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Tesco’s Price-Hike Strategy

Jim Prevor’s Perishable Pundit, September 6, 2007

In late June we ran a piece, Tesco Launches Price War In The U.K., but now there are reports coming out of the U.K. that Tesco has a new strategy:

GOING UP: THE NEW TESCO PRICE STRATEGY

Retail giant signals an end to the cost-cutting war as concern grows over the quality of cheap food.

It was the £2 chicken that finally ended the war. When ASDA slashed the price of its birds by almost a quarter last month and began selling poultry for less than a tin of cat food, the supermarket dared its most bitter rival to match the price. But instead of accepting the challenge, Tesco has surprised the industry by claiming the moral high ground. In what has been hailed as an end to loss-leading cheap food, Tesco is going to put up its prices.

‘For decades, food has been a falling proportion of total consumer spending and as a business we have contributed to this by cutting prices to help people spend less,’ Sir Terry Leahy, Tesco’s chief executive, said in previously unreported comments at a company meeting. ‘That won’t change, but the long-term trend of declining spend on food has stopped.’

When ASDA slashed the price of its 1.55kg chickens by 22 per cent, the market was both appalled and attracted, with customers clearing shelves of the birds while farmers warned that they could not produce safe, healthy chickens at such low prices.

Tesco will now sell the same size bird for £3.39, a rise of 4 per cent. It is, hopes Leahy, a price increase that will draw the shoppers through the doors by reassuring them of the quality of produce and humane farming methods, combined with a fair deal for producers.

‘I believe we’re seeing a fundamental shift in the priority that consumers place on food,’ said Leahy. ‘The link between diet and health, interest in cooking, provenance — including local and fair trade — is also not only about affluent customers. The growth in the proportion of our customers buying organics is fastest among less affluent customers. This could be a big long-term positive for the industry.’

His comments represent a volte-face in the long-running and increasingly vicious price war between Britain’s two largest supermarkets. In June, Tesco and ASDA announced they were going to step up the battle to protect and preserve their market share. They were, they said, going to go head-to-head on price.

ASDA, recently named Britain’s cheapest supermarket for the 10th year running by the trade magazine The Grocer, immediately instituted price cuts worth £250 million on 10,000 items. It launched a complete school uniform for less than £10 and sparked a Harry Potter price war by selling JK Rowling’s final adventure for £5 — almost £13 less than the publisher Bloomsbury’s recommended retail price.

Tesco hit back, claiming that an independent price-checker proved it was winning on low prices. A week after ASDA’s price cuts, it followed suit, with £270 million worth of reductions on more than 3,000 products.

Tesco’s decision to pull back from this skirmish and concentrate on making a virtue of higher prices may also be the result of an announcement earlier this month by the Competition Commission that it is investigating Tesco and ASDA for threatening suppliers into granting discounts that the supermarkets could use to undercut rivals. Preliminary findings are expected this month.

But the rise in prices is, say experts, not entirely the result of altruism in Tesco’s boardroom. Soaring wheat prices will soon force all supermarkets to raise prices to cover the rise of nearly 100 per cent in livestock feed.

‘The cost of wheat has hit an all-time high owing to poor harvests and rising global demand,’ said Richard Crane of the accountants Deloitte. ‘The price of wheat is likely to prompt hikes in the cost of bread and meat. These price hikes are a global issue and cannot be absorbed by the food producers.’ Foot and mouth has also added to pressure on British meat producers, he added.

The farming industry, however, has been taken by surprise by Tesco’s announcement. It praises the supermarket for alleviating some of the pressure on farmers. ‘This price hike is the first sign that we’re finally coming to an end of cheap food. Tesco has been the first to move and that needs singing from the rooftop,’ said Charles Bourns, chairman of the National Farmers’ Union poultry board. ‘It has resisted the move towards the £2 chicken and is now going the other way. Other retailers will have to follow suit. There are people out there who will always buy £2 chickens, but we can’t go on selling chicken for less than the cost of cat and dog food,’ he added.

Tesco is refusing to say whether it will increase prices on other produce, but industry experts say that it is significant it has chosen poultry as its first shot across the bows.

Between them, the big four supermarkets sell more than 235 chicken products, from chicken chargrills and thighs to chicken pies and curries, chicken soups and breaded birds. Until now, the wide-spread popularity of the meat has encouraged supermarkets to use it as a loss leader — selling it at heavily discounted prices to lure customers into their stores.

