October 8, 2014 / 2:03 PM / in 3 years

Price cuts no quick cure for Tesco's ills

LONDON (Reuters) - Cheaper meat and vegetables should draw shoppers back into Tesco (TSCO.L) stores but it will take time for the new boss of Britain’s biggest grocer to win back market share.

File photographs shows shopping trolleys lined up at a Tesco supermarket in London April 15, 2014. REUTERS/Luke MacGregor/Files

Customers seeking to save money in a sluggish economy have turned away from the market leader to discounters such as Aldi [ALDIEI.UL] and Lidl [LIDUK.UL], igniting a price war in British grocery shopping and contributing to a series of Tesco profit warnings.

Tesco still wants to be a mid-range retailer and not a discounter but former Tesco directors, retail experts and analysts say Dave Lewis must urgently put lower and simplified prices for staples at the center of a new trading strategy.

He has over 1 billion pounds ($1.6 billion) to further cut the cost of goods such as milk, bread and carrots in the hope that shoppers will fill their baskets with more profitable products but international experience shows it takes time to impact sales.

“He can make a difference pretty quickly. Will it show up in the numbers straight away? Probably not,” said a former director of the British business, which makes up two-thirds of group profit.

Tesco declined to comment for this story.

Having grown rapidly through the 1990s and 2000s by offering low prices, a range of high quality food and innovative marketing, Tesco responded to falling sales in the economic downturn by hiking prices. A second former Tesco director said that prices are now as much as 10 percent above Aldi and Lidl.

Tesco is now reeling from an accounting scandal and a downturn in trading that has knocked 4 billion pounds off its market value in a matter of weeks. Fears are also growing the scandal could impact Tesco’s sales in the crucial Christmas period.

To make matters worse, Britain’s grocery market is growing at its slowest pace in over 20 years due to falling food prices, consumers shopping around and restaurants luring diners out.

Tesco’s “big four” rivals - Wal-Mart’s (WMT.N) Asda, Sainsbury’s (SBRY.L) and Morrisons (MRW.L) - have all cut prices and with the latter also taking Aldi and Lidl head on with a price matching scheme and loyalty card, there is an urgent need for a strategy re-think.

“Tesco has to address the fundamentals of its economic model and become more competitive,” said a third former Tesco director, who asked not to be named.

Under Lewis’ predecessor Phil Clarke the higher prices failed to make up for the lower sales. It issued three profit warnings in two and a half years as it lost market share to the discounters as well as upmarket players Waitrose [JLP.UL] and Marks & Spencer (MKS.L).

Industry data published last month from Kantar Worldpanel showed Tesco’s share continuing to slide at an alarming rate, down to 28.8 percent from 30.2 percent in September 2013.

A year-on-year total sales fall of 4.5 percent implied a fall of 6-7 percent at stores open over a year, said analysts, making Tesco by far the worst performer of the big four.

ENTRY TICKET

According to the second former Tesco director, price cuts are the “entry ticket” to a fight back for a group that has most recently confused shoppers with a range of different promotions.

“Moving from where Tesco are now to get back to being where they were, which was competitive with Aldi and Lidl just a few years ago, you are going to have to (either) take a huge hit (to profit) or start now and take five or six years to get there,” he said, on the condition of anonymity.

Tesco’s Aug. 29 profit warning has given Lewis some initial firepower to further cut prices and improve customer service, store standards and product availability. It slashed its half-year dividend by 75 percent, saving 900 million pounds assuming a similar cut to the final dividend, and reduced planned capital expenditure by 400 million pounds.

In the longer term additions to the war chest could come from other cost savings, such as trimming Tesco’s UK head office staff, the disposal of peripheral UK businesses and of struggling overseas operations, such as Turkey and central Europe, or from a separate flotation of its Asian businesses. A rights issue is also possible.

Clarke always maintained that Tesco could not beat the discounters on price alone, hence his focus on improving stores.

However, in February he launched 200 million pounds of price cuts on basic products and invested a similar amount on a fuel savings’ scheme for holders of Tesco’s Clubcard loyalty card. More rounds of price cuts, involving unquantified investment, followed and he had pledged more before he was fired.

Last year Clarke also launched Tesco’s “Price Promise” price-matching scheme, which gives customers coupons if their basket of shopping proves to be cheaper at big four rivals but not the discounters.

However, some analysts think the scheme merely serves to remind customers how much more expensive Tesco is and could be scrapped by Lewis if he opts for a simpler pricing proposition.

With genuinely lower prices Tesco could highlight the elements discounters don’t have, like wide ranges of branded goods and general merchandise, and retail services like online shopping and banking.

YEARS NOT MONTHS

Lewis’ problem is that dramatically reducing prices does not result in an instant sales increase as they reduce actual cash sales going through the tills before volumes, or basket sizes, improve.

The experience from all the other major grocers that have undertaken significant price repositionings and had some success, such as Delhaize in Belgium, Carrefour (CARR.PA) in France, Ahold AHLN.AS in the Netherlands and Kroger (KR.N) in the U.S. is it takes years rather than months to make an impact.

“You have to wean customers off the high low promotions and educate them to the benefits of everyday low prices,” said Bryan Roberts, Kantar Retail’s director of research.

“You need to re-capture the lapsed shoppers and you need to communicate to potential new shoppers what you are doing and the benefits of it.”

In March Morrisons, Britain’s No. 4 grocer, set out a plan to restore its low-price image and boost sales volumes by spending 1 billion pounds cutting prices over the next three years. CEO Dalton Philips says he does not expect the plan to start to benefit its sales performance until next year.

Asda moved from being a promotional grocer to an everyday low prices stance in 2013 and reckons that this year it has stemmed the loss of customers to discounters and attracted some from its three big rivals.

Any move by Tesco will hit its UK trading margin, which fell 18 basis points to 5.03 percent in its 2013-14 year and is expected by analysts to fall to about 2.5 percent in 2014-15. Industry operating margins have come down to an average of about 1.6 percent in the last twelve months from 4.1 percent in the previous five years, according to Reuters data.

And others even argue that the traditional relationship between price and volume has changed, making price wars futile.

“The problem the market has got is that volumes are not increasing as prices have come down. That old putting price down, volume goes up adage has not worked because the market’s saturated,” Steve Rowe, head of Marks & Spencer’s (MKS.L) food business told Reuters.

Additional reporting by Kate Holton; editing by Anna Willard

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