Tesco Central Europe: four scenarios for what could happen next

Amin Alkhatib
Senior Retail Analyst
@RetailAnalysis

Date : 09 September 2020

Tesco has been reporting slow revenue growth, with little to no profitability across its business in central Europe since at least 2017. The retailer has already disposed of much of its business in Asia, putting up for sale its Southeast Asian business, and withdrawing from its joint venture in China. Potentially, the retailer is looking to sell more low performing parts of the organisation to improve its sales performance and profitability.

As of 2020, it disposed some of its businesses in central Europe, Poland, which was expected by many suppliers who trade with Tesco in the region. No announcement has been made about the long-term future for these operations, but the question now, is what direction the retailer will take next across its remaining operations in Czech Republic, Hungary and Slovakia.

4 scenarios for Tesco in central Europe

Source: IGD Research

Transformed the business, but could it compete?

Tesco has faced a lot of competition from discounters such as Lidl, Biedronka and Aldi in central Europe. To compete it has transformed the business, between 2017 and 2020, offering competitive prices and reducing costs, which together have helped boost profitability.

It has shifted towards an EDLP strategy. This led to it guaranteeing shoppers low prices on 600 SKUs across the region. These products were labeled as Starlines and marketed under the campaign Our Price. It reduced the number of SKUs its hypermarkets and supermarkets carry by 25% and 50% respectively, which have helped lower inventory handling costs. It has also shrunk the size of its hypermarkets and leased or sold some properties to reduce overhead and operational costs.

Source: IGD Research, Tesco Poland

Following the implementation of these initiatives it has reported improved profits across the three markets but continued to struggle to grow its market share. Tesco saw shoppers switch spending (mainly) to discounters, with the latter’s competitive pricing and expanding assortment attracting their attention.

Transformation to an EDLP model was not effective enough

The retailer appeared to struggle to successfully balance an EDLP strategy with its aim of growing market share and maintaining profitability. In the same countries, Lidl and Kaufland have been able to successfully implement an effective pricing strategy built on their expertise of efficient sourcing and distribution infrastructure.

The two German retailers are adding new SKUs, while Tesco was rationalising its range. The former was effectively marketing its growing assortment, which attracted shoppers from the supermarket channel more widely. They have also improved the in-store shopping experience and opened new branches in convenient locations.

To compete with all these elements, Tesco would have to rethink the way it looks at its assortment, distribution network and category management to implement an EDLP strategy more effectively.

With improved sales and profits, Tesco CE could be sold in parts

Tesco reports improving sales performance and rising profitability in the region, and so can get more value out of the sale of the business. It could break up the business into the distinct formats it operates and sell them separately. Interest will come from retailers whose banners align with each format.

Kaufland could acquire the large format stores, Lidl the supermarkets or a multi-channel retailer like SPAR or Auchan could buy a combination of stores. These scenarios make the most sense, as it is the direction Tesco took in Poland. It is likely to gradually cut its losses in the comparatively slow growing markets to maximise its return on the sale.

Very few buyers that can afford to buy the CE business as a whole…

In 2019 Tesco CE centralised the region’s distribution operation in Slovakia, as part of its transformation programme. To sell the business a whole, the asking price Tesco would want is likely to price-out potential acquirers, as many do not have the financial clout to buy a leading retailer’s network across three markets. Therefore, it is expected Tesco will break up the businesses, so they operate independently, then put each piece up for sale to make them more affordable and attractive.

…but more options if sold in parts

There is an option to sell the supermarkets to an incumbent retailer, who has a comparatively low share in the market, such as Rewe, the parent company of Billa and Penny. This would mean any potential purchase would be less likely to be affected by any monopoly restrictions.

Another scenario is if a retailer enters one of these markets. For example, Kaufland to enter Hungary by buying Tesco’s large format stores. However, the country is one of the region’s strictest markets when it comes to expansion of international retailers.

If the buyer is not one of the incumbent retailers, this makes it easier for the competition authority to approve the sale. But it is unlikely that a local national player, such COOP in Slovakia and Czech Republic or CBA in Hungary, will have the finances for such an acquisition. Unless they buy part of the business to boost their regional presence.

Streamline the store network to focus on ecommerce

As Tesco looks to broaden its omnichannel business in the UK, it is possible it could use its learnings from its home market to grow the online business in central Europe. It already has an established online delivery operation across the three markets, covering the major cities in each.

There is potential for growth in the region as the channel is still in its infancy. Also, the pandemic has boosted shoppers’ adoption of online grocery. But Tesco would face competition from leading local pure play grocery retailers, such as Rohlik and Kosik in Czech Republic.

The British retailer is expanding its online service presence by adding more Click & Collect points in major cities in its three markets. There are around 10 collection points in operation in each, which operate as support and adjacent to a hypermarket or supermarket. This could help revive traffic to store.

Source: Tesco Czech Republic, Slovakia, and Hungary

The model makes sense because it avoids the last-mile logistics challenge, which has better profitability when compared to the home delivery service. It could also help retain existing shoppers and perhaps gain new ones, while Click & Collect customers might be attracted to go in-store to buy some additional items or those they want to see or feel before buying. Investment in this channel could help recoup some of the traffic lost to competitors, but it will dilute its profit per transaction.

For more insight on Tesco's strategic outlook click here.