Tesco - a tragedy in three parts

The saying “Pride goes before a fall” has its roots in ancient Greek tragedy, which was based on the inevitability of human hubris triggering retribution. Tesco’s increasingly precipitous fall from favour – with customers, shareholders and now regulatory and government bodies – is the stuff of which trilogies could be made. As this article in The Independent describes, the conditions that made it possible for Britain’s largest and best known (if not loved) retailer to overstate its first half profits by an estimated £250m arose from a widespread culture of fear, intimidation, aggressive chasing of targets and immunity to criticism at the top that has been the dark side of Tesco for decades.

In fact, as far back as 1986 Bill Grimsy, who was brought in by then CEO Ian MacLaurin as Tesco’s first ever customer services director and who later went on to run Park ‘n Shop in Hong Kong and Iceland and Wickes in the UK, described Tesco managers as “a bunch of leather-jacketed bully boys” who enjoyed terrorising those beneath them. Despite MacLaurin’s best efforts to get change such behaviour, it was already too deeply embedded and only grew worse as Tesco’s ascendance over Sainsbury (which was suffering its own period of retribution for its prior hubris) under Terry Leahy attracted hard-hitting “winners” and fueled managers’ belief in themselves and the superiority of the Tesco way. As the company’s market share, profits, international presence and share price rose continuously, so did the level of arrogance at the top, epitomised it must be said, by Leahy himself. As several Tesco insiders told me previously, Leahy’s word was God and not to be questioned. I found this for myself in a small meeting of analysts in 2008 when I dared ask whether he thought customers liked going to Tesco as much as they used to and if it might be worth investing a bit less in new stores and more in renovating existing outlets. Leahy took it as a personal affront and instead of answering the questions (whose validity has since been proven all too clearly) launched the most aggressive, condescending, and generally unpleasant  “counter-attack” I have ever been unfortunate to experience. It took me a while to realise this was the result of Leahy’s insecurity and lack of experience of being questioned, not just his dislike of City scribblers.

Leahy’s successor Phil Clarke was different but still a product of Tesco’s tough culture, having spent all his working life there. Like Leahy he was not naturally sociable and more of a loner, which may help explain why he ended up being the sole member of the management board left by the time he was given his marching orders by Tesco’s genial but utterly ineffective chairman Richard Broadbent (who it should be noted had given Clarke his full support up until the month before he was fired - we suspect shareholders told Broadbent either he or Clarke had to go).

The investigation into how Tesco managed to overstate its first half 2014/15 profits by £250m, and collapse of corporate governance along with its share price, clearly strengthens new CEO Dave Lewis’s mandate for radical change. The question is whether someone with no experience of food retail understands what needs to be done. Lewis’s recent comments about the need to change Tesco’s culture and put more staff into stores are encouraging, but one has to wonder whether he understands the importance of engaging employees at all levels, and if so whether he is capable of doing this. When Archie Norman took over a similarly disfunctional Asda in the early 1990s, he fired 70% of managers in order to break the culture before remaking it. It will be interesting to watch “drastic Dave’s” next moves and once again I can only wish him the best of British luck in what will be a truly formidable turnaround challenge at a time of unprecedented challenges for the traditional supermarket industry.

Tesco's formidable turnaround challenge

Following Tesco's latest and biggest profit warning, with group earnings now expected to be 15-20% lower than previously indicated and the interim dividend cut by 75%, incoming CEO Dave Lewis will no doubt be advised to cut prices more aggressively and take other radical measures. Price cutting is the easiest weapon to deploy in the battle for market share, but also the costliest and least effective when everyone is cutting prices at the same time. Despite the margin investment they have made so far this year, value perception for Tesco, Sainsbury and Morrison has continued to decline, in both absolute terms and relative to the hard discounters Aldi and Lidl. This is partly because the relative gap hasn’t moved that much and partly because it is very difficult for mainstream full range supermarkets to match the value for money that the limited range discounters’ own label provides.

