Tesco's 3-in-1 Opportunity for Suppliers

A brief examination of Tesco’s latest results, the 52 weeks ended 28th Feb. 2015, show interesting differences in their trading margins for the UK, EU, and Asian businesses.

Whilst the Tesco overall trading margin is 2.2% - itself too low for a City that would prefer at least 4% - it can be seen that the results are significantly different for the three geographies. This would suggest that global suppliers will need three different strategies to optimise the profitability of their overall Tesco relationship.

In other words, Tesco’s three retail businesses have to be viewed and managed as separate SBUs to optimise the overall global potential for your brand.

In practice, with trading margins in the UK at 1.1%, the EU at 1.9%, and Asia at 5.7%, Tesco clearly have a need for three different but complementary strategies:

UK: With Tesco’s ex VAT sales of £43.5bn, coupled with Sainsbury’s and Morrisons expected falls in profits this week, maintaining market share at the expense of competitors via deep price-cutting, has to be a priority for the major multiples.

Given these margin pressures, the temptation for Tesco to transfer ‘excess’ back margin to front margin, may be difficult to resist. In addition, suppliers' willingness to invest in the trading partnership via lower trade prices in exchange for long term commitment to Tesco’s customer-centric policy, may become a negotiating point.

Obviously, 100%, zero-defect service levels and availability have to be a given, from now on…

On balance, suppliers need to come to terms with structural – i.e. ‘permanent’ – changes in the market, and make fundamental decisions re the relative importance of the mults vs. discounters, and Tesco in particular, to their UK business. Having made these decisions, calculating and demonstrating the impact of your trade investment and retail margin on Tesco's trading profits has to be a must…

EU: With ex VAT sales of £8.5bn, Tesco needs to both increase its EU geographical footprint, and grow share in key countries.

Essential for suppliers to ensure that EU colleagues conduct harmonised dealings with Tesco in order to avoid compromising trading relationships in either territory. It is also important that prices and terms are defensible vs. other retailers, in the event that Tesco decides to sell off low margin local business.

In addition, given the move from individual teams for Czech Republic, Hungary, Poland and Slovakia to one regional team focused on buying and operational synergies, there will be more emphasis on investing in the customer offer. Suppliers will need to match this CEE re-structuring, if only to ensure their fair-share levels of investment in Tesco’s customer offer….

Asia: With ex VAT sales of £9.9bn, and a trading margin of 5.7%, it is obvious that Tesco will resist selling off their Asian interests to help re-build their global balance sheet. Instead, it is possible that they will try to increase their regional foot-print, possibly at the expense of some trading margin in the medium term.

Given the potential scale advantages of 24/7 retailing, South Korean restrictions on opening hours means suppliers need to focus on increasing store productivity during permitted times. Restricted demand due to economic conditions in Malaysia and Thailand means that a focus on availability, service and targeted price reductions is essential in order to optimise the productivity of available traffic, without compromising the bottom line.

On balance, it is time for Tesco suppliers to step up and be counted, time to decide if your biggest customer is going to make it via their 3-for-1 global policy.

Signs are that despite these unprecedented times, they will lead a comeback in retail, meaning this is a real opportunity for innovative suppliers to think long-term and join Tesco for the return journey…

Aldi's version of gift-with-purchase?

Over €15m worth of cocaine - the biggest haul ever in Berlin - has turned up in boxes of bananas delivered to Aldi supermarkets in and around the capital, according to police.

This apparent foray upmarket by the discounter was an obvious mistake in a shipment from Colombia to Hamburg, and was in no way intended to stimulate repeat purchase and encourage customer loyalty…

Tesco's latest trading profit: What your trade investment is now worth to Tesco UK

Given all the recent big numbers coming from the UK’s No.1 retailer, your £10k trade investment may seem paltry….

If, however, it is being treated like a pittance, it might be worth pointing out that, based on its latest UK trading margin* of 1.1%, £10k is equivalent to ex VAT sales of £909k…

A point to ponder over the long weekend?

