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Tesco PLC Slashes Costs For Customers As Price War Escalates

The supermarket price war kicked off by Morrisons — supplemented by another recent volley of price cuts on about 1,200 products — has so far consisted more of skirmishes than some grand clash of the Titans.

And the latest salvo from Tesco (LSE: TSCO) fits the pattern.

Tesco has announced it is cutting prices on over 30 basic goods, as well as making online shopping cheaper for both couch potatoes who want a full delivery to their door and those who use its Click & Collect service.

But remember — this supermarket sells tens of thousands of different products in its largest stores. And when it comes to online shopping, the price-war instigator Morrison has yet to really show up to the battlefield.

No, this is a tactical strike from Tesco, seemingly designed to cause maximum impact for minimal cost to its bottom line.

Even Greater British Breakfast

Tesco says it has lowered prices on among others bacon, baked beans, tomatoes, broccoli, peppers, sugar, lettuce, cucumber portions, and some of its breads.

These are all commodities that we are more likely to notice the price of. The theory is that you’ll spot that beans are cheaper in Tesco, but perhaps not realize that, say, a packet of fajita seasoning is 20p more expensive than at a rival down the road.

The supermarket also seems to have deliberately chosen its targets to generate headlines about a cheaper Great British Breakfast, with its UK marketing director boasting:

“We’ve been able to make the traditional English cooked breakfast cheaper just in time for St George’s Day. By cutting the price of eggs, bacon, tomatoes, bread, butter and baked beans, a family of four who like a cooked breakfast once a week will save around £96 a year.”

I’d note that Tesco’s maths leans on some previous price cuts, and also presumes the cooked breakfasters are eating wholemeal toast – a rare choice in my experience.

Also as my own sister would be the first to insist: “What no sausages?”

tescoOnline cost-cutting

Away from the cheeky marketing gimmicks, the changes made to the price structure of online shopping with Tesco look more interesting.

Home delivery via its one-hour slot system now costs just £1 – a big reduction from the previous £3.50 charge. Prices for its annual Delivery Saver schemes — to which 200,000 customers have signed up — have also been lowered. Finally, Click & Collect customers will be able to pick up their shopping for free. Previously they paid £2 to £3.

These changes increase Tesco’s competitiveness with its high-street rivals. ASDA for example already offers free Click & Collect, although there’s a minimum spend and it’s not available at all locations.

J Sainsbury and Morrisons don’t even offer the service.

No pain, no gain?

These latest changes to the price of online shopping with Tesco suggest the company is doubling down on becoming a leading player in Internet shopping in the UK.

Tesco’s CEO Philip Clarke has stated that he sees Tesco’s future as increasingly digital, and lowering the cost for customers plays in to the ‘land grab’ strategy that Tesco once waged with its physical stores.

Still, it will be interesting to see what impact it has on margins. A couple of quid here and there might not amount to much with respect to any particular customer, but it could easily represent most of the profit margin on an online delivery.

Tesco said in February that its online business was profitable to the tune of £127 million last year, when it revealed detail on its online business for the first time in its strategy update. Will the same be true when 2014 is tallied?

The cost of war

Tesco certainly has the margins to make these strategic gambits – trading profit margin at 5.17% as of its latest financial year is much healthier than, say, Sainsbury – but I’d bet the company doesn’t want to get into a position where a faster-growing online business starts to suck profits too quickly from its main operations.

After all, this price war could get ugly and drag on for longer than people expect, and the City is already running out of patience with the UK’s largest grocer.

Tesco may well prove to be a good opportunity for investors betting on a turnaround in fortunes on the High Street, but for now its days as a growth share seem to be over. If you're more interested in backing companies with clear growth potential, then you'll want to read our latest report.

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Both Owain and The Motley Fool own shares in Tesco. The Motley Fool has recommended shares in Morrisons.