1 Huge Problem For Tesco PLC, WM Morrison Supermarkets PLC & J Sainsbury plc

UK supermarkets Tesco PLC (LON:TSCO), WM Morrison Supermarkets PLC (LON:MRW) and J Sainsbury plc (LON:SBRY) are faced with a huge risk that could damage profits. What does this mean for investors?

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Prices are being slashed at Tesco (LSE: TSCO), J Sainsbury (LSE: SBRY) and WM Morrison Supermarkets (LSE: MRW). Scrambling to respond to recent trends of tumbling like-for-like sales, worsening profits and dwindling market share, these retailers hope to turn their fortunes around by wielding a non-exclusive, unexceptional competitive tool: the labelling gun.

They cite as a primary concern the rise of discounters such as Lidl and Aldi, which have been rapidly gaining market share in the UK. In a desperate attempt to staunch the outpouring of customers, the three biggest conventional UK supermarket chains have committed to investing hundreds of millions of pounds in price cuts.

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Investments

In fiscal years 2014-15, Morrisons spent the bulk of £315m to reduce charges on 1,700 items by an average of 17%; Sainsbury’s has touted price decreases on 1,100 items; and Tesco has lowered prices across several ranges. All three grocers say these cuts are permanent. Effectively, they have initiated an “everyday low-pricing” strategy, whereby goods are priced extremely competitively and are kept low for sustained periods. To make this pledge concrete, the grocers have each launched their own price-checking tools that enable customers to compare baskets of goods with, at minimum, the top three competitors.

Tesco’s Price Promise programme will match items to comparable goods at Asda, Sainsbury’s and Morrisons using daily or bi-weekly price updates. If the Tesco shopper’s basket costs more than the competitors’, Tesco will offset the difference by providing a voucher. Sainsbury’s launched a similar scheme. Morrisons’ Match & More will reward shoppers with loyalty points that eventually translate into vouchers. These programmes are meant to negate any excuses a customer might have to shop elsewhere, and they might benefit the few shoppers who use them.

But this strategy is problematic. Unless Tesco, Sainsbury’s and Morrisons revamp the entirety of their store strategies – which currently emphasise service, range and quality – they will be poor competitors in a game perfected by the budget retailers. These strategies require higher spending needs that discounters have largely avoided. At Aldi, for example, customers are not provided the luxury of free carrier bags; customers bring their own. Stores are not designed to exude a comforting, relaxing quality; what matters is operational efficiency. Products are displayed inelegantly, with items remaining in their shipping cartons until the very end of their journey, when they’re plucked out by the customer for purchase. Reducing the handling of merchandise reduces labour costs. By restricting its hours of operation to peak times only, Aldi lowers labour and energy expenses. The services provided are minimal, the selection is slim, and the company’s concern for quality is secondary to its concern for price.

Tesco wants to improve service, not reduce it – the company has been hiring thousands more client-facing personnel. Sainsbury’s has proclaimed, “Our investment in quality where it matters to our customers is at the heart of our strategy”. Morrisons has expressed the need to “improve the small details of the customer shopping experience”. These are noble objectives, but they contradict the companies’ primary strategy of price deflation. To be a low-price leader, the companies need to be a low-expense leader.

Industry Destructiveness

Even if the grocers could compete effectively with discounters, it still probably wouldn’t be a particularly good idea. Intense competition based solely on price can be destructive to the industry. When a grocer attempts to poach customers by waving the ‘lowest cost, highest value’ flag, it’s visible to all competitors, and retaliation can be nearly instantaneous. Through successive rounds of price cuts, in this zero-sum competition, margins for all grocers can get crushed. The only players that come out ahead in this game are the customers.

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R.D. Greengold has no position in any shares mentioned. The Motley Fool UK owns shares of Tesco. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.

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