Analysis: How Tesco is tackling retail’s three most ‘significant uncertainties’

Despite hailing “strong momentum” after pre-tax profit more than tripled to £2.03bn in the year to February 26, the boss of Britain’s biggest retailer, Ken Murphy, warned that the trading landscape has become “more challenging in recent months”.

As a result of the “significant uncertainties” Tesco faces in the new financial year, it provided wider than usual earnings guidance – retail adjusted operating profit is expected to come in between £2.4bn and £2.6bn, compared to £2.65bn in 2021/22.  

The supermarket giant pinpointed three big unknowns hanging over the business, and indeed many, if not all, of its retail contemporaries, that drove the more cautious view.

It said that changing customer behaviour as the UK emerges from the pandemic, the level of cost inflation within the supply chain and the investment required to maintain prices would all affect full-year performance.   

Changing customer behaviour

Trying to ascertain the ‘new normal’ of customer behaviour has become a nigh-impossible task against an ever-changing economic backdrop.

As Murphy states, there is now “more than one dynamic” influencing how consumers shop and spend – the unwinding of pandemic-induced habits and the cost-of-living crunch. 

Some retail leaders, including Next boss Lord Wolfson, have suggested that customers have shifted back into pre-pandemic habits. 

While Murphy acknowledges the return to eating out more frequently, an increase in foreign travel and greater spending in urban convenience stores as commuters return to the office, he warns: “We definitely haven’t swung right back. I think we are halfway between the two, and the kind of cost pressures we are seeing on household incomes might slow that reversion down further – people may choose to work from home more often, they may choose to eat in more often, just to help them manage their budgets.” 

“There is definitely an intent among customers to look critically at their budgets”

It is too early to say that customers are changing their habits radically, given that increases in National insurance and energy bills will only hit wallets this month, but he insists there is “definitely an intent among customers to look critically at their budgets”. 

Murphy refers to Tesco’s trio of the Aldi Price Match, everyday low prices and Clubcard Prices that combine to drive its value message. It will “refine and sharpen that value proposition” as shopping habits change over time.  

He adds that Tesco has become “a key destination for great quality meals for tonight” having increased its focus on its ‘Finest Dinner for Two’ deal during the pandemic. In a year when restaurants, bars and pubs were shut for lengthy periods and consumers sought to treat themselves at home, sales of Tesco’s Finest premium ranges jumped 9.3%. 

Just as consumers have got used to eating out again, the cost-of-living squeeze coupled with an increase in VAT for hospitality businesses could convince many to return to lockdown habits.  

“We can see that customers are already starting to look at how they manage their budgets and they are starting to make trade-offs,” Murphy says.

“Whether that is a trade-off in terms of eating in rather than eating out – we are going to make that as great a quality experience and as affordable as possible – or if they need to trade down to own-brand or ‘Exclusively at Tesco’ products, that is a choice they will be able to make and manage their budgets as they see fit.”

One behaviour Murphy insists is “here to stay” is online grocery shopping. Although Tesco’s ecommerce sales dropped 6.5% year on year to £5.9bn, that was still 66.1% up on pre-pandemic levels. Online now accounts for 14% of sales, down 1.1 percentage points from last year, but up from 9.2% in 2019/20. 

Murphy believes online grocery shopping is now “embedded” in the consumer psyche and thinks consumers will remain “attached” to ecommerce long after the Covid-19 pandemic has passed.

As a result, Tesco is opening more urban fulfilment centres in its larger supermarkets and extending its Whoosh rapid delivery service from 200 stores to 600 this year. It is also piloting a partnership with Gorillas in three stores. 

Tesco is “curious” about the future of the rapid delivery model, particularly whether shoppers will be willing to pay a premium for delivery from a local c-store “in a world where restrictions have been lifted and customers are seeking value”.

However, Murphy says: “We think the mission is here to stay and we think it’s a mission that needs to be served by Tesco.”  

Offsetting cost inflation

Tesco flagged that the level of cost inflation it experiences in its supply chain, and its ability to offset those pressures, represent the second big uncertainty heading into 2022/23.

Murphy warns that energy and fuel prices are “as significant a factor for us as they are for everybody else” and the grocer is taking steps to strip out such costs.

