August 13, 2004

Talk with Tesco Chairman David Reid

David Reid, Chairman Tesco (photo: Tesco)
David Reid: "Don't bet against Tesco"
He would probably be the first to quibble with the characterisation.

However, quiet-spoken non-executive Chairman David Reid is generally regarded as one of the brains behind the international success story that is Tesco Plc.

Like his board colleague, Lucy Neville-Rolfe, Reid also represents a friendlier, kinder side to Tesco than some of the more hard-ball players around CEO Sir Terry Leahy.

This doesn't mean that he is any less ambitious for the company though. Reid's pose with hand on globe at head office in Cheshunt, near London, looks significant for the future: Tesco intends to conquer the world.

Rhodesian-born David Reid is quietly proud of Tesco's achievements. The 57-year-old top manager clearly feels that the UK's leading grocer has successfully contained Aldi and Lidl at home, while out-competing global retail titans Carrefour and Wal-Mart in South-East Asia. Significantly, he carefully sidesteps, but does not deny an interest in expanding the business to the US.
 
That said, Reid warns against arrogance. This particularly applies to his younger managers "because they have never known hard times or our earlier difficulties".

INTERVIEW


Mr. Reid,
Aldi and Lidl have been trying to expand in UK groceries since the early 90s. Why do you think these international successful retailers have failed to gain a meaningful market share?


I think UK retailers have made good use of their value lines against the discounters thus neutralising some of their price advantage. But I believe the real reason lies in the difference between national retail formats and consumer cultures.

France and Germany have been traditionally well-served by hypermarkets, but less so by supermarkets so discount stores could help fill that gap. But in the UK, one of its strengths historically has been very strong supermarkets.

So customers have been brought up on supermarkets and have learned to appreciate their wide range and choice, the quality of their fruit & veg, their good fresh foods, and their value for money.

So the UK consumer is different to the consumer in Germany and a number of other continental European countries where the hard discounters have been relatively successful.

One could infer from your statement that you don't rate German supermarkets that highly?

To be frank, I haven't found much of a supermarket culture on my trips to Germany, and I haven't seen the same quality of stores as those of the four leaders here in the UK. German consumers have never had much of a choice, so they've stayed loyal to the discounters there.

Tesco has now also become a very strong non-food retailer. What are the key non-food areas you intend to grow?

We came off the back of the superstore format where basically you sold mass consumable-type non-foods in a corner. The only departments that we could fit into our superstore spaces were therefore things like newspapers, magazines, cards etc.

Now that we open larger stores under the "Extra" banner and are extending some of our smaller stores, we can get much bigger ranges. For example, in clothing we now have our own labels "Cherokee" and "Florence & Fred".

But why in the UK do you have relatively small non-food assortments when compared, for example, to the hypermarkets in France?

Our hypermarkets in emerging markets do carry long rows of washing machines, TVs etc. In the UK, where space is limited, planning permission stricter, and stores generally smaller, you will see more selective ranges.

Another reason is that the UK has much more developed specialist non-food retailers on the high street such as Currys, whereas in central Europe and Asia there are hardly any at all.

How did a traditional food retailer like Tesco make a success of diversifying into non-food?

I think you have to look at the way retail was structured in the UK where traditionally non-food was sold on the High Street. The high cost of operating in British towns, due to the rates, infrastructure and logistics costs etc., obliged traditional high street retailers to charge higher prices.

Over the years, this led to many accusations about the high price of non-food retailing in the UK compared with other countries.

This created an opportunity for supermarket operators, lead principally by us and Asda, to use large new sales spaces, not for the traditionally high-margin non-food items food retailers offered in the past, but to undercut specialist retailers by 20 or 30 per cent.

It's a volume strategy not a high margin strategy.

How is this possible?

We have huge footfall running through our stores which are well-positioned on main roads and roundabouts. So people can drive to our stores and shop simultaneously for food and non-food 24 hours a day, seven days a week.

We then route these huge volumes through an efficient supply chain, which enables us to undercut our competitors' prices.

Where did you get the expertise to market non-food in your stores?

In the early years we struggled to do non-food well because we not only didn't have enough space but also lacked the same capability as we had in food.

But in the last few years we have brought in non-food specialists and built our own non-food supply chain, warehouses and systems to handle the flow of goods, and the results are excellent.

How much of the non-food you sell is sourced abroad?

A lot. We already have about 250 buyers working in seven or eight central sourcing hubs based around the world, e.g., in Hong-Kong, Shanghai, Bangladesh, Turkey etc. and all the countries we operate in have now access to this sourcing model.

Are you satisfied that that your operating profits from international operations are increasing fast enough in relation to the cap-ex they require?

Returns are pretty much on track overall and our returns are increasing, although obviously they are faster in some countries and slower in others.

There is no retailer in the world that has been able to deliver the level of international annual cash profits within the time we have, despite a number of unexpected issues along the way.

We like to remind investors that it took us 40 years to build our current business in the UK. I expect that it will have taken us 15 years to develop an equally good business internationally.

Where do you see the limits to your international growth?

The name of the game now is not necessarily the number of extra countries we want to be in, but about delivering returns in the countries where we already are. In other words, we must add volume in order to get better buying terms and also increase efficiencies by reducing costs.

So you will see a further increase in the operating margins of our international operations.

Ahold once came a cropper, among other things, through ambitious international expansion. How in retrospect do you view the crash they had?

They were almost obliged to take on a lot very quickly because Ahold was more of a financial engineering unit than a food retailer. They used their rapid growth to give them a PE ratio which they then employed to acquire other companies. The result of these acquisitions then gave earnings accretion.

