Initial Report of the Premiers Advisory Council

7/26/2019 Initial Report of the Premiers Advisory Council

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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



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2.4 Winery Retail Stores (WRS) ......................................................................................................... 47

Background .......................................................................................................................................... 47


3. THE ELECTRICITY SECTOR ...........................................................................................................50

3.1 Overview ..................................................................................................................................... 50

3.2 Hydro One ................................................................................................................................... 53

Overview .............................................................................................................................................. 53

Our Approach ...................................................................................................................................... 55


3.3 Ontario Power Generation .......................................................................................................... 64

Overview .............................................................................................................................................. 64

Our Approach ...................................................................................................................................... 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.


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.


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

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Initial Report of the Premiers Advisory Council

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