The rise and fall of U.K. grocer that 'owned the world'

Berkshire Hathaway Inc. Vice Chairman Charles Munger recently summed up the past seven years of Tesco Plc, Britain's biggest grocer, in a beat.

"Tesco owned the world," said Munger, whose firm last disclosed a 3.7 percent stake in the company. And "one day, it stopped working so well."

Between the late 1990s and 2007, when the shares hit a record and former Chief Executive Officer Terry Leahy, was knighted, the company was considered a titan of British corporate success. Its biggest challenge was convincing critics such as the national regulator that its 31 percent share of the grocery market wasn't strangling smaller shops.

Tesco's dominance at home gave it the misplaced confidence at its peak to try to crack the U.S., as Leahy, now 58, looked beyond Europe for growth. Yet, the company now stands accused of hubris after it was forced to abandon that venture last year and this week unveiled a probe of its accounting practices. It also faces an assault from all sides at home from cheaper German rivals Aldi and Lidl and the upscale Waitrose chain.

Tesco's fall from grace underscores a series of managerial missteps that has undermined investor confidence, best illustrated by the 60 percent decline in the stock from the record. In the latest mishap, the company yesterday said it overstated profit guidance by 250 million pounds ($410 million) in the first half and suspended four senior executives. Chairman Richard Broadbent was left defending his position, saying "shareholders will have to decide for themselves whether I'm part of the solution or part of the problem."

New CFO

Now, the company is forced to scourge its management team. Philip Clarke's replacement as CEO, Dave Lewis, started a month earlier than scheduled and today managed to get incoming Chief Financial Officer Alan Stewart into the company two months ahead of time. Lewis, 49, is tasked with restoring the fortunes of a company as well-known in Britain as Wal-Mart is in the U.S., and reversing a perception among shoppers that its once-loved stores are now dingy, overpriced and populated by rude staff.

It was very different two decades ago. In 1995, Tesco had started to expand overseas and that year overtook J Sainsbury Plc as Britain's largest supermarket chain after shaking off its image as a "pile-em-high, sell-em-cheap" retailer by starting its Clubcard -- a loyalty program that told it exactly what shoppers were buying.

Cabbage, Homeware

"It really stood out in the corporate landscape as a fast, dynamic, innovative and market-leading company," said Robert Gregory, global research director at Planet Retail in London. It was a company of its time, said David Arnott, principal teaching fellow in marketing & e-business at Warwick Business School in Coventry, England. "The housing market was growing, there had been a good period of growth and people in general were happy. Tesco knew how to exploit that with clever marketing."

It was the first British retailer to give newly upwardly mobile shoppers large out-of-town stores that stocked everything from cabbage to televisions and homeware. For those who didn't fancy a laborious shopping trip to an industrial park, Tesco convenience stores, selling staples and ready meals, became ubiquitous in the center of U.K. towns.

Loyalty Cards

"All other retailers failed to match Tesco's pace," said Bruno Monteyne, a former Tesco executive who is now an analyst at Sanford C. Bernstein in London. "However, the wheels came off around 2006 and 2007 when market share in the U.K. peaked. Management had gotten addicted to double-digit growth in market share and had to find other ways to expand in the home market, doing that by raising prices for example."

As Tesco increased prices, other British grocers upped their game by opening stores at a similar pace, revamping their food offerings and introducing rival loyalty cards. German discounters Aldi and Lidl started to shoulder their way into the U.K., bringing their successful model of low frills and low prices. That accelerated after Lehman Brothers Holdings Inc. collapsed in 2008 and the ensuing recession curtailed household spending.

"The natural course of competition is that it gets tough," said Munger, speaking in Los Angeles this month at the annual meeting of Daily Journal Corp., a publishing company where he is chairman. Munger is the longtime business partner of Warren Buffett, Berkshire's chairman and CEO. "It's the people who expect everything to keep going wonderfully who are nuts."

Squeezing Costs

Tesco didn't react to its cheaper competitors, counting on consumers to start spending more once the economy recovered. Meanwhile, it tried to squeeze costs by not investing in stores, diverting resources to support its international endeavors. That is when customers really fell out of love with Tesco, said Neil Saunders, managing director at consumer research company Conlumino in London.

"It really was the basics," he said. "It was pricey, there was bad service because there were not enough staff in the stores, the stores looked tired and dirty, and often they didn't have what customers were looking for."

When Clarke took over in 2011 from Leahy, the man credited with making Tesco a dominant force, the company's management recognized they had cut costs too aggressively at the U.K. operations. Under Clarke, it spent more than 1 billion pounds trying to remedy that by remaking stores, adding children's playgrounds, artisan bakeries and Zumba dance classes to lure back customers. Clarke, 54, also spent on technology products such as tablets and building the company's online media.

Sales Decline

Yet the extra spending did nothing to stem the flow of bad news. Tesco had its worst sales decline in more than two decades this year, when revenue dropped 4.5 percent in the 12 weeks ended Sept. 14, and market share fell 1.4 percentage points to 28.8 percent, Kantar Worldpanel data showed. Meanwhile, Aldi and Lidl have maintained record shares of 4.8 percent and 3.5 percent, respectively.

"There was certainly hubris on the part of the last management team, when it turned its focus away from being a food retailer and wanting to become Amazon," Monteyne said.

And Leahy's once-feted reign has not been untarnished by Tesco's recent travails, notably his decision to pursue international growth through the creation of the Fresh & Easy chain on the U.S. West Coast. Last year, Tesco's former Chairman Ian MacLaurin criticized Leahy's legacy, saying it was "a very sad situation, the enormous writedowns, the situation in America."

That view of the U.S. as a graveyard of Tesco's ambition is echoed by Berkshire's Munger. "They thought they were so smart they could do something difficult," he said.