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Tesco in crisis – “The end of the beginning for a great retailer”

27/11/2014 12:40

Definitely, 2014 can be considered a watershed year for Tesco. Faced with a series of problems in its largest market, the largest British retailer turned to a series of solutions to the crisis that culminated with a new appointment at the top. They tried everything in an attempt to recover lost market share and consumer confidence. There are opinions that equate what is happening now on the British market with the spectacular rise of discounters, in recent years. But this is the only part of the equation?

 

Brandprivat.ro propose to you today an extensive and detailed analysis of the UK retail market in an exclusive interview with Brian Moore, Global Retail Consultant & CEO of EMR-NAMNEWS Ltd. A truly international retail guru who has spent the past 30 years conducting a variety of consulting projects and training (Trade Marketing, Finance, Key Account Management, Category Management, Global Customer Planning and Management) for FMCG clients in the UK and worldwide. An exceptional source of material from which Romanian manufacturers and retailers can draw many observations and conclusions extremely useful in adapting their medium and long term strategies. Because also here, in Romania, the discounters and their rise may eventually lead to a radical change in the national FMCG market.

 

 

BMOORE

Brian Moore, CEO EMR-NAMNEWS Ltd. – Learnings for Retailers in Romania

 

We can’t talk about Tesco's UK retail market without a brief overview of the main causes. Where have these came from how have they influenced the evolution of the national market?

So what is it about?

Essentially, because of a combination of market pressures, Tesco has overstated its 2013/4 6-month profit statement by £263m in a period covering the past three years, resulting in a reduction of 93% in annual profits for the latest year. Profits to August down 91.9% to £112m, compared to £1.3bn a year earlier.

This has resulted in:

- The growing importance of the savvy consumer, demanding demonstrable value-for money, unwilling to outsource their purchasing decision-making to marketers or retailers, ever again

- A series of profit warnings leading to a £263m profit forecast over-statement in half-year accounts

- The replacement of CEO Philip Clarke and appointment of outsider Dave Lewis from Unilever

- The suspension of four key senior managers, including the UK managing director

- A boardroom purge being conducted and two new non-executive directors appointed

- Government investigations: The UK’s Financial Conduct Authority had begun an investigation into the accounting scandal, while the Financial Reporting Council was considering launching its own probe. These two probes have now been replaced by an investigation by the Serious Fraud Office announced last week.

- A sell-off of a new corporate jet: TESCO's new chief executive Dave Lewis has meanwhile moved to head off shareholder anger over its new £31.1 million Gulfstream G550 executive jet by ordering its sale and the sale of its four aircraft fleet.

All of this resulted in a 50% fall in share-price, to a market value of £14bn, its lowest value in 11 years.

By way of context, Tesco’s external debt is approximately £14bn, which combined with a shortfall of £3.4bn in its pension fund, means that it may have to sell off its Thai and Eastern European businesses, its research arm Dunnhumby and Tesco bank for what analysts estimate could be a total of £10.5bn, in order to significantly reduce debt and focus on rebuilding the business.

However, it is important to realise that Tesco is on the ropes but not on the canvas.

 

What will be the main impacts of these special measures?

First of all, certain moves to increase profitability are off-limits.

In this situation, moving the credit period from 40+ days to 90 days, a potential cash-flow gain of approximately £5bn would help, but would do little for enhancement of supplier relations. Equally, any attempts to increase supplier trade investment or escalation of deductions would not only attract the attentions of the authorities and media i.e. consumer, but would alienate suppliers, the essential collaborators in any recovery. Given the current scrutiny by the authorities, it seems obvious that Tesco will be unlikely to rely upon increases in credit, trade investment, or deductions as cash generators. This means that the above mentioned sell-offs are inevitable.

We believe that five years of flat-line are ahead, where growth in brands will only come at the expense of the competition.

As far as retail competition is concerned, other retailers will also have the same challenges, and grow only at the expense of other retailers. This means increased use of private label, a key differentiator in retail. Before the 2008 global financial crisis, typical brand-private label split in the UK had evolved to 50/50 in a retailer’s offering. The past five years of flat-line demand resulted in a drift upmarket by affluent consumers and at the same time a downwards shift to the discounters, resulting in the ‘squeezed middle’, represented by the major multiple retailers.

These big players responded to shopper demand for lower prices and switching to more private label. This has resulted in a change in balance to 45/55 brand to private label.

There is therefore considerable potential in Romania for a higher proportion of private label in retailers’ assortments.

 

What can the suppliers and large retail chains do, as they adapt their strategies to market fluctuations?

