What next for the toxic grocer?

Tesco's troubles are deep-rooted and multiplying. Does new boss Dave Lewis have the beans to turn the retail giant around, asks Matthew Lynn.

by Matthew Lynn
Last Updated: 26 Feb 2015

Dave Lewis is a big man, with the square granite jaw of a natural rugby player. He speaks fluently and with a natural good humour, but there is a hint of steel threaded through every sentence. On the morning of 8 January, he addressed journalists to unveil the first steps in his turnaround strategy for Tesco. Five months after being parachuted into a supermarket chain that appeared to be in chaos amid falling sales and a Serious Fraud Office investigation, he was about to impose his own stamp on the business.

During the long and torrid Tesco autumn, the ex-Unilever executive could be forgiven for wondering what he'd let himself in for. On 22 September, the grocer admitted to overstating its profits by around £250m on payments from suppliers. Four senior executives including the UK supermarkets boss, Chris Bush, were suspended and the matter was referred to the Financial Conduct Authority. A day later, Alan Stewart, a former Marks & Spencer director, was hustled into the office two months early as Tesco's new finance director to help with the accounting investigation. Before the end of the month, Tesco's second biggest shareholder, BlackRock, had dumped its shares.

October wasn't any better. The month opened with Warren Buffett saying buying shares in Tesco was 'a huge mistake' and news that the firm had recently taken delivery of a $50m (£32m) Gulfstream G550 jet bought by former CEO Phil Clarke in 2013 – and which Lewis promptly put up for sale. On 23 October, its interim results showed not only that the black hole was bigger than expected, at £263m, but that the accounting errors went back at least two years. The chairman, Sir Richard Broadbent, quit.

November was slightly quieter, with only an unhelpful intervention from ex-boss Sir Terry Leahy (who retired in 2011), saying Tesco had lost contact with its customers. But December got off to a bad start with Lewis taking over running the UK supermarkets after a disastrous Black Friday sales event, in which police were called to disturbances in at least 16 stores. Then on 9 December, the company issued another profits warning, admitting profits for the year would be more like £1.4bn rather than the £2bn forecast. The shares dived again and had lost half their value by year end. Tesco's credit was down-rated to junk status. To say schadenfreude was in the air would be an understatement: all manner of folk seemed to be enjoying kicking Tesco when it was on the canvas.

So Lewis needed to offer a radical vision for a floundering business which for 30 years had done nothing but expand relentlessly. Across the country, 43 stores would be closed, while plans for 49 new megastores were scrapped. Overheads would be cut by 30%, involving hundreds if not thousands of job losses. Tesco Broadband and the Blinkbox streaming service would be sold to TalkTalk, while Goldman Sachs would look at selling the highly covetable data unit Dunnhumby. The final dividend would be scrapped. Thirteen stores in Hungary would be closed. Matt Davies was poached from Halfords to run 

the UK operation. Perhaps most symbolically of all, at least for the internal culture of the business, Lewis planned to move the headquarters from Cheshunt, the Hertfordshire Lubyanka, to Welwyn Garden City. It was a decisive break with the past, and a signal that he was determined to create a fresh and very different sort of Tesco.

The questions came thick and fast. Which stores would close? Where and when would the axe fall? But there was only one that really struck home. Where did it all go wrong? 'I'm not a company historian,' snapped Lewis in response. 'I'm here to make changes and to turn Tesco around. Investors want to know what I'm doing in the future.'

Well, up to a point that is true. But only up to a point. To have a chance of restoring the chain's fortunes, Lewis might well need to delve more deeply into its past. A company of Tesco's size does not get into this much trouble overnight. It takes time. And the roots of the crisis were very deep indeed.

The Leahy succession

On 8 June, 2010, Sir Terry Leahy announced his departure from Tesco in a typically low-key fashion. In a statement that was slipped out quietly through the Stock Exchange, he said he planned to depart the following March after 14 years at the helm, which he modestly described as a 'good innings'. Leahy had never been a flashy chief executive, and he had not built up much of a cult of personality, at least in public. There were no Rolls-Royces or trophy wives and no epic takeover battles. He talked Tesco but little else. To the extent that he was well known, it was because the company he ran was so enormous, an unavoidable fixture in British life.

The manner of his departure was in keeping with that. Phil Clarke, a trusted and reliable long-serving Tesco executive, would take over, and the City expected the Tesco juggernaut to roll relentlessly onwards. 'Leahy is an outstanding executive who has intellect and vision that are second to none,' said Shore Capital analyst Darren Shirley when the news was announced. 'He must surely be written up as one of Britain's greatest businessmen.'

