14th March 2013
Financial journalist Tony Levene considers what Tesco’s purchase of Giraffe means for the overall strategy and the supermarket wars.
“Even some fans concede the world food repertoire leave much to be desired and the service is ever more hit-and-miss.” That quote might sound like a judgement on Tesco, Britain’s biggest retailer, even if the world food has improved substantially, at least in some stores.
It’s not. Those lines come from the latest Harden’s UK Restaurant Survey entry on Giraffe, the restaurant chain. Harden readers give the eateries 5 (it’s the lowest mark) for food, 4 for service and a depressing 5 for ambiance.
But from now on, any confusion will be understandable, following Tesco’s £48.6m purchase of the child friendly restaurant group from private equity. This now appears to be part of a new thread in the retailer’s strategy – paying small sums to acquire non-core assets. The deal follows its purchase of a 49 per cent stake in coffee chain Harris & Hoole, and a deal to acquire upmarket Euphorium Bakery.
Investors in the retailer, which takes around one pound of every eight spent in the UK, must wonder what is going on. They have seen their shares hit 442p in April 2010, fall to 304p by June 2012, and recover to a current 377p. Despite the recent upswing, it has dramatically underperformed the wider market. The Giraffe acquisition has created interest – as did some of the negative anti-Tesco coverage for Harris + Hoole – but on their own, these purchases are hardly a game changer in the struggle against Sainsburys, the war on Waitrose, or the aggression on Asda.
The Giraffe chain made £4m profits in its most recent full year (2011-12) on sales of £40m. Tesco’s most recent results show annual global sales topping £72bn. And there is a danger that Giraffe’s core audience of yummy mummies and their well-heeled offspring will find somewhere else – it never pays to underestimate potential anti-Tesco feeling – the horsemeat scandal was just icing on the negative cake. Hampstead, Kensington High Street, Royal Festival Hall and Holland Park Avenue are just some of the upscale Giraffe locations in London.
Will they want to spend the £41 per head that Harden claims is the cost of a three course meal, wine, coffee and service in a restaurant that could sit cheek by jowl with the Krispie Kreme display in some of Tesco’s larger stores? Maybe, if they get free parking at the same time.
The retailer obviously believes the strategy will work. Kevin Grace, Group Commercial Director at Tesco said: “We have the opportunity to develop some of the space in our larger stores to create retail destinations that offer customers even more choice. Giraffe is hugely popular with a wide range of ages and particularly families – we think our customers will love it.”
He continues: “The acquisition forms part of Tesco’s strategy to develop the space in some of its larger stores and create even more compelling retail destinations where customers can meet, eat and drink, as well as shop.”
It already has a deal with Costa for coffee shops in some larger stores so this will add to the Tesco list – my local Tesco large store has a Costa but a nearby standalone Costa seems to attract more consumers with time to kill reading the paper or surfing online. Doing this is in a Tesco is perhaps not the most attractive locale.
Reading between the lines of the Tesco statement, the store needs something to fill up the gaping, zero or low profit spaces in its enormous Tesco Extra outlets where its range of non-food items has been hit by online (and specialist) retailers.
Assuming, however, that Giraffe works, what does it mean for Tesco shareholders?
Put into context, the £48.6m purchase price is roughly a quarter of worldwide daily turnover, about 40 per cent of one day’s sales in the UK. It is not a big idea in the way that Clubcard revolutionised group sales. But neither is it a risk such as setting up the Fresh’n’Easy chain in the United States. This has swallowed up a billion or so after five years in operation and still to show a profit – it is hoped it will go into the black in 2014.
Even if Tesco doubles or trebles profits at Giraffe, it will barely register – Giraffe will have to be profitable at its current rate for 250 years to make up for the Fresh’n’Easy losses.
Instead, think of Tesco as a tobacco company without the toxic product. Tobacco companies used to spend a fortune on advertising, market research, product development and all the other facets investors expect. Legislation, regulation and health awareness over the past four decades or so has changed all that. Instead, cigarette firms do little more than manage for decline in sales in developed countries and push the product at relatively low cost in other locations. It has proved remarkably profitable with the sector a superstar since the end of the dotcom boom.
Tesco has now reached the level where the main options are either managing for decline or managing for something new. Assuming the latter, the strategy now seems to be to accept that the concreting over of Britain with superstores is going nowhere – while the carpet-bombing of areas with Metro and Express local store formats cannot go that much further. In some areas, there are up to four Tesco local outlets within a square mile or so – and the opposition including Sainsbury’s and Waitrose have muscled in on this game. Morrisons has just announced it will join them.
So Tesco finds itself with a lot of spare space in its large stores and a lot of cash but with no ground breaking model – little has come so far of its move into retail banking. A solution could be for Tesco to seek growth (or at least prevent decline) by turning itself into a mix of investment bank, private equity investment trust, and property owner.
It has loads of easy to develop space in retail parks. Some of this will become Giraffe outlets. If it can offload a part of each superstore into a Giraffe and earn the profit margins these restaurants have so far reported, it could be a more profitable use of those square metres than leaving it to low margin non-food – its F & F clothes brand has failed to set the world alight in the same way as Primark or rival Asda’s George. If it can then use that model many times over, it could solve its surplus space problem.
This could be what Tesco is really doing – although if its stated ambition of using Giraffe to ensure customers stay on site longer and spend more works, then it gains twice over.
As Apple’s gravitational share price collapse since it became the biggest stock market firm in the world early last autumn shows, nothing is forever in finance.
The pressures on Tesco are such that its historical expansion model now has little traction. Stakes in foodie brands such as Giraffe, Harris + Hoole and Euphorium may only be the start of this move to a portfolio strategy. Expect other similar purchases – and remember that all these are concepts which so far no one can put online. The Guardian’s Zoe Williams even applauded the deal for being child centric.
Not even Silicon Valley/Roundabout has found a way of delivering coffee shops or restaurants for better off mums to chat with their friends via a broadband connection.