August 31, 2017

Chairman John Allan talks the new Tesco

Tesco Chairman John Allan (photo: Mark Mackenzie)
Mark Mackenzie
John Allan: "Tesco has gone from being a bit of a sinner to being exemplary"
Some encouraging figures of late should not make one forget that Tesco was in crisis mode only three years ago after a balance sheet scandal rocked the retail icon to the very core. Unilever manager Dave Lewis was catapulted in as CEO and chief trouble-shooter, but soon had to announce a massive property write-down as well as one of the largest annual losses in UK corporate history.

Among the first events of his tenure was the Tesco Board's appointment of Dixons executive John Allan as Chairman. Since then, the management duo have presided over an impressive turnaround at the UK's largest grocer by sales. An overgrown assortment has been pruned, the vast store base streamlined, and, above all, consumer end prices sharpened.

Tesco's latest quarter reveals the strongest growth at home since 2009 and a positive trend for the sixth season in a row. But the market leader with annual net revenues of €57bn is challenged as never before on its own turf by the German discounters and Amazon Fresh. Your call John...

Aldi and Lidl are growing in popularity with local consumers, while Amazon Fresh has been extending its online home delivery service from London over the last year. The challenge to and Tesco's physical stores will only increase long-term now that Amazon has purchased US organic retailer Whole Foods, which also runs nine outlets in London.

Add to this a generally heavily-stored market and a post-Brexit inflationary environment, where higher input costs cannot easily be passed on to the consumer during a price war with Aldi and Lidl, and you don't exactly have either much operative margin or a joyous scenario for your shareholders.

So how does the Tesco C-suite intend to deal with these issues from the new corporate HQ in Welwyn Garden City?

"We've changed!"

Tesco Chairman John Allan (photo: Mark Mackenzie)
Mark Mackenzie
John Allan
Mr Allan, CEO Dave Lewis was parachuted in as a trouble-shooter to a crisis-torn Tesco in August 2014. Since then, he has earned the soubriquet 'Drastic Dave'. How would you rate his performance to date?

Very highly indeed; I think he has done an outstanding job, although he would be the first person to say that it has been a team effort. Notwithstanding the nickname you have used, he is very thoughtful about what he does and would be the last person in the world to make short-term decisions.

He has taken the company to a new business stage after it was negative on virtually every parameter, whether by sales volume, number of customers or by standing with customers and suppliers. All of these have not only been stabilised, but reversed under his tenure.

So why is your share price still roughly where it was when Dave Lewis took over three years ago? Doesn’t this mean that financial markets lack faith in him?

The share price depends on the balance of opinion among analysts and on the buying and selling behaviour of shareholders. Also external events, such as Amazon’s intended purchase of Whole Foods in the US, have  an impact, even when they are unlikely to have any impact on the UK market in the short-term.

But what matters is the long-term value of the business, which is what we are focussing on. Otherwise I wouldn't have put my money where my mouth is. Every penny that I have earned from Tesco since I have become Chairman has been invested in either Tesco shares or bonds.

Also, I wouldn't have taken on the role of leading the Board and supporting what Dave is doing, if I wasn't confident that this is a business with a great future.

You have just recorded your best UK quarterly performance since 2009, but Tesco is still very far from the pre-tax earnings of £3.8bn achieved in 2010-11…

The whole market has changed, as have other markets I have been in. There are periods in the life of markets when people can make extraordinary amounts of money, which are not really economically justified.

Those days are over for everyone because the market has become much more competitive. Nobody in the future will make the nearly 6-per-cent operating margins that Tesco and J. Sainsbury enjoyed in the past.

Tesco Chairman John Allan (photo: Mark Mackenzie)
Mark Mackenzie
"Nobody in the future will make the nearly 6-per-cent operating margins that Tesco and J. Sainsbury enjoyed in the past"
So shouldn't investors avoid the sector altogether?