Indeed, to the outsider, it looked like a masterclass in orderly succession planning.

Behind the scenes, however, it was a different story. If anyone had looked closely enough, there were already signs that Tesco was a fraying organisation and that Leahy had increasingly lost his focus and grip in his last few years at the helm. The board was weak, it had over-reached itself, and the company was draining hundreds of millions from its core business to fund hubristic ventures abroad. The chalice that was handed across to Clarke at that point turned out to be poisoned.

'It was an autocratic company, where no one was able to challenge Leahy, and where bad news started to be ignored,' said one former board member. 'And that is always a signal that a company is going to run into trouble.'

For a long time, Tesco could do no wrong, either for its customers or its shareholders. The business had been founded by Jack Cohen, a Polish immigrant, who took the name from the first three initials of a tea supplier (TE Stockwell) and the beginning of his own name. The first two shops opened in Beacontree
and Burnt Oak in 1931 and by 1939 there were a hundred of them. Post-war, Tesco expanded into the newly built shopping centres and, by the start of the 1970s, it was the UK's fourth-largest grocery chain.

And yet it was not Tesco that really pioneered the supermarket in the UK. That was Sainsbury's and to a lesser extent companies such as the now largely forgotten Safeway. It was a player, but a lesser one among many, and placed in the shade by the classier Sainsbury's. Under Ian MacLaurin, however, as Tesco's managing director and then chairman through the 1980s and 1990s, that started to change. Its formula of relentlessly low prices, lots of new stores and its ability to squeeze suppliers (plus its skilful use of new technologies to streamline logistics and its introduction of new marketing schemes such as the formidable Clubcard) enabled it to gradually overtake Sainsbury's and become the dominant force in the British market.

'The thing you have to understand about Tesco is that MacLaurin was the real creator of the business,' says a former board member. 'He set the template and he really was a visionary retailer. Leahy took over a very successful ship and kept it going, but he was never really an innovator.'

There is much truth in that. After starting work at Tesco soon after he graduated, Leahy worked his way up the company, joining the board in 1992 and taking over as CEO in 1997. At that point Tesco was already the UK's largest retailer, having overtaken Sainsbury's in 1995. Leahy's task was to extend its dominance in the UK and lead its expansion overseas. He appeared to be brilliantly successful. During Leahy's reign the company built substantial businesses in South Korea, Thailand and Turkey, in Poland, Hungary and the Czech Republic and in the US with the Fresh'n'Easy chain. It pushed into new markets in the UK, launching a bank, a telecoms business and the Blinkbox entertainment site, and it started buying up new chains such as Dobbies Garden Centres and Giraffe restaurants.

In 2010, it even said it planned to move into making films and records to sell exclusively in its stores. By then, it was making record profits of close on £3.5bn, and was raking in one pound in every eight spent with a British retailer. So powerful had the company become that the 'Tescopoly' campaign was launched to try to resist its growing power. Across the country, there were protests against Tesco opening new stores, but the company easily brushed them aside and its dominance seemed unstoppable.

The origins of the crisis

And yet, behind the scenes, the picture was slightly different. Tesco's senior management team was increasingly incestuous. Leahy's most trusted lieutenant was Tim Mason, the chain's head of marketing. While Leahy was the business brains behind Tesco's expansion through the late 1990s and early 2000s, Mason was the flashier marketing wizard, creating a vast gap between Tesco and its struggling competitors. Mason had also married Lord MacLaurin's daughter, making him virtually Tesco royalty, and he was widely seen as the most likely successor as CEO. When the US venture was launched in 2006, Mason was the man chosen to run it and, as he departed for the US, he took with him the able head of UK marketing, Simon Uwins. While they tried to establish a business in California, the UK chain went through a series of marketing bosses without ever settling on anyone with the same kind of ability. The British supermarket started to lose some of its focus. 'We started to notice that it lost some of its image with the consumer,' says a former CEO of one of Tesco's main rivals. 'Tesco had always been cheaper than the competition, but it wasn't that any more. Yet it wasn't about quality either. It was quite hard to work out what it stood for exactly. It was usually nearby, which is a bigger deal than you might think, but that by itself wasn't enough to sustain the biggest retailer in the UK.'

