Tesco Trade investment: How to demonstrate your value to the buyer

Buyer: "Surely Tesco are worth more than a £10k investment, especially for a company your size?"

NAM: "Given your business model and latest net margin (2019 Tesco Annual Report) of 2.7%, our ‘mere’ £10k is equivalent to incremental sales of £370k for Tesco…."

As you know, apart from cutting costs, the only way a retailer can generate net profit is via incremental sales.

In practice, for a retail business on a net margin of 2.7% before tax, a net margin of £10k = 2.7% of sales.

So, £10k/2.7 x 100 = £370k, the incremental sales required to generate net profits of £10k.

Now, which would you prefer, my little £10k trade investment or having to generate extra sales of £370k in your category….?”

[Note for NAMs: If your company generates net profits of say 4.5%, the £10k trade investment in Tesco is equivalent to incremental sales of £222k. In other words, you need potential incremental sales of £222k to even begin the conversation…]

Source: NamCalc, a 34 calculation financial tool-kit for NAMs

Sainsbury's space productivity, getting into the space behind the headlines

Whilst the headline numbers provide some indication of the unprecedented pressures on Sainsbury’s and the other mults, in “...a marketplace changing faster than at any time in the past 30 years…”, working NAMs can derive usable insight by digging deeper into the detailed results issued this morning. (Sainsbury’s Results: 52 wks end March 2015)

Having written its space down by £900m i.e. 7.5% of a £12bn portfolio, Sainsbury’s have focused City attention on sales productivity i.e. Sales and Profit per sq. ft. per annum

See page 15, JS Results:
2015 Sales/sq. ft./annum       = £1,027
Op Profit/sq. ft./per annum   = £32.6

In other words, for the coming year Sainsbury’s have to be very receptive to supplier initiatives that drive Sales and Profit productivity.

For NAMs, this means calculating the ex VAT consumer sales generated in Sainsbury's by your brand footprint per annum – think number of facings x on-shelf backup stock x number of stores x SKU footprint - will give you a figure at least twice Sainsbury’s £1k/pa.

OK, they still have to carry all of the in-store waste area – non sales space like aisles etc.) - but it will still be possible to demonstrate that your brand is a high net contributor to Sainsbury’s major KPI for 2015/16…

However, your real contribution is via your brand's ability to improve on Sainsbury’s operating profit/sq. ft./annum.
(Sales per sq. ft. will keep you listed, Profit per sq. ft. will keep you in the inner circle…)

As you can calculate from their latest figures (page 15), Sainsbury’s are currently generating operating profits of £32.6/sq. ft./annum, i.e. 9p/day!

Your brand’s footprint, with its retail margin of 25%, trade investment of 20%, and 30 days credit has to be generating a lot more than 9p/sq. ft./day for Sainsbury’s…
(Why not grab an envelope and try it out, using your figures? – for precision, take off 15% to cover handling and shrink)

Space productivity is one of the biggest issues for the mults this year, your brand can help…  

Application to Tesco?
Incidentally, applying the above to another mult that occasionally makes the headlines, why not dig a bit deeper into Tesco’s recent results?

Page 3 & page 40 Results:
2015 UK Sales/sq. ft./annum               = £1,030
UK Trading Profit/sq. ft./per annum   = £11.04  i.e. 3p/sq. ft./day!

BTW, given that you are on the Tesco page, why not find some gems for your overseas colleagues in Asia and EU markets?

2015 EU Sales/sq. ft./annum               = £254
EU Trading Profit/sq. ft./per annum   = £5  

2015 Asia Sales/sq. ft./annum             = £298
Asia Trading Profit/sq. ft./per annum  = £17  

Tesco's 3-in-1 Opportunity for Suppliers

A brief examination of Tesco’s latest results, the 52 weeks ended 28th Feb. 2015, show interesting differences in their trading margins for the UK, EU, and Asian businesses.

Whilst the Tesco overall trading margin is 2.2% - itself too low for a City that would prefer at least 4% - it can be seen that the results are significantly different for the three geographies. This would suggest that global suppliers will need three different strategies to optimise the profitability of their overall Tesco relationship.

In other words, Tesco’s three retail businesses have to be viewed and managed as separate SBUs to optimise the overall global potential for your brand.

In practice, with trading margins in the UK at 1.1%, the EU at 1.9%, and Asia at 5.7%, Tesco clearly have a need for three different but complementary strategies:

UK: With Tesco’s ex VAT sales of £43.5bn, coupled with Sainsbury’s and Morrisons expected falls in profits this week, maintaining market share at the expense of competitors via deep price-cutting, has to be a priority for the major multiples.

Given these margin pressures, the temptation for Tesco to transfer ‘excess’ back margin to front margin, may be difficult to resist. In addition, suppliers' willingness to invest in the trading partnership via lower trade prices in exchange for long term commitment to Tesco’s customer-centric policy, may become a negotiating point.