Supermarket businesses can still be very attractive economic entities. When they are properly run, they are very cash-generative. You may have a lower aspiration in terms of operating margin now, i.e., 3.5 to 4 per cent by 2019/20 as opposed to 5 or 6 per cent historically, but that will still allow us and others to earn very satisfactory returns on capital employed.

Why then haven't these translated into big jumps in net profit?

You've got to decide what your priorities are, and ours are not first and foremost improving profitability. The reality is that we could have pushed profits up faster, if we hadn't made our offer more and more price-competitive. So we've been striving to reinvest quite a lot of the benefits which we have obtained from cost reduction.

This is because it is the consumer who determines whether or not we are successful, and competitive pricing is one of the factors that have helped us rebuild our relationship with British shoppers.

How strongly have you reduced prices?

If you take the average price of our three major supermarket competitors, J. Sainsbury, Asda and Morrisons, Tesco would be below that. The gap between us and whoever happens to be the cheapest in any particular week or month is very small indeed – at most a percentage point or two.

John Allan, Tesco Chairman (photo: Mark Mackenzie)
Mark Mackenzie
"Our stores still offer an Aladdin's Cave of choice and variety"
But the real price challenge comes from German discounters Aldi and Lidl. What is Tesco's strategy to stop them?

We can play to our strengths in, for instance, range, health foods, and own label fresh food. Here we can show a tremendous amount of product innovation. Only last week we brought in egg-sized avocados from Spain in packs of six which are peelable by hand.

We have also introduced 'Farm Brands', which are attractively packaged, but at one price tier below our conventional fresh food private label. So we are now very price-competitive with the discounters and are reducing market share losses to Aldi and Lidl.

So why are Aldi and Lidl still growing in the UK?

They are still growing overall, but mostly this is through adding a lot of extra space. Unlike the rest of the industry, they don't publish like-for-like sales figures. We know from our research that Tesco is not only reducing the erosion of market share to the discounters, but also starting to win customers back from them.

You also cite range as one of your trump cards vis-à-vis the discounters, but you have reduced your assortment by about a quarter over the last three years…

You wouldn't think it, if you went into our stores, because they still offer an Aladdin's Cave of choice and variety. So we have retained the width, if not depth, of our assortment while reducing product duplication, complexity and therefore cost.

Tesco Chairman John Allan (photo: Mark Mackenzie)
Mark Mackenzie
"We are now very price-competitive with the discounters and are reducing market share losses to Aldi and Lidl"
But isn't the whole business model of a UK supermarket retailer like Tesco based on the commercial income obtained from supplier slotting fees?

No, not any longer because we have radically simplified our approach by moving to reduce the number of ways we take commercial income from 24 to only five. All our suppliers' payment terms are published online, and you can see their feedback in the reports from the Groceries Code Adjudicator. So Tesco has gone from being a bit of a sinner in that direction to being exemplary.

Amazon Fresh has been one year in the UK and will probably complete its purchase of US organics retailer Whole Foods, along with its nine British outlets, at the end of this year. Will it be a game-changer?

It is way too early to tell. It is clearly a significant step for Amazon and will transform its internet-only model to one combined with retail stores. We don't know quite why they have bought Whole Foods, and they haven't made their reasons for doing so clear. Is it about the distribution system, the supply chain, or the brand? Who knows?

They certainly still need to master the supply chain when it comes to fresh produce. I suspect there will be a transition period where they will work out what they are going to do with the business.

In the meantime, Tesco will continue to combine internet shopping with physical retail, and is not waiting to see what Amazon may or may not do. Only a few weeks ago, we announced, for example, the introduction of same-day delivery throughout the UK.

Doesn't that just increase your costs?

It may do, but the real issue is whether we get sufficient margin to compensate for it. Our belief is that our mixed model and leadership in UK home delivery groceries, where we have a market share of around 40 per cent, is satisfactorily profitable.