In 2008, Leahy had a bad skiing accident that left him with some broken ribs and vision difficulties. Tesco said little about it but, according to company insiders, it took a far greater toll on him than anyone, and perhaps Leahy himself, realised at the time. 'When he came back from the injury, he wasn't the same man,' said one former senior executive. 'His energy seemed to have gone.'

Leahy was famous for his ruthless attention to detail, making a point of visiting a Tesco store at least once a week, and never hesitating to point out any flaws. But with Mason departing for America - going on to lose £1.2bn in the process – and with Leahy less attentive to detail than he had been, the core UK business started to drift.

Indeed, the perma-tanned MacLaurin himself has since been fiercely critical of Leahy's reign. 'I'm disappointed that it turned out the way it did,' he told the Guardian in 2013. 'I think for the first five or six years he did a very good job, but then he lost his way. I think he lost the plot. He was very aware of my own views on America when I said we would never go there, and I've been proved right because it has been disastrous. We felt we couldn't add value there when we looked at it in the past, so I don't know why Terry decided to go there. It was a bit stupid to go to California. It's also unforgivable that he took money out of the UK business and allowed it to flounder when our rivals were catching up and expanding.'

With hindsight, many in the City can see the same flaws. 'To some degree, Tesco became a victim of its own success,' says Clive Black, head of research at Shore Capital. 'It stopped listening to its customers and became very complacent. The irony was that it had massive amounts of data about them through the Clubcard but it didn't listen to any of it. The business became supply driven.'

Despite the recession of 2008/2009, Tesco kept expanding at a ferocious rate. It was land-grabbing, opening new megastores, and clogging up high streets with Metro and Express convenience stores. The number of new outlets it opened was breath-taking. It took the company 84 years to reach its first 20 million square feet of space, a landmark it arrived at in 2003. It took only another five years to hit 30 million, and planned on 40 million square feet by 2013.

Its new out-of-town hypermarkets were built on a vast scale. The biggest, in Walkden in Manchester, was 185,000 square feet, the size of more than three football pitches.

For a time, it seemed a great way of driving the business forward. More shops meant more customers, and more space meant bigger ranges. That translated into greater bargaining power with suppliers, lower prices and greater profits. At its peak, Tesco was making profit margins of more than 5%, significantly above rivals such as France's Carrefour or America's Wal-Mart. It seemed as if nothing could stop it.

Below the surface two things were happening: the company was changing and so was the market.

Take the company first. Where it had once been a pioneer of value and convenience, it became more interested in dominating space. 'It became impossible to compete with it on store openings,' says a rival supermarket boss. 'It would bid whatever it had to, not because it wanted the site, but just to keep someone else out.'

Tesco became notorious within the industry for bullying suppliers and extracting generous co-payments for promotions. It was no longer about getting a better deal for its customers. The firm almost ended up in court after demanding a £1m kickback from the mighty L'Oreal. 'Tesco became more and more like a landlord,' says Professor Andre Spicer of the Cass Business School. 'It was not really aiming to sell to its customers. It was basically renting out space to suppliers. All retailers have become a bit like that but Tesco was one of the most aggressive.'

Companies change over time, and Tesco had matured from a scrappy underdog to the market leader. Along the way, it was always likely to become more aggressive and to concentrate as much on fending off competition as developing new lines of business. It might have been able to get away with that if it were not for the way the market changed as well. 'The big four guys have been very cost driven,' says Shore's Black. 'Customers understand that if it is about giving them a better deal, but if it is just about the company, they don't. All of them allowed the shopping experience to become subordinate.'

After the recession, the grocery market started to change. 'You have to remember that the supermarket model is only 50 years old,' says Spicer. 'For most of that time, the middle was a pretty good place to be. There was an expanding middle class and with falling food prices due to industrialisation, they had more and more to spend on groceries. But that has ended. There are now a few very affluent people at the top and the rest are increasingly getting poorer.'

The total spend on groceries has not changed significantly. But three important things have happened in the past five years. The first is that food has started to fall in price – indeed for most of 2014, food was falling at an annual rate of almost 1%. When prices are rising, a lot of mistakes get covered up. When they begin to come down, they get horribly exposed. The second was the rise of internet sales. No one wanted to buy a TV or a lawnmower in one of Tesco's vast sheds any more. On the web they could get more choice and better prices. The third was the arrival of the hard discounters, Aldi and Lidl, which got rid of the bewildering displays of buy-one-get-one-free offers, vouchers and Clubcard boosts that made shopping in Tesco about as easy as studying quantum mechanics and replaced it with low prices on a simple range of stuff.

