Monday 27 April 2015

Is Back to Front the Only Way Forward?

Given that Tesco plans to reduce the negotiating elements of Back Margin from 24 to just three by 2017, namely volume, prominent positioning, and compensation payments in the event of product recalls, it may be useful for NAMs to work this through in terms of the financial impact on their Tesco relationship, especially given the latest £6.4bn loss….

Essentially, it is probable that the total Tesco take from your brand will remain the same i.e. they are unlikely to surrender any income currently coming from Back Margin; a proportion of this will simply move into Front Margin.

In other words, say the current 20% of trade price represented by trade investment will translate into 15% of ex VAT shelf price, assuming a 25% retail margin.

The issues for suppliers include: 
  • What will happen to shelf prices if Tesco want to drive sales really hard via an extra 15% price cut, using the ‘excess’ back margin?
  • Will the resulting scale economies be sufficient to satisfy Tesco (i.e. their January price-cut test appeared to be profit-neutral, according to a Dave Lewis interview in The Grocer)?  
In practice, given Tesco’s need for cash, it is probable that they will simply absorb the ‘freed-up’ back margin within the business, and finance price-cuts via current front margins. One of the remaining Back margin elements - Volume Rebates - will hopefully be sufficient to help make the price-cuts profit neutral…

On balance, Tesco’s move from Back to Front Margin represents a quantum leap for suppliers in that their front margin income will be a direct result of sales made and all back margin will be sales-based and paid in arrears.

This is a major breakthrough in UK supplier-retailer relationships and should not be underestimated.

However, we are now at a point where suppliers could lose control of some historical back margin monies, unless they are prepared and able to negotiate alternative, Tesco-specific uses of the investments.

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