Scottish Pubs Code and related regulations: business and regulatory impact assessment

Annex B

Guest Beer Agreements

Background

The Tied Pubs (Scotland) Act 2021 provides that the Scottish Pubs Code must require pub-owning businesses to offer to enter into a guest beer agreement with tenants, in certain circumstances. A guest beer agreement under the Act, must allow a tenant to sell one beer of their own choice, regardless of who produces the beer.

Presently, most tied pubs can only purchase beer from their pub-owning business, although some tied pubs currently do have a guest beer agreement in place, with the tenant usually sourcing the guest beer from the pub-owning business.

As part of a formal open consultation, it was proposed that guest beer agreements should be restricted to brands of beer with a small production capacity, whose annual production level does not exceed, or is not estimated to exceed, 60,000 hectolitres (hL). The 60,000hL level was seen as arbitrary by some in the consultation^[51], so further work was carried out to determine a medium level option by comparing brand sales data. This BRIA considered the impact of a guest beer agreement under three options – an annual production level of 5,000 hL, an annual production level of 100,000 hL and a guest beer agreement with no production limits.

The approach to the analysis set out in this annex has been to infer the annual sales of beer for an average Scottish tied pub and model the potential transfers in profits and revenues between a tenant, pub-owning business and guest beer provider, as a result of substituting a proportion of beer sales away from tied-beer to a guest-beer.

Assumptions

Firstly, for the purposes of the analysis in this BRIA, it is assumed that the overall sales volume of beer from a typical tied pub in Scotland remains constant after the pub starts offering a guest beer, but that a proportion of the sales is now guest beer, displacing some tied-beer sales. This is a simplifying assumption and does not reflect the reality that sales of beer (and by implication the profitability and viability of tenanted pubs) will vary over time and between different pubs. The implications of relaxing this assumption are discussed below and recognised elsewhere in this BRIA.

Table 1B below shows the estimated number of beer brands sold in the UK with a total sales volume below a given hectolitre threshold used in the options in this BRIA, as well as the share of total volume of beer sold in 2022 from these brands. Under Option 2, although the vast majority of beer brands fall under the 5,000hL threshold, cumulatively these beers represent a very small share of overall beer sales, at less than 5%.

Source: CGA by NielsenIQ, rounded to nearest 1,000 hectolitre

There is a significant degree of uncertainty around what proportion of total beer sales in a typical tied pub would be substituted away from tied-beer towards a guest-beer under each option. In an analysis conducted by London Economics (2013) for the Department for Business, Innovation and Skills^[53], expert evidence gathered suggested that between 35% and 40% of wet-rent would come from a single lager brand for a typical wet-led tied pub and that it was likely (in an unrestricted guest beer scenario), that a tenant would seek to replace its most popular selling lager with a non-tied lager. This 40% figure is taken as the maximum level of substitution in the calculation of the potential profit transfer under Option 4 for a guest beer agreement, where there is no hectolitre restriction.

In consulting with businesses on the impact of a hectolitre restriction on guest beer, we were unable to obtain reliable or robust estimates of the likely impact of these restrictions on the degree of displacement of tied beer, although it was generally accepted the degree of displacement would be lower than in the unrestricted option. Based on insight from a single stakeholder, it was suggested that the extent to which guest beer sales would displace tied beer sales could be as low as 2% under a low hectolitre threshold, but that it would be entirely dependent on the market position of the guest beer. It was suggested that the most popular brands with larger market shares currently would be expected to displace a greater share of current tied beer sales.

For the purposes of calculating illustrative impacts for this BRIA, we have therefore assumed a range of guest beer substitutions associated with each option within the BRIA: 2-15% for Option 2 (5,000 hL), 10-30% for Option 3 (100,000 hL), and 30-40% for Option 4 (Unrestricted). These estimates should be treated with caution and are used for illustrative purposes only in this BRIA.

Secondly, for the purposes of the analysis, it is assumed that the sales price of a pint of beer is the same regardless of whether the beer is tied or a guest beer. Therefore, the sales revenue the tied pub makes remains the same, as the total volume and unit price of beer sold is constant. However, the level of profit will be influenced by the volume of guest beer vs tied-beer sales and the cost differential between guest beer and tied beer.

