A little local difficulty

The Co-operative Group reported lacklustre interim results last week and chief executive Peter Marks described the retail environment as the worst he has seen in 40 years.

His comments are echoed by many in the industry as the tough economic environment continues to pile pressure on retailers. But is the climate the only reason for the Co-op’s woes? Or has the mutual struggled now it is playing with the big boys?

Three years ago the Co-op set out a three-year plan to overhaul and modernise the business, and the £1.6bn acquisition of Somerfield was billed as a “transformational deal”.

Marks said at the time that the buy would “cement our position as the UK’s premier community retailer” and “help us significantly as we lead a renaissance of the Co-operative brand”.

When it reported full-year results earlier this year Co-op said it had hit all its internal targets and delivered record profits and sales. However, Marks warned then that he did not expect growth to continue at the same rate because of the difficult climate, and last week his predictions came true.

Co-op, Britain’s fifth biggest food retailer suffered a 10% fall in group underlying profits to £275.1m in the 26 weeks to July 2. Operating profit at the food business fell from £171.6m to £135.4m, while sales were down 4.6% to £3.7bn. Food like-for-likes slid 3.6%.

Marks, who has worked through
the recessions of the 1970s, 1980s
and 1990s, said that the difference this time is that shoppers are spending less on food.

“It’s not a surprise given the dramatic squeeze on income and confidence,” says Marks. “Shoppers are seeing the prices of their houses going down, inflation on things such as fuel and energy hit disposable incomes and the middle to lower demographic is under tremendous stress in their finances. All that means of course is they are spending less in areas that are normally protected.”

Neil Saunders, consulting director at Verdict Research, agrees with Marks’ sentiments that consumer spending has softened and points out: “Co-op is a little more exposed to the economic vagaries as a lot of its customers are older and more downmarket. They tend to be less mobile, less affluent and those people are feeling the squeeze more.”

But he adds the caveat that its performance is not all about the trading climate: “Co-op still needs to up its game to compete,” he says. “It is local and convenient but it has to be more compelling so people want to shop there rather than just do it out of necessity.”

Time to change

Co-op has been busy since the acquisition of Somerfield, rebranding and integrating the businesses. While sales suffered more last year at some former Somerfield stores after rebranding than Co-op had planned for because of integration problems, the deal gave the community retailer the firepower to compete more effectively.

Last week, Marks declined to give sales figures for converted Somerfield stores. He said he is “satisfied” with the shops, “but it will still take time”. He maintained that the modernisation of the business is on plan and pointed to the investment Co-op is making as a sign of ongoing progress. The group as a whole invested £280m in the first half. In the food business, two new distribution centres opened and two more are in the pipeline – altogether a £110m investment.

Marks says: “We’re very optimistic about the future. We don’t have to worry about sales fluctuations as we don’t have shareholders to answer to. We’ll continue to invest in our business for the long term.”

Co-op has also invested in its ranging. Top-end range Truly Irresistible was relaunched earlier this year and expanded by 50 products to 450. Sales in the first three weeks of the relaunch were up 30% year on year. The grocer also introduced Eat-in, along with new own-brand Free From range, and a new Wholefoods range.

Co-op finance director Steve Humes says: “We are seeing shopping behaviour polarising so there is a switch to value products but at the other end sales of premium products are also selling well. Our ethical ranges, which include fair trade, are up 8% year on year, and we will continue to stay true to our ethical heritage.”

Bryan Roberts, director of retail insights at Kantar Retail, says: “Co-op has done a lot of work in private label and seen strong growth in its premium range, and decent headway in its fair trade products. This along with its work on supply chain and availability has meant it is a marked improvement on its former self.”

Co-op said that in 2009 and 2010 its new product development work was put on hold while much of the integration was carried out, but it is now “firmly back on the agenda”.

Getting the prices right

Pricing is one area which commentators believe the Co-op needs to work on. Roberts says: “The food business is all about scale and therefore the Somerfield deal needed to happen for Co-op to be a big player, but that scale does not yet seem to have translated into buying power and prices.”

He says in some areas such as confectionery and impulse, Co-op has the clout to be able to offer good prices, but because most of the stores are not destinations for big weekly shops, other products will always be more expensive.

Roberts adds: “Co-op has a strong message on localness, and a cracking c-store estate rivalled only by Tesco, but has a long way to go on price perception. Paying a premium for products in a local store is not unique to Co-op, but in general the shopper perception is that Co-op prices are even higher.”

Saunders believes the Co-op offer does not yet warrant premium prices. “You are paying premium prices but not in a premium store environment, or premium customer service,” he maintains. “The prices are out of kilter and if customers have another local shop nearby that they can compare with, then they might well become a little bit resentful of Co-op’s prices, especially on branded items.”

Marks, however, is bullish about Co-op’s pricing. “We’re confident with our competitive position. We monitor accurately what the market is doing and are very aggressive in our promotional stance. I don’t think our price position is not as good as the competition.”

Saunders says Co-op needs to “make some tactical moves” in the tough climate in order to sustain growth. “The big four are all under pressure from each other and the climate but the Co-op has not yet had any serious impact and instead has seen growth stall,” he says. “Most of the big four are seeing growth of some description, and still growing on large turnovers, so Co-op needs to be more clever if it wants to keep up.”

Value for money

The Co-op’s ethical stance is a key part of its business, but Saunders says, it “should not be the be-all and end-all”. He says: “Ethical should provide added value once the main proposition is in place. Ethical is great to have but you need to get your house in order first to pull in the customers.”

Roberts agrees: “At the moment it is all about value not values, so Co-op’s ethical stance won’t resonate as much as it would like. However, it will stand them in good stead in the long term.”

Despite Marks’ claims that the whole market is down, Shore Capital analyst Darren Shirley says its trading statement shows it is “the weakest out there” at present. He says: “The overall market is bumping along at about 1% to 2% up so Co-op does seem to have suffered more than most.”

Marks, however, claims he does not care how Co-op fares against the big four: “We don’t focus too much on league tables. We’re growing the business, we’re continuing to invest, we’re modernising. If all that means we can move from fifth place to fourth then great but we’re just investing for our future.”

He is also adamant there is much more to do in the business. Supply chain systems and processes are being modernised at present, which Co-op admitted does bring some in-store disruption but it is expected to be ultimately beneficial. “We’re not in this for the short term,” says Marks. “Everything we do is for the long term.”

Co-op has made headway modernising, while also progressing with the integration of Somerfield, but it has some way to go to be a challenger to the big four.

As Morrisons’ acquisition of Safeway showed, integration is never as easy as retailers might originally think. However, Morrisons was improved and is now going gung-ho for growth. Co-op may eventually take a similar path.