Deposit return scheme for Scotland: full business case addendum

3 Financial Case – Summary of Changes

3.1 Approach

3.1 As a form of extended producer responsibility, the costs of operating DRS will largely be borne by drinks producers. We expect producers to opt to discharge their obligations through a single scheme administrator funded by a per-container producer fee. The FBC Stage 1 therefore presented the Financial Case from the perspective of the scheme administrator; this Addendum to the FBC follows the same approach.

3.2 The Financial Case continues to treat deposit inflows and outflows in a similar way to the Norwegian DRS, recognising the net benefit of these flows, i.e. the value of unredeemed deposits, as revenue in the profit and loss account of the scheme administrator and applying it against scheme expenses. It will be for the scheme administrator to finalise the accounting for the company.

3.3 Since the publication of FBC Stage 1, further work has been undertaken to gather additional evidence for the key assumptions that drive the revenue and costs of the scheme. This work has included a series of workshops with industry to better understand their plans for responding to the Regulations, further engagement with RVM manufacturers and ongoing discussions with operational international schemes.

3.4 Where there was confidence that the evidence provided was robust, an update has been made to the financial modelling assumptions (as set out in section 3.2) to arrive at a Revised Base Case. Where the evidence was considered less robust, an alternative scenario has been modelled to provide a range of possible outturns for the cost of the scheme (as set out in section 3.4).

3.2 Modelling Assumptions – Summary of Base Case Changes

3.5 Table 8 summarises those assumptions that have been updated as described at paragraph 3.4 and the additional evidence which supported the change. All other assumptions remain in line with those described in section 4.3 of FBC Stage 1.

Table 8: Financial Modelling Assumption Movements

Assumption	FBC Stage 1	Revised Base Case	Evidence
Key Drivers
Container Numbers	1.67bn	2.17bn	British Soft Drinks Association submission as revised by Eunomia analysis.
% Materials Eligible for sale	PET 97% Alumin/Steel 97% Glass 97%	PET 97% Alumin/Steel 97% Glass 95%	Stakeholder agreement to PET and aluminium/steel assumptions. Revised assumption for glass based on additional evidence provided by British Glass.
Sale of materials (£/tonne)	PET £200 Alumin/Steel £1,300 Glass - Flint £17, Green £6, Brown £12	PET £200 Alumin/Steel £1,000[5] Glass - Flint £20, Green £15, Brown £17	Stakeholder feedback validated PET and provided evidence to support increase to glass assumptions. Evidence was also identified to support a reduction in the aluminium/steel assumptions based on Eunomia research.
Average Container Weights	PET 0.033kg Alumin/Steel 0.017kg Glass 0.350kg	PET 0.027kg Alumin/Steel 0.014kg Glass 0.270kg	Reduction in container weights based on further information provided by British Glass, Eunomia research and Transparency market research.
Producer fee (Methodology)	Average annual contribution by producer	Producer fee as offset by material specific revenues	Agreed with producers (and consistent with other international examples) that the producer fee should consider the value of material.
Handling Fee
% Split Lease v Acquisition	100% leased	60% leased 40% acquisition	Based on stakeholder evidence. This has a marginal impact as a result of a reduction in the level of lease premium being applied
Installation cost per unit	£700 per unit (one-off)	£1,500 per unit (one-off)	Range provided from stakeholders from £1,000 to £8,000. Clearest evidence provided was in the range of £1,000 to £2,000 including direct evidence of experience in other countries. Mid-point of £1,500 adopted.
Maintenance cost per unit	£1,900 per unit pa	£2,500 per unit pa	Range provided from stakeholders suggested reasonably consistent view of £2,000 to £3,000, based on international experience and specific RVM contracts. Mid-point adopted.
Running cost per unit	£150 per annum	£300 per annum	Stakeholders indicated higher costs but were often also including maintenance costs (see above) in estimates. Acceptance of increase to costs based on stakeholders experience elsewhere. The revised assumption does not have a significant overall impact.
Lost staff time	£690 per return point per annum 1.25 hours per week x £10.66 per hour x 52 weeks	£920 per return point per annum 1.5 hours per week x £11.80 per hour x 52 weeks	2 key movements: The wage-rate assumption has moved from £10.66 per hour to £11.80 per hour (including on-costs assumption of 25%). The base rate reflects the median hourly wage for ‘Retail sale in non-specialised stores with food, beverages or tobacco predominating’ on the basis of evidence from the Office for National Statistics (ONS); Lost time associated with operation of a return point has moved from c. 1 hour a week to 1.5 hours per week. A range of estimates were received from stakeholders, ranging from 10 min through 154 minutes per day (one retailer suggested 1 FTE would be required). Evidence was provided based on trials undertaken to date and experience in other countries. The final position of 1.5 hours aligns more closely with evidence provided by RVM Manufacturers.
Non-Operating
Interest on borrowing	3%	10%	It has been recognised through further discussions that commercial lenders would not fully fund any borrowing, and there is a preference from producers not to fully fund set-up costs of the scheme. The expectation is therefore that the cost of borrowing will be a combination of equity from producers at a higher rate, and commercial borrowing at a lower rate. The increased assumption of 10% is considered reasonable to apply although the final figure will be subject to refinement as discussions with lenders/producers continue.
Corporation Tax	Nil	£0.7m	In light of additional clarity on the likely structure of the scheme administrator, it is deemed appropriate to apply corporation tax to trading profit.
Operating Costs
Workforce Costs and General Operating Costs – Counting Centres	£3.8m pa (average y6-9)	£4.8m pa (average y6-9)	A 30% increase in costs has been adopted to reflect the increase in container numbers passing through the scheme.
Cost of Fraud	£5.3m pa (average y6-9)	£6.9m pa (average y6-9)	A 30% increase in costs has been adopted to reflect the increase in container numbers passing through the scheme.
Logistics costs	£16.5m pa (average y6-9)	£20.2m pa (average y6-9)	The logistics cost is derived by multiplying the volume of material in tonnes by a respective £/tonne rate. The movement reflects the 30% increase in container numbers but this is partially offset by the reduction in the assumed weights of containers.
Regulator compliance Fee	£0.250m per annum	£0.965m per annum	Movement based on updated information provided by SEPA.