 

At the end of July, Philip Clarke, Tesco’s chief executive was shown the door after the company announced another drop in sales, a fundamental challenge to Tesco’s growth-based strategy?

Tesco in recent years became a ‘womb-to-tomb’ organisation, in that employees have tended to be ‘born with Tesco’ and ‘die with Tesco’, with company growth providing a desirable career-development environment for ambitious members of the team.

Tesco was founded in 1919 when entrepreneur Jack Cohen started selling surplus groceries from a market-stall in the East End of London. He handed over to his son-in-law Leslie Porter who is credited with developing the expertise of different departments in terms of purchasing, operations and marketing.

However, it was left to the succeeding CEO, team leader Ian MacLaurin to pull the company together and focus on growth to No 1 in the UK. 

Strategist Terry Leahy then took the retailer global, before handing over to Tesco-lifer Phil Clarke.

Unfortunately, Clarke took command at a time when the chickens came home to roost for many retailers in the wake of the global financial crisis of 2008. Up to this point, Tesco’s CEOs each made a unique and valuable contribution to a business that depended upon growth. Faced with years of flat-line demand, the company succumbed to a combination of internal and external pressures that severely challenged management’s ability to grow the business. Clarke thus became a high-profile casualty and was replaced by Dave Lewis from Unilever.

               

How true is it that Tesco became a driver of change in consumer behaviour?

Tesco was the original champion of the consumer, squeezing suppliers and competitors in order to sustain a ‘pile it high and sell it cheap’ policy. Gradually, the retailer became more sophisticated, and its growing 40,000+ range was designed to satisfy more consumer needs in term of goods and services. This resulted in the development of out-of-town shopping where large space superstores provided a one-stop shopping service for consumers prepared to drive for a monthly shop, and increasingly exotic food products, both brand and PL. They also pioneered online shopping and home delivery to cater for time-poor consumers.

It could thus be said that Tesco were pivotal in raising and meeting expectations of the UK consumer.

They also became very profitable in the process.

 

Why is Tesco a reference brand in UK?

From the early days of ‘pile it high and sell it cheap’ Tesco has been driven by a desire to place the consumer at the centre of the retail universe, bringing reasonably good product to the public at reasonably good prices. They also pioneered the use of private label, moving swiftly from basic foodstuffs through ‘me too’, to sophisticated competitor-products for leading national brands.

Tesco then introduced its Finest range, where quality was in a number of cases better than equivalent national brands, but at similar prices.

This increased the appeal and credibility of the Tesco brand in the UK.

Incidentally, I believe that this brand strength helped Tesco to survive the ‘horse meat’ crisis, a set-back that would have been terminal for lesser retailers.

This comprehensive range of private label products, targeted to meet all consumer segments, helped Tesco to grow to a 50/50 brand/PL split that not only optimised differentiation and margin, but also became a PL standard for the industry.

 

What part does the UK market play in Tesco’s strategy?

Any retailer hoping to be a successful global player needs to dominate its home market. With its 28% share, Tesco is still by far the UK’s largest grocery multiple retailer.

               

Loss in UK vs. growth on international markets. Is this a reasonable trade-off for Tesco’s shareholders?

While shareholders should judge a company on the basis of the total business, in practice the ‘rule’ for success in global retail is that it is necessary to have a large, dominant share of the home market, allowing management to focus on growth in emerging markets. Having developed the domestic business model, and securing say 25% + of the home market, the company can then roll the model out to other countries, and also provide career opportunities for ambitious staff that might otherwise be tempted to move to a competitor.

Any loss in the domestic market can become a drain on the overall business, apart from the dangers of applying quick-fix solutions that can have unintended consequences in terms of adverse media commentary.

 

I propose to discuss a little bit about the Big Four. Tesco’s results not only represent a management crisis or even a redundant strategy. Almost all players have problems, and the rise of discounters will affect the entire market.

This goes back to my point about ‘the squeezed middle’, a dilemma affecting all retail with the exception of the up market players like Waitrose, and the discounters at the lower end of the market. The major multiples such as Sainsbury’s, Morrisons and Asda (Walmart) are all suffering share loss at the expense of the discounters and Waitrose.

Essentially, with the exception of Asda to some extent, the multiples have failed to anticipate the swing to smaller, closer-to-home convenience retail, as the cash-starved consumers have searched for value amidst the austerity. As a result, the major retailers are stuck with redundant large out-of-town space, with little real prospect of a return to the high growth of the early years of the decade. The large space retailers have over-relied upon scale economies and being able to spread store overheads, designed to meet consumer demand for monthly one-stop shopping. All of that has now changed as the market has undergone fundamental structural changes.

