Notice pursuant to Article 19 (3) of Council Regulation No 17 (1) Notification No IV/35.079/F3 - Whitbread (97/C 294/02)

(Text with EEA relevance)

I. The application and notification

1. On 24 May 1994 Whitbread plc (Whitbread) notified pursuant to Article 4 of Council Regulation No 17 three standard forms of leases ('the Leases`), the subject of each of the Leases being a fully fitted out on-licensed (2) public house in the United Kingdom with a tie for beer as described below. The three standard forms are the 20-year lease, the pre-retirement lease and the 5-year lease. Whitbread requested negative clearance or confirmation that the Leases could benefit from the application of Regulation (EEC) No 1948/83 (3) or individual exemption pursuant to Article 85 (3) of the EC Treaty to take effect as from the date on which the agreements were entered into.

II. The Parties

2. Whitbread is a UK food, drinks and leisure company. Its activities include the brewing marketing and distribution of beer and the wholesaling of other drinks, the ownerships of leased public houses and management of public houses, restaurants, hotels, off licences and leisure clubs. The activities of the Whitbread Group are carried out through a divisional structure involving management by eight separate trading divisions. The division responsible for the leased estate is the Whitbread Pub Partnership (WPP).

3. In 1994, Whitbread owned approximately 5 007 on-licences, of which 1941 were managed (i.e. the operator is an employee of the company), 2 292 were leased to tenants and 774 were leased to multiple operators free of the tie. In its fiscal year ending February 1997, the leased estate totalled 2 130 outlets of which 1 970 were let on permanent agreements and 160 by way of temporary tenancy agreements. Of the 1 970 permanently let outlets, 1 938 were let out according to one of the notified agreements (1 643 20-year leases; 275 5-year leases and 19 pre-retirement leases). The lessees of the 1 970 permanently let outlets bought in that year 433 000 barrels of beer from Whitbread. These 1 970 outlets account for 2,4 % of the full on-licensed premises in the UK and the barrelage purchased from Whitbread by these licensees represents 1,6 % of the 1996 on-trade beer consumption (volume) in the United Kingdom. Whitbread's total turnover in the fiscal year ending March 2, 1996 was £ 2,7 billion. In that year Whitbread accounted for 14,2 % of the UK beer market in volume production terms.

III. The market

4. Since 1990, the date of introduction of the Whitbread Leases, significant changes have occurred in the structure and conduct of the UK on-trade beer market. These are for the most part the result of the Beer Orders made following the Monopolies and Mergers Commission's (MMC) report on the supply of beer, together with a fall in both overall demand and particularly on-trade beer sales, shifts in consumer demand towards pubs offering a wider choice of drinks and food, the withdrawal of several companies from brewing and the redefinition of relationships between brewers and pub retail chains on the one and tenants on the other.

The 1989 MMC report and the subsequent Beer Orders

5. The MMC's report of 1989 into the supply of beer led to a number of recommendations being made which were aimed at relaxing the traditional tie (exclusive purchasing obligation and non-competition obligation) between brewers and pubs. Most of the MMC's recommendations were implemented, mainly by the Supply of Beer (Tied Estate) Order 1989 and the Supply of Beer (Loan Ties, Licensed Premises and Wholesale Prices) Order 1989. The Tied Estate Order imposed the following changes upon the 'national brewers` (brewers with an estate of more than 2 000 on-licensed premises):

- their tenants would be free of tie for non-beer drinks and low-alcohol beers,

- their tenants would have the right to buy one cask-conditioned ale (a beer with fermentation in the cask) (4) from a source other than the brewer/landlord (the so-called guest beer), and

- they were only allowed to tie a certain number of pubs. This forced them to sell or free of tie about 11 000 of the then estimated 60 000 UK pubs.

Demand factors

6. Beer can be sold through the on-trade, e.g. pubs, hotels and restaurants, or through the off trade, e.g. supermarkets and off-licences. In addition, private duty paid imports, mainly from Calais, are estimated to account for 4 % of total beer consumption in the UK. Volume sales of all beer in the UK fell by 9,5 % between 1989 and 1995 and volume sales of beer in the on-trade fell by 17,3 % in the same period. The proportion of sales volume accounted for by the non-trade has thus fallen (from 79,3 % in 1989 to around 69 % in 1996) but, with the exception of Ireland, remains the highest proportion in the EC.

