The Business Of
Tesco | How Do They Make Money?
Every Little Helps...
Whilst Tesco is known for its UK and Ireland supermarket operations, like most strong businesses, the Tesco Group is actually fairly diversified. UK supermarket revenues (showed as ‘Retail - UK’ below) only make up two-thirds of Tesco's revenue. The other third is made up of revenues from a leading wholesaler (Booker), supermarkets in Central Europe, selling petrol (Tesco Fuel) and a tiny amount from lending (Tesco Bank).
Because the supermarket business is the main way Tesco makes money (75% of revenues), we’ll focus only on the Retail segment here. However, don’t worry! You’ll understand how the Booker wholesale business works when we analyse Costco. You’ll understand how the Tesco Bank segment works when we analyse Barclays. And you’ll see how the Tesco Fuel segment works when we analyse BP. So without further ado…
The Ultimate Middleman
As we touched on in the first section, What Do They Do?, Tesco is basically the middleman between suppliers and us. To name a few examples, Tesco buys apples from Stocks Farm, potatoes from Branston, and fizzy drinks from Coke. They then sell these apples, potatoes and fizzy drinks to us in their stores and online - and that’s how they make money in Retail!
We'll explore the cost at which they buy apples, potatoes, fizzy drinks, etc in the next section - What Are Their Costs - but in this section we'll look more at what products make up their revenue.
A Good Match
So what products and categories make up the highest portion of revenues for supermarkets like Tesco? The annual study by The Grocer gives us this information. As you may have guessed, fruit, vegetables, meat, are all high up there. Our kitchens and fridges are usually stocked up with some sort of meat and fruit and veg. But I was shocked to find out that the product that makes supermarkets in the UK the highest revenue is in fact cigarettes! And by some distance. The chart below shows that cigarette spend was more than 2x the spend on any other category.
If we look at it from a brand level, again cigarette brands dominate. Benson & Hedges is the leader with supermarkets making £1.84bn in sales from B&H products, followed by two more cigarette brands (Players and Sterling). However, ex-cigarettes, there are many family favourites that feature in the top brands list for revenue. Coca-Cola is the largest brand (ex-cigarettes) in terms of revenues for supermarkets (£1.35bn). With supermarkets also doing very well from Cadbury Dairy Milk, Warburtons and Walker’s Crisps.
The other interesting insight to draw when we're looking at revenues is own label vs branded. Own label refers to items that are packaged and marketed under the brand name of the supermarket chain, rather than the name of the manufacturer. The packaging that supermarkets use is usually cheaper than the packaging brands use and therefore supermarkets make a higher margin when selling own label products, despite the selling price being lower. ~20% of consumer spend in supermarkets is for 'own label' products. However, despite an average of 20%, there are many categories which have far higher or lower popularity of own label sales. The charts below show us that 90% of the chilled ready meals bought in supermarkets are own label, supermarket-brand meals. On the other hand, only 1% of the toothpaste bought in supermarkets are supermarket branded.
The reason for these differences is two-fold. Firstly, competition in the category is key. Colgate (toothpaste), Lynx (deodorant) and Wrigley’s (gum) are such popular, well-marketed brands that when people walk into Tesco, they’re unlikely to choose toothpaste, deodorant or gum outside of these brands, even if Tesco offered a cheaper, own-label option. However, when people think of meal deals, or microwaveable meals, there’s no real standout brand. And because of this, supermarkets like Tesco have chosen to package and market products in these categories as their own.
The second reason why we see differences in own label penetration in categories is because of consumer price sensitivity. Categories where people are going to be very price sensitive, give an opportunity for supermarkets to increase own label penetration. Toilet tissue is a good example. Whilst Andrex is the first brand most people think of when they think of toilet tissue, consumer price sensitivity towards toilet tissue is high. Why? Because we purchase toilet tissue fairly often and so people are looking for cheaper options. And because the difference between Andrex toilet roll vs Tesco’s toilet roll really isn’t that substantial. (Some of you may disagree!) And that is why we see 50% of toilet tissue sales being supermarket own label products.
Chugging Along
As we can see below, Tesco revenues have been growing consistently. And this should be no surprise. Every year, the company can increase the prices of their goods by a few percent (slightly above general inflation), without seeing volumes decline. After all, if toilet tissue went from £1 to £1.05 (5% price growth), would you stop going to the toilet?! Probably not. In fact, due of this relative consumer price inelasticity, the business is well protected from inflationary pressures because they can pass these costs on to consumers - this is why we’ve seen food inflation reach dizzying heights this year.
Another way the company has grown sales over the years has been to open more stores. However, as we’ll touch on more in the ‘Outlook’ section on Friday, Tesco has become much more focused in their operations. The company exited its retail operations in Asia in 2019 and has recently sold many of its stores in Central Europe too.
: Even during the 2007-08 recession, the Tesco business model showed its resilience with the company’s revenues growing from £42.6bn* in 2007 to £47.3bn in 2008 and £53.6bn in 2009. Profits (EBT) also grew from £2.65bn in 2007 to £2.92bn in 2009. Amazing stats given the UK was in recession. Although I suppose, recession or not, people still need to eat, brush their teeth and wipe their bums!
* the reason why Tesco revenues in 2009 are greater than in 2018 is because the company sold a lot of their operations outside the UK - more of this in the ‘Outlook’ section.
21st Feb 2023
That’s all for today. We’re back tomorrow with part 3 of Tesco where we’ll be looking at the costs required to operate this business model. More surprises in store!
Have a great day.
The Business Of Team