased to cover these additional costs.  "


But that's not right is it? That would only be the case (at the retailing end) if variable costs remained the same.  But the whole point is to give the option of buying beer out of tie (at lower cost), increasing the gross profit available to those tenants who chose that option. And doesn't this then increase the incentive for the tenant to sell beer (they would get to keep more of the profit), while offering pubcos some insulation from the actual wet beer market (they'd have a portfolio of market rents to wave at their shareholders / lenders)?

Wouldn't a FOT option allow tenants to obtain a higher share of the profit while accepting a higher risk? Or, alternatively, allow them to choose the tie for  lower risk & lower profit. And contrariwise for the pubco? There being only so much risk (and profit) to go around.


21 comments:

Cooking Lager said...

For sure, other things equal if wet rent is removed and dry rent is increased in a manner that is broadly cost neutral then yeh.

But if a pub co is only getting a dry rent then they are 100% in the commercial property biz. They effectively leave the pub biz. They no longer deal with breweries or bother too much what the tenants are up to. They just want the best commercial rent they can get.

It no longer matters what commercial property. Its square yards of retail space. Space that may yield more as offices, flats, convenience stores, parking lots.

Currently they may be just property companies but they are selling a business to run in their property and might be expected to think it is in their interest that the business they sell enables tenants to pay their commercial rent. Much like fast food franchising. In practice they may not show much sign of this logic, but a free of tie option is an end to any notion of business partnership. It is leasing retail space off a commercial provider and nowt else.

StringersBeer said...

But pubcos are already 100% commercial operations, they have to get the best return for their investors - whatever mix of dry/wet rent gives rise to this. If they're not doing this, then the capital moves elsewhere. They're not dealing in beer because they love it. They're running this model because it's as good as (or better than?) the pure property biz. You'd hope.

Personally, I don't see that publicans lose by dealing with a pure property co, viz the number of micropubs, bar-style outlets opening in non-pub premises.

There's a fair bit of FUD about how a FOT option will precipitate a raft of closures. As if pubcos are currently subsidising charming non-viable pubs. You think?

Cooking Lager said...

Pubcos are property companies and no I don’t think they are subsidising anything. But currently they are in the pub business too in so far as that is the business they sell to tenants as a tool to enable the paying of commercial rent. It is in their long term interest that they recruit good tenants that run a viable pub that enables them to pay a commercial rent on the property. It may be in their interest to get shut of some tenants to get back the property and change its use. You would expect that in many cases it actually is a partnership and that a vocal minority are being stiffed. Ending the tie ends any notion of partnership. That might be a good or bad thing, as you say. I doubt it is the panacea of saving pubs from rapricious capitalist property developers, though

StringersBeer said...

But tenants would be free to (and I suspect many would) choose the tied "partnership". I'm sure that for many it's a genuine and valued partnership. Indeed, if it's such a good deal, then the market will ensure the survival of that model. Won't it?

Cooking Lager said...

Wouldn't freedom of choice work both ways? Faced with a significant number going free of tie, would the tenanted model be viable for a minority?

StringersBeer said...

Well, yes, I suppose, if the benefits that the tied partnership is supposed to offer (to the tenant) are actually worth what they're claimed. FOT option is a way of having the market test that.

Of course what FOT does undermine is the pubco's business as wholesaler. If they've got a smaller tied customer base they'll be buying less beer and perhaps won't be able to demand the discount that they're used to. The reduction in the power of this oligopsony (great word) might be interesting.

py0 said...

"the problem of hold‐up identified by BIS should be greater the fewer, not the more, agreements a pub company has. Moreover, if one party has the possibility to engage in hold‐up, other individuals may be unwilling to engage with this
individual"

I think he has got this wrong. Punch and Enterprise between them have a virtual duopoly over the tenanted market, and if they're both engaging in the same dubious behaviour, then there really is no other option if you want to run a pub.

Due to the informational asymmetry in the market, its unlikely they're ever going to run out of new tenants. There may be no competition problems in the final retail market for beer, but there are certainly lots of competitive issues in the intermediate market for pub tenants.

StringersBeer said...

Yep, py0, that's another point I didn't understand at all.

Curmudgeon said...

"As if pubcos are currently subsidising charming non-viable pubs. You think?"

To some extent they probably are keeping zombie pubs going because they're not really sellable at anywhere near the book value.

py0 said...

There are three issues as far as I can see, not all of which are easily rectifiable.