It turned out that Tesco had expanded most aggressively at precisely the worst time. And it had taken its eye off the ball at exactly the moment it was spinning towards its own goal. It was about to pay a price for that, and the person who would pay it was the hapless Phil Clarke.

Clarke ousted

On Tuesday 22 July, Tesco had been planning a party to celebrate Phil Clarke's four decades with the company. A day before, it had to be hastily cancelled. On the Monday, the company warned that sales and profits would come in lower than expected. It was the latest in a series of disappointments that had included the share price collapsing and Tesco's market share falling from more than 30% of UK grocery retailing to less than 28%.

Tesco had no choice but to make the deeply unpopular Clarke walk the plank, and soon afterwards the chairman, Richard Broadbent, followed him out the door. 'It was a classic example of weak corporate governance,' says a former board member. 'Clarke was not up to the job, but there was no one there who could challenge Leahy.'


Clarke, according to insiders, had shown little grasp of how to turn the business around. He neither understood the challenges it faced, nor came up with any strategies to meet them. Instead he allowed promotional payments to be overbooked, leading to the £263 restatement of the accounts that prompted his early departure. Subsequently, Leahy has accused him of 'a failure of leadership'. He was followed out by a series of senior execs. A whole generation of managers – Leahy's boys – were swiftly ejected from the company, their reputations in tatters.

But would that be enough? After all, getting rid of people is easy. The question now is whether Tesco can be turned around, and if so how. 'Dave Lewis has started to grasp the nettle,' says Spicer. 'He publicly named and shamed illegal behaviour. He has started to restructure where the company makes money. Instead of charging suppliers, the focus is now on consumers.'

It is likely to be a long journey back, however. Tesco gets a lot of criticism for its overseas adventures. But they were not the real problem, except in the sense that they drained cash and expertise from its core business. The only one to lose significant money - the US chain Fresh'n'Easy - has already been closed. Sales are declining fast in Ireland and the central European business does not look much healthier, but they are peripheral. It is in the UK that Lewis needs to restore Tesco's fortunes and that is not going to be easy. 'He needs to do two things,' says the former boss of a rival. 'He needs to start closing stores that are too big and won't ever make money. And he needs to get competitive on price. And both of these involve a lot of financial pain.'

No one thinks that Tesco is going to disappear, or that it will go bust, even if it might require a financial reconstruction. It remains enormous, the market leader, and there are still benefits in bulk. The problem is strategic rather than terminally existential. 'The business will have turned the corner when the market share in the UK has stabilised,' says Black. 'At the end of the day, without sales you don't have a business.' Where will that be? Black reckons it will stabilise at around 25%, but admits that it could be lower.

To get there, Lewis will have to refashion the business, and decide what it stands for. He will need to take on the discounters and then reconnect with a shopping public that is no longer very interested in doing a big weekly shop in a massive, rather dull supermarket. 'These factors are beyond the control of the CEO. They will require some careful navigation skills in the future,' says Spicer. 'They also mean Tesco is likely to be a very different business in 10 years.' Indeed so. Jack Cohen and Ian MacLaurin built Tesco into the largest retailer in the UK by being on the side of the customer, and by pioneering new forms of retailing. Perhaps Lewis needs to spend a bit more time on the company's history and discover how to recreate some of that spirit.


SECRET CONFESSIONS OF A TESCO GRADUATE TRAINEE

Some years ago, I managed to navigate my way onto the Tesco graduate programme and after donning an ill-fitting, double-breasted Next suit dutifully arrived at Tesco plc.

On my first day I joined about 20 other graduates selected for the retailer's commercial trading arm. I very clearly remember the HR folk gathering us together to assign us to our departments with a single word. Some of those words were quite exciting. 'Wine', for instance. Others were dubious. 'Fish', for example. My own orders were equally succinct: 'Meat'. I don't know why, it may have been the look of pity on the face of the HR, but I knew I had drawn the short straw. This proved to be completely accurate. It was later explained to me that the meat department was where they sent the graduates who the business thought needed to be 'brought down a peg or two'.

So off I trundled to the Tesco plc meat-trading division – my first experience of the adult workplace. It wasn't pretty. The department was composed of a group of men, several of whom had been butchers, who took every chance to bolster their unreconstructed, alpha-male credentials.