Tesco Chairman John Allan (photo: Mark Mackenzie)
Mark Mackenzie
"We won't be making any significant reductions in store count"
You say 'satisfactorily profitable', but your last annual report states that your online division made a below-average contribution to group operating profit?

Grocery home delivery is satisfactorily profitable, but non-food is less so because you are stocking and fulfilling a very large number of different items. Food can be delivered from a nearby store or fulfilment centre to a highly populated catchment area, so you often get very high utilisation.

In non-food, however, you might get just one order from a customer in the North of Scotland who wants a tent or something, so there are issues of scale. We are therefore working very hard on fulfilment productivity and have just opened a new national non-food fulfilment centre in Fenny Lock in Milton Keynes.

You can also use your 3,500-odd stores as fulfilment hubs, but won't these also prove a costly burden on a generally overstored UK market?

There may be some overcapacity in food retailing, but it is still considerably less than in many non-food sectors. Try comparing our business with fashion retailing! The people who have really suffered from this are the non-food retailers in secondary towns where the High Streets have been blighted. Often you will only find coffee, charity and betting shops there.

By contrast, I am optimistic because food is a fundamental human need. And Tesco has the scale and expertise to get food from the farm to the consumer very efficiently and in excellent quality.

So why have you reassigned some of your store space and closed a number of larger outlets during Dave Lewis's tenure. Will you be making any further closures?

It is true that we have closed a modest number of stores since Dave joined, perhaps around 60-odd, but we have no plans for any material number of store closures. I say material because with our large store base there will always be a handful of outlets that come to the end of their lease and where it is a convenient point to exit.

But we won't be making any significant reductions in store count. In fact, we are still opening convenience stores every year and will also open larger stores where we think the opportunity exists.

Tesco Chairman John Allan (photo: Mark Mackenzie)
Mark Mackenzie
"The redundancies are also a consequence of our simplification of the business. We simply didn't need all the people we have had historically"
At the end of June, Dave Lewis announced another big round of redundancies in the name of cost cutting. Isn't that hard to convey to your staff after announcing that results are picking up?

No one enjoys making further reductions in staff overheads, but we are acting in a very competitive market, and it is significant that Tesco's initiative has been followed by a number of our big supermarket competitors. The redundancies are also a consequence of our simplification of the business. We simply didn't need all the people we have had historically.

But these include thousands of staff who have been loyal to Tesco throughout the turnaround…

The alternative is to be uncompetitive on costs and therefore prices, which would force the business to decline in the long-run. You should also not forget that we still employ more than 300,000 people in the UK, so the number of redundancies is only a small percentage of our total workforce.

We are trying to ensure that the priority in terms of people is getting it right at the coalface. That means manning the stores adequately, which is where the customers are, and not head office where we have made most of the cuts.

Tesco's new HQ in Welwyn Garden City (photo: Tesco)
Tesco's new HQ in Welwyn Garden City
The Daily Mail, the UK's largest national daily by circulation, writes that David Lewis 'was handed £142,000 to help him move around 35 miles from London to nearer…head office in Welwyn Garden City.... This was doled out even though the commute is around an hour, houses are a quarter of the price and Mr Lewis…earned £4.2 million last year.' Any comment?

Let me talk the facts: Dave left a very promising career at Unilever to join Tesco in 2014, a few months before me. This relocation allowance was part of the deal negotiated between him and Tesco.

It was clear that he would have to effect a mega-turnaround and that it would be desirable for him to live very close to head office because this man doesn't just work from 9 to 5, he works, quite frankly, from dawn to dusk.

At Tesco we have a policy to support colleagues with relocation when their role requires it – the allowance Dave received follows the same principles we'd offer to anyone else, for example one of our store managers.

At the end of the day, isn't this just another fat-cat perk signed off by the Board on the recommendation of the Remunerations Committee?

Nonsense, this is a man whose first act was to sell all the company planes and to curtail all sorts of company entertainment things that had been there in the past. Tesco is a very cost-conscious business now, which is very much to Dave's credit.

