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Tesco's era of rolling out its aisles is over, for now Tesco's era of rolling out its aisles is over, for now
(5 months later)
The shocking part of Tesco's £1bn loss on exiting its US Fresh & Easy business – really a loss of about £1.5bn in cash terms over the life of the adventure – is that management waited so long to admit defeat. Fresh & Easy was billed at launch, in 2007, as a low-risk way to test the US market. But weak initial results on the west coast did not lead to the obvious conclusion: that Tesco had got its homework wrong and made a bad bet.The shocking part of Tesco's £1bn loss on exiting its US Fresh & Easy business – really a loss of about £1.5bn in cash terms over the life of the adventure – is that management waited so long to admit defeat. Fresh & Easy was billed at launch, in 2007, as a low-risk way to test the US market. But weak initial results on the west coast did not lead to the obvious conclusion: that Tesco had got its homework wrong and made a bad bet.
The company rationalised failure as the temporary influence of recession, and made a few tweaks to the format such as fitting doors to fridges and softening the utilitarian look of the shops. But none of the changes suggested the business would achieve the hoped-for sales densities within a reasonable time horizon.The company rationalised failure as the temporary influence of recession, and made a few tweaks to the format such as fitting doors to fridges and softening the utilitarian look of the shops. But none of the changes suggested the business would achieve the hoped-for sales densities within a reasonable time horizon.
Sir Terry Leahy should have pulled the plug before he departed as chief executive in 2011; and it should have been the first act of his successor Philip Clarke. There was nothing wrong with the original idea of spending £250m to experiment – big international retailers have to take a few risks. The mistake was to lose the equivalent of 15 months worth of shareholders' dividends.Sir Terry Leahy should have pulled the plug before he departed as chief executive in 2011; and it should have been the first act of his successor Philip Clarke. There was nothing wrong with the original idea of spending £250m to experiment – big international retailers have to take a few risks. The mistake was to lose the equivalent of 15 months worth of shareholders' dividends.
The harder-to-measure cost of the misadventure is the effect on the rest of the company. Was it coincidence that Tesco UK went off the boil as the US pain was most intense? Probably not. The UK business, it now appears, was milked too hard to meet the City's profit expectations in the face of US setbacks.The harder-to-measure cost of the misadventure is the effect on the rest of the company. Was it coincidence that Tesco UK went off the boil as the US pain was most intense? Probably not. The UK business, it now appears, was milked too hard to meet the City's profit expectations in the face of US setbacks.
Clarke's repair job amounts to a fundamental rethink, as evidenced by the hefty 8.3% decline, to £2.27bn, in UK trading profits. Tesco can point to high scores on customer approval ratings as its pours in £1bn of investment, but the open question is whether the old profit margins can be restored. Again, probably not.Clarke's repair job amounts to a fundamental rethink, as evidenced by the hefty 8.3% decline, to £2.27bn, in UK trading profits. Tesco can point to high scores on customer approval ratings as its pours in £1bn of investment, but the open question is whether the old profit margins can be restored. Again, probably not.
Margins peaked at 6.2% in 2010; today, Tesco reported 5.2%. The difference doesn't sound vast but when turnover is £43bn, a percentage point matters. The arrival of online shopping – which, with current delivery charges of £5, is painful for supermarkets – suggests Tesco will have to learn to live with lower margins.Margins peaked at 6.2% in 2010; today, Tesco reported 5.2%. The difference doesn't sound vast but when turnover is £43bn, a percentage point matters. The arrival of online shopping – which, with current delivery charges of £5, is painful for supermarkets – suggests Tesco will have to learn to live with lower margins.
Easy profits from property are also history. Official confirmation that the "space race" is over came in the form of an £804m writedown on the landbank. Not building new hypermarkets means fewer sale-and-leaseback transactions, and thus profits from property development in the UK will tail off to zero.Easy profits from property are also history. Official confirmation that the "space race" is over came in the form of an £804m writedown on the landbank. Not building new hypermarkets means fewer sale-and-leaseback transactions, and thus profits from property development in the UK will tail off to zero.
The non-US businesses are a mix of the good, the bad and the ugly. In the good camp are Korea, Thailand and Malaysia, where returns on capital employed are about 15%, close to UK levels. Eastern Europe, hit by recession, has fallen below 7%. And Turkey, China and India, the main development markets, are still recording losses.The non-US businesses are a mix of the good, the bad and the ugly. In the good camp are Korea, Thailand and Malaysia, where returns on capital employed are about 15%, close to UK levels. Eastern Europe, hit by recession, has fallen below 7%. And Turkey, China and India, the main development markets, are still recording losses.
The Chinese story is the most startling. In 2010, Tesco put a smoggy Chinese skyline on the front cover of its annual report under the title "a business for a new decade". On current form, though, it won't be this decade. Expansion plans have been reined in, like-for-like sales are going backwards, and Tesco grumbles about too much capital (foreign and local) chasing Chinese consumers.The Chinese story is the most startling. In 2010, Tesco put a smoggy Chinese skyline on the front cover of its annual report under the title "a business for a new decade". On current form, though, it won't be this decade. Expansion plans have been reined in, like-for-like sales are going backwards, and Tesco grumbles about too much capital (foreign and local) chasing Chinese consumers.
Is this the end of the Tesco success story? No. The first fall in profits for two decades is a major event, but the empire is not about to crumble. Overall returns on capital – ignoring the US disaster, the UK property hit and other "one-offs", such as the PPI mis-selling bill and the goodwill charge in eastern Europe – are still 12.7%. That's a healthy base, and Clarke is promising 12-15% in future.Is this the end of the Tesco success story? No. The first fall in profits for two decades is a major event, but the empire is not about to crumble. Overall returns on capital – ignoring the US disaster, the UK property hit and other "one-offs", such as the PPI mis-selling bill and the goodwill charge in eastern Europe – are still 12.7%. That's a healthy base, and Clarke is promising 12-15% in future.
But the Leahy era of go-go expansion on all fronts is over. In Clarke's world, capital allocation is paramount. It makes for duller, slower growth. But, after a year in which Tesco brought out all its dirty linen, that's the only approach shareholders would tolerate.But the Leahy era of go-go expansion on all fronts is over. In Clarke's world, capital allocation is paramount. It makes for duller, slower growth. But, after a year in which Tesco brought out all its dirty linen, that's the only approach shareholders would tolerate.
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