Source: Zero Waste Scotland (ZWS)Analysis

3.3 Financial Impact

3.6 The impact of these updated assumptions is described below.

Operating Costs

3.7 Current modelling indicates an increase in average annual expenditure during steady state from £78.2m to £92.9m. This represents an increase of £14.7m, or 19%. Movements in the annual cost base can be attributed to the increase in container numbers (30%). However, this is partially offset by the decrease in assumed container weight assumptions which reduces the impact on costs that are calculated on a tonnage basis i.e. logistics fees.

Figure 1: Steady State Expenditure FBC1 versus Revised Base

Source: Deloitte Analysis

3.8 Logistics costs have increased by £3.7m (22%). While a lower £/tonne cost has been applied compared to FBC Stage 1, overall costs have increased due to a 30% increase in the assumed number of containers, partially offset by a reduction in the assumed weight per container.

3.9 Other costs have broadly increased in proportion to the container number increase.

3.10 The handling fee has increased by £7.6m (15%); taking into account the 30% increase in container numbers, this results in a reduced pence-per-container figure. The cost increases are mainly driven by increases to the assumptions for maintenance costs (£4.6m increase), running costs (£1.2m increase), lost staff time compensation (£0.9m increase) and installation costs (£0.6m increase). These costs reflect estimates prior to commercial negotiations and are derived through consultation with industry, RVM manufacturers and the experience of other jurisdictions.

3.11 As the total costs are being recovered over a higher number of containers, the handling fee decreases from the FBC Stage 1 assumption of 3.1p per container for automated returns to 2.8p per container. The weighted average handling fee for manual return also decreases from 1.5p at FBC Stage 1 to 1.1p. This is due to staff-time compensation no longer being applied where drinks are sold exclusively for on-site consumption, reducing the overall costs to be compensated. This is consistent with the approach taken to the handling fee in the DRS Regulations.

Table 9: Summary Handling Fee Movement

Category	FBC Stage 1	Revised Base Case	Movement (£)	Movement (%)
Containers in System	1.67bn	2.17bn	0.5bn	30%
Containers Returned	1.53bn	1.93bn	0.4bn	26%
Handling Fee	£50.6m	£58.2m	£7.6m	15%
Auto Handling Fee (p/container)	3.1p	2.8p	(0.3p)	(10%)
Manual Handling Fee (p/container)	1.5p	1.1p	(0.4p)	(27%)

Source: Deloitte Analysis

3.12 The overall split of operating costs remains broadly consistent with FBC Stage 1. The largest cost remains the handling fee, at 63% of the overall operating costs (although this is a marginal reduction from FBC Stage 1); this is a result of handling fee costs per container decreasing while the logistics and other costs have broadly remained static on a per-container basis.

