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Tesco’s first-quarter results showed an almost unprecedented decline in its like-for-like sales in the UK, drawing renewed criticism from the City, while its shares were downgraded two notches by Moody’s. Its 27th June AGM gave a forum to impatient shareholders to vent their frustrations at the company’s results. Is Tesco’s current strategy well-founded and should investors be confident in its CEO Philip Clarke’s ability to turn a corner towards recovery, or is it simply following the wrong path and in need of a radical rethink?

Should Tesco Engage in an All-Out “Price War”…

Tesco’s price cut ambitions appear to be too modest, with a £200 million target to invest in price reductions. Asda and Morrisons have unveiled plans to invest £1 billion in achieving price cuts through cost savings over a three-year and five-year period, respectively. While these top line amounts cannot be directly compared, not least because they cover different timeframes, they do indicate that Morrisons, facing even deeper market share erosion than Tesco, is making price cuts its top strategic priority. In contrast, Tesco appears to remain hesitant with regard to engaging in so-called price wars, balancing price cuts against other strategic goals.

At the heart of the “price war” dilemma is the question of whether the threat from discounters is being overplayed. As their penetration still lags well behind other European markets, the stellar performance of the two largest discounters Aldi and Lidl is likely to continue being a fixture of the UK grocery retailing landscape in the short to medium term. Reasserting its low-price positioning could be a cornerstone of Tesco’s recovery efforts and the most reliable way to reverse the erosion of its customer base to the discounters.

…or Should it Pursue Other Competitive Advantages?

As the UK’s largest retailer, Tesco has to cater for a broader range of customer needs than smaller players such as the discounters or the premium grocery chains Marks & Spencer’s Simply Food or Waitrose, and therefore has to juggle conflicting strategic goals.

The plan to launch Euphorium bakeries and Giraffe restaurants, among other services, are sound alternatives to reviving the performance of Tesco’s largest hypermarkets, where it is confronted with surplus space, while differentiating the brand from its rivals. The continued push towards convenience stores and internet retailing should enable Tesco to strengthen some of its major other competitive advantages and avoid some of the trappings of a price race to the bottom.

However, for a large proportion of its stores, more aggressive pricing is likely to be the most important element of a strategy to maintain footfall. Unlike Morrisons, whose profits have melted away in its last financial year, Tesco’s profit margins remain higher than those of its direct competitors, backed by its large size and operational efficiency, and Tesco could pull out the “price bazooka” to undercut rivals on price more clearly while retaining profitability, even if this temporarily reduces profits. Philip Clarke’s recent statements underlined that shareholders will need to be prepared for Tesco’s financial performance to become worse before it gets better.

GB-Grocery retailers profit margins Jun14.jpg

NOTE: Financial year end February (Tesco Plc, WM Morrison Supermarkets Plc) and March (J Sainsbury Plc)

 

No Substitute for Low-Price Perception

Highlighting the risks associated with its mid-market positioning, Tesco needs a clearer competitive edge that would give customers a better idea of what its brands stand for, but it cannot let its price perception be eroded against Asda, Morrisons and the discounters. Establishing a clearer price differential with competitors will help regain market share, an essential goal for any large grocery retailer to achieve a long-term recovery, as Carrefour has learnt in France. Once customers have a better perception of Tesco’s prices, they should become more loyal to the brand and its other attributes should come more into play.

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