Are you also satisfied with the standard of corporate governance at Tesco?

Very, we only have two executives on the Board, the CEO and the CFO, with me as Chairman and eight non-executive directors who chair the Remunerations and Audit Committees etc. So we have a majority of non-executive directors who are not involved in the day-to-day running of the business.

This complies with a fundamental requirement of UK corporate governance whereby the non-executive directors should be in the majority.

Tesco Chairman John Allan (photo: Mark Mackenzie)
Mark Mackenzie
"Food is a fundamental human need"
You have served on management boards in the UK as well as on both management and supervisory boards in Germany. Do you prefer the UK single-board or the German two-tier system?

The German two-tier system is excellent in theory, but UK corporate governance is, I believe, superior in practice. Let me give you a practical example. We have just launched a bid to buy Booker.

The project was discussed by our Board over a whole series of meetings for almost a year before we eventually satisfied ourselves, after carrying out loads of due diligence, that it was something we wanted to go ahead with. We then just pressed the button and went for it.

I don't believe this degree of scrutiny would have been easy under the German two-tier model.

Isn't your purchase of Booker just a costly distraction in terms of management time?

Absolutely not, the move is a critical part in extending and creating growth opportunities for our business. We think it is essential to get more heavily involved across the board in food in the broader sense, not just food that is bought by shoppers for their own consumption, but food as it is distributed by restaurants, caterers and so on.

How does Tesco view Brexit?

Personally, I voted to stay in the EU and still believe that would have been the right decision. But both Remainers and Brexiters got it wrong in predicting dramatic consequences in the short-term. I believe that the impact for good or ill will be felt gradually over many years rather than instantaneously.

Obviously no one knows at the moment quite how Brexit is going to work out because we are only at the beginning of a series of negotiations, which need to take place by March 2019. We are working hard to provide whatever input we can to the government in terms of how to handle some of the complex issues involved.

One example would be Ireland where we are market leader in the north and joint-market leader in the south.

Tesco Chairman John Allan (photo: Mark Mackenzie)
Mark Mackenzie
"The last person who thought he could resist price increases was King Canute"
Some of your suppliers are pushing for better terms to offset the higher input costs caused by Brexit-induced currency weakness in the pound. Will Tesco raise its prices in order to accommodate them?

We will do what is right for our consumers, but we haven't put our head in the sand. We recognise that sometimes there are genuine demands, which are driven by cost increases arising from currency exchange rates or other factors such as commodity prices etc.

So we are holding conversations with our suppliers as to whether the price increases involved are really justified, and what can we do to mitigate the problem in order to minimise the impact on the consumer.

Can we resist price increases totally? Of course not, the last person who thought he could resist price increases was King Canute.

Between early 2015 and mid-September 2017 Tesco will have closed 29 outlets in Poland. Tesco has also trimmed its store portfolio in Slovakia. Are these preliminaries for leaving Central Europe?

We certainly have no plans to withdraw from Central Europe. We are industry leader in Hungary and well positioned in both the Czech Republic and Slovakia. Obviously there is still room for improvement in Poland.

But we have just created a new and centralised management team for Central Europe headed by one of our very best managers who used to run our fresh food business in the UK. We wouldn't have done this had we not genuinely believed that there is scope to do better.

This interview has certainly been a lot more pleasant than some past interviews with Tesco's management…

We've changed! There is a big difference in the way we treat people today, including analysts and journalists. Now we are more than happy to discuss contrary points of view. Otherwise we wouldn't be talking today…

Lebensmittel Zeitung with digital sister (photo: LZ)
photo: LZ
Our German retail B2B newspaper, Lebensmittel Zeitung, in print & digital
Read in German: 'Vom Saulus zum Paulus' by international editor Mike Dawson on pages 33 to 35 of Lebensmittel Zeitung, no. 35, 01.09.2017

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