Figure 2: % Split of Expenditure during Steady State

Source: Deloitte Analysis Source: Deloitte Analysis^[6]

Non-Operating Costs

3.13 Non-Operating costs relate to financing costs, depreciation and tax.

3.14 The average steady-state financing costs have increased from £2.9m^[7] to £3.6m (principal repayment and interest). This is as a result of the assumed borrowing rate increasing from 3% in FBC Stage 1 to 10%. The figure of 10% better aligns with the expectation of a blended rate, reflecting a funding solution that will require both member loans and commercial borrowing.

3.15 Depreciation costs remain consistent with FBC Stage 1.

3.16 No tax costs were reflected in FBC Stage 1. The financial model now reflects an assumption that, as a Company Limited by Guarantee, corporation tax will be payable on trading profits. While these are minimal at present, a tax cost of £0.7m per annum during steady state has been assumed.

Operating Revenue

3.17 Current modelling indicates an increase in average annual revenue during steady state from £80.8m to £95.3m (£14.6m, 18%). This is driven by the increase in the costs of the scheme administrator which necessitate additional revenue to break even.

3.18 Revenue from sale of materials has reduced by £1.6m (8%) from FBC Stage 1. While container numbers have increased, this has been offset by reductions in the assumed weights and prices of materials (per section 3.2).

Figure 3: Revenue by Heading FBC Stage 1 vs. Revised Base

Source: Deloitte Analysis

3.19 Net Unredeemed deposits have increased by £10.2m to £44.1m per annum in line with the increase in container numbers (30%).

3.20 The producer fee is in effect the balancing item for revenue purposes. Total costs have increased by £14.6m and revenue from the sale of materials has fallen by £1.6m. Net unredeemed deposits increase by £10.2m (directly in proportion to the increase in container numbers). The remaining £5.9m requirement is funded from an increased producer fee (from £25.9m to £31.9m per annum). This amounts to a 23% increase in the revenue to be raised from the producer fee; as this is less than the 30% increase in container numbers, the producer fee per container falls from 1.5p to 1.4p.

Table 10: Summary Producer Fee Movement

Category	FBC Stage 1	Revised Base Case	Movement (£)	Movement (%)
Containers in System	1.67bn	2.17bn	0.5bn	30%
Producer Fee	£25.9m	£31.9m	£5.9m	23%
Producer Fee (p/container)	1.5p	1.4p	(0.1p)	(7%)

Source: Deloitte Analysis

3.21 The proportion of revenue funded by unredeemed deposits increases to 46% during the steady state period, compared to 42% in FBC Stage 1. This offsets the reduction in the sale of materials (from 26% to 20%), so the producer fee continues to account for around 33% of total revenue.

Figure 4: % Split of Revenue FBC Stage 1 vs. Revised Base

Source: Deloitte Analysis^[8]

3.22 In FBC Stage 1, the producer fee was calculated on a ‘whole of scheme’ basis in order to understand the contribution required to achieve full cost recovery. Further work has been undertaken subsequent to FBC Stage 1 to understand the impact of calculating the producer fee by material type. This approach takes account of the contribution that different material types make to the scheme in terms of material sales revenues. The methodology may be further developed by any scheme administrator going forward but initial figures have been identified per Figure 5.

Figure 5: Producer Fee by Material Type in Steady State

Source: Deloitte Analysis

Non-Operating Revenue

3.23 Recognising unredeemed deposits as revenue results in significant cash balances being built up by the scheme administrator during the observatory period. It is assumed that interest can be earned on this cash balance. During FBC Stage 1 the average cash balance during steady state was around £200m, resulting in interest earned of £2.0m per annum. As a result of the increased container numbers and proportionate increase in unredeemed deposits, the average cash balance held rises to around £360m, increasing interest earned to £3.6m.

Profit and Loss

3.24 Table 11 sets out the resultant average Profit and Loss (P&L), including a comparison between the FBC Stage 1 and the Revised Base Case position.

3.25 In summary, the overall annual revenue required to fund the scheme has increased from the FBC Stage 1 by £14.6m (18%) to £95.3m. This is mainly driven by an increase in the operating costs of £14.7m (19%), although this is partially offset by movement on the non-operating costs and revenues. The producer fee is set to provide a profit after tax matched to the principal repayments on borrowing (£2.9m during steady state).

