Why long term investors should be worried
As many news outlets have reported, this week Tesco reported its best sales growth in a decade, making this the eleventh consecutive quarter of sales growth, along with a pre-tax profit increase of over 2% in the first half of their year.
Their most recent acquisition, the wholesale business Booker, has also grown sales since they took it over, by a remarkable 15%, and yet the group’s share price fell by over 8% on this week's announcement. Most of the analysts’ concerns centre on the softening margins within the group’s accounts, with profits below where the market would like them to be. But this is short-term thinking, retail is a long-term game, and it’s the long-term threat that should be the Tesco investor’s bigger concern.
Over the ten years running up to the Tesco acquisition, Booker profits rose from just under £22m per year, to over £150m per year. It’s a strong business in great growth and on paper, should benefit immensely from its acquisition by Tesco. But that could all be about to change.
Eight months before the Booker acquisition completed last March, Chinese online retail giant Alibaba (think Amazon, but way bigger) launched “Ling Shou Tong”, a potential game-changer for independent retail. Ling Shou Tong is the combined EPOS, stock control, replenishment and management information platform, which Alibaba made available in August last year, for free, to all 6 million independent retailers in China. By January 2017, they had already recruited 10% of them onto the platform, essentially building a franchise network of 600,000 stores in less than six months, from scratch. The challenge for Booker (and therefore Tesco) is that two thirds of its revenue comes from exactly those kinds of store in the UK.
Unlike the traditional wholesale model, where retailers will shop around at different wholesalers for the best products at the best prices, Ling Shou Tong is incredibly sticky. The value added from the system analytics, the simple integration with replenishment, the cost-saving switch from cash-and-carry to pure delivery, the sheer breadth of inventory available, will make it, not impossible, but very difficult for a signed-up retailer to justify sourcing elsewhere. Which is why the opportunity for the likes of Amazon, who’ve been wrestling with ways to gain bricks-and-mortar retail share for years, to replicate the Alibaba approach in the US and UK, can’t be understated. You can bet your bottom dollar that they are watching the performance of Ling Shou Tong with particular interest, and over here, it’s Booker’s retail trade that would be right in the crosshairs.
This presents a huge challenge for Tesco. They are one of the world’s most sophisticated retailers, and could, without doubt, develop a similarly sticky proposition of their own to integrate Booker much more deeply with its customer base. But would they want to? Would they give, for free, the power of their own product selection, merchandising and promotional tools to independent stores who, on high streets up and down the country, are in direct competition with Tesco Metros? How would their investors, who are already baulking at softer margins, feel about a huge systems and field-sales investment, that could well cannibalise a major chunk of one of its most profitable revenue streams?
It remains to be seen what Tesco will do, and they may still have a year or two before the competition for supply to independents really fires up. But the slight softening of margins that drove their shares down this week could look like a walk in the park compared with what’s to come.