Last Updated Mar 25, 2010 8:15 AM EDT
This week, Mitchells & Butlers has announced the results of its strategic review, and will now be focusing on food, consolidating its brand portfolio and reducing its exposure to drink-led occasions. In the same week, Punch Taverns has announced the intention to reduce its tenanted estate, once almost 8,000 strong, to around 5,000 units, and to re-direct its investment to the managed estate.
So what are the key dynamics driving these, and many other, structural changes within the industry? Here are six of the most significant factors:
For over two decades, drink volumes have continued to shift from the on-trade to the off-trade, as the price differentials have increased. In real terms, on-trade prices have been rising every year, whilst off-trade prices have been decreasing. Part of this has been fuelled by the supermarket price-wars on key lines over recent years. Supermarkets can afford to make virtually no margin on alcohol, generating profit from the large associated basket of products that customers buy whilst in store, but pubs, especially drink-led pubs, generate the bulk of their gross profit from drink, and run with much the higher overheads of a service, rather than a retail model. This means that dropping much below 50% margin on drink is virtually impossible for a pub, so prices will always be at least double that of the supermarkets, if not more.
2. Consumer Trends
In times gone by, the pub was a core part of the social fabric, especially for working people, and particularly for working men. Over the past decade, the number of people who visit the pub at least once a week has declined dramatically, and the occasions have narrowed considerably. Over the last two years, for instance, the number of visits per week by 18 to 25 year-olds has almost halved. Whilst punters are spending more when they do go out, the overall spend levels have dropped by almost a quarter from this key demographic. Quite simply, in addition to all of the economic factors, there are so many more ways for the average person to socialise, and to pass an evening, than there used to be, that the traditional pub is, and will continue to be, the big loser in the mix.
The pub industry has suffered quite heavily from legislative changes over the past couple of decades. The BEC report, and the ongoing discussions about referral of the industry structure to the Competition Commission, underlines how small the true impact of the beer orders of the 1990s has actually been. The smoking ban, for better or worse, has impacted many segments in the industry, as have the alcohol duty escalator, minimum wage, and legislation on gaming machines, to name just a few of the factors. The fragmented nature of the market, and low levels of cooperation between the players, are also key factors in the industry's inability to effectively defend itself against these events.
4. Low Buying Power
The large pubcos generally have index-linked price contracts with the key drinks suppliers, and the supermarkets have at least as strong a balance of power. This means that the main area for drinks manufacturers to push through price increases is through the wholesale and independent stockist channels. It's no surprise, therefore, to find that pub closure rates are at their highest in the independent / freehold sector, followed by the tenanted sector (see point 4 below), followed by the managed chains. The smaller players simply can't compete on price, whilst making enough money on a pint, to survive, unless they're offering a highly differentiated and value-added experience which, unfortunately, not that many are.
5. Pubco Debt
One of the biggest structural issues preventing tenanted pub operators from competing with both the off-trade and the large managed pub-chains, is the level of indebtedness of their landlords. Tenanted pubs, on paper, pay a lower rent, but are tied into a beer supply contract with the pub company, which may cost up to double the price than it would cost through other distributors. The pubco will typically generate half of its income from rent, and the other half from the margin on beer. Despite having strong contracts with suppliers, pubcos will generally pass on the full wholesale price increase to tenants, keeping the difference. So why do pubcos continue with this approach, systematically undermining the competitiveness of the very tenants upon whose success their profits rely? Quite simply, the largest ones, particularly Punch and Enterprise are so highly leveraged, that they can't afford not to. Hence both businesses are frantically selling off properties to raise cash to pay down debt and, belatedly, to invest in giving some relief to their tenants.
It's easy to point the finger at the many external factors, and one look at the message boards of key industry sites like 'The Publican' and 'The Morning Advertiser' will show you just how much enthusiasm there is within the trade for finger-pointing. However it's impossible to get away from the fact that, even within this extremely difficult market, some people are doing very well. JD Wetherspoon operate an extremely robust model, with a single fascia across over 700 pubs, and an almost supermarket approach to managing their range, pricing and their supplier-base, regularly trading off brands and destabilising the market. At the other extreme, nimble, customer-centric local operators across the country are picking up great sites at knock-down prices and creating truly diferentiated, high quality venues, that can more than justify the prices they need to charge to make a good profit. So clearly, it can be done, but clearly, only those with the vision, skill and imagination to do something different to the mainstream, are actually pulling it off.