According to BBPA statistics the average sales price of a pint of beer in Scotland was £4.12 in 2022 (including VAT) or £3.43 (excluding VAT)^[54]. The gross margin on a pint sold in a tied pub based on a survey of tenants by the SLTA (see annex E) was just over 50%. Therefore, we assume the cost to the tenant of a pint of tied beer is £1.62 per pint^[55]. It is assumed that the tenant will retain more profit from the sale of guest beer than from tied beer. The OFT found that pub-owning businesses sold a tied-beer at a 40-45% mark-up^[56]. Therefore, we assume the average tied pub tenant could acquire a pint of guest beer for £1.14 per pint from a wholesaler^[57]. The gross margin on a guest beer is therefore around 67%. In the calculations of costs and benefits we assume that the average consumption of beer in a typical tied pub was around 77,400 pints per year per pub (based on BBPA statistics for on-trade beer consumption^[58]).

Thirdly, we assume that not all tied pubs will choose to take up a guest beer agreement under the code as some may deem the option too risky. Although taking up a guest beer agreement may result in a transfer of income from the pub-owning businesses to the tenant, it will also result in a transfer of risk as well. Due to this increased risk to the tenants, it is expected that not all tenants will make use of the guest beer agreement provision of the code. It is expected that the take-up of the guest beer agreement provision across the 700 or so tied pubs in Scotland increases moving from Option 2 through to Option 4. This is because at the lower production level, it is expected that it will be riskier, more difficult and costly to acquire a guest beer and turn a profit. For Option 2, we assume 25% of tenants will adopt a guest beer agreement, for Option 3, 50% and for Option 4, 75%.

Fourthly, it is also assumed that ’Dry rent’ will remain the same in the short run. The pub-owning business may wish to increase this to make up some of the losses in wet-rent incurred as a result of a tenant adopting a guest beer. However, the Scottish Pubs Code Regulations 2024 state that a guest beer agreement must not

vary the existing lease except to include the guest beer agreement and to provide for a service equipment charge. As such, for the period remaining in the existing lease, dry rent is assumed to remain unchanged. It is important to note however that this situation is likely to change when a lease is renegotiated. A tied lease might also permit the pub-owning business to increase the price at which they sell tied beer to the tenant, which may be another avenue for the pub-owning business to protect their income – however the code requires that the tenant must not suffer detriment for taking up rights under the code. Moreover, we assume that the pub-owning business would not increase the price of the tied beer as doing so could potentially reduce demand further and encourage more switching by consumers to a guest beer.

Nevertheless, the gains to tenants outlined in this section of the BRIA would represent a short-term benefit for the time remaining on the existing lease which may not be expected to remain when the lease is up for renewal. Furthermore, such gains would be unlikely to accrue to new tenants as pub-owning business would be expected to factor in the potential impact of a guest beer agreement on wet-rent when setting the rate of dry rent in the lease.

Finally, it was raised by stakeholders that pub-owning businesses may incur some minor costs associated with drawing up a guest beer agreement and that tenants may incur some minor costs associated with maintenance of equipment used to dispense a guest beer. These are both assumed to be negligible (less than £100 per year for both the tenant and pub-owning business) and are not reflected in the illustrative costings.

Results

Although the figures vary by scenario, in broad terms, it is expected that the implementation of a guest beer agreement will have:

• A relatively small net positive effect for tenants, as profits from guest beer sales are likely to exceed the combined losses expected from lost profits of an equivalent volume of tied beer.
• A net negative effect for pub-owning businesses, due to the loss of ‘wet rent’ associated with the reduction in tied-beer sales.
• A net positive effect for guest beer brewers, as they realise revenues from additional sales of guest-beer but set against an equally net negative effect for brewers supplying the pub-owning company.

As set out above, in the baseline scenario we assume a typical tied pub sells 81,500 pints per year at £3.43 per pint (excluding VAT), bringing in a turnover of £336,000 per year from beer sales. Approximately £147,800 is revenue for the tenant (or profit, excluding other non-beer related costs), around £131,900 of the revenue is for the pub-owning business (of which £92,600 is revenue for the brewer and £39,300 is profit for the pub-owning business or wet-rent).