Tesco’s main problem is customer satisfaction, which started declining before Terry Leahy left as CEO due to under-investment in staff and stores and continued throughout Phil Clarke’s tenure, reaching record lows today. People just don’t like the experience, it’s too bland and the staff attitude is too variable. Meantime the shift to online shopping adds more cost than it does incremental sales; Tesco’s share of the online market is nearly 50%, double its offline share. Yet that hasn’t helped stop erosion of its market share and profits. As we said in a previous blog, the changes Clarke was trying to make, notably adding staff and renovating stores, were along the right lines but far too incremental. You don’t escape a tidal wave created by a perfect storm of change by taking small incremental steps. So Tesco’s new CEO should heed calls to take much bigger bolder action.

Fundamental change is needed in three areas. First, Lewis needs to address Tesco’s culture, which is too siloed and still retains a bully-boy element that keeps good people down. Archie Norman’s turnaround of Asda and Justin King’s of Sainsbury were primarily cultural turnarounds. This is by no means easy and takes time, but is crucial in such a people-intensive business.

Second, Tesco store staff at all levels should be trained and empowered to be able and willing to advise customers on how best to choose, prepare and store food –i.e., actually sell food, instead of just sticking commodities on the shelves and letting customers fend for themselves. Consumers, especially the less well-off, desperately need help in figuring out what’s good for them and what’s not, and on how to prepare healthy, tasty meals easily and cheaply. Stop treating staff as robots or they will be replaced by robots (Amazon’s or Ocado’s). Take note of the fact that the food retailers that spend the most on their staff actually end up being the most profitable. 

Third, Tesco needs to find a way to address the elephant in the room – i.e., that the cost of serving online customers is eating into overall profits, and that this problem will only worsen as the online market grows, as picking is shifted from stores to “dark stores” that add incremental cost but minimal incremental sales. Solving this dilemma will require true out of the box thinking and testing new models and formats that combine the best of the online and in-store experience.

It will be a formidable challenge, especially given Lewis’s lack of food retail experience and the ineffectiveness of Tesco’s chairman Sir Richard Broadbent, who it could be argued should share some of the blame for Phil Clarke’s failure to stop the rot in his three and a half years at the helm. It will be interesting to see how Lewis approaches the task. In the meantime, I can only wish him the very best of British luck. 

Pouring oil on the fire

On holiday with friends in Tuscany recently I was struck by how little is generally known, even by professed foodies, about a product that has been used in regional dishes for thousands of years, and in recent decades increasingly throughout Western Europe - olive oil. Many people I've talked to use extra virgin olive oil to cook with, thinking it is healthy - which it is most of the time. However, extra virgin olive oil has a relatively low smoke point, which means it oxidises at medium to high heat, producing potentially toxic by-products and carcinogenic free radicals. Non-virgin olive oil - i.e., that which has been extracted by chemical means and/or has been more refined - has a higher smoke point but contains less healthy fatty acids and anti-oxidants that help "mop up" free radicals. On the other hand coconut oil, being high in saturated fats - which contrary to received wisdom recent studies suggest have no clear causal link to heart disease - is much better for high-heat cooking methods like frying. In fact, unrefined coconut oil has actually been shown to improve cholesterol and blood lipid profiles and has anti-bacterial properties. Clarified butter (made by heating ordinary butter and removing the milk solids that rise to the top) is also good for frying and can help the body absorb healthy nutrients. 

How is it that those responsible for selling basic food products such as olive oil and butter - i.e., supermarkets - don't advise customers on how to use them properly, even when misuse may be harmful to the health? How do you think customers would react if they received advice on how to choose, use and store food from staff who are well trained, engaged and empowered? Surely they would want to come back to that store more often, and tell all their friends about this cool new type of store that ... actually sells food, instead of just putting commodities on shelves and letting customers fend for themselves. 