In fact, they had to move fast on the acquisitions trail because they needed more and more to maintain their earnings growth.

Ahold was not what we should call a food retail trader; it was a financially-geared company involving rapid and increasingly large acquisitions. So for a period of time it was successful.

Why do you think you will be better able to resist the temptation of not biting off more than you can chew?

At Tesco we've deliberately rationed ourselves as regards organic growth. We've limited the number of countries we've expanded to, but gone fast in the countries we've entered so as to maximise the speed with which we gain significant, and hopefully leading, market share.

Rapid growth helps us to become more efficient and attain profit more quickly. We've never said: “We've got to have 25 countries by date X!”

Instead, our decision is based on which countries we think our model can work where we can focus our capital expenditure and management resources.

What criteria have to be met before you consider entering a new country?

When there is not a lot of modern retailing in the country concerned and Tesco looks able to obtain a strong market position, when the target country is sufficiently large and has an adequate infrastructure, and when political and corruption risks are at an acceptable level.

To what extent does your policy of rapid expansion after entry in each new country oblige you to make rapid acquisitions?

Our business strategy is essentially incremental so we don't do any large acquisitions. In fact, I think our acquisition of “Hit” in Poland was the biggest we have ever done in the international market.

But don't you think you overpaid for “Hit” on a market where you were struggling to lift like-for-like growth?

We paid a full price for a strategic position to become hypermarket leader in Poland. We are already one of the few people who make any money in Poland, and I think that we shall make a lot more over the next few years.

What is the minimum size you need to be successful in a foreign operation?

I think it is more about capability than size, in other words, what the retailer does when you actually get to a country and how you perform to your customers. You have to have some scale to get a viable economic unit.

There are some countries we enter where we think we need 15 stores as a bare minimum, but ideally 20 to 25 hypermarkets are needed to support our distribution and to let the economic model make a return.

You do need some scale in our business, but it's more about know-how, how you look after customers, what your customer processes and HR policies are, and how you manage people to ensure success.

Would you ever consider entering Germany or returning to France?

One should never say “never”, but I think there must be very few retailers who would be queuing up to go into Germany.

Also, I should be surprised to see many foreigners entering France in a big way because you can't grow through building stores there, so it's very difficult to make returns when you have to pay stock markets the sort of premiums they demand for acquisitions.

Would you just stand by if Wal-Mart was to buy Carrefour?

We have proven we can compete with Wal-Mart at home and abroad. In fact, we've grown faster since they've arrived in the UK. Our experience is that competition usually makes you a better retailer forcing you to react and become more competitive.

This was one of the reasons why we took an international strategy. We knew that sooner or later we were going to have to compete with people arriving in the UK, and sure enough they did. So we had to learn pretty quickly how we could compete both at home and abroad, and we have.

How do you rate Wal-Mart and Carrefour as international competitors?

We respect both of these competitors, but are not frightened of them. If you look at where we compete head-to-head with Wal-Mart or Carrefour in a variety of different countries, in most cases we take more money per store than they do. So it's not about size, it's about capability.

If you've got capability, you get more customers in your stores than your competitors. Just being big is no guarantee for success.

One should remember all the propaganda in the media that Tesco was on the shelf etc. when Wal-Mart entered the UK. However, the main thing is that it's customers who decide, not analysts or pundits. So at Tesco we're not put off, and, if I were you, I would never bet against Tesco.

How does Tesco regard the increasing global concentration of retailing and its role within that process?

It's important to remember that there aren't huge buying synergies across borders. Retailing is still a local business, and how well you perform in a country depends on the efficiency of your national supply chain, so cross-border synergies are small.

Therefore, if you're obliged to pay premiums on acquisitions, what is going to pay for the premium?

Where are you going to get the return from? There has been so much talk about international mega-mergers, but what actually happened? Very little!

But how about the Carrefour/Promodès and the Morrisons/Safeway deals?

Both examples prove my case. The merger between Carrefour and Promodès was essentially an acquisition within France.

It was trumped up in the media as a great global event, but in reality it was nothing of the sort, it was an in-market acquisition, where there were indeed great efficiencies and synergies to be gained.

The same applies to the Safeway/Morrisons deal. The synergies were huge, but they will be purely internal UK ones.

How do you react to media criticism blaming the buying power of Tesco and other major international retailers on the demise of regional independent operators?

I see no reason why independents and regional multiples can't buy well. They tend to blame buying power, but as Morrisons have shown when competing with Tesco, you can be relatively small and still buy well.

Morrisons were once regarded as a small regional player, but when one looks at the facts they bought as well as anyone else did.

However, if smaller companies base their model, for instance, on high-service, high-price, American-style supermarkets, that is absolutely the wrong thing to be in today's mass markets.

Contemporary customers say they want quality food and increasingly good service, but aren't prepared to pay for it. So that means that even small operators must have a very efficient supply chain, buy well, and run very efficient store operations.

If smaller operators don't make their supply chain efficient, don't get their central warehousing working, and run stores full of labour points taking little money, then they are in for trouble.

In view of your continued success over the years how do you fight against becoming arrogant?

You need to be quite arrogant and confident when dealing with people who think we should just lie down and die because Carrefour is in more countries and Wal-Mart is bigger than we are. That said, we always respect one's competitors.

We stress this particularly to our younger managers because they have never seen hard times or experienced our earlier difficulties. Happily it's not commentators or analysts who decide these matter; it's customers!


Related article in German: Interview by Mike Dawson in
Lebensmittel Zeitung, no. 33, 13.08.2004


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