These big ships have a lot of momentum, and will take time to change direction.

 

According to Warren Buffet, a man who tends to put his money where his mouth is, and had invested heavily in Tesco, it takes 20 years to build a reputation, and five minutes to ruin it.

As you know, having admitted that he made a big mistake with Tesco, he then significantly reduced his shareholding to 3% of Tesco in the past year, following losses of £500m in the value of his Tesco shares. Unfortunately, this was a major indicator loss of confidence in the company, by one of the world’s most influential investors.

In turn, many of Tesco’s management are remunerated via stock-options, and their wealth was also impacted significantly by the drop in share price.

 

Loyalty to supermarkets? It will take time and will be very difficult to bring back all customers.

I believe that one of the key casualties of the global financial crisis has been consumer loyalty to brands, PL and retailers. We are now in an era where a consumer demands demonstrable value for money, and has the means of comparing prices anywhere, but especially in the aisle, at the point of purchase.  Customers will not return unless retailers can meet these new criteria, and traditional supermarkets will be no exception. All I can say is that discounters rarely surrender market share in an economic upturn, and given the flat-line demand environment, supermarkets have a tough fight on their hands if they wish to regain share loss from the discounters.

 

Is buying power growing?

The Savvy consumer approach is spreading up the pipeline, with buyers becoming more savvy, wanting demonstrable value for money, increased trade investment, more retail margin and extended credit. However, the global financial crisis and its aftermath have weakened the retailer’s ability to simply demand more help from the supplier, without offering fair-share dealings in return. This I believe is a permanent change in the market.

 

Kantar Worldpanel revealed new data showing recent sales at Aldi and Lidl up 35% and 22% respectively compared with the same time last year, while Tesco was down 1.9%. The discounters' growing impact had pushed down food price inflation to its lowest level in eight years. How good is this strategy for the UK economy?

Deep down this is destroying value in brands, both supply and retail. In turn this will lead to less incentive to invest in innovation. Weaker players will disappear through acquisition, or will simply be removed from the market.

In general, the consumer will benefit from lower prices and simpler purchasing, as duplication and overlap is eliminated from the market.

 

Ronny Gottschlich, Lidl’s CEO, in an interview for The Guardian said: "We won't be beaten on price. We will consistently adjust prices based on negotiations with our suppliers." Do you think this will end with a price war? A price war will affect all the producers with negative impact on the entire economy.

For sure, a price war is one way of providing growth for the big guys, at the expense of the less powerful players. This will also result in more government interference, and generally lead to less choice on the shelf.  But it will also lead to more innovation, as retailers seek new ways of doing business, especially via multichannel access to the consumer.

 

Tesco is only the visible part of iceberg. What is happening now in UK can be a warning signal for all supermarkets. How fast they can adapt their strategies or is it already too late?

The signs have been there since 2008, so the supermarkets have already had six years to see the obvious and change their strategies, in these unprecedented times.

However, the changes in the market have been so fundamental, not all have been able to adapt fully. We still have trouble in the pipeline. However, the key thing is that opportunities exist for those that are prepared to accept the new conditions as the norm, and act decisively, while their competitors await a return to the normal ways of doing business.

 

After a generation of dominance, life seems to be suddenly pretty tough for supermarkets. It’s an overall scenario, in almost all important European markets. How can you explain this sudden reversal in fortunes?

In my opinion these changes are based not only on prices. The Discounter’s format is much more flexible, with smaller outlets, limited personnel and a high proportion of private or surrogate labels. On the other hand, discounters want to meet more consumer need by increasing assortments, with more articles, many of them with high added value, some close to premium.

 

The discounters are offering limited choice but are not confined to limited quality. The market tolerates limited assortment in discounters, based mainly on PL, vs. Tesco’s model with thousands of articles. The discount model works and seems to be much more profitable. Does the answer lie in the consumer’s search for simplicity?

In fact, each model can be profitable, provided each retailer sticks to the model’s key criteria. In other words, discounting success depends upon a limited range, in a small retail space with minimum overheads, whereas supermarkets and superstores depend upon a large comprehensive range of brands and PL, scale economies and a high level of store traffic. Consumers want simple, direct and transparent offers, or will vote with their feet and shop elsewhere.

 

People can now compare prices and offers very fast, searching on the internet. Do you think Tesco is prepared for this?

The unintended consequences of encouraging the use of mobile phones in the aisle means that by helping the shopper to compare prices, then the Tesco offer needs to compare well with competitor alternatives, or they will suffer loss of business. Tesco reacted too slowly to this change.

