Tesco's price war ignores its failings

For many years the consequences of intensifying competition among the UK's grocery retailers have been visited on their hapless, bullied suppliers through a cocktail of 60 odious ploys, including breath-taking chutzpah and even veiled blackmail threats to squeeze the last drop from suppliers. Matters had seemingly improved in 2013 when the code of conduct was enforced by the Groceries Code Adjudicator but now that is ignored following Tesco's resurgent, macho stance as it prepares for a price war with the leading discounters, Aldi and Lidl.

Past apologies by Tesco's chief executive, Dave Lewis, for his company's "naked pursuit of growth" that led to an investigation into its bullying of suppliers account for nothing as Tesco now delivers its suppliers an ultimatum for swingeing price cuts of up to 50% with only a few weeks' notice. The motive behind the move is clear enough, which surely will be followed by its competitors, but could it have been long foreseen because the big grocery retailers have struggled with logistically outmoded business models within a new retail paradigm shift, and who are likely to be the winners.

David Sables, chief executive of Sentinel Management Consultants, which trains suppliers to negotiate with supermarkets, put his finger on the pulse when he claimed that suppliers were being asked to fund deficiencies in Tesco's business model relative to the discounters, but without going into specifics. So what are those specifics and can and should Tesco win and if so what would be the consequences for consumers?

Part of Tesco's problem is its refusal to cut its relatively high profit margin of 4%+ compared with the 2% the discounters are happy with but how can these upstart Continental challengers continue their growing grab of market share at the expense of the big four supermarkets?

The recent paradigm shift in retailing sees value for money as the new mantra pursued by a growing army of consumers which the discounters have delivered in spades, typically undercutting the big four grocers' prices by 30% for a typical shopping load. They have partly achieved this through a no-frills approach to new shop openings which are much cheaper and quicker to commission than the big superstores, but far more important has been its approach to inventory control. Warehouses put money to sleep, so much so that stock-holding costs can dwarf all other logistics costs combined. A typical Tesco store could have about 40,000 SKUs compared with around 1,600 for the discounters, almost all of which would be fast movers. Any that became slow movers would be promptly dropped and replaced with anticipated fast movers. This puts the big grocers at a serious disadvantage because most of their stock would be slow to medium movers, even though, admittedly, they mitigate their stock-holding costs by using their suppliers to finance them through egregious payment delays.

The big retailers must now see their superstores as an albatross but their online side of the business could bring relief if and when they decide to trim their costly, giant property portfolio. But online shopping could also be a threat if many of the big food producer suppliers, exasperated by buyer price gouging, band together to build large, shared-use, order picking warehouses for direct deliveries to consumers, thus disintermediating the traditional retailer. Amazon has shown success in this by acting as a wholesaler to the public, but it still means a cost layer that could be eliminated if producer suppliers banded together. Meanwhile, sole traders with a slick website working from home already place orders with manufacturers for direct home delivery to their customers.

One attempt to fight off the discounters was the ill-conceived manoeuvre by Sainsbury to merge with Asda, a move that undoubtedly would have harmed consumers' best interests had it been allowed to go through owing to monopoly control that a 35% market share would have effectively given them. Yet we cannot be sure that more such attempts will not be made obliquely, like the curiously approved merger between Tesco and the wholesaler, Booker.

So where does this leave the suppliers and consumers? It would not be surprising to see many of the smaller suppliers fail in what has been described by one such Tesco supplier as a straight forward money grab. This would diminish consumer choice. If Tesco succeeds and reverses the discounter' fortunes then the ultimate losers could also be the consumers because they would once more be in the grip of the big four who will have the leeway to raise prices while keeping suppliers squeezed.

Could all this angst by the big four supermarkets over the discounters have been foreseen? Nearly 40 years ago I warned of trouble ahead for the big four grocers following my visit to Netto in Denmark, a food retailer with 120 shops supplied by just one national distribution centre (NDC). Their slick business model, supported by EPOS and EDI, saw all sales replaced at each store every 24 hours. This meant that the NDC, equipped with fast sortation conveyors, saw 90% of all its stock pass through it every day, partly because Netto stocked only abut 600 SKUs, nearly all popular, fast movers. In my Materials Handling News editorial I warned that if this slick business model crosses the North Sea it would give Britain's big supermarkets "nightmares". The rest, as they say, is history.

END