*...52 weeks ended 28th Feb. 2015 - UK Sales ex VAT = £43,573m, Trading profit = £467m.
£10k = 1.1% of equivalent sales i.e. £10k/1.1 x 100

Making Tesco's £6.4bn loss a winner for you

According to The Motley Fool, some City analysts now believe that Tesco’s accountants inflated the company’s loss, to get as much bad news as possible out of the way now, and flatter figures going forward.

In practice, their £2.3bn write-down of the value of currently trading UK stores means that Tesco is now very focused on ways of driving sales and profits per store. As you know, they determine the value of a store by calculating its future cashflows, so if you can demonstrate that your brand-footprint's sales are significantly greater than £1,000/sq ft/annum, this has to be a plus.

However, Tesco's real gain has to be the additional net margin represented by your brand.

Typically, say Tesco have an average 25% gross margin that nets to 3% in a reasonable year. With store running costs of about 15% including say 2% shrink, this leaves 10% to cover central costs and profit. This means that your brand's 30% gross margin, with average handling costs and shrink, could reach the bottom line as a conservative net 5%...

Day to day, your brand's 'surplus' profit intensity will help Tesco off-set some of the long-tail products' short-falls and also finance some of the 20+% space redundancy in large outlets.

But the real leverage has to come from demonstrating that you are a net contributor to Tesco's inevitable turnaround..

Incidentally, given that a further £2.4bn was written off stores trading outside the UK, it might be worth extending your insight to overseas colleagues..

Meanwhile, why not feed your actual Tesco Gross Margins into the above calculation and really open up that buyer-seller discussion?

NAM Deadline-app......?

Taking Back Some Back Margin from Tesco, by re-negotiating its usage...

Given that supplier investment in back margin was originally intended to stimulate sustainable sales of the brand and should always have been conditional, many suppliers will be reluctant to simply surrender the allocation and use of trade investment monies – other than the three permitted buckets – to a retail partner working to a different set of priorities.

Moreover, as the surrender of any influence over the use of trade investment by the supplier could result in elimination of any discussion re KPIs and compliance conditions in monitoring retailer performance, even the effectiveness of the three permitted buckets could be compromised.

This could possibly result in either additional transfers to front margin, or even de-listing in extreme cases of poor performance.

It is therefore imperative that suppliers and Tesco find ways of jointly optimising the discretionary use of trade investment budgets by the two partners.

In other words, assuming that the three permitted back margin buckets account for half of a supplier’s 20% trade investment in Tesco, this leaves the ownership/control of the remaining 10% subject to further negotiation… 

In order to convince Tesco of the bona fides of such trade investment ‘retention’, a supplier has to be able to guarantee that the monies are fully allocated to the development of their business with Tesco.

The funds will need to be invested in initiatives that drive traffic to the retailer’s stores, where incremental sales of the supplier’s brands will reward Tesco via a combination of front margin and volume rebates.

It is unlikely that a retailer in Tesco’s current condition would agree to anything less…

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.

When we say fastest...

                                                                                                        Pic: Wim Schipper via Brilliant ads

(For added ooompf, why not slope the logo backwards?)

In a game where all eyes are on the profit ball, can Tesco afford to forget Net Margin?

Given that share price is driven by ROCE, in turn a result of  Net Margin times Capital Rotation, no one, especially share-incentivised senior management, will allow Tesco to long ignore the bottom line…

Tesco now has other priorities in terms of offer simplification, rebuilding of consumer and supplier trust, but ensuring adequate - at least 15% ROCE - rewards for risk will always be close to the surface.

The issue for cull-survival suppliers has to be not only contributing to Tesco Top Agenda items, but also finding ways of translating this support into bottom line impact.

Essentially, in terms of faster capital rotation, by simplifying their offer and cutting out over-lap and wastage, Tesco will be able to focus on optimising stockturn. This means that suppliers that can deliver more often in smaller quantities will be seen to benefit the company in terms of speed and availability.

By reducing the number of unprofitable (large) stores, and franchising off redundant space in remaining stores, Tesco will make their fixed assets more productive. In the short term, suppliers that can make the space work harder via in-store theatre will help….

