Booze bloat

There are big problems with the LCBO and its shabby financial performance. A recession-proof, legislated monopoly like the LCBO should be showering the government with riches. It is not. An accounting trick hides the fact that it loses money, though the government and the union would have you think otherwise.

Report on Business magazine
June 1, 2004

Booze bloat
Consumers think Ontario’s liquor monopoly is doing a great job. Something must be clouding their heads, because the numbers tell a different story.
Eric Reguly

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The sale of the Liquor Control Board of Ontario is dead. Officially, Premier Dalton McGuinty's Liberal government is still mulling the idea. But the government and Bay Street know the booze business will not be flogged to plug the province's gaping deficit. Still to be convinced, however, is the LCBO employees' union. Their angst-ridden TV ads, ubiquitous during the hockey playoffs, would have you think that investment bankers are moments away from slaughtering the fattened hog. The employees should relax, but not too much. There are big problems with the LCBO and its shabby financial performance.

A recession-proof, legislated monopoly like the LCBO should be showering the government with riches. It is not. An accounting trick hides the fact that it loses money, though the government and the union would have you think otherwise. Government ownership doesn't mean the LCBO can't be run like a real business with real discipline.

Rumours that the LCBO is up for grabs began circulating the moment the Liberals took power last autumn. An endless stream of investment bankers pitched ideas. Converting the LCBO into an income trust would raise as much as $1.5 billion, according to one banker. Another proposal would have had the government sell the stores, but keep the back endthe purchasing, the warehouses, the distributionas Alberta did in 1994, to mixed results. Another option had the LCBO combining its retail operations with The Beer Store, Ontario's monopoly beer retailer, which is owned by the major brewers.

But there were problems. If privatized stores were to jack up prices, there might be a voter backlash. A larger issue was whether a privatized LCBO as a whole could keep its monopoly. Supermarkets and other retailers might argue that was illegal, and demand the right to compete.

The biggest issue, however, was simple popularity. Consumers like the LCBO, and there is focus group data to prove it. The stores no longer look like government unemployment offices, circa 1973, and the selection is vastly improved. The fuzzy concept of social responsibility was a factor, too. Evidently, a government shop is less likely to sell Jack Daniels to minors than a private shop, where the goal is maximum sales and profit.

Finally, the booze makers weren't crying for a privatized LCBO. They like dealing with a single buyer, especially one that does most of the work for them, such as providing warehouses and delivery trucks. In the United States, wine and spirits makers have to deal with thousands of retailers and middlemen. Costs go up. Favours, to put it politely, are required. You want your Chateau Welland Canal prominently displayed? Give us a free case and we'll think about it.

With privatization a non-starter, the question is whether the LCBO is delivering real valuemake that any valueto the taxpayer. The headline numbers in its perennially late financial statements suggest that it is the most profitable retailer in Canada, if not on the planet. In the 2002-2003 fiscal year, sales totalled $3.1 billion, up 6.1% from the previous year, and net income was $939 million. That's a gross profit margin of 31.3%.

Okay, so what's the true story? The LCBO counts the booze tax on every bottle sold (about 31 cents on every $1 of net sales) as "profit." The total tax receipts, paid as a "dividend" to the province, came to $970 million last year. Subtract the dividend from the reported net profit and you get a loss of $31 million. The average Canadian grocery store has a profit margin of 3.3%. If the LCBO was even average, its profit should have been more than $100 million. As a monopoly, it should have made far more.

But that's not all. Operating expenses climbed from $468 million in the 2000-2001 fiscal year to $526 million in 2002-2003. The LCBO's retail costs as a percentage of sales are in shallow decline, but those savings have been more than offset by inefficiency in the warehouses. Capital expenditures soared to $75 million last year, up 35% from the year before, as small fortunes were spent upgrading stores where sales wouldn't drop even if they weren't prettied up.

Apply conventional financial measures to the LCBO and there is only one conclusion: The empire, though loved by employees, consumers, the government and product suppliers, doesn't work. If it was a publicly listed company, heads would roll—from the head office, where former Conservative cabinet minister Andrew Brandt has been CEO since 1991, down to the loading docks. There are many sound reasons to keep the LCBO in government hands. But the soundest reason of all is to provide a healthy return to the taxpayer. It's time to run the bloated LCBO like a real business.


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