In a recent commentary on a Statutory Code I drew attention to the scramble to seek reaccreditation for company Codes of Practice and asked whether this is really the answer to the various issues facing the sector. I suggested that these issues were not caused by a lack of Codes of Practice, which will not, by themselves, solve the issues because it is a cultural change that is required.
Achieving cultural change
Cultural change is not going to be achieved by transferring profit or income from the pubco to the tied tenant, so as to match the tied tenant’s returns with the returns achieved by a free of tie tenant. Apart from the fact that appropriation of private property is morally (and probably legally) wrong it simply doesn’t solve the problem and certainly doesn’t provide a solid base for the investment in both people and property – which is undoubtedly required for successful pubs. Any scheme by the Government that effectively props up or prolongs the life of failing pubs will not ensure the good health of our pubs and is likely to be viewed in the future with the disdain with which we now view the Beer Orders for having produced some unanticipated consequences.
Can I suggest that a possible solution lies in the notion of “partnership”. This should be not a difficult concept, at least in principle, for the industry. Indeed, a cursory examination of accredited company Codes on the BIIBAS website reveals various references to “partners” (this means the tenants) and “partnership” (this means the pubco and tenant relationship). I invite you to consider the following points with a view to achieving the partnership which might just provide an answer to the current impasse:
The tie can work
Evidence available to me from up and down the country tells me that, far from failing, the traditional tenancy (i.e. a shorter term arrangement) is, generally, in good health. Those who propose abolition of the tie would do well to recognise this. There is nothing wrong with the tie and there is nothing wrong with the traditional tenancy model. It is just that it has been applied in some cases which have proved unhelpful. If this sounds like the Government’s line the conclusions drawn will be very different.
Investment is the key to success
The same cannot be said, alas, for leases. There are certain profiles of operator and house which are suitable for longer terms arrangements which go beyond the traditional tenancy. However, these are often limited to cases where one or, preferably, both the landlord and the tenant have the operational skills and financial resources to invest in the outlet. We can all think of good examples of these houses (I had lunch in one of them in Saffron Walden the other Saturday) but unless there is a willingness and ability to invest (in both the people who run the business and in the property) this is unlikely to work.
Accordingly, a different financial model and different rules should apply to leases. The treatment afforded to leases in the IFC version 6 is simply not far reaching enough to address these underlying issues. Unless there is investment in outlets there will be decline. Long leases do not necessarily lead to the correct levels of investment to make them succeed. The correct treatment for leases is a subject I may return to in the future.
Rebalancing the equation
The way Pubcos derive their income from the tied model can be easily summarised by the following equation:
R + PM + MI = PI
R means Rent
PM means Product Margin
MI means Machine Income
PI means Pubco Income
What the Pubco makes (PI) is not equal to what the tenant makes and is never going to be. However, tinkering around by reducing or removing one part of the landlord’s return and adding it to the tenant’s return does not go to the essence of the problem which is that, in practice, the Pubco will get its return first and then the tied tenant gets whatever is left.
This has been presented by various commentators as an issue for rent setting or discounting or not double-counting machine income and there is no doubt that there are issues with the way in which the individual constituents of PI have been calculated. But the net effect of these proposals is to transfer an element of PI to the tenant to increase his return which is broadly similar in principle to the Government’s plan to transfer profit from pubcos to their tenants. In contrast, in a genuine partnership each side gets their return, but without any priority for one side to get their share first. An answer to this is to have the tenancy turnover related – but there would have to be some limits and conditions in the model. These would include:
- Minimum levels of return for both sides so that no one has to support a failing operation.
- Possible sharing arrangements in respect of the tenant’s profit. If the constituent elements of PI are reduced so as to increase the tenant’s potential share of the house income there can be no objection in principle to some elements of tenant profit sharing.
- Some priority of returns to reflect the requirement for returns on invested money (in much the same way as bank borrowings would be prioritised).
The Government’s perception seems to be based on the view that there isn’t enough left in it for the tenant. This might often be true but Pubcos and tenants should get the rewards they deserve. This means, in the context of turnover rents:
- If your reward is a share of turnover you (the Pubco) are going to take a lot more effort to ensure that the tenant is the right person to take it forward. This means ruthless tenant selection and vigorous training in order to minimise the risk.
- If your reward is turnover based you will increase your return if you invest. The principal objection to the Government proposal is that it doesn’t encourage investment and, candidly, the comments made in the consultation paper and the impact assessment relating to investment are laughable.
I realise that there are range of deeply held objections to these proposals which I have no doubt the industry will be quick to voice. However I note, as we go to press, the announcement in the trade press that Enterprise is considering a move to turnover related rents.
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