Firstly, there is informational asymmetry. A new tenant looking to start running a pub has a lot less information at his disposal (both about the market and about the different pub co options) than the pub cos do. This leads to a lack of competitive pressure on the pub cos to offer a fair contract. This should be made more transparent and there should be a comparison service (comparemypubco.co.uk ?) that sets out all the deals and tariffs and projections that different pub cos offer so prospective tenants can make a better informed choice.

Secondly signing deals in which the pub co has the right to change the rent/tariffs pretty much however they see fit is just stupid. This should either be more heavily regulated, either directly or by advisory services that encourage tenants not to sign up to such loaded contracts.

Finally, if a tenant is not happy about the way a pub co is treating him, it is very difficult for him to "switch providers", because it involves him both moving house and abandoning all the work he has done in building up his business. This creates the chance of holdup. Fixing this would go a long way to fixing the ultimate problem, however I can't see how you could do it seeing as the pub co generally owns the property.

StringersBeer said...

Well, if it's true that pubcos are "keeping zombie pubs going" (and I can see how that might work) it's an unsustainable strategy (barring some kind of huge property bubble that gives them a profitable "out"). If the demand's not there, those pubs will close. But why should we accept a situation where viable businesses are "taxed" to support the dross.

StringersBeer said...

Good points, py0.
of course Hviid's assertion that:
"the problem of hold‐up identified by BIS should be greater the fewer, not the more, agreements a pub company has" is, on the face of it, hard to swallow.

If there was only one pubco holding all the pubs wouldn't they be able to "hold-up" all their tenants? If there were many small pubcos and only one was a bad actor, wouldn't that one soon find itself without tenants?

py0 said...

I wasn't particularly impressed with his report, he didn't seem to get to grips with the systemic inefficiencies intrinsic in the current structure and just churned out a rather simplistic one-size-fits-all piece of "the market always knows best" dogma.

Mind you, I'm not convinced the proposal for the compulsory FOT rental option will make things much better as there is nothing to stop the pub co's simply charging extortionate dry rent. The information and bargaining power asymmetry problems and resulting opportunity for holdups remain.

The viability of a pub depends very much upon what else it could be used for. There are a lot of pubs with healthy operating cash flows have suddenly become technically unviable simply because of the perceived weakness of change of use regulations.

Curmudgeon said...

"But pubcos are already 100% commercial operations, they have to get the best return for their investors"

Yes, of course, but while it is looking to maximise return to investors, the vast majority of businesses are in business to do a particular thing. They are not, in general, constantly looking to change their core activity.

The business of a pubco is running pubs - if it converts them to a compeltely FOT model it turns itself into a commercial property company which is an entirely different animal. Plus, having lost the wet rent, it no longer has any stake in them being run as pubs as such.

From a financial point of view, that may be a good thing, as the company is transferring all the business risk to the tenants and getting itself a more reliable income stream, but it's hard to see it as a long-term business model as opposed to a run-out strategy.

Curmudgeon said...

"Punch and Enterprise between them have a virtual duopoly over the tenanted market".

Greene King, Marston's and most family brewers also operate substantial tenanted estates.

StringersBeer said...

GK and Marstons have about 3 thousand tenanted, franchised and leased pubs between them. Enterprise currently has about 5.5K (down from ~ 9k) Punch is primarily a tied, leased thing isn't it? With "around 4000 pubs" (down from 7K at the peak). Or as Punch calls them, "cash generating units (CGUs)"

StringersBeer said...

@Mudgie, "the vast majority of businesses are in business to do a particular thing. They are not, in general, constantly looking to change their core activity". Indeed, but capital needn't be so wedded to a particular way of doing business. If Punch, say, needs to swing a 'restructuring of securitisation arrangements' they'd better hope they can show a good potential return.

py0 said...

I wonder if one solution might be a gvt scheme to provide fixed interest mortgages to pub tenants to buy their pubs off the pubco for a fair price. Pubcos would get rid of their assets and be able to deleverage as they are so desperate to do, and tenants would be able to run a freehouse however they see fit.

StringersBeer said...

I know what you mean, but wouldn't this look a lot like the Gov. "baling out" the pubcos?

py0 said...

Only if they pay over the odds. I would imagine that if offered 80% of market price, Punch and Enterprise would bite their hand off.

StringersBeer said...

... and another number. I read that we've about 21000 leased and tenanted pubs in the UK. So between them, Punch and Enterprise own about 45% That's a very significant chunk, arguably a market-distortingly large share. A "virtual duopoly"? You decide.