7. Falling beer sales volume in the on-trade has been offset by:

(a) a rise, in real terms, in on-trade beer prices of 21 % between 1989 and 1996, only a negligible proportion of which was accounted for by tax increases; and

(b) a rise in the proportion of non-beer sales in pubs to 37 % of total revenues in 1996, largely as result of the increase in catering sales.

8. Consumption of draught beer accounted in 1996 for 63 % of total consumption. This is also, with the exception of Ireland, the highest figure in the EC. In contrast, the figure from Belgium, which has the third largest draught consumption in the EC, was 39 %. UK pubs also offer a bigger choice of draught beers than elsewhere in the EC, with an average of 6,5 brands per pub.

Supply factors

Brewing

9. The main change since 1989 is that the brewing market has become more concentrated. The increased concentration has been caused by companies leaving the brewing market and selling their brewing operations to existing competitors. In 1996, the remaining 4 national brewers, Scottish & Newcastle, Bass, Carlsberg Tetley Brewing (CTB) and Whitbread, commanded 78 % of the UK beer market in terms of supply. Four larger regional brewers also left the market between 1989 and 1991, reducing the number of large regional brewers from 11 to 7.

Wholesaling

10. One result of the Orders was the sale of some of the national brewer's tied estates. This was expected to lead to an increase in the free trade and to a greater role for independent wholesalers. However in 1995/96 independent wholesalers still only accounted for some 6 % of distribution, compared to 5 % in 1985. The national brewers still dominate the wholesale sector, with a share of distribution similar to their share of production.

11. The pubs that were sold by the national brewers were purchased mainly by retail pub chains or by reginal brewers. In general, pub chains either have their own wholesaling operations or are supplied directly by the brewers. Similarly, regional brewers do not require the services of independent wholesalers. This, combined with the general decline in sales of beer and the increased efficiency of national brewer-wholesalers, has resulted in marginal growth in the independent wholesale sector.

Retailing

12. In the UK, the retail sale of beer and other alcoholic drinks for consumption in the premises requires a justices' (local courts of law) licence. Three distinct classes of licences are currently in operation:

- full on-licences: where a person can buy an alcoholic drink, without being a resident or having a meal. There are approximately 83 100 full on-licences in issue, of which around 57 000 are pubs. There remainder include hotels and wine bars,

- restricted on-licences: where it is a condition on buying a drink that the customer is either a resident or having a meal. Covers some 32 300 private hotels and restaurants,

- clubs: a person has to be a member before buying a drink. Covers some 31 500 outlets, mainly jointly owned by their members.

13. By forcing changes in the ownership of pubs, the Orders have also had an effect on the proportion of beer sold through the different retail channels: (a) the tied estate of the brewers, (b) the managed estate of the brewers, (c) the tied estate of independent pub companies, (d) the managed estate of independent pub companies, (e) loan tied premises and (f) untied or free premises. This can be seen from the following overview on beer sales (volume). The 1985 data come from the MMC report and can be considered as representative for the years 1985 to 1989; the 1995 data are from the Brewers and Licensed Retailers Association (BLRA), including estimates for non-members.

>TABLE>

14. The Orders also reduced the restrictive scope of loan ties, by allowing their termination at any moment in time by the tenant on three months' notice. The Orders also introduced the guest beer right for publicans with trade loans from the national brewers. From information supplied by the BLRA, it appears that approximately 20 % of loans are terminated or advanced each year. An unestimated proportion of these terminations and new issues must be accounted for by publicans paying back an existing loan with money loaned to them by another brewer (in exchange for a new loan tie). It appears that the larger outlets such as clubs not only receive much larger loans, but they are usually non-exclusive as these operators want to have dual or multiple sourcing. However, the purchasing obligations are usually for a specific quantity of beer. No estimate was made by the BLRA as to the number of such non-exclusive loans, the total on-trade volume-percentage accounted for by such non-exclusive loans, or the percentage of total throughput of the relevant premises accounted for by the quantity of beer stipulated in such loan ties.

