Tesco: Aisles of plenty?
The major challenges facing Tesco’s new CEO, Dave Lewis.
Chris Middleton and Stuart Lauchlan present a strategic analysis of a declining force in UK retail: Tesco. Despite the gloom, the opportunities for mixing ‘bricks and clicks’ remain massive if Tesco can better differentiate itself in store. But the supermarket giant is in tough times, as its new CEO grapples with scandal and slashed profits.
UPDATED NOVEMBER 2014
While the knives may be out for Tesco as it experiences financial scandal and its worst performance in 20 years, a dose of realism is essential. With 1,346 stores in the UK and a European footprint of 1,507, Tesco remains a colossus of mass-market retail. Tesco is also the UK’s largest online merchant, with 1.6 million registered customers. The company generates sales of £2.5 billion annually from its online presence alone.
In recent years, Tesco has launched its smaller Metro and Express stores to keep pace with consumer demand for more flexible shopping in urban centres. But Tesco knows better than most that the UK high street is undergoing a more profound change than that, with increased competition from discount retailers and digital channels, leaving some middle-market brands struggling to differentiate themselves.
The days of being ‘all things to all people’ are over – and not just for Tesco.
As the Strategist explored in Neil Gibb’s Spring 2014 report, ’Subsitute!’, the poorly differentiated middle of the high street retail space is being pulled apart by polar forces.
At one pole are speed, convenience, low cost, and/or responsiveness to customer demands, as represented by Aldi, Lidl, Poundland, and, in a different sector, by ‘fast fashion’ stores such as Zara, Bershka, and Pull and Bear (all owned by Inditex). At the other pole are depth, exclusivity, refinement, focus, and ‘aficionado’ experiences, represented in the supermarket space by Waitrose and M&S food halls, for example.
The ‘collapse of the middle’ is one reason that Tesco has faced declining profits and market share in its bricks-and-mortar business. In August 2014, Tesco slashed its annual profit forecast by £400 million to £2.4 billion. This reflected a year of steady decline. It also announced that it expected trading profit for the six months to 23 August to be in the region of £1.1 billion.
However, on 22 September it revealed that this figure had been overstated by £250 million “principally due to the accelerated recognition of commercial income and delayed accrual of costs”. A source within the company is reported to have blown the whistle, and Tesco called in Deloitte to undertake a full investigation.
A number of executives were suspended, including UK MD Chris Bush and UK finance director Carl Rogberg, who were informed that data on their phones and computers would be examined. £2 billion was wiped off the company’s value within 24 hours, and Tesco was forced to fast-track the appointment of its new CFO, Alan Stewart, who joined on 23 September from M&S, two months earlier than planned.
What is certain is that Tesco’s grip on the UK supermarket sector fell to a 28.9 percent share in June 2014, from 30.7 percent in March 2011, when former CEO Philip Clarke joined. In the same timeframe, Aldi’s share grew to 4.7 percent from 2.1 percent and Lidl’s to 3.6 percent from 2.5 percent.
Since then, Aldi has gone from strength to strength: in September 2014, it announced a 65 per cent increase in UK profits to £5.3 billion, on a 36 per cent rise in sales. By the end of 2014 it will have opened 54 new UK stores, and plans to open 65 more in 2015.
However, Sainsbury’s and Asda’s UK market share has remained comparatively stable – suggesting that customers perceive Tesco as representing the poorly differentiated middle of the market, and Sainsbury’s and Asda as being more innovative or responsive. But that is not to say that their share is more profitable: in November 2014, Sainsbury’s announced pre-tax losses of £290 million, and pledged to take a price-cutting war to the discount retailers. Sainsbury’s, like Morrisons, believes it is in a race to the bottom and the discount sellers are dictating how the market behaves.
