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RETAIN & GAIN:Making OntariosAssets Work Better forTaxpayers and
Consumers
Premiers Advisory Council on Government Assets
Initial Report
November 13, 2014
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Table of Contents
FOREWORD .......................................................................................................................................1
Overview ................................................................................................................................................... 1
Beverage Alcohol ....................................................................................................................................... 3
Electricity ................................................................................................................................................... 7
Conclusion ............................................................................................................................................... 12
SUMMARY OF COUNCIL PROPOSALS ................................................................................................13
Beverage Alcohol ..................................................................................................................................... 13
LCBO ..................................................................................................................................................... 13
The Beer Store ..................................................................................................................................... 15
Winery Retail Stores ............................................................................................................................ 15
Electricity ................................................................................................................................................. 16
Hydro One ............................................................................................................................................ 16
Ontario Power Generation .................................................................................................................. 17
1. INTRODUCTION .........................................................................................................................19
1.1 Establishment of the Council ...................................................................................................... 19
1.2 Mandate and Principles .............................................................................................................. 19
1.3 Terms of Reference ..................................................................................................................... 20
1.4 Scope of Our Review ................................................................................................................... 21
1.5 Our Perspective ........................................................................................................................... 22
1.6 Our Approach .............................................................................................................................. 25
2. THE BEVERAGE ALCOHOL SECTOR ..............................................................................................26
2.1 Overview ..................................................................................................................................... 26
2.2 LCBO ............................................................................................................................................ 29
Background .......................................................................................................................................... 29
Our Approach ...................................................................................................................................... 30
Our Observations ................................................................................................................................. 30
2.3 The Beer Store (TBS) ................................................................................................................... 42
Background .......................................................................................................................................... 42
Our Approach ...................................................................................................................................... 43
Our Observations ................................................................................................................................. 43
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2.4 Winery Retail Stores (WRS) ......................................................................................................... 47
Background .......................................................................................................................................... 47
Our Observations ................................................................................................................................. 49
3. THE ELECTRICITY SECTOR ...........................................................................................................50
3.1 Overview ..................................................................................................................................... 50
3.2 Hydro One ................................................................................................................................... 53
Overview .............................................................................................................................................. 53
Our Approach ...................................................................................................................................... 55
Our Observations ................................................................................................................................. 55
3.3 Ontario Power Generation .......................................................................................................... 64
Overview .............................................................................................................................................. 64
Our Approach ...................................................................................................................................... 67
Our Observations ................................................................................................................................. 67
3.4 Labour and Pensions ................................................................................................................... 71
SUMMARY OF COUNCIL PROPOSALS ................................................................................................73
Beverage Alcohol ..................................................................................................................................... 73
LCBO ..................................................................................................................................................... 73
The Beer Store ..................................................................................................................................... 75
Winery Retail Stores ............................................................................................................................ 75
Electricity ................................................................................................................................................. 76
Hydro One ............................................................................................................................................ 76
Ontario Power Generation .................................................................................................................. 77
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FOREWORD
Overview
The Advisory Council on Government Assets was charged by the Premier to review the
Liquor Control Board of Ontario (LCBO), Hydro One and Ontario Power Generation
(OPG) and to recommend ways to maximize their value to the people of Ontario.
In doing so, we took into account the governments preference to retain core assets in
public ownership and, in maximizing the value to the taxpayers, we also found ways to
improve customer service and maintain an engaged employee workforce.
We were greatly assisted in our work by previous reviews done on these companies.We benefited from excellent cooperation from the companies themselves. We received
numerous submissions from and met with many stakeholders. We found their
comments well-researched and thoughtful. We also had constructive discussions with
the unions representing workers in each of the companies. The Public Service of the
Ontario Government has an enormous well of experience and capability that was made
fully available to us.
We structured our review in two phases. Phase I, the results of which are included in
this report, incorporated detailed reviews of the subject entities, stakeholder
consultation and the development of our initial thinking on proposals for the future
direction of each company. Phase II will incorporate further discussion and consultation
on the proposals. This will further our goal of reaching agreement among the
appropriate parties, leading to definitive recommendations to government for
consideration in the 2015 Provincial Budget.
We have tried to conduct our review as transparently as possible. We approached our
task with a genuine effort to have no preconceived answers to the issues raised, but to
search for what is best for the people of Ontario, recognizing that we brought different
visions and experience to the exercise. We are pleased that we are unanimous in our
conclusions, which have also found broad agreement with the management of the
companies themselves.
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We have concluded that significant value can be added to the assets we reviewed
within the parameters set by the government for this review. Indeed, we believe that
the Province can, with the Councils proposals, meet its key goals. It can retain all three
core companies and significantly improve their performance. The Province can dilute
its interest in some non-core assets where government ownership is not critical and
where private sector involvement could facilitate more efficient electricity distribution.
Our proposals would, over time, reduce the growth in electricity rates from those that
would otherwise occur and keep liquor prices below the Canadian average, while
improving consumer accessibility in a responsible fashion. Meeting these goals would
free up $2 to $3 billion of funds to finance much-needed infrastructure investments
without adding to the Province's debt or increasing the deficit.
Premiers Advisory Council on Government Assets
Ed Clark, Chair
David Denison
Janet Ecker
Ellis Jacob
Frances Lankin
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Beverage Alcohol
We examined the liquor distribution system in Ontario that centres around three
quasi-monopolies the LCBO as well as the privately-owned Beer Store (TBS) and
off-site Winery Retail Stores (WRS). This system provides a highly-controlleddistribution system for liquor that generally serves the consumer well, but limits
accessibility and innovation. It is also a complex system with many interlocking parts
that is prone to the creation of unfair value for those powerful enough to obtain
certain rights.
We believe that the Province can retain the value of the existing beverage alcohol
system while, at the same time, improving the customer experience, increasing access
in a limited way and giving taxpayers a fairer share of the benefits of the system.
We considered selling the LCBO. There is a definite interest in the market for such an
option, which offers simplicity and a large one-time financial benefit. However, we
struggled with the concept of handing a monopoly over to a private owner. We were
concerned that large outright sales of this kind in the past have proven to be far less
attractive than they initially appeared. Privatization or sale to a private buyer would be
a radical change to a system that actually works quite well and might require the
creation of new regulatory systems. As far as consumer benefits are concerned, it is
not evident to us that Ontarians would be materially better served by a privately
operated LCBO. Further, any new owner would want to ensure that the monopoly they
acquire is preserved. The Council believes that competition is a good thing, particularly
for businesses like the LCBO which are not natural monopolies. Indeed, we would
prefer to see some limited increase in competition rather than locking in a perpetual
monopoly. Therefore, we rejected privatizing the LCBO.
We also examined the possibility of dramatically opening up the market structure
currently controlled by the three quasi-monopolies in Ontario: the LCBO, TBS and theoff-site Winery Retail Stores. Experience elsewhere suggests this would materially
increase the number of access points, creating a more open marketplace but a more
costly distribution system. Such a bold overhaul of the system would represent a
radical change for the Province and would require a broad consensus that it is the right
thing to do. Such a consensus does not appear to exist today.
