Jul 2, 2015
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Tesco seeks fresh start with suppliers who survive cull

Jul 2, 2015

Suppliers to Tesco can expect a better deal from Britain's biggest supermarket chain as it tries to sustain a tentative revival -- providing their wares survive a cull that is removing thousands of products from shelves.

Last week Tesco enjoyed the first fruits of a radical shake-up of its 3,000 British suppliers as new deals and changes to product ranges helped to feed price reductions that drove better than expected quarterly sales.

Chief Executive Dave Lewis faces a tough battle to rebuild trust with suppliers shattered by a 263 million pound ($414 million) accounting scandal last year.

Lewis, who joined Tesco from consumer goods company Unilever (ULVR.L) last September, is axing almost a third of Tesco's 90,000 product lines. He is focussing on securing better deals with fewer partners on best-selling items to help fund lower prices.

The plans are good news for suppliers of the most popular brands. They'll have more clarity on income and will benefit from increased shelf space and potentially higher sales volumes.

Premier Foods CEO Gavin Darby, whose company makes British kitchen staples such as Mr Kipling cakes and Bisto gravy, told Reuters he welcomed the Lewis plan.

"After 30 odd years in this industry I have rarely seen an alignment of the stars in terms of where the big retailers are going and big branded manufacturers," Darby said.

Own label suppliers and producers such as meat farmers are also seeing traditional one-year agreements extended to three or five year deals as Tesco looks to strengthen ties.

But for those who miss out, it's grim news. Notable household names no longer to be found on Tesco shelves include Rachel's Organic yoghurt, while AB Foods' Kingsmill bread returned this week after being absent since late March.


After decades of dominance, Tesco's sales and profits dived as shoppers fell out of love with its big out-of-town stores and took a shine to German discounters Aldi and Lidl which keep prices down by limiting their product ranges to about 1,500 items.

Tesco will expect suppliers to part finance its multi-million pound price cuts by trimming their own margins. In return, Lewis is offering more straightforward contracts.

The aim is to reassert Tesco's dominance of a sector in which Asda, Sainsbury's and Morrisons remain its largest rivals. Despite its problems, Tesco still has a market share of over 28 percent, compared with 16.5 percent for closest challengers Sainsbury's and Asda.

"Tesco is still the market leader in the UK and scale is very important in this industry, leading to purchasing synergies and therefore a pricing advantage," said Chris Watt, fund manager of Tesco investor Jupiter Growth and Income Fund.      

Tesco investors have so far backed Lewis, with the firm's shares up 14 percent over the last six months.

Savings, estimated at up to 1 billion pounds ($1.6 billion) by Shore Capital retail analyst Clive Black, will fund price cuts that boost sales volumes but don't hurt margins.

"This is, alongside improving store sales densities, the central component of his (Lewis') belief that Tesco UK can achieve industry average margins or better," said Black, who thinks margins of 3-4 percent are achievable after they evaporated last year.

The Lewis impact is already evident. In the last few months he has axed 30 percent of Tesco's sandwich range with space given over to top sellers and expanded sushi and salad lines. Both sales volume and value increased significantly, outperforming the wider market.

Lewis has completed 15 of 33 category reviews, culling on average 20 percent of products. The rest will take place over the next 18 months, with decisions to be made on which of 238 lines of coffee and 224 different air fresheners to keep.


In the past, Tesco's suppliers agreed deals only to be stung by tactics such as unilateral demands for funding to maintain relationships with Britain's most powerful supermarket.

Such behaviour came under scrutiny last year after Tesco's huge profit misstatement which is now the subject of several investigations, including one by Britain's Serious Fraud Office.

Historically Tesco and suppliers would agree an upfront price, known as the front margin. But Tesco also had no fewer than 24 other ways of gaining commercial income from suppliers -- the back margin.

Lewis has pledged to shift Tesco's emphasis to the front margin and by 2017 slash back margin options to three that are common across the grocery industry -- retrospective payments for achieving volume targets, payments for shelf promotions and compensation for product recalls.

Tesco still has work to do to win back the confidence of those suppliers it retains.

"(Suppliers are saying) I don't know whether they (Tesco) are going to come back and rattle the tin for back margin when they're under performance pressure at the year end," said David Sables, CEO of Sentinel Management Consultants, a firm that coaches major suppliers on how to negotiate with big UK grocers.


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