 

What about promotions? Every Day Low Prices vs. Discounters strategy, with weekly promotions, with a lot in-out articles.

In effect suppliers now need a one-off approach to their Aldi and Lidl strategies. Traditional National Account Managers and their marketing colleagues have been reared in a culture of continuity. In other words, we spent years building up relationships with consumers and customers, on the premise that a strategic approach to brand optimisation produced a predictable and acceptable return on investment, growing a level of brand equity that would carry us over the troughs in demand.

This all changed with the 2007/8 global financial crisis and the emergence of the savvy consumer, gradually morphing into the savvy buyer, each unwilling to outsource their purchase decision-making to marketers and retailers, in a continuous search for demonstrable value-for-money, for each purchase.

The results are evident in the successes of Aldi and Lidl at the expense of Tesco and the other multiples.

We are now as good as yesterday’s sales results, everywhere.

Any supplier attempting to build up a continuous relationship with the discounters, soon realises that life in this channel consists of a series of one-off initiatives, each bearing little or no relationship with previous moves made with the retailer.

In fact, thinking about it, the same now holds true for dealings with the major multiples (the over-rider agreement is now seen as ineffectual and is fast becoming increasingly dis-credited as the row about commercial income, also known as trade investment, escalates…).

And perhaps this is how it should be in business.

If this is the case, perhaps all branded manufacturers should target Aldi & Lidl with one-off experiments to help their colleagues become accustomed to discontinuity, developing skills that can then be applied, hopefully with even more effect, via their traditional customers, making each initiative ‘the best ever’, as if our livelihood depended upon it… as it probably does. In these changed circumstances, price has become but one part of the total offer package.

 

Sorry, but I don’t know so many things about Tesco’s home delivery service. As far as I know this can be an advantage vs. discounters. Is it?

For those time-poor consumers that want a delivery to the home, Tesco at the right price will always be more appealing than the discounters.

In fact, Tesco operate the world’s most successful grocery online service, but even in their case there are limits to the premium that a consumer is willing to pay for home delivery in terms of prices charged and delivery fee. The dilemma for Tesco is that while they charge £5 for a home delivery, the actual cost to Tesco is allegedly £20 per delivery. This means that the company loses more as the use of home delivery becomes more popular.

 

Lidl have announced that they plan to open more stores, for the coming years. In this regard they are much more flexible, being part of a family business. On the other hand, Tesco’s investment plans need shareholder’s approval.

The influence of third parties i.e. shareholders, will always impact the strategy of a publicly-listed retailer. However, even in the case of private companies, the members will want the company to generate an acceptable return on investment, if only to secure pensions for those involved and their families. Whilst most moves can be made in secret by a private company, in the end the economic problems are the same for private and public companies.

 

Neighbourhood store can be a solution against discounters?

Local stores that can offer convenience at reasonable prices with the right products can compete with the discounters.

 

If you can’t beat them, use their own strategy: Sainsbury's new joint venture with Danish discounter Netto. Can this be an efficient weapon against discounters? 

The way forward for supermarkets that want to adopt discounter strategies is to allocate special discounter-aisles that replicate the normal 1,400 lines of a typical discounter, and charging slightly more for other lines that the consumer needs.

The Sainsbury’s –Netto approach is an experiment whereby they are keeping the discounter offering at arm’s length to avoid shopper confusion. If it works, fine. If it fails, little harm is done to the Sainsbury’s brand.

 

What other European markets are vulnerable to the British scenario?

In my opinion, all countries in the Eurozone are in trouble in terms of economics and politics. The euro is proving to be an unsustainable currency model.

This means that the changes in the UK retail market will cause pressures on all retailers to boost their stock-market performance, causing retailers to try to save money by offering less rather than more variety in meeting consumer needs.  Moreover, the savvy shoppers increasing access to price-comparison and social media means that it will be increasingly difficult for problems to be restricted to local areas. As a result I see all markets being challenged by Tesco-related issues and having to adapt, or suffer loss of business.

 

What’s happening now in UK is an open lesson for all European retailers. We’ll see some changes in their future strategy?

The global financial crisis is resulting in austerity. Consumers are reverting to daily, even one-meal shopping, and are less willing to drive out of town to be tempted to buy more products in large space retail outlets.

All retailers will need to focus on the needs of consumer-shoppers that are demanding demonstrable value-for-money, and are making their own purchasing decisions in terms of when and where they shop i.e. the savvy consumer. They are unwilling ever again to outsource these decisions to retailers in the case of PL, or even suppliers, in the case of brands. These are fundamental changes that I believe are permanent within most existing markets.

