Friday, March 25, 2011

Gross profiteering

The duty increases announced in this week’s Budget would result in an increase in the price of a typical pint of beer in the pub of about 4p, once VAT was added on to the additional duty. However, it’s been widely claimed that this is likely to lead to an increase of more like 10p in the price of a pint passing across the bar. Hang on, you might say, doesn’t that mean that licensees and pub companies are profiteering?

Well, maybe they are, and maybe they aren’t. The reason for this is that pubs typically look at “percentage gross profit” when assessing their financial viability. The pub will seek to maintain a fixed percentage, usually at least 50%, between what they pay for their beer and other drinks, and what they sell it for. This has to cover overheads and staff wages as well as the licensee’s own share. Obviously, over time, overheads and staff wages tend to go up roughly in line with the overall rate of inflation, so you have to increase the amount added on to the cost of beer to cover that. And, if you don’t maintain the %GP, over time inflation will steadily erode the licensee’s income in real terms.

Clearly, on Day 1 after the price increase, if the licensee maintains the same %GP, he will be raking in more money than he was before, assuming that sales do not fall. But, over time, all that it doing is compensating for the rise in other costs the pub pays, and maintaining the real value of the licensee’s income. So far, so good. It all makes sense, and nobody is profiteering or cheating the customer.

However, as any economist will tell you, in a competitive market, pricing isn’t simply a question of adding a fixed percentage to cost, it also needs to take into account what customers are able and willing to pay. Over the years, in maintaining their %GP, pubs have slowly seen the prices they charge increase over and above the general level of inflation, and above the prices charged by the off-trade and other competitors for the leisure pound. What seems a sensible idea in the short-term is, in the longer run, seriously detrimental to trade.

Then Wetherspoons have come along and smashed the old cosy model by adopting a “pile it high and sell it cheap” approach that deliberately sacrifices some margin for higher volumes. Nowadays, if you run a traditional leased or tenanted pub within a competitive radius of a Spoons, you haven’t a hope in hell of competing on price.

Now, I’m not suggesting that licensees’ incomes are generally too high, or that crude price-cutting is a good strategy for pubs. But, in recent years, the pub trade hasn’t been helped by adopting a lazy and complacent pricing model that ignores market realities. If they are to succeed in future, pubs will have to look at a more sophisticated, flexible and market-sensitive approach to pricing rather than just simplistically banging on a fixed percentage of the cost of beer.

I also often think there is more pubs could do through pricing to stimulate customer interest, such as, say:

- each week, selling one of its regular draught beers (including kegs) for 50p off
- having a discounted “wine of the week” or “malt whisky of the week”
- having a permanent house beer of cooking strength from a local brewery at a significantly lower price than other beers
Many promotional techniques that are commonplace in other retail businesses seem to be largely absent from pubs.