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We believe the LCBO should be retained in government ownership, but with the
constraints of public ownership somewhat unshackled and a limited increase in
competition to improve access and increase innovation. This would allow the LCBO to
improve profitability and enhance service in a socially responsible way, essentially
freeing up a public monopoly to act less like a public monopoly. This would include
more effectively using the LCBOs buying power to lower costs. This should be done
gradually. The initial focus of the LCBO will be to increase margins from suppliers and
realize operational savings without affecting consumer prices. Should it be
subsequently decided to raise prices, we would suggest that they should be maintained
at below the national average.
Finally we believe, and the LCBO agrees, that there are a number of ways that
customer choice and access can be improved and operations streamlined to improveprofitability. The LCBO wants to update its website and create warehouse stores in
major cities to carry alternative items not offered in standard stores. We also think the
LCBO should explore the creation of specialty stores which emphasize craft beer or
spirits, and should further orient certain locations to reflect the neighbourhoods in
which they operate. As well, the online channel could make a broader array of products
available than are carried in LCBO stores. These would support an aspiration for the
LCBO to become a best-in-class liquor retailer. We expect to explore these ideas
further with the LCBO in the next phase of our work.
The Council believes that the LCBO can be improved by better distinguishing between
its true profit and the notional taxes it collects, as well as separately reporting its
various businesses. The creation of this new disclosure framework will enable
management to better represent and monitor performance and report on the
implementation of our proposals, as improvements to the LCBO's margins can be
better evaluated.
In supporting, retaining, and improving the LCBO, the Council believes it is important to
introduce more, even if limited, competition to provide more access as well as incentive
to innovate. To this end, the Council is open in Phase II to exploring suggestions of
how competition can be increased without undermining the fundamental economics
and advantages of the monopoly system. Specifically, we would like to explore with
craft brewers the possibility of opening a limited number of stores featuring craft
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beer from around the world. We would like to explore with the wine industry the
possibility of opening new private stores offering both Canadian and international
wines. Additionally, we would like to explore with distillers ideas regarding new
sales channels.
In the case of the other distribution channels the Beer Store and the off-site Winery
Retail Stores we do not believe as a matter of principle that the government should
continue to foster a marketplace that provides unique benefits to these privately-owned
quasi-monopolies. In our view there is unfair value flowing to the private sector owners
at the expense of Ontario taxpayers. As changes are made to the LCBO to enable the
Province to capture more value, we believe that similar adjustments should be made to
the other quasi-monopolies.
We believe that the relationship between the provincial government and the Beer Store
should be revised to ensure that Ontario taxpayers receive their fair share of the
profits from the Beer Store. Consumers should not see an increase in prices as a result
of this change. The Beer Store should be required to provide greater transparency, to
ensure that costs are allocated equitably among suppliers, and to treat both owners
and non-owners fairly, including with respect to the display of their products. The LCBO
should be enabled to sell 12-packs and should increase its Cost of Service charge
on beer.
In the case of the off-site Winery Retail Stores, only a select few wineries have off-site
wine store licences. This seems unfair to the other producers. We also note that these
wine channels permit the sale of what are essentially non-Canadian wines under the
brand of a blended Canadian wine at very favourable tax rates relative to LCBO wine
sales. This also seems unfair.
Given our bias to create more competition rather than less, we believe that wine stores,
in some format, are a positive feature of the distribution system. As well, we recognizethat stand-alone wine stores may not be able to sustain the same tax/mark-up system
as the LCBO with its broader product assortment. We propose to engage the
participants in a constructive dialogue to develop change that would reflect a fair tax
system and continue to see strong demand for Ontario-grown grapes.
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We need to find a balanced way to effect these changes so that value is not destroyed
for the participants, but rather is more equitably shared. We believe that there could be
a limited expansion of availability and would like to see an opportunity created for
competitive distribution outlets to be established which would provide ongoing
competition to the existing networks and force innovation.
In summary, we believe Ontarios alcohol distribution system works relatively well. If
consensus can be reached with the relevant parties and with the necessary political
will, its limitations are largely fixable within the current construct by changing the
behaviour of the three quasi-monopolies, adding some selective competition and
making sure the public gets its fair share of profits.
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Electricity
Hydro Onecomprises three main businesses within one company: a transmission
business as one part of Hydro One Networks Inc. (Hydro One Networks), a large
distribution business spread across the province as the other part of Hydro OneNetworks; and Hydro One Brampton Networks Inc. (Hydro One Brampton), a separate
urban distribution business.
There are opportunities for operational improvements in both the transmission and
distribution businesses. These have been recognized by management which is
committed to exploring them. Many of these changes can be implemented without
changing the current labour contracts. Other savings opportunities would require the
cooperation of the unions and agreement of the shareholder. Where improvements can
be made, the savings will accrue over time to electricity ratepayers.
Our view is that the transmission business is a well-run part of Hydro One with some
opportunities to deliver savings on both capital and operating costs that should be
pursued. While selling all or part of the transmission business would be attractive to the
capital market, we believe this is an asset that, if retained in public ownership, can play
a positive role in many aspects of electricity policy, including ongoing energy-sharing
discussions with Quebec. Accordingly, we believe Hydro One transmission should
remain in public hands as a core asset at this time.
We view the distribution business differently. There are huge challenges in Ontarios
local electricity distribution system. There are too many entities, some of them
inefficient, that lack the capability and capital to modernize and adapt to the
changing environment.
The electricity distribution sector was reviewed in 2012 by the Ontario Distribution
Sector Review Panel. We agree with the Panels core conclusions the need to foster
consolidation and promote agile action in a changing energy world. Indeed, we believe
these conclusions are supported by almost everyone in the industry, though not
everyone agrees on how best to implement them. Ontario needs a more consolidated
and efficient electrical distribution system. The system needs more capital, which is
unlikely to be available from the public sector owners given other pressing needs.
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The system also needs companies that can innovate and adjust nimbly to a very
different energy world in the future. The current system fails that test.
Two entities that are key to breaking this logjam are Hydro One Brampton and the
distribution business in Hydro One Networks. We propose that both be used, not toforce consolidation but to catalyze it. Consolidation will facilitate efficiencies, reducing
costs that in turn will reduce electricity rates from what they would have been. It will
also improve adaptability of the system and create companies that can grow and
create jobs. The Council would make this recommendation whether or not the Province
needed money to fund new infrastructure. It is simply good energy policy. The Province
should take action now as a catalyst and achieve savings over the long-term. We do
not believe that the Ontario Government should divert resources from its priorities to
fund consolidation of local distribution companies. Private sector capital is available todo this.
We are open to looking at different ideas as to how to encourage consolidation. One
way would be to use Hydro One Brampton as a catalyst by merging it with one or more
GTA-area distribution companies and then bringing in private capital to give it the
financial capacity to undertake further consolidation. The Province could sell some of
its interest in the company in a secondary offering along with the other existing owners,
should government choose to do so.
We also recommend the separation of the transmission and distribution businesses
now within Hydro One Networks into two entities. We would then propose that the
government dilute its interest in that resulting distribution business by bringing in
private capital. We would suggest that the Province initially retain a minority share
(40% to 45%). This new company would then have the capacity to undertake further
consolidations. These moves would create two champions of consolidation that would
provide an entrepreneurial base for growth. We would expect other municipalities to
respond either by joining these entities or seeking their own new partners public or
private. We would encourage both such moves.
