Contained in Tesco‘s trading update yesterday (8 January) were some key strategic initiatives that will have a profound impact on the companies that supply the UK’s largest retailer.
Recommended Buyer's Guides
Tesco, which has in the past been accused of using negotiation tactics that amount to bullying, is adopting new guidance governing so-called “commercial income” (payments required from suppliers) and associated year-end cash management.
Go deeper with GlobalData
Speaking during a meeting with analysts, CFO Alan Stewart explained: “The first [topic] we want to talk to our suppliers about is cash.”
The new management team, under CEO Dave Lewis, hopes these discussions will go some way to “regenerating” relations with suppliers. “We are reshaping the relationships with our suppliers,” Lewis, a former Unilever executive, said.
The move speaks directly to the need to address practices that contributed to Tesco’s recent accounting scandal. A GBP263m (US$424.6m) black hole was uncovered in Tesco’s accounts after the books were apparently manipulated by bringing forward payments from suppliers and delaying costs.
As it works to build trust and transparency in its supply chain, Tesco is likely looking at how to simplify its complex system of payment calculations, currently based on various performance targets and supplier penalties, Conlumino’s George Scott tells just-food. “They have been well-known for operating a very complex system with regard to supplier payments,” he says.
How well do you really know your competitors?
Access the most comprehensive Company Profiles on the market, powered by GlobalData. Save hours of research. Gain competitive edge.
Thank you!
Your download email will arrive shortly
Not ready to buy yet? Download a free sample
We are confident about the unique quality of our Company Profiles. However, we want you to make the most beneficial decision for your business, so we offer a free sample that you can download by submitting the below form
By GlobalDataThe accounting scandal is only part of the issue. It would also seem Tesco plans to reduce the number of SKUs it carries to boost margins, with tighter category management apparently on the cards.
Lewis said yesterday that, on completion of a far-reaching category review, the retailer will emerge with a lower SKU count, more volume runs on high demand SKUs, fewer promotions and lower unit prices.
In short, Tesco hopes to sell more through a leaner supply chain. This process, if executed effectively, could bring a number of operational benefits to Tesco. “Mr Lewis brings an awful lot of good to the party in terms of store and supply chain processes and his experience and capability clearly shone through in the meeting in our view,” Shore Capital analyst Clive Black said. “When talking about the household paper products market and how SKU rationalisation and product priority kicked into store operating costs, through replenishment, and working capital, plus production and distribution efficiency, we gleaned a small insight into a massive programme of work that can make Tesco sell more at a lower cost from a leaner supply chain.”
That said, for this strategy to be effective, Tesco needs to grow volumes. In order to do this, the company must effectively combat the threat presented by the discount sector, with the likes of Aldi and Lidl stealing the march on some of its larger rivals in the UK.
Tesco has already kicked off a process of “selectively investing in price” as it works to move away from promotions to pricing that focuses on delivering everyday low prices on essentials.
The first salvo came in the form of an investment in fresh produce over Christmas – reducing the price of the five vegetables most desired in Christmas lunch to GBP0.45. Management claimed the strategy has been welcomed by customers, who believe it delivers better value than conventional promotions. The company’s Christmas trading beat analyst expectations, with UK LFL sales over the 26 week period down 0.3%. For the first time in five years, Tesco was able to report volume growth in fresh food.
Tesco continued to build on this pricing strategy when it announced yesterday it is cutting the price of around 300 branded products – delivering low prices that will not be promoted against. “This is a significant move from us in terms of brands’ unit pricing and not promoting,” Lewis noted. The cuts have been funded by Tesco not its suppliers, the chief executive added.
Lewis was quick to emphasise the benefits SKU rationalisation and a move from promotional activity creating spikes in demand will have on Tesco’s supply base.
“My supplier can run his or her operation in a much more simple, much more efficient way. And that is how we can lower prices without impacting Tesco’s margin,” Lewis predicted. “If you can get the wheel moving on volume, you get the range right… you can [find] operational efficiencies.”
Conlumino’s Scott believes these changes are about “benefiting everyone: customers, suppliers and ultimately themselves”. Simplifying the supply chain should improve product quality and traceability, Scott suggests.
“It is about broader issues of supply chain transparency. Tesco has so many suppliers that when something like horsemeat happened they struggled to trace product or know who it was from,” he observes.
However, there are some potential pitfalls. If Tesco cuts the wrong products, it could well disillusion those customers that have remained loyal through the recent period of turbulence. Meanwhile, there is a risk the country’s largest retailer could kick-start a race to the bottom as it attempts to play the discounters at their own game.
Morrisons has already indicated it will match the discounters on price, Sainsbury’s has spoken of going “toe-to-toe” with the market and Asda this week announced it is investing GBP300m in fresh price cuts, looking to build on its credentials for every day low prices, or EDLP.
With the discussion centring on price the question is whether volumes can be increased enough to counteract lower unit prices. In the highly competitive environment of UK grocery, this is a significant question mark hanging over Tesco’s strategy.
As the supermarket giant reduces the number of lines it carries, it is also likely the group will pare down its suppliers. This is good news for those that remain as they stand to benefit from potential increased shelf space allocation. But, for suppliers that fail to make the cut, the initiative could prove disastrous.
