Although retail giant Tesco still controls the market, the company should look at how it does its business and how it can entice customers.
Dave Lewis, the CEO of Tesco, couldn’t have been clearer in saying that sales won’t become the god of Tesco’s business. Last January, during a conference call with analysts, he kept repeating that sales growth depends on improving customer offer and service, and boosting the commitment of his colleagues.
However, Lewis has inherited a company with lacklustre sales, high operating costs and a hefty debt. To succeed he has to tackle these challenges and face a market that has been marked by the rapid growth of discounters and the rise in online shopping.
“You have to sell a story if you are doing a presentation to the City,” says Daniel Lucht, Global Research Director at consultancy firm ResearchFarm, talking about Dave Lewis’ strategy. “The issue Tesco has now is getting people back into the stores,” he adds.
Although still in decline, Tesco’s sales in the UK have gradually improved since Dave Lewis took the helm of the company in 2014.
Christmas sales have beaten analysts expectations, growing 1.3 per cent compared to last year. John Ibbotson, Managing Director at consultancy firm Retail Vision, argues that a series of factors have contributed to the result, among them lower prices and large holiday shopping.
In the past eight years the biggest retailers in the UK – Tesco, Asda, Sainsbury’s, and Morrisons – have experienced a change in shopping habits. Fraser McKevitt, Head of Retail and Consumer Insight at research group Kantar Worldpanel, says: “Shoppers are leaving larger stores at the moment, and are taking the shopping trip in two directions: towards online and towards discount retailers, Aldi and Lidl.”
According to the Institute of Grocery Distribution, online sales account for 5 per cent of the grocery market. David McCarthy, Head of Consumer Retail for Europe at HSBC, considers this market segment not profitable and loss making.
“The only reason it’s 5 per cent is because retailers do not charge the right economic fee to shoppers who go online. If they did, the online market would be a lot less,” he says.
John Ibbotson adds that it costs Tesco £20 to make a delivery, but it can only charge customers £5. He believes that the recent deal struck by Amazon to offer fresh products from retailer Morrisons will keep online shopping a loss making operation because Amazon isn’t interested in making a profit, but aims at winning customers.
According to David McCarthy of HSBC the real challenge for Tesco comes from discounters: “you have got one market, that is online, that has grown 5 per cent in 20 years, and another competitor, that is Aldi, that has grown 5 per cent in 4 years. You would be better dealing with the discounters than worrying about online.”
After the 2008 financial crisis, discounters such as Aldi and Lidl, have successfully leveraged their ability to offer fresh products at a lower price and attract customers.
“There is a big move towards all the fresh categories: this is what shoppers are looking for now,” says Daniel Lucht of Research Farm, adding that, “if you are strong in these categories, you have to make sure people come back into your store.”
David McCarthy thinks that Tesco can still grow, but if it wants to get margin recovery and deal with the competition, it has to continue lowering prices. According to the analyst, 90 per cent of the discount shoppers also go to Tesco or Sainsbury’s.
“If you are giving them low prices, then they don’t need to go back to the discounters,” he says.
McCarthy, moreover, believes discounters aren’t an unbeatable horde, and remembers how Tesco had to face similar struggles in the past.
“They have had few good years because Tesco has gone wrong in its strategy, but whether they’ll have a good year in the future remains to be seen. It’s not an absolute given,” he adds.
Nonetheless, John Ibbotson expects Tesco to return to growth, although lower than in the past.
“They cannot make 6 per cent net margin anymore. They would have to go down to 2 per cent,” he says.
According to David McCarthy, the way Tesco is controlling costs is another important factor to measure the company’s ability to grow again.
As part of the cost review, Tesco closed 53 unprofitable stores between January and October 2015, has reduced prices on various product ranges, and has regained sole ownership of 21 superstores in order to reduce the costs associated with their lease. The company has also decided to not open new stores and to review their relations with suppliers.
Fraser McKevitt of Kantar Worldpanel explains that these actions have been justified by the necessity to make Tesco’s business cheaper and more efficient to run.
The company has also had to deal with a large debt. As of February 2015, the company owes £21.880bn in total debt. Tesco has agreed to sell its Korean retailer, Homeplus, thus cutting £4.2bn of debt, but has failed to sell Dunnhumby, it market research harm.
While John Ibbotson believes that Tesco will have to sell more foreign businesses to consolidate its debt, Daniel Lucht of ResearchFarm believes that this could be an option only if Tesco’s debt were deemed unsustainable by the City.
Eventually, David McCarthy thinks that sales and costs control are the most important elements to look for in the results for the 2015 fiscal year, that Tesco will publish in April.
McCarthy is convinced that Tesco has to prove it is reconnecting with consumers. “It’s about the overall brand, the overall offer, making the Tesco brand where it was in the eyes of consumers, as the consumer champion,” he concludes.