Alex Waugh, director of the National Association of British and Irish Millers, says that it remains to be seen whether Tesco’s gamble will pay off, but he said he shares Leahy’s belief that the public is beginning to mistrust ever-decreasing food prices.

‘This is a sign that supermarkets are finally beginning to understand that persistent below-cost selling is not a sustainable practice,’ he said. ‘It is not even what customers want any more: the market for the cheapest lines has declined for bread by about half in recent years. There is a growing market for quality and fairness where price is not predominant.’

Other supermarkets are already giving hints that they are considering following Tesco’s lead. ‘We believe that consumers do need to understand that true value is always going to be a balance between quality, price, and fair prices to farmers,’ said a spokeswoman for Waitrose.

ASDA, however, is standing firm: ‘At the moment we have no plans to react,’ said a spokeswoman. ‘We’ll try to keep prices as low as possible for as long as we can, working with our suppliers to ensure that customers get the best possible deal. While the rising cost of commodities does provide both suppliers and retailers with an ongoing challenge, we owe it to our customers to try to give them the best possible price for their shop.’

It is a fascinating subject. Although some of it is surely PR, Tesco also has its finger on an insight into consumer perceptions: Price is part of what influences consumers as to the value of things.

Although some people who value organic are thoughtful people who have studied the issues and have come to a personal conclusion, many people who intentionally buy organic are in search of the “best.” And what makes something the “best”? Many attributes, of course, but price is high among them. Whole Foods is both a natural/organic store and an upscale shopping experience. If organics were always cheaper than conventional, it would reduce the allure considerably.

It is interesting to note that although reference is made to “…a price increase that will draw the shoppers through the doors by reassuring them of the quality of produce and humane farming methods, combined with a fair deal for producers…” at no point does Sir Terry Leahy, Tesco’s Chief Executive, say that Tesco’s chicken or other specific foods are superior to ASDA’s in any of these specific aspects.

It will be a fascinating thing to watch whether simply raising prices, while asserting these values, will be sufficient to make the public believe that Tesco’s perishables are worth paying more for.

It is also interesting to note farmers applauding retailers increasing the price level on their products. As far as we can see, this is because the producers have allowed retailers to brainwash them that, somehow, retailers have to make money on everything they sell.

The truth is that the very definition of a “loss leader” is a product the retailer loses money on in order to woo customers into the store and sell them more profitable things.

Perishable products happen to be the ideal loss leaders because they are the products that consumers need most frequently.

In fact, people forget, but the great fear of supermarket executives when Wal-Mart launched its supercenter concept was that Wal-Mart would run the entire food business as a loss-leader in order to draw consumers, who would then buy highly profitable general merchandise.

There are really three separate points to come out of this:

  1. Farmers need to not get caught up in retail price points. Retailers price individual items differently depending on their pricing philosophy and merchandising emphasis. Retailers have to make a profit — overall — not on every item. Retailers also have an opportunity to make up losses on one item over another; few growers have that opportunity. If a retailer wants to sell your item below cost, that is the retailer’s merchandising and marketing decision. A farmer can cooperate because he will get higher volume, but no farmer should take it as an imperative to drop his price or lose money just because a retailer wants to focus its promotion on one item.
  2. ASDA and other low price leaders need to realize that in an era when sustainability and related green and social responsibility is all the rage, low prices are sometimes viewed with suspicion. Low price promotions thus should always be partnered with copious information going to the quality, safety and sustainability of the product. In this case, ASDA better make clear that these chickens aren’t “cheaper;” they are the same or better chickens that Tesco sells, sold less expensively.
  3. The real complaint Tesco could typically make against another operator that promotes low prices on individual items is that unless a customer only buys that item, the customer will likely overpay for some other item as the retailer tries to “average up” its margins. In this particular case, that is a more difficult case to make as ASDA — as the article mentions — was just named as the cheapest grocer for the 10th year running.

Our hunch is that Tesco is making a virtue out of a necessity. It is counting on its U.K. division to perform while it proceeds to invest heavily in the U.S., and it sounds better to position a price increase as part of a commitment to sustainability than it does to whine about the need for margins.

It is, however, a technique that all discounters should expect to encounter, a vague whisper that, because the price is good, ipso facto, shortcuts must have been taken.

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