Competition between brewers

15. At the wholesale level, the major brewers have some guaranteed sales through their tied and managed estates. The brewers have to compete to supply the remainder of the market, through individual agreements with free houses and supply agreements with pub chains and other brewers. This competition takes place mainly on price and brand strength, although the brewers also try to gain sales by offering other benefits such as promotional support.

Market entry at brewing level

16. The main barriers to entry at this level are the need to secure outlets for supplies and to have access to a distribution system. A new entrant has to secure supplies to free houses, pub chains, or to the brewer's estates as part of their portfolio of beers or (in the case of a national brewer) as a guest beer. Possession by competitors of well-known brands is a further barrier to entry, or to expansion by existing brewers. This may be more important in lagers, which are normally marketed nationally, and where economies of scale in advertising may make small scale entry less viable.

17. The entry barrier of securing outlets has been reduced since the implementation of the Orders, owing to the reduction of the proportion of the market subject to ties and to the emergence of pub chains. It is easier for a new entrant to enter supply agreements with a chain rather than with individual pubs. The need for a distribution system remains a barrier to entry. However, brewing over-capacity has ceased to be a significant barrier to entry since brewing capacity utilization stood at 90 % in 1996, up from 79 % in 1991.

18. Most foreign producers of beer (mostly lager) have chosen to enter the UK market by entering into exclusive licensing agreements with existing national brewers whereby the beer is brewed in the UK and sold as part of the national brewer's portfolio of brands. These foreign lagers have often been marketed as premium brands. Whitbread has concluded such licensing agreement with Interbrew (Stella Artois), Heineken (lager and export Heineken) and for the Murphy's Irish Stout brand.

Market entry at retail level

19. Pubs compete only with others in their locality. Broadly speaking, each area has a local price for a certain type of package, which comprises the total pub 'offer` (facilities, ambience) and not just the price of beer.

20. Entry barriers in the retail market are relatively low. The only one of any significance is the presence of licensing laws, which can prevent new pubs from being opened unless there is a need for them. This law is not applied strictly throughout the UK, but where it is, it can result in entry within that locality being difficult. Also, in some areas of the UK, licences are now being refused mainly on public order grounds. However, a particular pub company has succeeded in opening over 100 pubs on greenfields sites in recent years.

Changes in arrangements between pub tenants and their landlords

21. Historically, pubs were let by means of 'traditional` short-term pub tenancies. Brewers retained responsibility for the fabric of the building and its fixtures and fittings and tenants were responsible for selling beer supplied by the landlord plus other drink and food. Following the MMC report, pub tenants were provided with security of tenure by being brought within the Landlord and Tenant Act 1954. However, well before the MMC's recommendation, the first long full repair and maintenance leases, which provided some security of tenure and the ability to assign the lease, were offered.

IV. The agreements

22. The Leases are contracts between Whitbread and the lessee, whereby Whitbread makes available a licensed public house together with fixtures and fittings to a lessee for the purpose of carrying on the business of the public house and under which the lessee pays a rent to Whitbread and agrees to purchase the beers detailed in the Lease from Whitbread or its nominee and from no other source.

23. The differences between the 20-year lease and the other two standard leases are that in the case of the 20-year lease: (i) the lessee has to put and keep the premises and the fixtures and fittings in good repair (under the other two leases the tenant is not liable for structural repairs or exterior decorations); (ii) the lessee is not allowed to make any alterations without Whitbread's consent (in the case of the pre-retirement lease alterations are prohibited except that non-structural alterations to the interior may be made with Whitbread's consent - in the 5-year lease alterations are prohibited); (iii) the lessee is not allowed to assign the lease during the first three years of the term and thereafter if the lessee wishes to assign then, if so required by Whitbread, to assign to a nominee of Whitbread on open market terms and not to assign the lease to a brewer (in the pre-retirement, lease assignment is prohibited except, with Whitbread's consent, to the lessee's widow or widower - in the 5-year lease, assignment is prohibited).