 Brian Moore

In Romania, Lidl is has a unique appeal in the market. Obviously Penny (from Rewe) is also here, but we can’t compare with Aldi. So, slowly, Lidl evolved from hard discounter to soft discounter. Higher margin, extended assortment, branded articles even in aggressive price promotions. And, surprise, the model is working. Like-for-like sales are growing. It seems for me other retailers are not paying attention to this...

Sophisticated traditional retailers will always tend to criticise the limitations of discounting. However, the world changed in 2008, and some would say it changed permanently. Successful discounting represents a new model that proves that traditional supermarkets are now out of step with latest market needs, and some companies cannot accept this degree of change, to their cost.

In practice, the evolution of discounters will eventually reach a point where ‘normal’ inefficiencies will kick in, and the discounter will need to raise prices to restore profitability.

 

What about “discounter prices”. It’s used in Romania, by Kaufland (same group with Lidl) even if they are a hypermarket.

The key issue is the consumer-shopper’s attitude to what a product is worth. They then would in the past factor in the shopping experience i.e. ambience, theatre,  ease-of shopping, and range of sizes and types available when they were willing to pay a little more for products in a supermarket and/or hypermarket. Austerity means that the shopper is now less willing to pay a premium for these ‘extras’. Therefore the price gap between the same product in different channels or retail formats will almost disappear. Given that these market conditions – i.e. flat-line demand will probably continue for a further five years, retailers with larger outlets will either have to find ways of reducing prices via internal efficiencies, or lose share to smaller outlets.

 

You’ve been in Romania 10 years ago. How does the Romanian market appear to you now?

The market has evolved as expected over the years, drawing upon development in global retail, especially where some retailers have entered the market. Like most markets, the global financial crisis has obviously impacted the consumer in Romania, leading to the emergence of the savvy consumer, determined to make their own buying decisions, and retailers and suppliers would be unwise to ignore this trend.

 

Officially, PL’s market share is in Romania between 12-13% of the market. In my opinion the share is already higher, perhaps over 17%.  Do you believe there is still room to grow compare with UK’s PL market share? 

I believe that there is a “dynamic equilibrium” in brand/PL share of 50/50 in most categories that will optimise differentiation and profit margin. Anything less in terms of PL means missed profit opportunities, anything more means possible confusion for the consumer. PL success depends on being able to use a brand as a reference point in order to point out the advantages over the brand. Not having enough brands means the consumer cannot appreciate the equivalent private label.

 

There are rumours about a non-aggression pact between Tesco and Carrefour, on some European markets. There is the Hungarian example, with a very powerful Tesco and the Romanian one, with Carrefour and no Tesco. Can Romania be an interesting market for Tesco?

First of all, the UK Serious Fraud investigation of Tesco, coupled with the appointment of our GSCOP Adjudicator (Grocery Trade Code Of Practice), are symptoms of a growing worldwide trend towards government monitoring of grocery retailers’ relationships with suppliers, because of the possible impact on prices charged to the consumer, and possible limitations of choice. For this reason any ‘pacts’ between retailers would represent high risk for the parties involved. However, because of the speed of retail market reaction, it can be possible for competing retailers to closely monitor each other’s shelf prices, and by making minimal adjustments to their own prices, gradually build some price equilibrium in the market, and thus minimise the potential damage of all-out price wars.

In terms of Tesco in Romania, it has to be said that this crisis has caused Tesco to move into survival mode, reviewing all activities, UK and global. I believe that this means they will re-prioritise their global ambitions in terms of sell-off of parts of the business in order to focus on investing in large emerging markets as a priority.

This means that smaller markets have moved down the radar for Tesco, meaning that it is likely that Romania faces at least a five year delay in any Tesco activity, in my opinion. In the short term they may however increase the use of their private label via third party retailers to safely develop a local presence and brand franchise in preparation for any upturn in the market.

 

Finally, is this the beginning of the end for Tesco?

Frankly, although Tesco is on the ropes, it is not on the canvas.

It is still a major global player, with a good market share in many countries, a new, highly focused management team, with the potential support of suppliers in all categories, who want Tesco to succeed. Hopefully, most of its issues are now exposed, and will be dealt with.

In other words, Tesco is now poised to continue its global growth with the benefit of having seen the downside, and survived.

In fact, rather than this being the beginning of the end, I would instead describe it as the end of the beginning for Tesco… 

ec. Florin Frasineanu

 

 

For Brian Moore full biography (here).

 

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