August, 2016

Opinion

Why Lidl Will Succeed Where Tesco Failed In The US

The Perishable Pundit Jim Prevor believes that the pressure on executives at a shareholder driven organisation such as Tesco to chase a quick buck gives family-owned discount chains a big advantage

Tim Mason of Tesco Clubcard fame and Fresh & Easy ignominy gave a somewhat wistful interview to The Grocer recently. He still mostly keeps his own counsel regarding Fresh & Easy, and we have already written over 800 pages on that adventure.  Those interested in exploring the comeuppance can read the summary articles here and here.

In the end, he blames the Fresh & Easy failure on two things, the economy and Tesco’s problems elsewhere:

“It was a great business,” he replies. “It had super products. It had a vertically integrated manufacturing capability, which meant quality was assured. It had a good value proposition and great staff.”

So why didn’t it work? “There were many very good reasons, not least the economy, that meant it was somewhere between very difficult and impossible to be successful in that timeframe. If Tesco had been financially stronger, the business could have taken everything it learned over six years and refined and developed the model and got it to an acceptable place. Unfortunately there wasn’t that economic firepower. There were problems all over the place, not least in the UK. And the decision was made.”

These are actually two sides of the same coin. A recession provides unique opportunities – if you have resources and are willing to commit them.

A severe recession is actually a fantastic time to launch a new retailing business. During times of prosperity, there are big restraints on growing such a business. Notably, it is hard to get quality locations and hard to get quality staff. During recessions, these problems lessen substantially.

So, if you have a viable concept and if you have financial resources, the recession is the time to put the pedal to the metal and zoom full speed ahead. When Marks & Spencer bought Kings in New Jersey, it had many expansion plans – but that was a time and place when getting both real estate and employees was difficult and expensive. So Fresh & Easy was given a runway to grow, and grow fast, by the recession.

In all likelihood the real problem was the concept, which is why Safeway, Kroger, etc., didn’t want to snap up the chain for a song at the end. In America, the big growth in retail is all in concepts that specialise: Aldi as a deep discounter; Trader Joe’s as an epicurean delight; Whole Foods as a healthy upscale concept; Costco as a high quality/high value/high volume operator; Amazon Fresh as a convenience play, on and on. Fresh & Easy offered a vague consumer promise. Though it was a small footprint store, in its DNA is still wanted to be a community grocer like Tesco.

Still, on one point Tim Mason is certainly correct. Fresh & Easy was abandoned by Tesco not because the concept couldn’t have evolved, but because Tesco decided to give up.

Now lamenting the financial weakness of the third largest retailer in the world will not bring much sympathy. And in launching a business, executives have a responsibility to know and understand the financial parameters they operate under. Recessions, which are predictable, even if the timing of them is not, are supposed to be included in a business plan. One can’t proceed in business expecting only blue skies and sunshine.

What Tim Mason doesn’t say, but is the real lesson to be derived from his comments, is the enormous difference between running a privately held and a publicly held company.

If you think about the entry of both Aldi and Lidl into the UK market – neither were instantaneous successes. The concepts had to evolve, and it took a steely commitment from the owners back in Germany to keep working on the concepts and committing to the market. It took time, and it took money. But these privately held companies had a strategic vision, and that vision included being successful in the UK. They were willing to pay the price.

Publicly held companies rarely are. On the level of the shareholders, they are often not as committed as a family ownership. The shareholder’s time horizon is shorter than a family focused on the grandchildren and great-grandchildren. And on Wall Street and in the City of London, only a few investors are like Warren Buffet, who declares his favourite holding time is “forever.”

It is not just shareholders, though; it is executives as well. Most executives at public companies receive substantial portions of their compensation in some form of contingent compensation -- Bonuses, profit shares, stock options, etc. This encourages great attention to short term profits. In other words, it is all very nice and good that Aldi, after a generation in the UK, became a big success, it is understandable that family ownership would focus on obtaining this long term success, but executives at publicly held companies, who are going to retire in five years don’t receive any personal benefit for successfully laying foundations that will pay off in decades.

This is one reason why many companies prefer to acquire rather than build. If they lose a hundred-million-pounds a year for 10 years to build a business, that billion-pound loss kills everyone’s bonuses etc., for a decade. If, however, the company spends two billion to buy the same operation, that is capitalised and has little effect on everyone’s contingent compensation.

It is not a coincidence that Wal-Mart perceives H.E. Butt, a family owned supermarket chain based in Texas, as its toughest supermarket competitor in America. Since HEB is a privately held, well capitalised organisation, it will not give up market share easily. Indeed, HEB is well known for having invested for many years in launching its upscale Central Market concept when others would have cut and run.

Right now, here is a prediction: We called it early in saying that Tesco would flop in America, and we were right. Now we feel comfortable saying that Lidl will succeed.

Partly this is because of attitude. In America, the Tesco organisation was built around secrecy and fear. They were just not psychologically willing to be open to outsiders, new ideas and critique of their plans. Lidl has been picking the brains of everyone they can get a hold of. Partly it is because the basic concept is clear – a deep discount format – and this is already known to be well received with the American consumer.

Mostly though, it is because it is clear that the ownership is deeply committed to success in America. They have no stores and yet have hundreds of employees working full time, many sent to Europe to learn the ropes. It is very clear that the Schwarz family has decided that, strategically, after conquering Europe, a stake in the large American market is imperative.

This doesn’t guarantee that the stores will be instantaneously successful, but it means that barring something catastrophic, Lidl is committed, and it will evolve its retail format and supply chain until it gets it right. Tesco, with the public markets watching every quarter, never had that strategic commitment.

When Ernest Gallo passed away, we ran a piece commemorating his life, and in that piece we quoted a letter we had received in response to another piece we had written about Wal-Mart and upscale:

This reminds me of a conversation I had with Ernest Gallo in another career about twenty years ago. He wanted to “upscale” the image of his wines. I explained to him that he’d spent a half billion dollars over a forty year period positioning Gallo as good cheap wine. (Remember Gallo Hearty Burgundy?) I told him it would take a generation and a billion dollars to accomplish this task. He said, “I better get started right away.” Family companies have options that public companies don’t.

— Frank McCarthy
Vice President of Marketing
Albert’s Organics/United Natural Foods

That is not 100% true. Some companies, such as Amazon.com, have been able to get such support in the public markets that short term profits are not a focus. So we see the great difficulty: Chains such as Tesco are competing against family owned Aldi and Lidl and against market-supported Amazon.com – all of whom are free to focus on building successful operations for tomorrow. Tesco has to make a dime today. Thus Tim Mason is on to other things, and Fresh & Easy is but a memory of what he hoped it might become.