Tesco Trade investment: How to demonstrate your value to the buyer

Buyer: "Surely Tesco are worth more than a £10k investment, especially for a company your size?"

NAM: "Given your business model and latest net margin (2019 Tesco Annual Report) of 2.7%, our ‘mere’ £10k is equivalent to incremental sales of £370k for Tesco…."

As you know, apart from cutting costs, the only way a retailer can generate net profit is via incremental sales.

In practice, for a retail business on a net margin of 2.7% before tax, a net margin of £10k = 2.7% of sales.

So, £10k/2.7 x 100 = £370k, the incremental sales required to generate net profits of £10k.

Now, which would you prefer, my little £10k trade investment or having to generate extra sales of £370k in your category….?”

[Note for NAMs: If your company generates net profits of say 4.5%, the £10k trade investment in Tesco is equivalent to incremental sales of £222k. In other words, you need potential incremental sales of £222k to even begin the conversation…]

Source: NamCalc, a 34 calculation financial tool-kit for NAMs

SFO Tesco investigation set to conclude this week

According to CityAM, quoting Cantor Fitzgerald’s Mike Dennis, the investigation could be wrapped up this week. Any fine/redress will obviously impact Tesco’s cash position in terms of repayment and re-financing bonds, adding to pressures on the company.

Longer term we believe that the government will legislate re the accounting for trade investment, and probably move to retro-payment based on auditable results. 

This means a move for suppliers to building in KPIs and compliance for every trade initiative, an inevitable and long overdue progression to fair-share dealing....

This development coupled with Tesco’s loss of market share, and unlikelihood of a return to old market dominance, means that suppliers are in a stronger position re negotiation of compliance.

A once-only opportunity for NAMs that are prepared to go all the way…

Trade Investment Accountability and how Governments will legislate…

Following the Tesco Accounting scandal, a lack of consensus among the UK's major food retailers is detracting from efforts by the Financial Reporting Council (FRC) to improve the way that companies report complex supplier arrangements and will prolong the uneven disclosure of supplier income, according to a new report by Moody’s Investors Service - more here

NAM Implications:

• The combination of inconsistency and scale of payments involved means that governments will eventually legislate to optimise taxable income
• It is probable that such legislation will be conservative (small ‘c’), retrospective, i.e. paid after-the-event and based on measurable results,  the only certainty...
• In other words, all trade investment will specify KPIs, build in compliance, and payments will be withheld until auditable results are available

NAMs and their customers had best prepare for the inevitable…

Back Margin audits - Now it's your turn.

Accountancy watchdog to focus on suppliers after Tesco profits scandal.

According to The Guardian, the Financial Reporting Council (FRC) will make retailers’ relationships with their suppliers a priority due to ‘increasingly complex arrangements’ in their inspections in 2015/16. The FRC will “pay particular attention to the audit of revenue recognition and complex supplier arrangements” at food, drink and consumer goods manufacturers, as well as retailers. They plan to check a significant number of audits - of the 140 checks planned - in these sectors.

More details of scope and process are given in the FRC latest Annual Report published today, and for convenience we have highlighted key sections below, but best point your finance colleagues at the original document, here.

As indicated, this is about Back Margin definitions and how suppliers and retailers account for payments made to retailers. 

We believe that we are headed towards further clarity, meaning that payments to retailers will eventually be measured more accurately, paid retrospectively - in arrears - and based upon results achieved vs. agreed KPIs, in order to comply with strict auditing standards and process.

Action for suppliers:

• Identify and clarify all of the ways in which you remunerate the customer
• Reassess the 'buckets', clarify the definitions, measurement process and ensure the customer agrees...
• Focus on Tesco's three permitted buckets (scale discounts, rewards for display and payments re product re-calls) that will probably  become 'standards' eventually, as SFO, FRC and GCA investigations begin to report findings
• Think through internal processes re proposal, objectives, agreement (you and the customer), timing and payment (if in any doubt about the eventual accounting rigour involved, check with your production colleagues re their capital requisition process...)
• Whilst your company will hopefully escape an FRC inspection in 2015/16, auditors will obviously be increasingly conscious of the risks involved and will be more than likely operating to the above standards anyway...