Tesco’s market share is still six times larger than Aldi’s, and so the opportunity for Tesco to reassert its dominance remains. Until then, it has everything to lose – and not just in the UK. In Ireland, Tesco’s market share is falling by about one-and-a-half per cent a year, according to September 2014 figures from Kantar Worldpanel, which also revealed that the supermarket is actually attracting more customers, but they are spending significantly less.
Embattled CEO Clarke was pushed onto his sword on 21 July – the day before he had planned to celebrate 40 years at the retailer, which he joined as a junior shelf-stacker. Former Unilever executive Dave Lewis took over on 1 September. Lewis is a turnaround specialist whose experience in a supplier to the retail sector gives him a poacher’s perspective in a gamekeeper’s market.
In a letter to staff, Lewis wrote: “You will know only too well that it has not been an easy time for our business. The retail market in all the countries where we operate has become extremely tough, and is changing faster than ever. ‘We are losing market share in our largest market and we need to address this with urgency.
“I know periods of change can be unsettling, but we have to take our destiny in our hands and be absolutely focused on delivering the best possible experience for our customers.”
Just three weeks later, Lewis was plunged into a full-blown crisis and was forced to make a further announcement in the wake of the accounting scandal: “The board, my colleagues, our customers and I expect Tesco to operate with integrity and transparency and we will take decisive action as the results of the investigation become clear.”
So how did the UK’s largest grocer get to this point?
In 2014 under Phillips, the supermarket giant had been cutting back on opening physical stores and focusing on expanding its multichannel capabilities, with the emphasis shifting towards what it calls the ‘nexus point’ between digital and offline (high street) experiences for customers.
By ‘multichannel’, Tesco means the ways in which traditional bricks-and-mortar retailing can be enhanced and complemented by digital services, including location-specific ones.
Retail is not about IT
But at its core, retail is not about technology. For customers, it’s simply about the right goods, the right price, and appropriate standards of service. So can Tesco move to the ‘second curve’ of growth – digital – without damaging all that it achieved on the first: building a mass-market high street presence? Its challenge is to do that while its once-stable high-street platform is disintegrating under its feet in the face of cut-price alternatives.
For any supermarket or convenience chain, there remains a lurking problem in the UK’s towns and cities: getting the right blend of price and service in store as the high street becomes polarised and the middle market is stretched to breaking point.
For many customers, ‘convenience’ now equals ‘online’, while the high street represents either low-cost or ultra-differentiated. On the high street, some mid-market stores find themselves in a trough between those two peaks – as the Strategist explores in its separate analyses of HMV’s sales strategy and Tesco rival Morrisons’ woes.
Under Clarke, Tesco believed that its strategy of shifting away from physical stores and towards multichannel alternatives represented a necessary change of focus – a strategic investment in the future. The problem for jittery investors and analysts is that they are only seeing the high street decline today, and are not considering the long-term pay off tomorrow from the digital strategy that Clarke initiated.
Let’s put it another way: despite the scandal, the headline figures, and the declining market share on the high street, there’s some evidence in Tesco’s financial performance for Clarke’s view having been correct.
Christmas is, traditionally, many large retailers’ most prosperous time of the year, and certainly the period in which supermarkets face off against each other to assert their market dominance. Tesco’s in-store Christmas 2013 figures revealed an overall drop of 2.3 per cent in UK like-for-like sales, and a 3.1 per cent fall in sales at its largest stores. It’s likely that Christmas 2014 will reveal a similar decline, if not a more precipitous one.
By contrast, however, online activity increased significantly at the end of 2013: online grocery sales grew by 10 per cent year on year; general merchandise grew by 25 per cent; online clothing sales by 70 per cent; and digital entertainment – Tesco’s on-demand Blinkbox service – registered a massive upswing of 245 per cent. Again, ‘convenience’ equals ‘online’ for many of Tesco’s customers.
That said, Tesco is reportedly considering offloading Blinkbox to focus on its core business.
Either way, the company’s recent performance suggests that multichannel retail offers the biggest prize: those who shop in-store and buy groceries online spend over twice as much as those who only shop in-store. Customers who add general merchandise shopping into that mix spend nearly three times as much money.