Obviously, 100%, zero-defect service levels and availability have to be a given, from now on…

On balance, suppliers need to come to terms with structural – i.e. ‘permanent’ – changes in the market, and make fundamental decisions re the relative importance of the mults vs. discounters, and Tesco in particular, to their UK business. Having made these decisions, calculating and demonstrating the impact of your trade investment and retail margin on Tesco's trading profits has to be a must…

EU: With ex VAT sales of £8.5bn, Tesco needs to both increase its EU geographical footprint, and grow share in key countries.

Essential for suppliers to ensure that EU colleagues conduct harmonised dealings with Tesco in order to avoid compromising trading relationships in either territory. It is also important that prices and terms are defensible vs. other retailers, in the event that Tesco decides to sell off low margin local business.

In addition, given the move from individual teams for Czech Republic, Hungary, Poland and Slovakia to one regional team focused on buying and operational synergies, there will be more emphasis on investing in the customer offer. Suppliers will need to match this CEE re-structuring, if only to ensure their fair-share levels of investment in Tesco’s customer offer….

Asia: With ex VAT sales of £9.9bn, and a trading margin of 5.7%, it is obvious that Tesco will resist selling off their Asian interests to help re-build their global balance sheet. Instead, it is possible that they will try to increase their regional foot-print, possibly at the expense of some trading margin in the medium term.

Given the potential scale advantages of 24/7 retailing, South Korean restrictions on opening hours means suppliers need to focus on increasing store productivity during permitted times. Restricted demand due to economic conditions in Malaysia and Thailand means that a focus on availability, service and targeted price reductions is essential in order to optimise the productivity of available traffic, without compromising the bottom line.

On balance, it is time for Tesco suppliers to step up and be counted, time to decide if your biggest customer is going to make it via their 3-for-1 global policy.

Signs are that despite these unprecedented times, they will lead a comeback in retail, meaning this is a real opportunity for innovative suppliers to think long-term and join Tesco for the return journey…

In a game where all eyes are on the profit ball, can Tesco afford to forget Net Margin?

Given that share price is driven by ROCE, in turn a result of  Net Margin times Capital Rotation, no one, especially share-incentivised senior management, will allow Tesco to long ignore the bottom line…

Tesco now has other priorities in terms of offer simplification, rebuilding of consumer and supplier trust, but ensuring adequate - at least 15% ROCE - rewards for risk will always be close to the surface.

The issue for cull-survival suppliers has to be not only contributing to Tesco Top Agenda items, but also finding ways of translating this support into bottom line impact.

Essentially, in terms of faster capital rotation, by simplifying their offer and cutting out over-lap and wastage, Tesco will be able to focus on optimising stockturn. This means that suppliers that can deliver more often in smaller quantities will be seen to benefit the company in terms of speed and availability.

By reducing the number of unprofitable (large) stores, and franchising off redundant space in remaining stores, Tesco will make their fixed assets more productive. In the short term, suppliers that can make the space work harder via in-store theatre will help….

This leaves Net Margin, with transfers from Back to Front margin an obvious option, unless Tesco can be persuaded to embrace supplier-driven alternatives…

Deep down the City does not care about Net Profit in itself, they know that a business can either be small margin, fast rotation, or big margin slow rotation. All they want is an acceptable overall result - ROCE - to justify risk and exposure, and invest in the share price.

Retailers and their suppliers will be left to deliver the rest… See how here

Tesco profits overstatement - what it means for NAMs

Tesco’s announcement that it had overstated its expected first-half profit by an estimated £250m is obviously an embarrassment and patently impacts the share price.

Given that £250m represents approximately 22.7% of the original £1.1bn forecast, City reaction is understandable...

The overstatement is apparently down to a combination of the accelerated recognition of commercial income and delayed accrual of costs. In other words, possible booking of anticipated future income, like trade investment in advance of sales and could include, among others, delaying accounts payable, deferred tax liability etc.

As far as Dave Lewis’s reputation is concerned, the error occurred in the month before he joined, he went public as soon as the mistake was discovered, and announced that Deloitte will undertake an independent and comprehensive review of the issues, in collaboration with their legal advisers, i.e. All positive.

The real issue is the impact and distraction that will be caused by an independent audit of process conducted under a City spotlight ‘with lawyers present’, in troubled times.

In other words, accounting procedure that was fine in good times could now be re-assessed from a different perspective, and with the benefit of hindsight….

In practice, it could be difficult to prevent the project becoming a fundamental review of how Tesco does business with suppliers and the public.

As far as NAMs are concerned, this means that retail margins, days credit, settlement-discount arrangements, trade investment and deductions could be assessed in terms of their calculation and how settled.

At best, expect delays and distraction from the normal job of developing joint business opportunities, not only from Tesco, but also from other customers as they conduct lite-versions of the same process, just-in-case….

However, one positive result has to be the buyer's heightened sensitivity to, and appreciation of, the cost and value of dealing with NAMs that can rationalise their cost-base and demonstrate deliverable financial value in every element of their offerings....

Tesco's fall in share price - why should NAMs bother?

