Credit: Tesco plc

Dave Lewis's lose-lose dilemma at Tesco

Brand or budget? Tesco can barely afford to fix one problem, let alone both.

by Adam Gale
Last Updated: 13 Apr 2016

Last year, MT noted that Dave Lewis was faced with a crucial strategic dilemma: cut costs to fix Tesco’s wayward financials, or invest in the brand to restore customer love. Lewis listened to his inner FD, rather than his inner CMO, and set about closing unprofitable stores, selling non-core businesses like South Korea’s Homeplus and cutting Tesco’s considerable product range.

It was the right call, at the time. The pay-off is that Tesco’s 2015 full-year results show a return to pre-tax profit (just) - £163m, compared to a £6.3bn loss in 2014. That frankly horrific figure was directly caused by impairments on Tesco’s property assets, but behind that was the decline in sales and prices as German low-cost rivals Aldi and Lidl waged a successful price war against the Big Four, snatching considerable market share in the process.

Lewis has managed to arrest one of those declines – like-for-like sales finally rose (by 0.9% in the UK) in the fourth quarter to February 27 on growing volumes – but has had no such success with the other. The price of a basket of goods at Tesco is now 4% lower than last year, Lewis confirmed.

This deflation is the straight jacket that Lewis has to wear and the reason he will be unable to restore Tesco to the glories of its halcyon days. Four years ago, Tesco was posting profits of £4bn, but with the price war destroying its margins, such figures are now impossible.

Crucially, there’s no good reason to expect conditions to become more favourable in the future. Aldi and Lidl are growing their store counts rapidly, which means if anything competition is going to increase. Tesco has been thoroughly and permanently outflanked on price – unless he can come up with something new with which to tempt customers back to the shrinking middle market in which Tesco sits, Lewis will be unable to deliver anything other than negligible sales growth off razor thin margins.  

It comes back to the dilemma he faced when he first took the helm last year – brand or budget. Cutting costs has averted the crisis and is likely to remain a feature of Lewis’ strategy, but it will never be enough to regain Tesco’s lost market share. Low costs are built into Aldi and Lidl’s business models in a way Tesco can never match.  

Now that the profit loss account has been appeased, the emphasis is instead likely to fall on getting more people to choose Tesco. There are signs of it already with the launch of Tesco’s budget ‘farm ranges’, an own brand marketing device straight out the Lidl playbook.

Making a meaningful change to Tesco’s proposition will require much more than that, however – and no matter how Lewis decides to approach the problem, it will almost certainly require serious time and money, two things he really doesn’t have. ‘We have to invest in our business in a time when the market is deflating and there are some significant challenges ahead,’ Lewis admitted to the BBC.

Investors hoping for a dramatic turnaround in the near future – or more specifically a return to the good old dividend days – are likely to be disappointed as a result. Tesco stock fell 5.6% by lunchtime to 185p – up from its December nadir, but still only half what it was worth three years ago.

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