The recent potential credit downgrade, coupled with Tesco’s inability to restore its pre-January share price, following the start-of-year profit warning, makes it inevitable that the company will have to resort to a major price-cut initiative in order to restore its UK status.
No one, including Tesco, can say exactly what will happen in the UK market in the coming weeks, but it would be reckless of any stakeholder not to attempt to shorten the odds by eliminating or factoring in some of the ‘obvious’ variables in the meantime…
Tesco patently has deeper pockets and greater scale advantages than other players, but any positive momentum has to be sustainable in the long term, in order to avoid wasting gains made here and abroad over the past 20 years. However, the mention by Standard & Poor of ‘lower profits’ as a contributory cause of the downgrade means that Tesco is effectively prevented from drawing heavily on current profitability to fund its £1bn revitalising initiative, or indeed any ‘nuclear pricing’ options.
Moreover, the downgrade also means that Tesco will effectively pay more interest on its debt, an additional pressure on profitability…
How to prepare for the inevitable?
Accurate and comprehensive forecasting of Tesco’s next moves would require the benefit of 100% hindsight, but in the meantime, any strategic change by the retailer will involve taking a stance on a combination of the following factors. In the process, systematic elimination of the ‘impossible’ will leave us much closer to the possible solution (thanks Sherlock).This means we will be able to focus on fewer variables as we await what has to be a very high impact move by Tesco in order to have any hope of reversing current trends in the UK.
The key factors include:
- Share price maintenance: As you know, Tesco’s share price has still not budged since its 20% drop following the January profit warning. Any share price improvement will still be driven by ROCE performance, in turn driven by Net Profit on Sales, and Capital Turn, so these ratios cannot be allowed to be diluted, even in the short term i.e. this will require a combination of cost-price reductions, optimising of credit terms/settlement discount trade-offs, increased trade funding, strict application of deductions and improved service levels…
- Deep-cut pricing: In order to sustain its current marketing approach aimed at retrieving lapsed shoppers, any price changes have to be credible and sustainable – cosmetic cutting of a handful of KVIs will not be sufficient. The ‘typical ‘shopping basket will obviously have to be cut deep enough to attract the attention of a savvy shopper, and not just the media. However, to retain any lapsed shopper ‘regains’ the company will have to make across-the-board price cuts permanent and sustainable, in order to avoid unnecessary de-stabilising of marketing strategies currently in place.
- Brand–Own label balance: This may be allowed to shift a little from its current 50/50 to perhaps 45/55 in acknowledgement of not only the credibility of the Tesco brand, but also the own label pull resulting from unprecedented market change. However, we can be certain that this balance will not be allowed or encouraged to move to levels of 65/35, if the company has learned anything from its past 30 years in the UK market…
- UK/Rest-of-world balance: The UK has to continue to be a feeder for overseas development. In fact, like any globally ambitious retailer, Tesco needs the security and cashflow of home market dominance in order to drive rest-of-world growth.
- Market share: Here Tesco has three options: recovery of lost share, stop the current loss of share, i.e. maintain market share at current level, or allow market share to drift down to 25%, thereby removing it from its current ‘kicking-post’ role in terms of being a political scapegoat, a target for grievances by special interest groups. Of these, we believe the more likely will be the ‘maintain current share’ option, then using internal efficiencies to drive profit improvement…
- Food/non-food balance: Who knows, but the fact remains that Tesco’s approach to non-foods reflects many of the advantages of being able to apply FMCG food principles to categories that were hitherto regarded as requiring ‘special‘ treatment because of traditional routing to consumer.
- Online/traditional retailing: Any marketing instinct would cause Tesco to follow and fuel natural development of a market, online being no exception…
By developing an ‘obvious’ strategic context using the above factors, but fine-tuned to their specific categories, suppliers (and Tesco’s retail competitors) should then devote the remaining weeks to monitoring and modifying the above variables to incorporate latest hard data, before retiring to the fall-out shelter…