Tables 2B, 3B, and 4B set out illustrative impacts on the revenues and profits of the brewers, the pub-owning business and the tenant under different guest beer agreement options set out in this BRIA. Under general perfectly competitive market assumptions, both the guest beer brewer and pub-owning business brewer will not be making a profit, therefore changes in revenue represents a transfer of production from one brewer in the economy to another brewer. In the illustrative scenarios we assume the guest beer is not provided by the pub-owning business/brewery.

However, it should be noted that currently, tenants that have a guest beer agreement can have their guest beer provided to them by their pub-owning business. Therefore, it may be the case that the pub-owning businesses will continue to provide the guest beer to their tenants. In such a case, there is no transfer of revenue to a guest beer brewer as shown in the analysis below. Regardless of this, under each illustrative scenario part of the profit or ‘wet rent’ achieved by the pub-owning business, is effectively transferred to the tenant under every option, with the amount of profit transfer increasing with the production threshold of the guest beer.

Under Option 2, the illustrative transfer of profits is estimated to be between £800 and £5,900 per year per pub. Under Option 3, the transfer of profits is estimated to be between £5,900 and £11,800 per year. Under Option 4, the transfer of profits is estimated to be between £11,800 and £15,700 per year. It should be stressed that the ranges presented are illustrative and the true values may well lie outside these ranges. The figures presented also show results for an average tied pub based on average sales and prices. In reality, most pubs will have characteristics that differ from the average and therefore one could expect an even wider range of outcomes.

As set out in the assumptions above, it is not clear how many of the estimated 700 tied pubs in Scotland would take-up a guest beer agreement under each option. For Option 2, we assume 25% of pubs will adopt a guest beer agreement, for Option 3, 50% and for Option 4, 75%.

Therefore, under Option 2, with a 25% take-up of guest beer agreements, the total benefit to tenants, overall, ranges from £0.1 million to £1.0 million per year, which is offset by an equal cost to pub-owning businesses, as a whole, ranging from £0.1 million to £1.0 million per year. Under this option guest beer brewers/suppliers will benefit from increased annual turnover ranging from £0.3m to £2.4m. This is offset by an equal decline in turnover of tied beer brewers.

Under Option 3, with a 50% take-up, the total benefit to tenants, overall, ranges from £2.1 million to £4.1 million per year. This is offset by an equal cost to pub-owning businesses. Guest beer brewers/suppliers, as a whole, benefit from increased turnover ranging from £4.9 million to £9.7 million, which is offset by an equal decline in turnover of tied beer brewers.

Finally, under Option 4, with a 75% take-up, the total benefit to tenants, overall, ranges from £6.2 million to £8.2 million per year. This is offset by an equal cost to pub-owning businesses, ranging from £6.2 million to £8.2 million per year. Guest beer brewers/suppliers as a whole, benefit from increased turnover ranging from £14.6m to £19.4m, which is offset by an equal decline in turnover of tied beer brewers.

Costs/benefits which cannot be quantified

Effect on consumers – It is assumed that there will be benefits to consumers should tied pubs offer a greater variety of beers. Consumers will have an additional beer brand option to choose from in a tied pub.

Increased autonomy – It is expected that allowing the tied pub to choose a guest beer, the tenant will achieve a higher degree of autonomy in running the pub. In relaxing the assumption that the total volume of beer sold after a guest beer agreement remains the same, it is recognised that it is possible for the tenant to either increase sales by choosing a particular brand of guest beer and by advertising it successfully or reducing sales if the guest beer is unpopular.

Standardised approach – With the policy introducing an approach to guest beer agreements, it is expected that pub-owning businesses will benefit from having a standardised approach to guest beer agreements. This way pub-owning businesses know that they will be offering similar guest beer agreements as each other.

Market access – Under Option 2, small production guest beers are likely to have increased market access. This may allow guest beers to grow and compete with other more well-known brands.

Undermining the tied pub model – From stakeholder evidence, it is expected that an unrestricted guest beer agreement option (Option 4) would potentially undermine the tied pub model. This is because it is assumed that the tenants would choose a highly competitive brand of beer. 100% of responding pub-owning businesses to a SBPA survey said that if there were no exemptions for guest beer, they would turn tied pubs into other pub business models or sell as an ongoing business, and 43% said they would close tied pubs. This could reduce the opportunity for new entrants to the tied pub sector in Scotland if there are fewer pubs.