Our preference would be to keep the distribution business in Hydro One Networks as a
new separate distribution firm and not break it up. We recognize that there may be
some limited circumstances where merging parts of the distribution business with
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specific municipal electrical utilities would foster further consolidation. But we would
resist cherry picking, as that would compromise the best outcome for taxpayers and
electricity ratepayers. We would want to ensure that, if portions were to be sold, any
sales would not reduce the value of the distribution business as a whole, and more
importantly, not raise electricity rates from what they would have been. The Council is
also open to other proposals and ideas that will come forward as part of Phase II.
We are very sensitive to the labour issues such a change of ownership raises.
There are a number of rights that have to be respected and a number of concerns
that will arise. We believe we understand these concerns but also believe that it is
very important to have the right process to talk through and understand each
partys interests and concerns with the goal of finding sustainable, mutually
acceptable solutions.
We also recommend that the government insist on provisions to protect against
undesirable changes in ownership in the future. This would ensure that the Province
can safeguard against unintended consequences from diluting its ownership.
We view Ontario Power Generationas being two distinct businesses a complex
and challenging nuclear business and a much more stable and straightforward
hydro/thermal business. We focused mainly on the non-nuclear business looking at
possible operating improvements and whether there are assets that it would make
sense to sell.
Cost savings in the hydro/thermal business are not overly large, but should be
pursued. Similar savings are likely to be had in the much larger nuclear business.
Management, which has been working on a business transformation initiative since
2011, is aware of opportunities and is committed to exploring them further.
OPGs portfolio includes assets specifically its hydroelectric stations other than the
large hydroelectric generating stations at Niagara Falls and on the St. Lawrence River
that could be sold to finance additional investments in provincial infrastructure.
There is an active market for such assets.
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However, a transaction involving these assets should not be OPGs first priority as it
would involve a number of issues central to energy policy that would have to be
resolved before reaching a conclusion that such a sale would be in the public interest.
More important than pursuing a sale of hydroelectric generating stations, OPG faces a
core issue: the refurbishment of the Darlington nuclear power station. This is
paramount from a cost sustainability perspective. The scale and risk in this capital
project dwarfs all other business issues at OPG. We recommend a laser focus on
making sure Darlington comes on line safely, on time, and on budget. We also suggest
that the government consider strengthening project management experience on OPG's
board to help support the Darlington refurbishment.
To that end, we propose that OPG should consider creating, on a staged basis, an
internal structure as if they were two separate entities focused on their very differentbusinesses. This could eventually lead to two separate organizations a nuclear
company with a Board that has predominantly large project management experience
and a non-nuclear company. However, moving aggressively now would risk
diverting managements attention from the core priority of the Darlington refurbishment
and would also deprive the nuclear business of the financial support provided by
the non-nuclear operations. Accordingly, any structural changes should be made
over time.
Cost savings that are attainable at Hydro One and OPG are relatively small unless
both companies can alter their labour practices or modify their total compensation
packages. Both have total labour costs that feature elements of above-market wages,
benefits and pensions. Pension costs have recently been highlighted in the Report on
the Sustainability of Electricity Sector Pension Plans(the Leech Report) and both
entities operate under government-imposed restrictions that make them less productive
than their private sector counterparts in heavy industries with field operations. These
restraints impose a significant burden on electricity ratepayers and taxpayers.
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To understand how we got here one has to understand a very long history of give
and take in bargaining. But, in todays environment, the package of wages,
benefits, pensions, and practices, in some cases, exceeds not only private sector
standards, but public sector standards too. This is not true in all cases, especially
with highly specialized and technical staff, so one must be careful not to make
sweeping generalizations.
The Leech Report eloquently outlines the unsustainability of the pension plans in the
electricity sector, including both OPG and Hydro One. Simply put: they are not
consistent with public sector standards and are not, in Special Advisor Leechs
expert view, stable.
We recognize that both union leaders and employees at all levels are equally
concerned about ensuring the ongoing viability of these plans. We have a joint interest
in finding a good, mutually agreed-upon solution. There has been broad agreement on
a process to deal with this conversation. We recommend the government put urgency
behind this initiative and ensure a coordinated government response.
If these companies are to stay and thrive in the public sector, modernizing labour
practices to improve productivity is also critical.
Almost none of the potential improvements or restructuring at Hydro One or OPG willbe possible without consulting and negotiating with the Power Workers Union and the
Society of Energy Professionals. These negotiations will be complex and challenging,
but they are essential to long-term, sustainable operations. The current labour
agreements were struck at the bargaining table and should be changed at the
bargaining table. What is needed is to initiate a dialogue with management and the
labour unions in order to agree on the facts and work together to understand the issues
and the range of solutions.
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Conclusion
We believe that our review has produced a sound, actionable framework to improve
the operations of the entities we examined, to streamline the systems within which
they operate, and to improve service to customers. This would free up funding formuch-needed transit and transportation infrastructure investment.
Reducing government ownership in our electrical distribution systems through injecting
private capital while retaining a minority share will help spur needed consolidation in
the electrical distribution system to improve our electricity infrastructure.
At the same time, we estimate that between $2 billion and $3 billion, depending on
market conditions at the time, can be realized and invested in Ontarios transit and
transportation infrastructure. These investments will create jobs directly and indirectly
through investments in critical infrastructure which will remove impediments to
economic growth. While the provincial government would get less ongoing income
directly from these companies, the investments in economic growth will help mitigate
this shortfall over time. In addition, this lost income would be more than covered from
the savings generated by the improvements we are proposing for the entities we
believe should remain publicly owned, including the LCBO.
The current beverage alcohol structure should continue providing the benefits of a
lower-cost, controlled model but changes are needed to improve customer
experience and returns to the Province. In addition, introducing limited competition will
add further incentives to innovate.
All of this can be achieved without increasing the expected debt levels or increasing
the expected deficit.
In the next phase of our work, the Council will engage with the companies and
stakeholders to explore the proposals we are making in this report and seek to develop
solutions that are pragmatic and, to the extent possible, supported by all parties.
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SUMMARY OF COUNCIL PROPOSALS
The following proposals, which have been developed based on our review and flow
from the observations outlined in this report, constitute an actionable frameworkfor change.
Beverage Alcohol
LCBO
Ownership
The Province should retain the LCBO.
The current beverage alcohol market structure should be retained but opened up to
greater competition.
Pricing & Mark-ups
The LCBO should move in a staged way to introduce a new pricing strategy,
enabling it to use its buying power to reduce costs based on objective criteria,
consistent with Canadas international trade obligations.
Ontario beverage alcohol prices should be maintained below the Canadian
average.
The LCBO should continue to review minimum prices.
Retail Enhancement
The LCBO brand should take advantage of its brand by associating it with certain
products (co-labelling).
The LCBO store network should be expanded and differentiated by creating
warehouse (Depot) stores, converting some existing LCBOs to specialty shops
which emphasize craft beer or craft distillery products, and orienting the product
selection in certain stores to reflect their neighbourhood.