In 2021, for example, Tesco increased the number of containers it transports by rail from 65,000 to 90,000 to cut down on petrol costs – and CO2 emissions. In December, it launched a partnership with DRS for a new refrigerated rail service that will take 40 lorries off the road for every journey made.  

Cost inflation is being most keenly felt in proteins, as feed costs increase “significantly”, and all products that “require a lot of energy to produce”, Murphy says. A slide in Tesco’s results presentation laid bare the impact on costs of commodities such as wheat, corn and sunflower and rapeseed oils.

Murphy reaffirms that Tesco is working closely with suppliers “to manage their input inflation” and says the retailer is “very rigorous to make sure we don’t accept any costs that would be unnecessary”. 

In some cases though, such as milk, cost inflation is proving unavoidable. At the end of last month, Tesco agreed to increase the price it pays its milk suppliers by 20%. “We felt it was the right thing to do to accept that price increase,” Murphy says. 

“I am personally very, very empathetic and close to what’s going on with our farmers and our growers. We work closely with them to make sure that, together, we manage those costs and do our very best to mitigate them.”

“We will continue to look for solutions and look for efficiencies”

Tesco boss Ken Murphy

Tesco launched its Save to Invest programme last year, with the aim of taking out £1bn of costs over the next three years from areas such as property, operations central overheads, and goods and services not for resale. In February, for instance, the grocer axed counters in 317 stores and pulled the plug on its Jack’s discount format as it pressed ahead with that efficiency drive.  

Asked whether £1bn in savings would be enough to offset inflationary supply chain pressures that have only accelerated since the turn of the year, Tesco’s finance boss Imran Nawaz says: “We announced £1bn and want to use that to mitigate cost increases, but clearly cost increases have accelerated over the last months, exacerbated by the most recent events in Russia and Ukraine. We will need to do better.

“The good thing is that efficiency and figuring out ways to keep the customer happy while becoming more efficient is in our DNA. We will continue to look for solutions and look for efficiencies.  

“What’s critical is that we continue to do as much as we can to mitigate the cost pressures to be able to offer value for our customers.”   

Investing in price

The third “significant” uncertainty for Tesco going into 2022/23 was “the investment required to maintain the strength of our price position relative to the market”. 

Murphy is pleased with the ground the grocer has made up on price over the past few years and suggests a “relentless focus on value” has established Tesco as “a destination that customers can trust to spend less on their weekly shop” – a position it is not prepared to relinquish without a fight. 

Its Aldi Price Match initiative has grown to span 650 of the most commonly purchased grocery products since it launched in March 2020 and Murphy says Aldi Prices now feature in 99% of weekly baskets that go through the tills in its supermarkets. 

Clubcard Prices, meanwhile, now account for 100% of Tesco’s promotional activity and have been extended into non-food categories and its convenience store network. 

Tesco says such initiatives boosted its value perception 483bps during the past two years, outperforming the market by 91bps during that time period. 

Murphy insists the combination of everyday low prices, Aldi Price Match and Clubcard Prices leaves customers with “fewer reasons to shop elsewhere” and trumpets: “We don’t think there is a more compelling offer in the market.” 

But as the cost-of-living crunch hits with increasing ferocity in the coming months, will customers mirror the shopping habits of the 2008/09 financial crash and turn to the discounters?   

“We’ve been really working hard to hold back the effect of inflation”

Tesco boss Ken Murphy

“We offer no reason to go anywhere else other than Tesco from a price competition point of view, and we are going to make sure you get a great quality product at that price. That is our commitment and it is unwavering, regardless of what happens in the market,” Murphy states. 

“Through the low everyday prices model, we can take away the need to go to a Home Bargains or a B&M for your household products or your health and beauty products because you’ll get them just as cheaply at a Tesco.”

Just how much will Tesco need to invest in price to ensure that remains a reality? “We just don’t know,” Murphy admits, adding that the retailer is already “in a really good position” on price versus the market. 

“We’ve been really working hard to hold back the effect of inflation,” Murphy says. “Our policy and our strategy has been to increase [prices] by a little bit less and a little bit later than the market and do our best to manage the impact of those cost price pressures on our customers - and that’s been really successful for us.”

It is not just that strategy that has proved “really successful” for Tesco – its 2021/22 financial year was, all things considered, a triumph of retail execution.

Emerging from the next 12 months with an equally impressive set of results presents an entirely different challenge, but one that Britain’s biggest retailer is preparing to tackle head-on.

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