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?)