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The LCBO should develop into a best-in-class online retailer, fully integrating its
website with its business to make a broader selection of products available to
consumers and to provide suppliers, including those that don't have access to
LCBO stores, access to the Ontario market. It should:
make products available for online order (click & collect);
connect shoppers to the LCBOs warehouses; and
create an on-line marketplace to allow any supplier in the world to register
its products.
Labour
The bargaining process must be respected; any changes to current agreementsshould be made at the bargaining table.
Labour practices should be updated to improve productivity and to implement our
recommendations.
Introducing Competition
Opportunities should be considered to introduce competition in a limited way, such
as exploring with:
craft brewers, the possibility of opening a limited number of stores featuring
craft beer from around the world;
the wine industry, the possibility of opening new private stores offering both
Canadian and international wines; and
distillers, the possibility of new sales channels.
Other Proposals
The LCBO should better differentiate its true profit from the mark-up it collects, as
well as separately report its various businesses.
The LCBO should realize the operational savings identified.
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The Beer Store
The LCBOs Cost of Service charges on beer should be increased.
The LCBO should be enabled to sell 12-packs.
Ontario taxpayers deserve their fair share of the profits generated from the
Beer Store.
Consumers should not see higher prices as a result of this change.
The Beer Store should be required to:
provide greater transparency;
ensure that costs are allocated equitably between suppliers; and
treat both owners and non-owners fairly, including with respect to display of
their products.
The possibility of opening a limited number of stores featuring craft beer from
around the world should be explored with craft brewers
Winery Retail Stores
The off-site WRS owners should be engaged in a constructive dialogue to achieve:
a taxation system that is fair; and
a set of changes that continue to see strong demand for Ontario-grown
grapes.
The possibility of opening new private stores offering both Canadian and
international wines should be explored with the wine industry.
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Electricity
Hydro One
General
The Province should retain the transmission business at this time given its current
policy role.
Hydro One should work to realize operational savings identified over time.
Hydro One should separate its distribution assets from the rest of its business.
The Hydro One distribution assets should be used as a catalyst to encourage much
needed consolidation and modernization of the electricity distribution system.
Distribution
Private sector capital, rather than public funds, should be used to support the
required consolidation of LDCs.
The Province should dilute its interest in Hydro One Brampton by merging it
with some other LDCs, including possibly with other GTA entities, based
upon a pre-agreed business plan to bring in private capital to help grow and
modernize the electricity sector.
The transmission and distribution businesses of Hydro One Networks should
be separated into two entities; the Province should dilute its interest in the
resulting distribution company to a minority interest (40% to 45%) by bringing
in private capital.
o The Councils preference is to keep the distribution business whole to
ensure a better outcome for ratepayers and taxpayers.
Provisions should be used to protect against specific undesirable changes in
the future ownership of these businesses.
Any transaction should not create further upward pressure on rates.
The current barriers and incentives, such as taxes, which impede consolidation
should be reviewed during Phase II.
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Labour
The bargaining process must be respected; any changes to current agreements
should be made at the bargaining table.
Labour practices should be updated to improve productivity and to implement our
recommendations.
Rights must be respected and specific concerns should be addressed as a result of
changes in ownership.
A co-ordinated government response is required to achieve sustainable pension
plans within Hydro One and OPG.
Ontario Power Generation
General
A laser focus should be taken to ensure Darlington comes on line safely, on time
and on budget.
The government should consider adding more large project management
experience to the OPG Board to oversee the Darlington refurbishment.
OPG should work to realize operational savings identified over time.
OPG should consider creating an internal structure over time as if there were
two separate entities focused on their very different businesses: nuclear and
non-nuclear generation.
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Labour
The bargaining process must be respected; any changes to current agreements
should be made at the bargaining table.
Labour practices should be updated to improve productivity and to implement our
recommendations.
A co-ordinated government response is required to achieve sustainable pension
plans within Hydro One and OPG.
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1. INTRODUCTION
1.1 Establishment of the Council
On April 11, 2014, the Minister of Finance announced a Council to provide advice on
government assets, reporting directly to the Premier. The Council is made up of Ed
Clark (Chair), David Denison, Janet Ecker, Ellis Jacob, and Frances Lankin.
Establishment of the Council was also discussed in the 2014 Ontario Budget.
1.2 Mandate and Principles
The Councils mandate is to provide analysis, advice and recommendations on howbest to maximize the value and performance of government business enterprises and
other Provincial assets. This is intended to help the government deliver on its multi-
year targets set out in the 2014 Budget. The government established three principles to
guide the Councils review. These were:
The public interest remains paramount and protected;
Decisions align with maximizing value to Ontarians; and
The decision process remains transparent, professional and independently
validated.
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1.3 Terms of Reference
We were asked to report to the Premier on the government business enterprises under
review by the end of 2014 to contribute to the 2015 Budget process. The Councils
terms of reference provided the following guidance:
Focus on core government business enterprises and operational agencies;
Give preference to continued ownership of all core strategic assets to generate
better returns and revenues to the Province;
Advise the government on efficient governance and how best to achieve asset and
income optimization targets as set out by the government in ways that enhance
services and value to the customers and recognize the need for highly performingengaged employees;
Consider possible asset mergers, acquisitions and divestments if there is a strong
business case and it would enhance value to the taxpayers of the province;
Advise on possible changes to the corporate structure of the government business
enterprises, including private-public sector partnerships;
Review and comment on possible directions and agency proposals and businessplans; and
Take into account the protection of the public interest, including providing for an
appropriate legislative and regulatory framework.
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1.4 Scope of Our Review
Within our overall mandate to review government assets, we were specifically directed
to examine three government business enterprises the Liquor Control Board of
Ontario, Hydro One, and Ontario Power Generation. They form the foundation of thegovernments participation in the beverage alcohol sector and the electricity sector.
Within the beverage alcohol sector are three major retail entities:
LCBO
Beer Store
Winery Retail Stores
Although neither the Beer Store nor the Winery Retail Stores are government business
enterprises, they are regulated by the government and are part of the provinces
beverage alcohol system. As such, the Council concluded that it was impossible to
consider the LCBOs place in the beverage alcohol sector without acknowledging the
Beer Store and off-site Winery Retail Stores as competitors and comparators with
the LCBO.
In the electricity sector, there are two government business enterprises:
Hydro One
Ontario Power Generation (OPG)
Given the short time frames associated with the Councils advice to government and
the size and complexities associated with nuclear power generation, we restricted the
scope of our OPG review to its non-nuclear operations.
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1.5 Our Perspective
As we began our work, we set ourselves a goal to craft our advice in a way that would:
Retain core enterprises within public ownership;
Possibly divest some non-core assets to support investment in much-needed and
productive infrastructure without adding to the Provinces overall debt or increasing
the deficit;
Improve both business performance and customer service in the subject entities
while not increasing commodity costs to consumers.
We recognized from the outset of our work that all the entities operate within a tightly
constrained regulatory or policy regime; furthermore, this is by no means the first time
these sectors and entities have been reviewed.
Both the beverage alcohol and electricity sectors have been studied intensively over
several decades. A number of studies have proposed different structures and operating
models. Some of the operational recommendations of these studies have been
implemented, but most strategic and transformational recommendations have not.
As we embarked on our review, we asked some basic questions:
Could these publicly-owned companies be better run?
Could they be more customer-focused?
