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The Tesco problem

One of the key tenets of management consultancy is to understand exactly what business a company is in.

Take Tesco, for instance.

It’s a food retailer, no?

No. The debacle in the last week over Tesco’s accounts reveals that  actually, the bulk of its profits come from the commercial deals it does with suppliers – the payments it receives for stocking or promoting certain products.  To quote the Guardian ” It is standard practice for suppliers to pay supermarkets for product placement, sales targets and promotions.”

Think about that for a moment. If you make the bulk of your profits from a few suppliers who pay you to stock and promote their products, why do you bother selling the rest? It’s an apposite question in grocery retailing, bearing in mind that Aldi and Lidl are growing, as businesses, by stocking only 2500 product lines per shop as opposed to 40,000 product lines per shop in the big Tesco’s and Asdas.

The answer of course is that Tesco only got to its position of making more money through promotion and advertising of key company’s products than it does through retail margins  by driving other people off the High Street, by making itself the go to shop for the bulk of the population – claiming at one stage almost a third of all grocery spend in England. All those accusations of predatory pricing, of deliberate attempts to drive other smaller competitors out of business make sense if the name of the game isn’t making profits on the bulk of your stocklines, but merely breaking even so that you can present yourself to the  suppliers who pay your ‘commercial income’ as being the biggest beast in the retail jungle.

What wrong-footed Tesco was the growth of an alternative business model; the discounter model of eschewing the big, expensive first division sites beloved of Tesco and Asda in favour of the retail park and industrial estate locations where you find Aldi and Lidl. Along the way the German discounters have become new anchor tenants for marginal retail locations that would otherwise be hard to let. They’ve also chipped away at Tesco’s market share, growing organically and building on their unusual business model. You can’t understand the success of Aldi without noticing that mad centre aisle of discounted goods, cycling gear this week, power tools next week, drawing in punters with cash to spend who’ll gradually get into the Aldi habit.

There’s a lesson here too, about fads and fashions in financial markets. Tesco’s huge market share was lauded by financial markets who valued the business on that factor, not on the profitability of the business. Market share was built not by the uniqueness of the Tesco proposition, but by its ruthlessness and its willingness to make no profits on many sales provided it could grow its market share and generate ‘commercial income’ on the lines where suppliers were willing to pay for the pleasure of being stocked by Tesco.

If you’re not in the business of selling food at a profit, you might end up forgetting how to make profits by selling food. The investigation into what went wrong at Tesco is ongoing. My guess, for what it’s worth, is that the income from commercial deals has been booked at the time they were signed, but the costs punted into the next financial year when they’re incurred. Like paying the rent with a post-dated cheque, that’s a game that can only end in tears unless you have a plan for how you catch up. In this case, I suspect that suppliers have squeezed Tesco, because of its declining market share.

I could go into a long rant about tax, value and marxist accountancy, but not in this blog -that pleasure is to come….

 

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This entry was posted on September 30, 2014 by in Uncategorized.

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