This leaves Net Margin, with transfers from Back to Front margin an obvious option, unless Tesco can be persuaded to embrace supplier-driven alternatives…

Deep down the City does not care about Net Profit in itself, they know that a business can either be small margin, fast rotation, or big margin slow rotation. All they want is an acceptable overall result - ROCE - to justify risk and exposure, and invest in the share price.

Retailers and their suppliers will be left to deliver the rest… See how here

Don't forget the money – but now it's all about consumer trust...

To us optimists, yesterday’s 5% fall in Tesco’s share price was hopefully the result of some profit-taking, with plenty of slow upside as the market absorbs the significance of the change in Tesco’s relationship with suppliers and shoppers…

No-one will ever be allowed to forget the money again, but the emphasis in now on rebuilding trust at both ends of the Tesco candle, and no taking of supplier-prisoners…. i.e. any tin-content issues will be ‘cullable’ offences

A reminder of the basics…
According to changingminds, trust is about:

1. Predictability
Trust means being able to predict what other people will do and what situations will occur i.e. less time spent second-guessing and checking compliance

2. Value exchange
Trust means making an exchange with someone when you do not have full knowledge about them, their intent and the things they are offering to you i.e. a simple buffer-free offer from both sides, with minimal just-in-case complexity

3. Delayed reciprocity
Trust means giving something now with an expectation that it will be repaid later i.e. no need to open the tin in the store

4. Exposed vulnerabilities
Trust means enabling other people to take advantage of your vulnerabilities - but expecting that they will not do so

How consumers manage trust
- Get it right, and they may tell a friend
- Get it wrong and they will certainly tell ten…

BTW, in case of any delay in achieving 100% trust-distribution, best to keep in mind that under the skin we are all third parties, however close the relationships…

Another UK record for Tesco - How a £6.4bn loss will impact suppliers

By posting the biggest ever loss in UK business history, Tesco is hopefully making a final test of shareholders’ confidence in their turnaround.

Dave Lewis will have to provide more detail, but essentially he has three priorities:
- Regaining competitiveness
- Protecting & Strengthening the Balance Sheet
- Rebuilding trust and transparency in the business and the Tesco brand

Regaining competitiveness:
- Price-cuts in anybody’s language (Same offer, reduced SKUs, 100% on-shelf availability, and prices low enough to make a difference, possibly via the moves from Back to Front margin…?)

Protecting & Strengthening the Balance Sheet:
- Improve Current Ratio (i.e. Current Assets/Current Liabilities) i.e. reduce Stocks via smaller, more frequent deliveries, and increase cash.  An obvious move would be to increase trade creditors, but this would damage Tesco credibility in the current climate, and would be a breach with recent promises to pay smaller suppliers in 14 days.

- Improve Cash-to-debt ratio (i.e. combination of cash and short-term investments, divided by combination of short & long term debt) Tesco will attempt to generate cash surpluses in the business, and pay down debt, possibly via pressure on cost prices, cost-cutting, back-to-front margin moves, and stripping out anything that does not contribute to availability and customer service.

- Improve Debt-to-equity ratio (i.e. long-term debt divided by shareholder equity) Shareholder equity is a combination of share capital and retained earnings i.e. net operating profit after dividend. This is why Tesco is not paying a dividend at this point, in order to reinvest as much as possible of their £1.4bn operating profit into the business. In practice this route will prove too slow in significantly improving their debt-to-equity ratio, so expect more emphasis on driving down debt..i.e. asset sell-offs.

Rebuilding trust and transparency in the business and the Tesco brand
- Whatever the cost, everything left on Tesco’s post-cull shelves will deliver what it says on the tin, or more, or else...
- Tesco will anticipate the potential flak arising from the Which? super-complaint re in-store offer ‘confusion’ by going for transparency and genuine, sustainable competitiveness.
- It hopefully goes without saying that brand contents-reductions to disguise retail price increases are now off limits, as Tesco changes its corporate colours from blue & red to whiter-than-white. They have nothing more to lose…

In other words, hold on to your hat, its not over yet…

Tesco property write-down - ‘official’ acknowledgement of the structural changes in UK retail

We all await - with bated breath - the extent of Tesco’s property write-down at Dave Lewis presentation of the annual results tomorrow. This will be the first official acknowledgement of the structural changes that have taken place in UK retailing, and at City estimates of £3bn+ the impact on Tesco’s Balance Sheet and the market will be fundamental.

