The Blog

The Danger of Hubris in Strategy - Learning From Tesco

Until recently Tesco was a company that was constantly expanding and, significantly, making greater profits each year. So that its profits have declined massively has come as a shock. Tesco is no longer the money-making machine it once was.

There is a saying that the bigger you are the harder you fall and they don't come much bigger than supermarket retailer Tesco which is the third largest in the world and has come a long way since the company was formed almost ninety years ago by market trader Jack "Slasher" Cohen.

Until recently Tesco was a company that was constantly expanding and, significantly, making greater profits each year. So that its profits have declined massively has come as a shock.

Tesco is no longer the money-making machine it once was.

Additionally, that Tesco has just announced it is abandoning its strategy of operating stores in the US can be seen as the latest example of how for difficult it is for British retailers to be successful there.

Tesco thought that would be able to do what others have found so difficult. However, despite huge investment in the nearly 300 outlets it has in the US - including the 199 Fresh and Easy stores on the West Coast - Tesco has never made been able to make profit.

Cracking overseas markets is not easy.

Only a couple of years ago Tesco was the darling of the city and could not put a foot wrong. It effectively rewrote the handbook of retailing based on a relentless strategy of rapid growth through opening cathedral-like stores dedicated to selling products and services which no other supermarket had ever considered selling and cheaper than the small local independent specialists which increasingly went out of business.

At the time it seemed to have found the magical ingredient of success and was leaving all other retailers in its wake. There was nothing that Tesco appeared unable (or unwilling) to sell.

Few competitors appeared able to compete against Tesco's ability to extract value by forcing cost reduction onto its suppliers.

The only 'test' of success in retailing is sales and Tesco shoppers flocked to take advantage of convenience and lower prices. It was a behemoth that appeared was unstoppable and as well as happy customers investors weren't complaining.

Almost a decade ago it was rumoured that Tesco was considering entering into the provision of hospital services and schools. At the time this seemed entirely possible and its evolution from the Cohen's 'pile it high and sell it cheap' philosophy appeared to be entirely correct.

The trouble is, as another saying goes, pride comes before a fall and Tesco's fall in profits is eerily reminiscent of another 'darling' of the UK high street that could do no wrong in the 1990s; Marks and Spencer.

After achieving its obsessive goal of making a billion pounds in profit Marks and Spencer's managers belatedly realised that obsession with profits takes attention away from the fundamentals that made it successful in the first place: customer service and selling making that were right for its clientele.

So, that Tesco's pre-tax profits have halved from £4 billion to £1.96 billion demonstrates that its strategy is no longer working and it can no longer either attract customers or extract profit in the way it used to.

Perhaps the major strategic error it made was its decision to expand its operations abroad.

So, Tesco has had to include the costs of leaving America (£1.2 billion), Central Europe (£495 million) as well as £804 million writedown as a result of not continuing its expansion of the larger stores in the UK as it will now concentrate on local convenience stores and online provision.

The result is that Tesco's post-tax profits are just £120 million which, in comparison to recent years, is dreadful news for investors.

Tesco's foray into America is especially interesting.

As its managers discovered at phenomenal cost, whilst there is an assumption that we share much with America, most especially language, we are culturally very different; most particularly in shopping habits.

As Richard Lowe who is head of retail at Barclays believes, the US is a more difficult country to understand from a retailing perspective than even China.

Tesco has made the classic mistake of assuming that it is made up of homogenous customers with consistent tastes and shopping behaviour. Instead Lowe contends, the US should be considered being like Europe and that each state is like a separate country which has "different markets."

Ajay Bhalla who is professor of global innovation management at Cass Business School believes that Tesco's attempt to expand into the US will be a 'harsh' lesson that expansion is not the way to create 'sustainable value creation.'

Moreover, Bhalla believes that whilst Tesco has invested so much effort onto developing its operations in the US, it lost sight of its core market in the UK where customers where were increasingly demanding superior customer service and quality; characteristics that other supermarket retailers such Waitrose and Sainsbury are more able to deliver effectively.

What Tesco has demonstrated is that strategy is never easy and least of all when you are enjoying phenomenal success as problems inevitably lurk around the corner.

BBC Business Editor Robert Peston believes that Tesco's problem is that having created a large and very complex organisation it has become 'less like an unstoppable juggernaut and more like a massive tanker that's hard to manoeuvre quickly or easily.'

The fact that Tesco also intends to withdraw from Japan and take a more cautious approach in opening more stores in China demonstrates the difficulty of seeing overseas markets as providing easy opportunities.

The authors of strategic texts which have included Tesco as an exemplar of how to achieve success will have to do some urgent rewriting.