Are all the companies assets truly core to their mission?
And because these publicly-owned companies (like any company in the private sector)
have limited capacity to act, is there a set of practical steps that are within theircapacity that would unlock value?
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Our bias was clearly towards the do-able. It is easy to come up with dramatic shifts in
strategy but such shifts would require deep cultural changes in the organizations,
and broad societal support to make them happen. We prefer a more measured
approach each step of which improves what we have and actually gets things done
rather than adds this report to the list of earlier reports never implemented.
The Council was also guided by the governments desire to find the financial capacity
to fund needed transit and transportation infrastructure in the province.
We started from the premise that all three entities under review would have
opportunities to realize value and improve performance as would almost any business
in Canada, whether public or private. However, we recognized that in many cases the
entities may have been constrained by the fact that they are government-owned;
in practice, they operate in an inherently political environment.
But we kept several things in mind.
As mentioned, governments preference is to retain ownership of core assets. The
Council also believes that rushed asset sales are not in the public interest. Any sale
must be a carefully staged and competitive process.
We asked whether the government is, indeed, the best owner of these assets, and the
purpose served by government ownership. Would a company in private hands be
better able to serve the consumer or electricity ratepayer? Would bringing in the private
sector unshackle a company, allowing it to grow and create jobs?
These assets all earn income for the Ontario government income that is important
given its deficit position. But the proceeds of any asset sale are unlikely to be
reinvested in new direct income-generating assets. The new infrastructure assets may
greatly benefit Ontarians and add enormous value to the provincial economy; this, in
turn, would create income indirectly, through increased economic activity for the
provincial government in the medium-term. But in the short-term, a loss of income is
likely. The Council was very mindful of that impact. So, to offset any loss of income,
it became even more critical to ensure better performance of the assets retained by
the government.
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The Council agreed that swapping ownership in infrastructure assets can make sense.
But it is important that any funds raised are used to invest in other assets that deliver
high societal or economic returns to the province. The government has made clear that
funds raised in this process will be used to invest in transit and transportation
infrastructure. Better infrastructure will allow the economy to grow faster, create more
jobs, and increase both competitiveness and productivity. In addition, of course, there
are jobs directly created by undertaking the investments.
Finally, we set out with a view that the Government Business Enterprises we were
reviewing have, in most cases, adapted relatively successfully to their operating
environment. The three management teams and boards have identified areas for
improvement and implemented several of those changes. We engaged each of the
organizations in our work so that we could explore opportunities collaboratively and,ideally, come to a collective view on how to effect change that is meaningful
and achievable.
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1.6 Our Approach
We structured our review in two phases:
Phase I incorporated detailed reviews of the subject entities, consultations with
stakeholders and the development of our initial thinking on proposals for the future
direction of each company. These are included in this initial report for consideration
in the Fall Economic Statement; and
Phase II will incorporate further discussion and consultation on the proposals,
which would further our goal of reaching agreement among the appropriate parties,
leading to definitive recommendations to the government for consideration in the
2015 Provincial Budget.
As we move forward, we will continue our commitment to a collaborative and
transparent process as we work out specific ways to implement our
recommendations.
Phase I.In Phase I, we undertook two main streams of work detailed reviews of the
entities in which we were supported by professional consulting expertise, and meetings
with selected industry associations and stakeholders who are either employed by, regular
clients of, partners of, or competitors with the three Government Business Enterprises.
The major work streams in each of the three companies involved an analysis of each
organization and its operations, investigating issues and then developing and
evaluating options for performance improvement, cost savings, and/or the optimization
of asset value. We engaged a number of advisors and consultants to assist us in
this work.
We met with a wide range of stakeholders, among them all the business entities
involved and the oversight ministers. We met with representative stakeholders,including unions, in both the beverage alcohol and the electricity sectors. The Council
also received a number of formal submissions in the course of our review, and we
very much appreciated the thoughtful and constructive input we received through
this process.
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2. THE BEVERAGE ALCOHOL SECTOR
2.1 Overview
The beverage alcohol sector in Ontario generated total retail sales of about $7 billion in
201314, of which about $3 billion went to the Ontario government through:
a dividend from the LCBO ($1.74 billion);
taxes on beer sales through the Beer Store and on-site manufacturers stores
($524 million);
taxes on wine sales through on- and off-site Winery Retail Stores ($33 million); and
the provincial portion of Harmonized Sales Tax on sales at retail stores and
licensed establishments ($650 million).
The Ontario system is dominated by three retail networks that are owned either by the
government (LCBO) or producers (the Beer Store and Winery Retail Stores) and that
have a quasi-monopoly on beverage alcohol wholesaling and retailing in Ontario:
The LCBOis owned by the Province and operates 639 stores across Ontario.The LCBO also authorizes 217 Agency Stores, which are privately operated and
provide retail access to consumers in less densely populated areas.
Brewers Retail Inc. (BRI), which operates as the Beer Store, is owned by a
consortium of three foreign-owned brewers, and has 447 stores across
the province.
Off-site Winery Retail Storesare owned by six wineries and retail only their own
products at 292 locations across the province.
In addition to the channels listed above, local producers can sell their own products
at on-site manufacturers storeslocated at their point of production. Along with the
LCBO and the Beer Store, authorized producers are also allowed to sell their products
to licensed bars and restaurants, referred to as licensees.
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Certain other provinces have modified their systems in recent years:
Albertais the only Canadian province or territory to fully privatize the retailing of
beverage alcohol. A provincial agency retains control over the importation of
alcohol into the province, and hires private companies to warehouse alcohol onits behalf.
British Columbiais an example of a Canadian province with side-by-side public
and private liquor stores selling a full range of wine, spirits, and beer. Private stores
purchase liquor from the provincial agency at a discount to retail price, which was
initially set at 10%. Today, that discount ranges from 16% to 30% for certain stores.
Quebecalso employs a hybrid model. The provincial agency is the only entity
permitted to retail spirits and wine bottled outside the province, with wine bottled in
Quebec and beer sold in private channels throughout the province, at convenience
and grocery stores, as well as specialty retailers.
The public policy rationale for the design of Ontarios system was originally and
largely remains to control the distribution and sale of beverage alcohol. As such,
government plays a strong role in the sector. Since the inception of the system in the
late 1920s, government policy has focused on balancing consumers desire for access
to beverage alcohol against the social responsibility of mitigating its harmful effects.The Province has focused on managing the health hazards of beverage alcohol by
limiting retail outlet density and controlling points of sale, preventing broader retail
availability. This public policy issue is not unique to Ontario or Canada. Few
governments treat beverage alcohol as simply a normal consumer product.
Many pieces of legislation, regulations and agreements govern the import, sale and
transport of alcohol in Ontario, including:
The Importation of Intoxicating Liquors Act(Federal) assigns importation authority
for beverage alcohol to provincial and territorial authorities.
The Liquor Control Actempowers the LCBO to retail beverage alcohol and to
regulate warehousing and pricing and authorizes BRI and the basis for on-site brewery,
winery, and distillery stores to sell their products to the public.
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The Liquor Licence Actregulates responsible use, licensee sales and service
requirements as well as establishes manufacturing and distribution conditions and
legislation for marketing and advertising practices.