...with other mults needing increasingly persuasive arguments for not following suit…

In round numbers, think 20% reduction in large space retail

Why the write-down?
As you know, large space UK retail works on the premise that sales per sq ft of £1,000 per annum are sustainable

Undershooting presents three alternatives:

• Sell ‘em, Close ‘em or Convert ‘em…
• Selling = ‘sell-off’ in an over-spaced market, Closing = write-off dilution of the bottom line, leaving fundamental Conversion as the only option…
• Action: Amazon permitting, the way forward for the mults has to be via conversion of large outlets to collaborative ‘shopping centres’ based on partnerships with specialist retailers in non-food categories, leaving grocers to sell groceries…

In practice, this will mean retail partnerships based on a rental – % of sales combination, with  both measures focused on space productivity

What can suppliers do about it?

• Short-term: Scope for any instore theatre at big venues, and best bit-parts locally
• Medium-term: Scope for demonstrably productive instore theatre, all venues, based on a sales/sq. ft. KPI
• Long-term: Think 1:1 consumer entertainment…

And by the way, back to the NAM-salesforce drawing board…

Scope for one more?

                                                                                                    Guillaume Quilliot via Silvana Ciraolo

Free Aldi bus for students' weekly shop

                                                                                                           pic: An Focal

Given the discounter’s primary audience-mix of students and senior citizens, and the likelihood that carefully managed long term loyalty will eventually bridge the generation-gap, this new initiative indicates the degree of Aldi’s determination to optimise its market share long term…

Currently operating at UCD, Trinity, Limerick, DCU, and Dundalk Institute of Technology, Aldi plans to serve all third level campuses by the end of 2015.

“The bus service is completely free, anyone can hop on, you don’t have to live on campus at all, you just need to email the UL Aldi Bus Rep, book your spot and even if you don’t you can show up and if there are spaces available you can get on.  They have allocated stops for the bus so it’s safe, the students will be signed on by reps and they will make sure everyone is on again after they are finished their shopping.”

Aldi’s “University” page on its website features weekly promotions of healthy recipes and cooking guides, along with the cost of purchasing each meal, in a weekly shop of €34.

Not bad for the ‘foreign, downmarket, cut-price retailer’ that had the cheek to enter the state-of-art, up-market, big-space UK retail scene 25 years ago…

With an 8.1% share of the Irish market, Aldi have no plans for extending its bus-service to the UK, yet…

New Walgreens Boots growth strategy - back-to-basics+ via Boots

Building on improved sourcing - scale economies - across the group, the Boots influence on Walgreens is being demonstrated via convenience, pharmacy modernisation and customer care. In the US, this merely represents the harvesting of low hanging fruit…

However, a key contribution will be Boots global vision applied to wholesale consolidation, with M&A a vital route to WBA global purchasing power. In the process, it is unlikely that the group will pass up many opportunities to expand its retail footprint via acquisition.

In other words, we are beginning to see the emergence of a fully global group aimed at selling any H&B goods and services that can be legally sold to consumers and retailers, with buying muscle to match…

It is vital that suppliers gear up to this new global reality, in terms of time, money and people.

When it comes to globalisation, McKesson-Celesio has the potential to go global, but is way behind Boots WBA vision.

The major grocery multiples are currently focused on protecting their national/UK interests, and are no longer acting globally.

This leaves WBA as the only global player in H&B. 

The group is being driven by the Boots culture in retailing, and Alliance Boots in wholesaling, implementing a global vision that has not missed a beat so far…

A diminishing window to get things right?
Suppliers need to prepare for the inevitability of full global coverage, and ensure that their prices and terms are fully synchronised, before WBA gets really serious about scale economising…