Why the Tesco story is part of a bigger UK retailing picture

Following today's news that the Serious Fraud Office (SFO) is moving in on the Tesco £263m auditing 'black hole', I suspect that several people I know and like will be feeling quite apprehensive at the prospect of some serious official questioning. There is something in this story - from what has emerged so far - that's rather reminiscent of the scandal that surrounded the British parliamentary expenses system a few years ago. But the numbers are, of course, bigger this time. 

In both cases, a group of people knew at least part of what was going on - and knew that others in the loop knew - but no one was talking. In the Westminster scandal, members of parliament annually pocketed thousands of pounds to cover payments for which they were absolutely not eligible. This is precisely what Tesco is accused of doing: asking suppliers for money that should only have been payable if sales of their products had been greater than they actually were. In technical terms, the accusation is that the retailer was 'bringing forward rebates': or, as an accountant might say 'claiming profits that have not yet been made'. Which sounds to me rather like the classic Israeli military term, 'pre-emptive retaliation'. 

Getting sales projections wrong is not very difficult; quite the reverse. But at Tesco, it looks as though it was happening on an industrial scale, and over several years. Profits are believed to have been overstated by £118m in the first half of 2014, by £70m in the 2013-2014 financial year and by £75m prior to that. Given the limited number of suppliers big enough to make these kinds of payments and with whom supermarkets have close relationships, it is more than likely that the retailer will have made a number of visits to the same well. (Wine-focused readers should note that as I mentioned previously, it is very likely that wine suppliers will only have been contributing in the same way - and at relatively smaller levels - as much bigger companies such as Coca Cola, Unilever and Procter & Gamble).

The SFO investigation will take a long while: the numbers are big and the stakes high. But while the wheels grind small and slow, there are bound to be increasing discussions over the nature and desirability of the 'commercial income' that lies at the heart of this saga. Some readers of own little piece may have gained the impression that I prefer the German discounter model of net sales in which the payments only ever go from retailer to supplier and not vice versa.

Far from it. In fact, I entirely understand the logic of suppliers contributing to retailers financially in the context of a strategy to build sales - and ultimately profitability - of a brand. 

The Tesco Wine Fairs are a brilliant example of how this can work at its best, with thousands of consumers being introduced to new and unfamiliar products and potentially being turned not only into customers but also unpaid brand ambassadors. Tesco's extraordinarily widely distributed wine magazine is another useful role model for others to follow. Efforts like these should be at the heart of the Joint Business Plans (JBPs) about which so much has been heard.

The JBP sounds like a very good idea. What's not to like? Well, actually, as several respondents to the piece have made clear, rather a lot. First, it naturally favours the trend towards small numbers of big retailers trading with small numbers of big suppliers. A JBP makes no sense when applied to smaller producers and importers. As Angela Mount, former wine buyer at the now-closed UK retailer Somerfield said in a recent Harpers piece, she was almost obliged to work with companies with the "most lucrative promotional strategies and marketing money". Her employers told her to "Get the brands listed who are going to give us money..."

Second, even when signed between grown ups, a JBP can be a very unequal arrangement.

In theory, the plan is supposed to represent a strategy that suits both sides of the equation.The supplier agrees a price at which they are happy to sell their wine and the retailer calculates the retail prices that give them the margins they require. If all goes well, the wine sells at the predicted rate and price and everybody is delighted. If all goes very well, the supplier will be super-delighted to share some of his extra income with the retailer who facilitated it.

Unfortunately, all does not always go well. The retailer has the power to change those retail prices as and when they please. And for whatever reason. Obviously, this might be because of the wine enjoying a slower than planned rate of sale. On the other hand, it might actually be flying off the shelves, but this very popularity might lead the retailer to want to offer it to their customers as an attractive bargain.

Obviously, reducing the price reduces the retailer margin, allowing it to reclaim its lost profit from the supplier as a rebate. These are the kinds of occasions when Mount might have had to make an uncomfortable call: "I know we did that deal but I now need another £15,000 from you."

In other words, rather like the UK being fined by the EU for having the fastest-recovering economy in Europe, wine producers can be penalised by their customers for making a product consumers enjoy drinking and believe to be good value. Suppliers can of course walk away from the table when the play gets too rough, but the world is full of wine and plenty of companies ready to adapt their modus operandi to the UK model. Like a Victorian schoolboy who keeps a book ready to stick down the back of his trousers in case of a beating from the teacher, they hold a cash reserve with which to fund retailers' unexpected calls for cash.

The point to be stressed is that nothing I have just described necessarily fits into the remit of the SFO enquiry. In other words, as long as the retailer keeps its accounts correctly, it will be breaking no rules. Whether this is all a Good Thing is a matter of opinion.