The Alcohol and Gaming Regulation and Public Protection Act (AGRPPA)establishes the Alcohol and Gaming Commission of Ontario (AGCO) and provides
legislation for beer and wine taxes and their collection.
The Beer Framework Agreement, signed in 2000 between the LCBO and Brewers
Retail Inc., acts as an operating agreement between the two entities. It gives the Beer
Store exclusive rights to sell beer in formats larger than a six-pack in communities with
a TBS location, and prevents the LCBO from wholesaling beer carried by TBS to
licensees. The Beer Framework Agreement can be terminated with six months notice.
International Trade Agreements, including the Beer Trade Memorandum of
Understanding between Canada and the US, North American Free Trade Agreement,
the Agreement between the European Community and Canada on Trade in Wines and
Spirit Drinks, as well as the proposed Comprehensive Economic & Trade Agreement
and Trans-Pacific Partnership, require treatment of imported products that is no less
favourable than that accorded to domestic products.
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2.2 LCBO
Background
The LCBO is a government business enterprise that has a monopoly for the
wholesaling and retailing of spirits and imported wine and competes with Winery Retail
Stores for Ontario wine sales as well as the Beer Store for beer sales.
The LCBO provides a direct return to the Province through an annual dividend.
This amounted to $1.74 billion in 201314, and has grown at a compound annual
growth rate of about 5.5% since 1994.
The LCBO is by no means a conventional liquor wholesaler and retailer. It operates
in a complex environment that has shaped the way the organization operates today.
The chart below illustrates some of the forces that affect the LCBO.
Governance
Publicly-appointed Board of Directors has authority
to execute operations under LCA
Reports to Minister of Finance
In practice, financial decisions are made in
collaboration with the Ministry of Finance
Labour Relations
Single union Ontario Public Service Employees
Union
Approximately 90% of workforce is unionized
Average age of approximately 45 years; average
age of permanent employees within union of over
50 years
Staff turnover of less than 5%
Regulatory Framework / Mandate
Liquor Control Act is guiding legislation
Balanced mandate between social responsibility
and financial returns to Province
Performs a number of activities because it is a part
of government (policy, communications, Freedomof Information, French Language Services, etc.)
Suppliers and other stakeholders routinely appeal
to government for changes to the LCBO
Market Dynamics
Monopoly on spirits; near monopoly on wine
Competitor to the Beer Store for beer sales
Product pricing set on cost plus basis
Intersects with public policy goals; LCBO provides
incremental support to suppliers
LCBO
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Our Approach
The Council worked closely with LCBO management to understand their perspective
and explore opportunities to improve performance. We were also assisted by
consulting teams that undertook a focused diagnostic review to identify potential
operational and profit improvements.
Our Observations
General.Ontarios beverage alcohol system is a product of its long history and has
evolved in piecemeal fashion over the years. It may well be that, given a clean sheet,
no one would design a system to operate as this one does. Given its status and
history, it is hardly surprising that the LCBO neither resembles nor operates like a
traditional private-sector wholesale/retail organization.
That said, the LCBO has evolved significantly over time, particularly over the past
decade or so. Substantial investments in stores and improved customer experience,
as well as a broad product assortment and a large footprint across Ontario, mean that
consumers are generally well served by the organization. Currently, 90% of the Ontario
population lives within 5 km of an LCBO or agency store. Operationally, allowing for the
constraints within which it operates, the LCBO has made substantial strides in
transforming itself from a government control mechanism into a modern wholesale and
retail organization.
All in all, we found that, despite the constraints put upon it by government policy and
labour agreements, the LCBO provides Ontario consumers with a very broad and
convenient network, a sophisticated retail experience and a significant assortment of
products that are, on average, priced below the Canadian average.
Ownership of the LCBO. One of the central questions we addressed was whether the
Province should continue to own and operate the LCBO or whether it should be
privatized in some manner. There have been arguments made over the years that the
proper role of government is to regulate and oversee rather than to own and operate.
In light of this, we considered the privatization options carefully.
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We considered selling the LCBO. There is a definite interest in the market for such an
option, which offers simplicity and a large one-time financial benefit. However, we
struggled with the concept of handing a monopoly over to a private owner. We were
concerned that large outright sales of this kind in the past have proven to be far less
attractive than they initially appeared. Privatization or sale to a private buyer would be
a radical change to a system that actually works quite well, requiring the creation of
new regulatory systems. As far as consumer benefits are concerned, it is not evident to
us that Ontarians would be materially better served by a privately operated LCBO.
Further, any new owner would want to ensure that the monopoly they acquire is
preserved. The Council believes that competition is a good thing, particularly for
businesses like the LCBO that are not natural monopolies. Indeed, we would prefer to
see some limited increase in competition rather than locking in a perpetual monopoly.
Therefore, we rejected privatizing the LCBO.
We also examined the possibility of dramatically opening up the market structure
currently controlled by the three quasi-monopolies in Ontario: the LCBO, TBS and the
Winery Retail Stores. Experience elsewhere suggests this would dramatically increase
the number of access points, creating a more open but more costly distribution system.
Such a bold overhaul of the system would represent a radical change for the Province
and would require a broad consensus that it is the right thing to do. Such a consensus
does not appear to exist today.
However, in supporting, retaining, and improving the LCBO, the Council believes it is
important to introduce more, even if limited, competition to provide more access as well
as pressure to innovate. To this end, the Council is open in Phase II to exploring
suggestions of how competition can be increased without undermining the fundamental
economics and advantages of the monopoly system. Specifically, we would like to
explore with craft brewers the possibility of opening a limited number of stores featuring
craft beer from around the world. We would like to explore with the wine industry the
possibility of opening new private stores offering both Canadian and international
wines. Additionally, we would like to explore with distillers ideas regarding new
sales channels.
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Maintaining government ownership of the LCBO does not imply a continuation of the
status quo far from it. Working closely with management of the LCBO, we identified
significant opportunities to create greater value and improve performance. In essence,
we endeavoured to find ways that the LCBO, as a public monopoly, could act less like
a public monopoly. If it turns out that this cannot be done, our bias would be to look
again at ways to introduce even more competition than we are suggesting today. As
previously stated, we believe that competition is a good thing.
The LCBO operates under significant constraints in both pricing and mark-up.
Contrary to what many Ontarians believe, the LCBO does not actually set retail liquor
prices in the province. Within specified price ranges, the LCBO applies a fixed mark-up
(generally a percentage) to a suppliers quote to determine the end price to
the consumer.
The government imposes only two pricing constraints on suppliers:
a requirement that minimum pricesbe charged for various categories of alcohol,
an important tool for the Provinces social responsibility mandate; and
a requirement for uniform retail pricesfor that product, no matter where it is sold
in the province or through which channel.
While the LCBO seeks the best value for consumers within these price bands, the
LCBO does not establish either wholesale or retail prices for products it buys and sells
it simply derives its operating margin from the fixed mark-up. It is important to
understand the incentives that this system creates. Since the LCBOs mark-up for wine
and spirits is based on a percentage of the suppliers quote, cost concessions by
suppliers actually reduce the LCBOs profits. As a result, there is little incentive for the
LCBO to use its buying power to reduce the price it pays to suppliers and, by
extension, the price it charges to consumers. Further, if the LCBO sees an opportunity
to increase prices, it cannot do so without suppliers charging a higher cost.