A new meaning for customer service

Last week I was in the US attending the FMI Connect conference, where I was presenting on the challenges and opportunities arising from the growth of online grocery shopping (http://www.progressivegrocer.com/industry-news-trends/trade-associations/live-fmi-physical-retail-digital-world?cc=10). I also took the opportunity to visit several stores in the Boston and Chicago area, including Aldi, Stop & Shop, Demoulas/Market Basket, and Wegmans. What struck me was that, with the clear exception of Wegmans, I got better service from other customers than from store employees. From offering product suggestions and cooking tips, to discounts using their loyalty card, other customers were far more forthcoming, helpful and knowledgeable than the staff I saw in the stores.

Now, one can't expect much in the way of service from a limited-assortment operator such as Aldi, whose prices for comparable quality products are 20-30% below regular full-range and "service" supermarkets. However, at the Stop & Shop I visited there were virtually no staff visible, or customers for that matter. This might be due to its location right next to a Market Basket store, where there were plenty of both. However, the staff I encountered at that store, including those wearing "Here to help" badges, ranged from poorly informed to plain rude. This might have just been a bad day or bad store within the Demoulas chain, but it is not so dissimilar to my experience at the average Tesco store, the UK "leader" as measured by market share. The experience I had at Stop & Shop and Market Basket made me appreciate the Wegmans experience even more, especially the guy I met in the produce area who let me try some rambutans on the spot, took me over to the prepared foods area to show me his favourite dishes, and talked proudly of the training he gets, which includes tasting lots of what is sold in Wegmans. 

The point here is simple: treat your staff as robots and they will act like robots. However, given pure online retailers such as Amazon and Ocado are now using robots to crack the logistical challenges of fulfilling online orders, and that it is easier to build mechanical robots than change people and culture, brick and mortar grocers need to start redefining the meaning of customer service, as a matter of urgency.

Hello Fresh ... Amazon?

This week I received my copy of "Contagious", a new book about the importance of word of mouth in the digital age, which I bought from Amazon (and will be the subject of a future blog). As expected, the book arrived exactly when I was told it would. What I didn't expect was the accompanying £25 voucher from a company called Hello Fresh, which offers weekly home deliveries of the exact ingredients required to make healthy, tasty recipes. Turning to their website http://www.hellofresh.co.uk/versus_supermarkets/ I found that Hello Fresh claims to offer these meal ingredients for 20% less than the major supermarkets, as a result of having no store overheads and sourcing direct from local suppliers (including a high quality butcher, fishmonger and greengrocer). Furthermore delivery, which generally costs between £1 and £6 at Tesco, Asda, Sainsbury or Ocado, is free at Hello Fresh.

These financial incentives, together with my personal and professional curiosity, were more than enough to prompt me to place my first order for a total of six meals, costing £39 (before application of the £25 voucher). The order is due to arrive in a couple of weeks' time, when I'm back from a business trip, and I'll be posting an update on the experience then. In the meantime, this is worth highlighting as another example of how online is fragmenting the grocery shopping experience and enabling new companies to tap consumer interest in nutritious, tasty and easy-to-prepare meals, and reducing waste, better than many supermarkets.

However, what I find particularly interesting here is the role of Amazon. When I called Hello Fresh to enquire about this, they said Amazon's role is limited to marketing, as part of the Amazon Local service, which sends subscribers daily deals from merchants in their local area. Delivery is handled by Hello Fresh, using couriers. One has to wonder though what benefits Amazon may be getting in terms of understanding the market for fresh food delivery in major UK urban areas such as London, and how the partnership with Hello Fresh and other similar ventures could develop once Amazon launches its Fresh grocery business in the UK. The ability to deliver a wide variety of locally-sourced specialist foods, as Amazon Fresh currently does on the West coast of the US, is one its main points of difference vs standard brick and mortar online grocery offerings, which are still mostly limited to what's available in-store. 

Get ready to say Hello to Amazon Fresh...