24. The 5-year lease is used in circumstances where the 20-years lease is considered inappropriate, such as unstable local economic conditions, a too high level of expenditure required to put the property into a full state of repair, or a refurbishment of the premises within the next three years is contemplated.

25. The pre-retirement lease was used when existing tenants on annual agreements were converting to 20-year leases in the years 1990 to 1992. Some lessees saw themselves wishing to retire from the industry over the next 5 years but wanted to ensure their security of tenure up to retirement.

The beer tie

26. The lessee agrees to buy all specified beers from Whitbread or its nominee with the exception of one brand of cask conditioned draught beer (guest beer clause). Specified beers are the beers of the type set out in the Appendix to the Schedule of the Lease which contains the Terms of Trading. These types are light, pale or bitter ale (known in Scotland as 70/-, heavy special or Scotch ale), export or premium ale (also known in Scotland as 80/- ale), mild ale (known in Scotland as 60/-, light or pale ale), brown ale, strong ale (including barley wine), bitter stout or porter, sweet stout, lager, export or premium lager (also known as 'malt lager` or 'malt liquor`), strong lager, 'diet pils` (or premium low carbohydrate beer) and low carbohydrate (or 'lite`) beer. These types are represented by the brands or denominations of beer listed in Whitbread's current price list.

27. The lessee may sell any type of beer other than the specified types if it is packaged in bottles, cans or other small containers or if it is in draught form and the sale of that beer in draught form is customary or is necessary to satisfy a sufficient demand from the lessee's customers.

Rent

28. Rent is paid quarterly in advance and the lessee will repay the premiums paid by the landlord for insuring the premises against: (i) loss or damage by fire and including three year's open market rent of the premises and expert's fees and (ii) loss of the justices' licence.

29. Whitbread may require the rent to be reviewed at the end of each third year and on the day before the expiry of the term of the lease or when the tie becomes unenforceable by Whitbread or when Whitbread reduces the tie. The reviewed rent is the higher of the existing rent or the market rental value of the premises at the relevant increase date. The market rental value is defined as either what the Parties agree to be the then market rental value or the sum as determined by an arbitrator.

Discounts and countervailing benefits

30. As individuals who are not tied for their beer purchases to another company (individual free-house operators) can obtain in the United Kingdom discounts for their beer purchases which are not available to the tied operators, the Commission has assessed: (i) the net price differential for beer purchases from Whitbread between the price paid by individual free-house operators and Whitbread's tied lessees; and (ii) the value of benefits which are granted by Whitbread to its lessees and which are not readily available to the individual free-house operators. The starting point for this assessment was the report of the Office of Fair Trading on their enquiry into brewers' wholesale pricing policy of May 1995 (the OFT report), which was supplemented by further investigations by the Commission.

31. The price differential is the difference between the average discounts in £/barrel granted by Whitbread to its individual free-house operator-clients across a typical product mix and the discounts granted to the WPP lessees which include the actual discounts on cask ale purchases and the value of the lower WPP list prices as compared to the Whitbread price list.

32. The rent subsidy is calculated by subtracting the actual rental income from the tied estate from 15 % of the turnover of the estate (the assumed rent for a free of tie-outlet being 15 % of turnover). To arrive at the rent subsidy per barrel, the overall rent subsidy is divided by the total number of barrels sold to the estate. For the calculation of the rent subsidy as shown in table below, the following assumptions were made:

- the estimate of the total turnover for the tied estate was calculated on the basis of the rent paid equal to 12,72 % of turnover. The figure of 12,72 % stems from internal Whitbread documents, mainly in preparation for rent or rent review negotiations, for a sample of 30 pubs chosen by Commission officials. Whitbread has informed the Commission that the average rent to turnover ratio for the entire WPP estate is 12,19 %,

- for the years 1990/91 and 1991/92 the data for the rental income, barrelage supplied and total turnover is for the totality of Whitbread leased pubs as supplied by Whitbread,

- for the years 1992/93 up to 1996/97, the date for the rental income, barrelage supplied and total estate's turnover refer to the pubs let on notified agreements as supplied by Whitbread with some estimates made by the Commission on the basis of this information.