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Consumer Prices:In our review of pricing at the LCBO, we excluded beer, given the
Beer Stores dominant market position. One might expect that wine and spirits prices in
Ontario would be higher than they are in jurisdictions where more competition exists.
However, our analysis indicates that this is not the case. In developing our price data,
our consultants:
i. examined self-reported provincial data aggregated by the Canadian Association
of Liquor Jurisdictions (CALJ), which provides price data for an agreed-upon set
of 42 wine and spirits products, four times per year; and
ii. conducted independent price checks of 43 wine and spirits products at seven
government- and 16 privately-operated liquor retailers in Alberta, British
Columbia and Quebec.
The CALJ data indicate that beverage alcohol prices in Ontario are generally below the
Canadian average. The independent store visits turned up a similar result when
comparing Ontario with Alberta, British Columbia and Quebec. The chart below
illustrates the price gaps. Based on the CALJ data, the LCBO would have to increase
prices for spirits by 3% and wine by 9% to reach the Canadian average.
3%
9%
Spirits Wine
Required LCBO Price Increase to ReachCanadian Average
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Reducing Cost of Goods Sold:The LCBO is one of the largest purchasers of
beverage alcohol in the world, yet has too little incentive to use its considerable
purchasing power to reduce the cost of goods sold (COGS) as any typical commercial
wholesaler or retailer would.
Using data from CALJ, we analyzed prices paid by the LCBO to wine and spirits
suppliers for 42 products, comparing those to other Canadian jurisdictions. Although
this limited set of items did not encompass the entire assortment available at the
LCBO, we found the results striking as, in many cases, suppliers received higher
prices in Ontario than they did in other Canadian jurisdictions. As illustrated in the
chart below, the cost of goods sold is higher than the average for all provinces
(the darker columns on the left) by 4% for spirits and by 3% for wine. Compared
with the lowest-cost third of the provinces (the lighter columns on the right), costs are10% higher for spirits and 7% higher for wine.
4%3%
10%
7%
Spirits Wine
Cost of Goods Sold Relative to Other CanadianJurisdictions (% Above)
Average of Provinces Best Third of Provinces
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In essence, in Ontario, products are purchased from suppliers at above-average costs,
yet the LCBO sells the same products to consumers at below-average prices. Two
factors largely explain this:
Cost:the distribution system in Ontario is highly integrated and much more efficientthan those of other jurisdictions; and
Margin:under the fixed mark-up structure, the LCBO cannot maximize its profits,
effectively transferring value from taxpayers to suppliers.
Nowhere is this latter point more apparent than with minimum prices. The combination
of a relatively high price floor and a fixed mark-up structure forces prices paid to
suppliers upwards. The effect of this reverberates throughout the LCBOs product
assortment, as these higher minimum prices put upward pressure on other products
within the same category. We do not believe it is good policy for suppliers to receive
windfall profits as a result of a social policy. As a result, we have discussed with the
LCBO opportunities to competitively procure products that are listed at the minimum
price. These initiatives would be based on objective criteria and consistent with
international trade obligations.
The current minimum price for wine is not effective, as only a small portion of wine sold
in the province changes hands at or near the minimum price. Given the role minimumprices play in encouraging responsible consumption, we note that wine has the lowest
minimum price per litre of absolute alcohol content, substantially trailing beer and
spirits. The government should consider raising minimum prices closer to real market
levels and be prepared to move minimum prices up even further if warranted.
This should be done in a way that allows the LCBO to capture the resulting increase
in profits.
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There are opportunities to improve the customer experience within the existing
storenetwork. Our discussions with LCBO management and our review of the retail
experience in other sectors and jurisdictions led us to conclude that the LCBO can
improve the customer experience in a number of ways. These represent meaningful
opportunities for the LCBO to increase margins while, at the same time, delivering
better value for consumers. These include:
Co-labeling:The LCBO could do more to monetize its strong brand by associating
it with specific products, to the benefit of both its customers and the LCBO. Tags on
products indicating Buyers Picks combined with preferential shelf space for
these goods could help consumers in their buying decisions. As these
opportunities would be auctioned to domestic and foreign producers for specific
products, this would provide strong financial returns for the LCBO. Both co-labelingand preferential shelf space are examples of non-discriminatory ways to
increase margins.
Store Network:Virtually all new LCBOs are large visually-appealing stores. This
enables the organization to offer meaningful shelf space to local wineries and craft
brewers and to allocate its high retail labour costs across a larger footprint with
higher sales. We have worked with the LCBO to find ways in which it can enhance
its overall store portfolio by creating variations within its network. Opportunities
identified include:
Craft and Cider Destination Stores: Elevating Craft. The LCBO now has
a small number of Destination Stores that carry a significantly broader
selection of local wines. We believe that this store-within-a-store concept can
be replicated to create certain specialty Craft Beer and Cider Destination
Stores. These would be of interest to consumers, while also representing a
meaningful opportunity for craft brewers.
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Craft Distillery Sections: Empowering Licensees. Craft distilled spirits
represent a small but increasingly popular market segment. To address this,
the LCBO has proposed setting up Craft Distillery Sections in specific stores
across the province. This specialized shelf space would enable licensees to
purchase craft distillery inventory in small quantities through the LCBO
store network, while highlighting this growing segment for retail consumers
as well.
Niche Stores: Meeting Local Consumer Demand. The LCBO could create
specialty boutiques in specific stores that better cater to the tastes and
demands of the local community. For example, a store on the Danforth in
Toronto could specialize in Greek wines and spirits while in Little Italy
customers could find an exclusive selection of Italian wines and beers.
These niche stores, while better serving their communities, could become
popular destinations for many customers.
Depot Stores: A New Buying Model. We discussed with the LCBO a
design for a select number of new stores that would offer a limited selection
of products sold by the case at all price points. These LCBO Depot stores
would be much more basic in nature and would sell competitively-procured
products not currently carried by the LCBO, emphasizing great value
for customers.
The LCBO could improve customer experience through an integrated online
platform, becoming a best-in-class online retailer. Although the LCBO is
introducing a new website and digital platform, we along with the LCBO
management team believe that more can be done to foster an integrated consumer
experience. Current proposals being explored include:
Online Retailing of In-store Assortment: Click & Collect. Stores would be
integrated with an online click and collect model that would enable customers to
order products online for pick-up at their local LCBO. We believe this would
represent a significant improvement for customers. When combined with new
initiatives such as Depots, it would expand the assortment of products available
and provide a different type of retail experience.
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Online Retailing of Warehoused Products: Private Stock. Today, LCBO
warehouses contain thousands of products, many of which are held for agents and
sold exclusively to licensees. These products are not available in LCBO retail
stores. We believe the LCBO can use its online platform to create a new sales
channel for these products; consumers could buy these products through the LCBO
website and pick them up in their local LCBO store. This would enable agents and
suppliers to benefit from a new sales channel and provide consumers with access
to niche products.