The FRS Annual Report (extracts)
Section 2-4 Page 7 refers to
...Given the focus in recent months in respect of complex supplier arrangements, food, drink and consumer goods manufacturers and retailers have been designated as a priority sector for our 2015/16 inspections and a significant number of audits we plan to inspect will be from those business sectors. These inspections will pay particular attention to the extent to which the audit team has challenged and corroborated the appropriateness of how complex supplier arrangements are accounted for. Corporate Reporting Review (CRR) as part of their programme of reviews of financial statements will also be giving priority to the reporting of these arrangements. We also plan to inspect a number of first year audits to assess the extent to which changes in auditors have an impact on audit quality.

In early 2015 we engaged external consultants to undertake an extensive review of our inspection activities and how these can promote continuous improvements in audit quality. The outcome of this review will be incorporated in the FRC’s Strategy for 2016/19.

Analysis of inspection findings: Section 3-5, page 16 Future Inspections: Section 7-2, page 32: ... planning to inspect around 140 audits.... The priority sectors for 2015/16 are insurance; food, drink and consumer goods manufacturers and retailers... Our inspections will pay particular attention to the audit of revenue recognition and complex supplier arrangements.

Appendix A, page 36 Inspection Process
Our inspections comprise a review of the firms’ policies and procedures supporting audit quality and a review of the quality of selected audits of listed and other major public interest entities that fall within the scope of independent inspection, as determined each year. 

Scope in Appendix B

Abolishing Trade Investment by suppliers - the impact on brands

News that Tesco is allegedly planning to dismantle the system of using Commercial Income, or Trade Investment, as a source of cash from suppliers raises a number of issues for NAMs and competing retailers.

What does it mean financially?

Conclusions:

• Supplier cannot afford additional investment (in fact the calculation shows why so many suppliers are struggling profit-wise)
• Retailers are not going to surrender Trade Investment & Deductions as sources of income
• Retailers may try to negotiate Trade Investment into Margin, thus removing the issue of how it is booked in the business
• Trade Investment may be absorbed into retail running costs and price-cutting, with less available for in-store customer incentives
• Eventually, additionally funding may be requested in order to 'create a bit of excitement' in-store....

Still ok with your trade agreements for 2015?
(Why not substitute your brand's % in the above calculation and see what it is costing you to be onshelf...?)

UK accounting watchdog warns retailers after Tesco scandal

Britain's Financial Reporting Council (FRC), which polices accountants and is examining how Tesco's error came about, said on Monday that the boards of all retailers and suppliers should provide investors with sufficient information on their accounting policies, especially Commercial Income (i.e. Trade investment).

This is particularly important for NAMs as the watchdog said it would focus on this area when it comes to reviewing audits for 2014 that will be published in 2015.

The FRC said there was no single accounting standard for such disclosures and there is an "absence of well-known industry norms", meaning that auditors have to resort to judgement in most cases.

Given the 20+ ‘buckets’ that suppliers use for trade funding, it might be useful if NAMs simplified and segregated their funding.

‘Supply and Demand’ rewards could provide a useful basis for clarification.  In other words, classifying elements of commercial income as either facilitating supply economies, or optimising consumer demand, might help, but still leaves complexity....

Supply rewards could include:
- Central assortment & listing
- Timely and committed forecasts
- EDI
- Central credit, settlement terms, and payment
- Returns/write-offs
- Deductions

Demand rewards could include:
- Listings
- 'Appropriate' range/assortment
- Category compliance: shelf space & level, fair-share facings
- Promotional compliance, price support, POS compliance, additional placements/displays
- Minimalising post-audit recoveries
- Sales achievement

It is likely that the SFO-Tesco outcome will result in new auditing procedures aimed at transparency, defensibility and like-with-like 'comparability' in dealing with Commercial Income in retail accounts.

Meanwhile, suppliers can anticipate the changes and possibly avoid major retrospective overhauling of their trade funding process, by taking action to clarify their trade funding process now, while others await the inevitable…