In March 2014, group multichannel director Robin Terrell explained: ”What Christmas told us is that our multichannel focus is the right one. But that if anything, we needed to go faster.
“Besides confirming the strong growth in online sales, Christmas confirmed some of the more sweeping changes taking place in customer behaviour. Most important of all is the continued rise in customer expectations.
“Customers want to shop however, whenever, and wherever they want. We have to respond to that change in behaviour and offer them a seamless and faultless experience.
“There’s no second curve without the first. There, we have some huge strengths to build on: our unrivalled store network, the unique customer relationship and insight we have with Clubcard, our portfolio brands and services, and crucially, our team. All of these things made Tesco a leader in the first curve: the bricks and mortar world.
“The second curve is about how we make Tesco as much of a leader in the multichannel world. That means building on all the historic strengths in a way that’s relevant,” he said.
So multichannel planning is where the serious investment must be. To that end, Tesco now has more than 1,750 dedicated desks for online general merchandise, and 232 ‘click and collect’ points for online groceries. These include pick-up lockers in the London Underground – let’s hope the company has fully explored the security implications of that excellent idea.
“People throw around terms like ‘multichannel’, ‘digital’, ‘online’, and God help us, ‘omnichannel’,” said Terrell in March, “but these terms are poorly understood. Multichannel cuts across the digital and the physical, but it’s not just about selling products. It’s also about how we interact and engage with our customers.”
The direction of travel is backed up by Tesco’s own research. Half of purchases are influenced by digital channels, he claims, while 43 per cent of customers use their mobiles to compare prices or look up reviews while shopping in store.
But customer “purchase journeys” are getting more complicated, he said. ”We no longer have that easy, linear journey. Customers bounce between channels and devices in whichever way they choose and they expect a seamless experience. And because their expectations have increased, they’re very unforgiving.”
Terrell also said that he rejected the oft-cited concern that digital channels merely cannibalise existing revenue streams. In Tesco’s analysis, something different happens: the two influence and enhance each other. Tesco’s Clubcard remains at the heart of that belief.
Data: the real currency
Having 17 million Clubcard members’ data at its disposal makes the goal of increased personalisation all the more tangible. Accordingly, Tesco plans to make Clubcard a “common currency” across all of its brands and services – from banking to its Giraffe restaurants. The group is also launching a digital Clubcard to tap into the growing customer use of mobile devices.
The company has also launched a social network, Orchard, which allows Tesco’s “most engaged” customers and colleagues to connect. It is “on track” to hit 100,000 users by the end of the year, according to the company.
While a supermarket-based social network might seem to be an odd or low-grade idea, in fact it obliges Tesco to keep its standards high to prevent hosting reams of negative chatter. The Strategist believes that all large, customer-facing companies should help their customers to talk to each other.
But despite all the confident visions that were set out in Tesco’s March 2014 presentations, it was then that Clarke made a serious error of judgement: he publicly admitted serious doubts about his own strategy: ”I’ve not known a situation like this in my 40 years, because of this ‘first curve, second curve’ phenomenon. The last time we had a recession that was as deep as this for consumers, I didn’t know what the internet was.”
He added: “This direction of travel… how big is it going to be? We don’t know. And we don’t know what that will mean to bricks-and-mortar retailing. All we know is that if we don’t have a ‘bricks and clicks’ offer, we’ll have a very serious problem. So I just don’t know.” Comments that now sound like a leader without any confidence in his strategy, adrift and reactive when he should have been setting out a clear vision for the future.
Clarke faced an uphill struggle to keep nervous investors onside, and it is clear that he did not succeed. However, the promising performance of its digital business lines in recent months suggests that the company may have been turning the corner before he lost his grip on the company.
Tesco’s new CEO needs to lead from the front with much greater confidence and bring his management team with him on the journey. TS
The Strategist says
Noise is the thing that’s always on.