Given that Tesco plans to reduce the negotiating elements of Back Margin from 24 to just three by 2017 (volume, prominent positioning, and compensation payments in the event of product recalls), it may be useful for NAMs to work this through in terms of the financial impact on their Tesco relationship, especially given the latest £6.4bn loss…
Essentially, it is probable that the total Tesco take from your brand will remain the same i.e. they are unlikely to surrender any income currently coming from Back Margin; a proportion of this will simply move into Front Margin. In other words, say the current 20% of trade price represented by trade investment will translate into 15% of ex VAT shelf price, assuming a 25% retail margin.
The issues for suppliers include:
- What will happen to shelf prices if Tesco want to drive sales really hard via an extra 15% price cut, using the ‘excess’ Back Margin?
- Will the resulting scale economies be sufficient to satisfy Tesco (i.e. their January price-cut test appeared to be profit-neutral, according to a Dave Lewis interview in The Grocer)?
In practice, given Tesco’s need for cash, it is probable that they will simply absorb the ‘freed-up’ Back Margin within the business, and finance price-cuts via current Front Margins. One of the remaining Back Margin elements – Volume Rebates – will hopefully be sufficient to help make the price-cuts profit neutral…
On balance, Tesco’s move from Back to Front Margin represents a quantum leap for suppliers in that their Front Margin income will be a direct result of sales made and all Back Margin will be sales-based and paid in arrears.
This is a major breakthrough in UK supplier-retailer relationships and should not be underestimated. However, we are now at a point where suppliers could lose control of some historical Back Margin monies.
Negotiating ownership and usage of Back Margin
Given that supplier investment in Back Margin was originally intended to stimulate sustainable sales of the brand and should always have been conditional, many suppliers will be reluctant to simply surrender the allocation and use of trade investment monies – other than the three permitted buckets – to a retail partner working to a different set of priorities.
This issue goes to the heart of fair-share partnerships in UK retail, whereas continental players have always had the protection of supplier-retailer contracts as a basis for establishing and maintaining the integrity of trade investment.
Moreover, as the surrender of any influence over the use of trade investment by the supplier could result in elimination of any discussion re KPIs and compliance conditions in monitoring retailer performance, even the effectiveness of the three permitted buckets could be compromised. This could possibly result in either additional transfers to Front Margin, or even delisting in extreme cases of poor performance.
It is therefore imperative that suppliers and Tesco find ways of jointly optimising the discretionary use of trade investment budgets by the two partners.
In other words, assuming that the three permitted Back Margin buckets account for half of a supplier’s 20% trade investment in Tesco, this leaves the ownership/control of the remaining 10% subject to further negotiation….
In order to convince Tesco of the bona fides of such trade investment retention, a supplier has to be able to guarantee that the monies are fully allocated to the development of supplier’s business with Tesco. The funds will need to be invested in initiatives that drive traffic to the retailer’s stores, where incremental sales of the supplier’s brands will reward Tesco via a combination of Front Margin and Volume Rebates.
It is unlikely that a retailer in Tesco’s current condition would agree to anything less…
Incidentally, it is also unlikely that these seismic shifts will be confined to supplier-Tesco relationships, in that if successful, other retailers will be placed at a competitive disadvantage unless they follow suit… So, getting it right with Tesco should provide a useful template for the rest of the trade.
By the way, whilst the current Tesco team are obviously focused on a clear path forward, it might be wise for suppliers to hold back some funds in case a change of Tesco management at some stage concludes that your category’s in-store presence needs a little ‘livening-up’ via an additional injection of trade investment