Tesco positions itself as merger threatens dominance

Tesco (Frankfurt: 852647 - news) 's dramatic shake-up, which could cost the jobs of 9,000 of its UK employees, has a number of causes.

The first and most obvious is that, in common with the entire grocery sector, Tesco needs to keep a lid on costs.

The weakness of the pound has pushed up the price of a lot of the imported goods Tesco and the other grocers sell.

As a business, whenever your input costs go up, you have a choice. You either hold prices and take a hit to your profits. Or you try to preserve your profitability by either passing on the higher costs to customers or by cutting costs elsewhere in the business.

Understandably enough, Tesco has opted for the latter approach. Dave Lewis, the chief executive, is in the middle of a turnaround of the business that began when he was parachuted into Tesco in 2014 and which saw him have to report an accounting black hole only weeks into the job.

That scandal cost Tesco a reputation it had taken many years of growth to build up and, even though Mr Lewis is generally regarded as having done a good job, he can hardly be blamed for wanting to play fast and loose with Tesco's profitability.

Just over two years ago, Mr Lewis pledged to restore Tesco's profit margin to between 3.5-4% by 2019-20 - a very specific target by which investors will judge him.

However, in the current retail climate, passing on higher costs to customers is also a non-starter.

The German retailers Aldi and Lidl are both privately-owned and indulged by their owners rather more than Mr Lewis is.

For as long as they show little willingness to raise their prices, neither can Tesco, the market leader by some distance.

:: Tesco says 9,000 jobs hit in restructuring

Tesco also probably has one eye on another aspect of the competitive landscape.

Sainsbury (Amsterdam: SJ6.AS - news) 's and Asda are hoping to seal their merger this year, a move that would see the combined business overtake Tesco as market leader, while Mike Coupe, the Sainsbury's chief executive, has promised to cut prices by 10% should competition authorities allow the deal to go through.

That would represent an enormous competitive threat to Tesco and Mr Lewis will naturally want to ensure the company is equipped for the battle to come.

Accordingly, Mr Lewis has to pull on as many levers as possible to increase the efficiency of the business, for example by changing the way goods are moved around the warehouses and stores.

That will result in fewer people having to work as many hours before. There will also be jobs taken out of head office, too, a continuation of a process that has seen an estimated 6,000 positions go at Tesco's head offices since Mr Lewis took the helm in 2014.

To that extent, these job cuts must also be put in context.

While some 9,000 jobs are at risk in total, Tesco says it hopes around half of those staff affected can be redeployed, resulting in a net loss of 4,500.

That is a tiny proportion of an overall UK workforce of more than 300,000 and probably less than the company loses each year through "natural attrition" - people retiring or leaving to take jobs elsewhere.

Tesco's UK workforce, despite the job cuts in head office, has been rising, not falling, since Mr Lewis became chief executive.

But there is another factor behind these reductions, too, which is that they are a recognition of the changing way in which people buy groceries.

People are making more trips to the shops, which is why both Tesco and Sainsbury's have invested heavily in expanding their convenience outlets in recent years, but the size of the "basket" has been falling. This reflects that most people are pressed for time and cannot hang around in stores in the way they once did.

Tesco says that, as a result, people are making fewer trips to its meat, fish and delicatessen counters - which it is why it is proposing to close some counters in some stores altogether or vary the opening hours of others.

Yet the decision to reduce the availability of counter service comes at a time when Morrisons - whose chief executive, David Potts and chairman, Andy Higginson, are both former Tesco executives - has been enjoying a renaissance, highlighting its popular "Market Street" concept in all of its advertising.

Waitrose and Sainsbury's, too, have been investing heavily in their counter service.

So rivals, as well as independent butchers, fishmongers and deli operators, may well be secretly cheering Tesco's decision.

As Clive Black of Shore Capital, one of the sector's most respected analysts, told clients today: "If counters really are closed and dismantled in the UK, such actions could lead to trading ripples around the market, maybe benefiting other supermarket's offers, particularly those with a very strong commitment to counter activity."

It promises to be another interesting skirmish in a battle being fought on numerous fronts.