Open Marketplace: Online Retailing of Any Products. Even with the above
initiatives, consumers in Ontario will have access to only a small fraction of the
beverage alcohol produced worldwide. We believe the LCBO can use its online
platform to create an open marketplace on its website, allowing suppliers andagents around the world to list products for consumers to purchase for pick-up at
their local LCBO store. The marketplace would be open to all producers, and would
also be an interesting opportunity in the context of interprovincial sales.
Accountability and measuring performance. Although many including the LCBO
management team view the organization as an integrated entity, we see the LCBO
as a business with three core segments:
Retailer: the largest liquor retailer in Ontario by points of sale and total dollar sales;
Wholesaler: one of the largest beverage alcohol buyers the world;
Private contractor: engages with private-sector agency store operators and
authorizes wineries to deliver products directly to licensees.
Each of the businesses has its own unique dynamics. Almost certainly, performance
differs across the three areas. However, the LCBO does not currently assign
accountability or measure performance in a way that reflects this.
In addition, sales of beverage alcohol within Ontario through non-LCBO channels are
subject to commodity taxes levied by the Province. LCBO sales, however, are not
subject to these, as they are effectively included in the businesss mark-up.
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Labour costs. Labour accounts for nearly half of the organizations operating
expenses. The LCBO has about 7,700 full- and part-time employees, of which about
7,000 are represented by the Ontario Public Service Employees Union (OPSEU).
The collective agreement between the LCBO and OPSEU establishes labour rates and
work practices that have a significant impact on how the LCBO operates. While these
reflect benefits that the workforce has achieved at the bargaining table, they also
impede the organizations ability to modernize and streamline its operations.
Our consulting review compared the LCBOs wages to several comparable private-
sector companies (Canadian Tire, Shoppers Drug Mart, and The Source), and
determined that, on average, LCBO wages are about 90% higher than those paid by
typical Canadian retailers. Further, LCBO staff and casual employees earn more than
their counterparts at the Beer Store (the middle columns in the chart below), which isalso unionized.
This difference was not uniform across all job categories:
$33
$26
$15
n/a
$21
$13
$23
$11
n/a
Store Manager Staff Casual Employee
Wage Rate Comparison
LCBO
TBS; Avg. of Starting & Maximum Wages for Staff (300 series) & Casual (Temp); does not reflect higher wage ratesprior to last collective agreement
Private Sector Peers
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The gap between staff wages and those of store managers is much narrower in the
LCBO (the dark columns on the left) than in the peer group (the columns on the right).
Most LCBO store managers are not unionized, and have had their wages frozen by
government for the past six years, while wages for unionized assistant managers and
staff have increased annually with government support over that same time period.
This wage compression limits the ability of the organization to promote from within.
In 30 extreme cases within the LCBO store network, a non-unionized store manager
actually earns less than a unionized assistant store manager.
Perhaps the starkest example of the constraints that the LCBOs labour costs impose
on the organization relates to staffing on Sundays. While full-time staff are paid an
hourly rate of $26, these employees earn one-and-a-half times their regular rate of pay
on Sundays. When benefits are included, this results in a fully-loaded cost peremployee of about four times the wage rates of our private sector peer group. This
makes the cost of having stores open on Sunday prohibitive and out of step with other
competing channels.
The existing collective agreement provides LCBO management with some measure of
flexibility to manage its operations, assign and re-assign workers and determine the
complement of the workforce. The LCBO has increasingly relied more heavily on the
use of casual staff as a tool to manage scheduling and costs more efficiently. However,
other provisions exist that inhibit managements ability to reorganize and restructure
the workplace to improve operational effectiveness.
The current labour agreements have evolved over time as part of the give and take of
the bargaining process. We believe that this is how they should be changed in the
future. It is in the interest of all stakeholders that the LCBO be able to evolve as a
customer-focused organization. If it cannot adapt, pressures will grow to increase
competition even further than what we have proposed. We would therefore recommend
that the primary focus be on addressing things that make it more difficult for the LCBO
to operate as a customer-focused retailer and to implement our recommendations. In
addition, we believe that it is important that any future wage increases remain
consistent with the government's labour strategy for the broader public sector.
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2.3 The Beer Store (TBS)
Background
The Beer Store was originally established as a brewers co-operative in 1927. Today,
it is owned by three brewers Labatt (owned by Anheuser-Busch InBev), Molson
Coors and Sleeman (owned by Sapporo):
Total beer sales to consumers and businesses in Ontario are about $3 billion annually,
almost 80% of which is accounted for by TBS. The Beer Store has an open-listing
policy; any brewer can list products in TBS stores, provided it pays certain one-time
and ongoing fees. In addition, TBS operates the Ontario Deposit Return Program
(ODRP) on behalf of the government, providing a network of locations where
consumers can drop off empty containers and redeem their deposits.
Labatt
(AB InBev)
The Beer Store
(Brewers Retail Inc.)
Molson CoorsSleeman
(Sapporo)
447 Retail
Outlets
Agency
Stores
Licensees
TBS Ownership & Operating Structure
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TBS employs about 7,000 people in Ontario. The three owners also operate breweries
in the province with an estimated 1,300-1,600 manufacturing jobs. The craft brewers
employ more than 1,000 people in Ontario.
The retail price of beer in Ontario contains a complex mix of taxes or mark-ups, leviesand charges, depending on where the product is sold.
Like all other beverage alcohol products, beer prices are set by the supplier and are
subject to minimum and uniform pricing rules.
The LCBO mark-up, which applies to imported beer and domestic beer sold in the
LCBO, is set equal to the Beer Tax, which is applied to domestic beer, to ensure
compliance with trade obligations. This value is a fixed dollar amount per litre.
To cover expenses associated with selling beer through their networks, the Beer
Store and LCBO charge brewers Cost of Service fees, which vary between the
two channels.
Several federal taxes and the Harmonized Sales Tax also apply to beer sales.
Our Approach
We approached our review of the Beer Store as an adjunct to our work on the LCBO.
Our principal focus was to assess whether the Beer Framework Agreement confers a
material financial benefit on the owner brewers. Our analysis used publicly available
information as well as information from the LCBO on its own beer retailing operations.
Our Observations
TBS operates an efficient and relatively low-cost retail system. We developed an
indicative assessment of costs per litre of beer between LCBO and TBS. Based on our
consultants analysis, we estimate that TBSs costs are significantly lower than those of
the LCBO.
A major contributing factor to this discrepancy is the cost of labour. As previously
indicated, TBS wage rates for both permanent and casual employees appear to be
meaningfully lower than those at the LCBO. Further, the LCBO has a very different
business model than the Beer Store, one that is more consumer-friendly and requires
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more staff in each store. There is also a significant difference in non-store selling,
general and administrative (SG&A) expenses between the Beer Store and the LCBO,
largely as a result of their structure and organization.
The LCBOs Cost of Service charges for beer are too low. The LCBOs in-storeCost of Service charge has not been updated since 1989. Since that time, consumer
prices have increased by 64%. As a result, the LCBOs Cost of Service charges may
not be high enough to cover the businesss fully-allocated costs.
TBS and LCBO networks overlap closely. Not only are 86% of people in Ontario
within a five-minute drive from a retail beer outlet, but almost 90% of TBS locations are
within two kilometres of an LCBO and just over 60% are within one kilometre.
The current system could work better for consumers. Only the Beer Store is
allowed to sell b