33. Whitbread has estimated the average value and benefit of the professional services per lessee for each of the relevant years. This value has then been multiplied by the total number of pubs let on notified agreements (with the exception for the years 1990/91 and 1991/92 where data are used for all WPP pubs) and then divided by the number of barrels supplied to these houses.

34. Whitbread has used two different methodologies to support its estimates. The first consisted in calculating the cost to Whitbread of services provided free of charge to lessees management resource (area managers, property surveyors, leasing managers and catering managers). This cost was then 'marked up` (doubled) to replicate the cost to the individual free trader. From this sum was then deducted the marked-up cost of Whitbread's sales executives for the individual free-trade operators.

35. The second methodology used an estimate of annual Whitbread management days spent supporting lessees. For instance for the year 1994/95, for which the estimate of the benefit for each lessee was set at £ 2 500, 8 man days (5 for the area manager for the monthly 'business` day-time visit, the quarterly evening visit, training sessions and development work, 2 for the property manager reflecting the annual property inspection, development work and legal type property advice and 1 for other managers) were considered as a benefit for all pubs and on average an additional 2,5 man days of catering advice for food-oriented pubs reflecting the monthly visit and formal training sessions.

36. The WPP subsidy cost for various training, marketing and catering related services provided to lessees is not included in this estimate. Whitbread estimates that the subsidy cost for the year 1996/97 equates to a further £ 180 benefit to WPP lessees.

37. To calculate the value of the procurement benefits, Whitbread supplied a 'support value` per lessee which was then multiplied with the total number of pubs let on notified agreements and then divided by the number of barrels supplied to those pubs. The methodology followed by Whitbread consisted of calculating the advantages for pubs that are 'major food outlets`, 'limited food outlets` and 'non-food outlets`, to arrive at the overall average. For instance, for the year 1996/97 the overall average was £ 3 580.

38. Whitbread supported the figures for the food and non-food pubs by supplying detailed information for each of the individual items for which procurement benefits existed and estimates of their value. For 1996/97 these details were provided for the following items: gas, insurance, credit cards, glassware, crisps and nuts, frozen food, water saving device, mixed gas, LPG, butchers, washroom services and pest control.

39. The benefit which is attributed to capital expenditure carried out with existing lessees is calculated by subtracting from this expenditure the additional income for Whitbread which can be expected over five years as a result of the expenditure. This additional income consits of the average rent increase following the expenditure multiplied by the number of projects multiplied by 5.

40. The results of this assessment of the price differential and the countervailing benefits are shown in the following table.

>TABLE>

41. In addition to these quantifiable 'countervailing benefits`, Whitbread has in certain circumstances agreed to a surrender of the lease or in a limited number of cases to a reduction of the rent. These 'partnerships` elements and the fact that the rent paid is lower than a free of tie-rent (at 15 % of turnover) (5) support the claim that tied tenants face a differing risk than free traders.

V. Conclusion

42. The Commission intends to take a favourable position in respect of the agreements, a summary of which is published here, by granting a retroactive exemption pursuant to Article 85 (3). Before doing so, the Commission invites all interested third parties to submit their observations within one month from the date of this notice, quoting reference IV/35.079/F3 to:

European Commission

Directorate-General for Competition

Directorate F

Rue de la Loi/Wetstraat 200

B-1049 Brussels.

(1) OJ 13, 21. 2. 1962, p. 204/62.

(2) On-licensed premises are those which are licensed to sell alcoholic beverages for consumption on and off the premises as opposed to off-licensed premises such as supermarkets which are licensed for off-premises consumption only.

(3) Commission Regulation (EEC) No 1984/83 of 22 June 1983 on the application of Article 85 (3) of the EEC Treaty to categories of exclusive purchasing agreements (OJ L 79, 23. 3. 1984, p. 38; corrigendum OJ L 281, 13. 10. 1983, p. 24). The Regulation contains in its Title II special provisions for beer-supply agreements.

(4) The UK Government is proposing to extend the scope by also allowing for one bottle-conditioned beer.

(5) Tied tenants pay a higher price and for beer but, if their rent is lower, the combination of lower fixed costs (rent) and higher variable costs (beer purchases) reduces volatility caused by varying output.