Market capitalisation i.e. value of the company in the open market falls and impacts all stakeholders, including NAMs. For instance in early February, Tesco was valued at £23.58bn whereas today it is valued at £18.23bn…a fall of 22.7% in 7 months!

Why does it matter?
Senior management on share options suffer a direct impact on their personal wealth. Employees on performance-related bonuses via shares become demotivated and begin to consider their options...
In extreme cases (!), there is a negative impact on company reputation i.e. good guys leave, good guys not attracted, while the less-able remain less able… 

Shareholders may force change like splitting the company, replacing board members, etc.

Meanwhile the cost of financing rises
- Loans from banks become more expensive via higher interest rates
- Rights issues i.e. the proceeds and ease of raising new money from shareholders obviously depends
  upon the share price

The growing threat of takeover becomes distracting, at least, and/or may even amplify the above effects..

Impact on suppliers
The resulting bad press can unsettle conservative suppliers, and their shareholders, resulting in pressure to re-balance the customer portfolio (in which case, think also re Sainsbury’s and Morrisons falls in share price?)

Suppliers then reconsider their options and may reclassify the retailer in terms of invest/maintain/divest criteria, ideally following a fundamental re-think…

Meanwhile, given the increased risk:
- A 44 day credit period looks increasingly vulnerable…and even a 2.5+% settlement discount
  seems cheap…
- Trade investment of up to 20% of turnover requires more justification
- 100% compliance becomes a ‘must-get’
- Deductions become challengeable...

Still think a retailer’s share price is simply something for the institutional shareholders?

In other words, Tesco is now in a position to appreciate the benefits of dealing with strong, profitable brands that can help them restore their profitability, and share value..

All it takes is for NAMs to be able to calculate the costs of their offering and demonstrate its value to Tesco’s Balance Sheet and P&L….fast

Tesco share-price plunge - a new opportunity for NAMs?

News of yesterday’s plunge in Tesco’s share-price to a 10-year low of 243.8p represents an opportunity for those suppliers prepared to re-interpret their Tesco strategies in terms of having a direct impact on share-price improvement, surely a top-of-agenda item for both the share-optioned Tesco team and the incoming Dave Lewis.

If share price is driven by ROCE, in turn driven by net margin and rate of capital turnover, then a supplier-template for helping an increasingly receptive Tesco emerges…

Essentially, Tesco’s ROCE has dropped over the years to 8.2% and its Net Margin to 3.6%, whilst Walmart’s performance has remained at a steady ROCE 18.2% and Net Margin 5.2%, despite the global financial crisis and its aftermath.

Therefore, to restore its historic share-price, Tesco needs to raise its financial performance to Walmart levels

Suppliers can help in two areas: improving Tesco’s Net Margin and improving its capital rotation as follows:

Net Margin improvement:
Reducing Operational Costs
- Better delivery arrangements
- Easier, more economic process
- Less damaged or defective stock
- Easier handling
- More economic use of labour
- More economic use of space

Reducing Administration Costs
- EDI
- Less time spent on administration
- Fewer administration tasks
- Better payment terms
- Simpler stock and order systems

Capital rotation improvement: 
Sales Volume or Value Increase
- Driving traffic and basket size
- Increasing Tesco yield i.e. sales/sq ft
- Improving quality of yield i.e. trading up

Asset Reduction
- Less capital tied up in stocks
- Less space required to stock
- Faster throughput
- Better use of spare cash
- Better use of fitments and space
- Fewer staff required

In fact, everything you are already doing, but expressed as a direct contribution to Tesco's ROCE and thereby share-price enhancement...

This direct focus on issues for a  customer currently pre-occupied with share-price performance has to represent a new opportunity to demonstrate the value of your trade initiatives and support in a way that connects directly with the buyer’s needs and wants, like never before…

...and why not throw in the fact that every £10k you invest in Tesco is worth £277k in incremental sales, based on their 3.6% margin!

Dave Lewis - a Brand New Approach to Tesco?

Today’s news of Philip Clarke’s replacement by a 28-year Unilever veteran, coupled with a need for fundamental change means that Dave Lewis will bring branding, global and supplier insight to the mix…

• With no retailer/Tesco baggage, he can be more decisive in eliminating sacred cows that have failed to deliver in terms of assets, process, initiatives and job functions
• As an FMCG marketer, he will understand that a new brand loses money on the initial purchase, makes a little on the second and begins to generate real profit when the consumer returns spontaneously having received more than was expected, and even tells a friend… The only issue for suppliers is that the brand is now Tesco, so private label and the Tesco shopping experience will now receive the state-of-art brand-marketing treatment it may have lacked in the past…
• His big-company global experience should be an asset in coordinating local, regional and global strategies
• The 28 years’ experience as a supplier has to mean a raising of the bar in terms of depth of supplier-Tesco relationships, with each side bringing more mutual insight and fact-based financial rationale to the negotiating table....

But above all, Dave Lewis will have 12 months to demonstrate sustainable improvement in Return On Capital Employed - and thereby share price - in the full knowledge that suppler-collaboration can help…

Over to you, in anticipation…