Amazon set for rapid Kiva deployment - the robot race is on

As outlined in this GeekWire article Amazon recently announced it expects to have 10,000 Kiva robots operating in its warehouses globally by the end of the year, up from around 1,000 currently. CEO Jeff Bezos did not elaborate on the reasons for this massive ramp-up in automation, but a spokesperson for the company said it will not affect employment levels or the rate of hiring in the warehouses. 

This move towards goods-to-picker technology is consistent with reports of Amazon's plan to extend its Fresh grocery business to 30-40 US markets this year, supported by a major re-organisation of its distribution network and fulfillment model (see our blog on 21/3/14). Improved picking efficiency is an essential part of this strategy. 

Kiva, which Amazon bought just over two years ago, has a number of drawbacks compared to other existing and planned automated grocery picking systems. Most notably, it is generally only cost efficient to operate at ground level, which makes it far less space efficient than multi-level solutions used by Ocado and Tesco in the UK, for instance. Kiva's robots are also relatively slow, which limits throughput rates. However, we estimate Kiva's autonomous robots could enable Amazon to roughly triple its current pick-rates of 100-150 items per person per hour. Amazon also has the advantage of being able to deploy this technology at cost, instead of paying Kiva's high gross margin, and the ability to develop future enhancements to optimize its utility in their applications. 

So now we can see Amazon starting to execute its strategy of using Fresh to deliver more products more frequently to more people, which will justify the operation of its own delivery fleet (at least in urban areas) and hence enable it to provide next and same-day delivery at a lower cost. This will further erode one of the main advantages of physical stores - immediacy.

All the more reason for brick and mortar food retailers to start considering how to automate online order fulfillment, if they haven't already done so. The good news is that Kiva is not best in class, even by the standards of what is currently available today, let alone what is being readied for tomorrow. 

Running faster to stand still

Food retail is a fiercely competitive business that demands consistent execution of numerous complex processes in order to get the right product in the right place at the right time, at the right price. It is also very people-intensive, requiring excellent soft management skills. The growth of new channels, notably premium/natural, limited range discount and online, is starting to put even more pressure on mainstream operators' profit margins. The normal response is to accelerate existing cost-cutting, store renovation and organisational change programs.

The problem with this approach is that it prevents companies from testing or even thinking about new ways of responding to the changing market place. Managers are so tied up with the immediate demands of ensuring the basics continue to run smoothly, while attempting to implement the latest new initiative, that they simply have no time to prepare for the future. The result is an industry that is increasingly playing catch up with itself and its customers. 

Now is the time to think about how to get off the treadmill, and to reconsider a self-service model of grocery retailing that is nearly a hundred years old. This will require vision, bravery and greater appetite for risk. However, running faster just to stay still may be the riskiest strategy of all. 

How online's "endless aisle" affects balance of power in grocery market

Given the imperative for supermarkets to maximise the productivity of their limited physical selling area, it's not surprising that suppliers have to fight so hard and pay so much to secure shelf space. The downside for consumers - and inevitably retailers - is that this can lead to product ranging being determined more by suppliers' ability to pay for the space, through slotting fees or promotional rebates, than customer preferences. This problem is exacerbated when buyers and store staff are not given sufficient training or incentive to properly understand the products they are providing to customers.

A recent meeting with a small, niche producer of fresh pasta to the UK market highlighted how the balance of power can shift once the selling area constraint is removed, as is the case with pure online grocers such as Ocado or Amazon Fresh. As warehouse space is so much cheaper than retail, these operators can make specialty products available to a far broader range of customers at marginal extra cost.

As Mark Garcia-Oliver, founder and MD of The Fresh Pasta Company, says "Online unleashes the power of the product, where the success of the product is defined by the end consumer and not by the retailer." Indeed, part of the attraction of Amazon Fresh's current offering on the West Coast of the US is its extensive selection of products from local specialty food suppliers, in addition to standard grocery items. This is surely good news for consumers and small suppliers, but could present new challenges for traditional food retailers, especially those that pick their online orders from stores.