The combination of January’s profit warning and the more recent credit agency downgrade means that Tesco now needs to make ‘targeted’ disposals, cutting back capital expenditure and/or shareholder pay-outs as possible ways of improving its ROCE performance, in the medium term.
However, in the short term, the rating’s threat means that Tesco will be forced to place more emphasis on internal savings in funding any significant price cuts… In other words, the retailer will not be permitted any ‘temporary’ dips in its net margin to fund investment for growth.
As you know, for a retailer, the cost-cutting options can include 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… This means it is perhaps time to re-evaluate your position on each of these elements of your Tesco trading relationship, as a basis for determining your fair share of any help Tesco may require in funding its market-share maintenance strategy.
In practice, you need to quantify the cost and value of each element as follows:
- Cost-price reductions: These need to be resisted in principle and in practice. For a supplier to continue to provide the same package, at reduced price, sends a bad signal in terms of the defensibility of the original pricing. To do so ‘on reflex’, i.e. without financial analysis of the consequences, borders on recklessness, and can even destabilise buyer confidence in continuity of supply. Above all, Tesco is now reliant upon availability and continuity of supply, with any shortfalls providing opportunities for deductions, below.
- Credit Terms: It is vital that a supplier can calculate and demonstrate the cost and value of credit days i.e. the free credit given to a retailer when banks are unwilling/unable to lend, particularly where a recent change in credit-rating has made it more costly to borrow from traditional sources…
- Settlement Discount: Given that suppliers are also in need of cash, and are essentially dealing with cash-rich business partners, it can be tempting to offer over-generous settlement discounts in exchange for earlier payment. However, it is vital to be able to calculate the true cost of discounting an invoice, and its value to a retailer in order to achieve a fair-share trade-off between credit days and cash discount… ‘Mistakes’ are seldom reversible…
- Increased Trade funding: With trade funding running at anything up to 15% of supplier sales, the temptation to maintain and even increase the allocation to a relatively high-compliance customer like Tesco can be tempting. However, in the current climate such funding can only be re-allocated on a zero-sum basis, meaning any such increase in Tesco funding has to result in truly incremental sales of the right magnitude. Think incremental sales based on your net margin on Tesco business. In other words, if you are making 5% net on Tesco business, you need incremental sales of £200k on every additional £10k invested…
- Deductions: These can run at up to 7% of a supplier’s sales, and are one of the greatest reasons for having enforceable contracts with your major customers… By the same token, a supplier has to be able to bear the deductions-consequences of any shortfalls in their contracted service levels. A Catch 22 dilemma in practice i.e. if you are good enough to be a contracted supplier, you have to be good enough to avoid deductions penalties… Tesco are no longer in a position to take deductions-prisoners…
- Improved Service levels: As always, the future is about smaller, more frequent deliveries…end of story.
In practice, all of the above requires an ability to analyse key drivers in Tesco’s Annual Report (like a credit reference agency), overlay all of your qualitative experience, identify the impact of your offering on Tesco’s P&L and be able to express its value by calculating the incremental sales required by a 5.9% Net Margin retailer to generate every £10k invested in Tesco by a supplier.
Following this analysis and tailoring it to their Tesco trading relationship, suppliers need to establish and agree their own limits in terms of willingness to fund Tesco’s revival initiatives.
Suppliers also need to take advantage of Tesco’s temporary ‘weakness’ by insisting on a fair-share, pro rata stance in return for any help given.
Not doing so can represent more risk than you need, in the current climate.
