With supermarket milk wars back in the headlines, how much will this latest round of price cuts cost the retailers ?
We decided to crunch the numbers, using Tesco as our example.
Of course, our back-of-an-envelope calculations involved a number of assumptions, but they provide plenty of food for thought. We also sought Tesco’s feedback on the figures we came up with, but it declined to comment.
Our calculations suggest Tesco’s price cut on four pints of milk alone will result in a good £100m in value sales being lost from the milk category over the course of a year, and we estimate the impact on gross profits could be about £25m.
So how did we make these calculations?
Our industry sources estimate Tesco sells roughly one billion litres of own-label milk a year, so that’s our starting point. Converted to pints, and we are looking at annual sales of 1.76 billion pints.
Figures from Kantar Worldpanel for the total UK milk market suggest about 70% of milk is sold in four-pint bottles, and about 10% is sold as six-pinters [52 w/e 2 February 2014]. We don’t know the exact split for Tesco, but we are assuming Tesco’s sales are in line with the overall market. Our sources tell us that’s a fair assumption to make.
If we apply that split to Tesco’s 1.76 billion pints, we arrive at 307.5 million four-pint bottles and 29.3 million six-pint bottles sold annually.
Tesco cut the price of four pints of milk from £1.39 to £1, and six pints from £1.99 to £1.48 this week.
A key challenge in calculating the impact of those price cuts is the role that promotions play in the milk category, particularly on four-pinters, where 3-for-£3 deals are the key mechanic. Again, we do not have specific figures for Tesco, but we are told by Kantar that roughly 15% of all liquid milk was sold on promotion last year, and we are using that same figure for our Tesco calculations.
Because the 3-for-£3 deals in effect already offer four pints for £1, we are completely discounting the 15% of bottles sold on deal from our price cut calculations and are focusing solely on the 85% sold at full price.
Those 85% equate to 261.4 million four-pinters, which would have resulted in sales at the till of £363.3m while they were at £1.39 and will now generate £261.4m – a difference of £101.9m.
Applying the same logic to six-pinters, we get 24.9 million bottles sold at full price, which would have made £49.6m when sold at £1.99 and will now make £36.9m under the new price - a difference of £12.7m.
All the industry experts we consulted agreed our calculations on four-pinters were fair, but one source told us the dynamics on six-pinters were sufficiently different from four-pinters so as to make our figures on six-pinters wide of the mark.
The impact is fairly small either way, given the vast majority of the market is in four-pinters, but to be on the safe side, we’ve taken six-pinters out of the equation for our final calculations, giving us lost value at the tills of £101.9m if Tesco keeps its £1 price for a full year and if its price cuts do not result in more milk being sold.
Whether that last assumption turns out to be true remains to be seen, but one of our experts tells us it is sensible to assume that Tesco will see little – if any – increase in milk volumes as a result of its price cut once the dust settles.
As for gross profits, assuming Tesco makes a gross margin of 25% on its milk lines, we’d be looking at a hit of about £25.5m as a result of its milk price cuts on four-pint bottles.
The validity of our 25% margin assumption is up for debate. Most of our experts agreed 25% was a decent starting point, but one suggested margin could be considerably higher, so our figures could be rather conservative. As for operating profit, we’d be looking at a theoretical hit of £5.3m based on a 5.2% margin, though some of our experts have cautioned against suggesting impact on net or operating profit on the basis of a single line.
What all this means in the overall context of Tesco’s £200m investment is difficult to gauge. While some have interpreted the £200m figure as an investment in retail price cuts (in which case, our calculations suggest milk would account for a staggering 50% of that), most believe it to be a gross margin investment (in which case, we’d be looking at a more modest 13% of the total investment). On top of that, Tesco hasn’t specified over what time period it intends to make its £200m investment. All we know on milk is that its adverts are promising the price of milk is “down and staying down”.
We asked Tesco to clarify those points, and a spokesman referred us back to what UK MD Chris Bush said at a recent investor day: “What we intend to do is shift some of our promotional investment into putting more money into lower, more stable pricing. This does not mean that we will be stopping promotions, but what it does mean is that the promotions that we will offer will be more focused, more competitive, and more relevant for customers – genuine deals that customers can trust. This commitment to better, lower, more stable pricing begins today, with an incremental investment of over £200m, to offer everyday low prices on the products that matter most for our customers.”