Table 11: Summary P&L Movements from FBC Stage 1 to Revised Base Case

£m (Nominal)	FBC1 (Ave Y6-9) (£m)	Revised (Ave Y6-9) (£m)	Movement (£m)	Movement (%)
Revenue
Deposits Received from Producers	339.4	441.4	102.1	30%
Sale of Materials	20.9	19.3	(1.6)	-8%
Producer Fee	25.9	31.9	5.9	23%
Total Revenue	386.2	492.6	106.4	28%
Expenses
Deposits Unredeemed and Outstanding (Deposit Liability fund)	-	-	-	-
Deposits Paid to Retailers (Cash Reimbursement)	305.4	397.3	(91.9)	30%
Handling Fee	(50.6)	(58.2)	(7.6)	15%
Logistics Costs - Collection - Automatic	(12.9)	(15.8)	(2.8)	22%
Logistics Costs - Collection - Manual	(3.6)	(4.4)	(0.8)	22%
Workforce Costs - Counting Centres	(2.6)	(3.3)	(0.7)	29%
General Operating Costs - Counting Centres	(1.2)	(1.5)	(0.3)	29%
System Administration Costs	(1.3)	(1.3)	-	-
Cost of Fraud	(5.3)	(6.9)	(1.6)	30%
Communications	(0.5)	(0.5)	-	-
Regulatory Compliance Fee	(0.3)	(1.1)	(0.8)	273%
Total Expenses	(383.6)	490.2	(106.6)	28%
EBITDA	2.6	2.4	(0.2)	-7%
Depreciation	(1.5)	(1.6)	(0.0)	2%
Interest paid	(0.2)	(0.9)	(0.8)	521%
Interest received	2.0	3.6	1.6	82%
EBT	2.9	3.5	0.7	22%
Tax	-	(0.7)	(0.7)	-
Profit after tax	2.9	2.9	(0.0)	-1%

Source: ZWS Analysis

Note: Total Revenue includes the deposit income and Total Expenses includes deposit expenditure, which results in the differences from the figures set out in Figure 1 and Figure 3. The difference between Deposits Received from Producers (£441.4m) and Deposits paid to Retailers (£397.3m) is £44.1m. The £44.1m plus the Sale of Materials (£19.3m) and Producer Fee (£31.9m) totals £95.3m as reflected in Figure 3. The total expenses of £490.2m less the deposits paid to retailers (£397.3m) gives operating costs of £92.9m as reflected in Figure 1.

3.4 Sensitivities

3.26 In addition to the Revised Base Case position outlined through this document, an alternative scenario has been considered that examines the impact of changes to some key assumptions.

3.27 The Highest Foreseeable Cost Case based on industry feedback assumes the number of RVMs increases to 3,888 (25% increase), broadly in proportion to the increase in container numbers. In addition, it also reflects a higher assumption for compensation for lost staff time. This increases from 1.5 hours per week to 7 hours per week. It should be noted that the evidence underpinning these assumptions is considered less robust than that adopted for the Revised Base Case position.

3.28 The outputs of this scenario are set out below:

Table 12: Scenario Summary Outputs

£m (Nominal)	Scenario - Foreseeable High
	Revised Base	Foreseeable High Scenario	Movement	Movement (%)
Revenue	95.3	123.7	28.3	29.7%
Operating Costs	(92.9)	(121.3)	(28.3)	30.5%
Non-Operating Costs	1.2	1.2	(0.0)	0.0%
Tax	(0.7)	(0.7)	0.0	0.0%
Profit after tax	2.9	2.9	-	0.0%
Handling Fee	(58.2)	(87.6)	(29.4)	50.6%
Handling fee (p/container) (automatic)	2.8	4.3	1.5	54.2%
Handling fee (p/container) (weighted-average manual)	1.1	1.1	(0.0)	-1.7%
Producer Fee	31.9	60.2	28.3	89.0%
Producer Fee (p/container)	1.4	2.7	1.3	89.0%
% of Revenue from Unredeemed Deposits	46.7%	35.7%		-11.0%

Source: ZWS Analysis

Note: Total revenue and operating costs reconcile to Figure 1 and Figure 3. The differences from Table 11 relate to the Deposit inflow and outflow being combined to reflect the ‘Unredeemed Deposit Revenue’ figure of £44.1m. Non-operating costs are the total of Depreciation, Interest Paid and Interest received in Table 11.

3.29 Under the Highest Foreseeable Cost Case scenario, handling fee costs rise by £28.3m. This increases the per-container figure from 2.8p to 4.3p. This is funded in full by an increased producer fee, resulting in an increase from 1.4p to 2.7p. The final costs of the scheme will be the responsibility of the scheme administrator and will be dependent on the negotiations with producers and retailers to agree an acceptable position for the handling fee and producer fee.