The boss and Pack Leader (basically the hardest bloke in the room) reported to an individual by the name of Terry Leahy, a man who was spoken of in hushed tones, followed with whisperings of his selection by the perma-tanned Ian MacLaurin as heir apparent. Leahy's reputation meant even the hard men of the meat department would go down a floor to use the toilets in case they bumped into him. I didn't know this of course and so once was quizzed by he-who-shall-not-be-named on the price of chicken quarters while we stood taking a pee.

My first job, naturally, was photocopying. And it was here standing at the car-sized photocopier behind the open-plan offices of the beef buyer (the most red-blooded in the bizarre meat-driven pecking order) that I first experienced how this macho world translated into the war zone of supplier relations. Such was the venom and violence of language that he was using on his desk landline that I could only presume he was talking to someone who had kidnapped his daughter. There was certainly a reference to legs being cut off - and he wasn't talking about cattle. However, I slowly realised he was tearing strips off a supplier and this call was in fact a commercial negotiation about silverside and brisket.

Having stood open-mouthed listening to the tirade, I wasn't surprised when the Pack Leader arrived and grabbed the phone from Mr Beef, presumably I thought to apologise. How wrong I was. Pack Leader was there to join the fun. Having wrestled the phone from his subordinate, he exploded down the line. 'What have you done to make my buyer talk to you like this?' was the gist of what he said - but obviously with a lot more swearing and violent intent. Surely this isn't allowed, thought the naive young innocent I was then. However, not only was it allowed, it pretty much set the tone.

Other than photocopying and being sent off to price check on the competition, my role was something akin to a boot boy whose job was to shine the shoes of the professionals before they entered the trench warfare of supplier negotiations, and to hold up the bodies of the sales reps who had found themselves knocking on the door of the meat-trading department.

One of my jobs was to escort these sorry souls from the reception to the fourth floor where the fun and games took place. Think hangman. Think gallows. Think dead man walking.

The orders I was given demonstrated the precise cruelty employed upon these men regularly sent from their meat farms to receive a good kicking. It went like this. I was given a name and sent off to find the target. Not that you needed a name. You could just look for the individual sporting the rictus grin of someone who had known mental cruelty and was about to experience some more.

The first step was to report that the lift was broken (it wasn't) and we had to use the stairs. Back then you didn't get into the meat-trading markets through svelteness. Most were big men whose greatest climb was probably onto the bar stools of their local. So they would arrive at the fourth floor very short of breath and in a bit of a mess.

My second instruction was, having recognised that this was someone who needed a rest, to offer him a fag. (I didn't even smoke.) Naturally they were all puffers and eagerly took the bait. Having carried out the first stages of the tenderising process, I was then instructed to take them into an office and prepare them for grilling. I'm not sure if they ever noticed that the seat offered was sometimes a stool, sometimes a chair, but the crucial detail was that it shouldn't have any arms, thus guaranteeing further discomfort.

I would then go off to prepare the final blow, which came in the guise of a cup of coffee; all part of the negotiation tactics. The instruction was a cup of scalding black liquid that, and this was the important part, was filled up to the very top. And – vitally – no saucer.

Thus the stage was set for the negotiations – or slaughter – depending on your viewpoint. A large man perched on a stool. Out of breath. Fag in one hand, molten coffee in the other, inevitably beginning to flow down the wrist of the trussed-up supplier. With no table or relief in sight. Job done.

At this stage the door would be smashed open and some initial volleys delivered onto the hollowed-out husk of that day's victim. Most of the time I was asked to leave. No need for you to see this, I suppose was the thinking. Occasionally, I stayed and watched from behind my fingers.

There were other delights. Lots of abattoirs obviously. A Christmas party where the only teetotal (and female) member of the department had her drink spiked with vodka. (The finger was pointed at me of course.) And several nights out with suppliers that ended up in the other type of meat market – at the suppliers' expense naturally.

The final straw came when the chicken buyer (relatively low down the red-blooded pecking order), who was berating me for a misplaced order to a store in Liverpool, exclaimed: 'It's almost like you don't care if these chickens get there or not.' We both knew the answer to that one.

The end came shortly afterwards. That final train trip out of Cheshunt was a dream. I have no idea if the experience was a positive one or not. Possibly character-building. Possibly a complete waste of time.

After his Tesco ordeal, the author became a successful management consultant.

Find this article useful?

Get more great articles like this in your inbox every lunchtime

Subscribe

Get your essential reading delivered. Subscribe to Management Today