Turning orange

IN THE third week of the job, the last thing a new chief executive wants to hear is that there is a £250m ($410m) black hole in his new employer's accounts. Yet this is exactly what happened to Dave Lewis, the new boss of Tesco, Britain's biggest retailer, on September 19th. Although an investigation has been launched by Deloitte, an accounting firm, to find exactly what went wrong, it seems that Tesco's British arm had been booking discounts on goods it had not yet sold as income, while simultaneously understating the costs of the sales it had actually made. All in all, Tesco's profits for the first half of the financial year should have been £850m, rather than the £1.1 billion announced earlier this month. When the news was announced to the public on September 22nd, it took the stockmarket by surprise. Tesco's shares lost 12% of their value in one day, reaching their lowest level for 11 years.

The announcement comes at a time when a string of bad news has battered the beleaguered retailer. In the past year Tesco's fortunes abroad have turned sour, with the sale of its American arm, Fresh & Easy, last September representing a loss of £2 billion on its investment in the country over the past eight years. At home, the situation is almost just as grim: competition from more upmarket food retailers such as Waitrose and Marks & Spencer, as well as deep-discount supermarkets like Lidl and Aldi, have squeezed the giant's share of the grocery market in Britain from 30.3% last year to just 28.9% today.

Tesco's reputation among its customers has also taken a bashing in recent months. Pictures of dirty, messy and under-staffed stores on the internet have damaged the brand's reputation; stories of management incompetence at both headquarters and branch level, as well as chronic supply-chain problems, on staff internet forums such as verylittlehelps.com (a pun on Tesco's advertising slogan, "Every Little Helps") have not helped either. As a result of this combination of problems, profits have almost halved from their peak in 2012.

In some ways, the narrative of Tesco's decline appears similar to that of its now second-placed rival, Sainsbury's, in the 1990s. Back then, Sainsbury's was Britain's biggest retailer, and it made similar strategic blunders to Tesco's today. It also neglected its core supermarket chain in Britain, and it too was distracted by its other investments, specifically in Homebase, a British DIY retailer, as well as in America. And rather like the budget supermarkets today, Tesco back then began to better its orange-tinted rival on price and innovation. Sales growth slipped, as Sainsbury's increased its prices at the same time as letting the quality of its products fall. It also lagged other supermarkets in terms of its strategy, being slow to see the importance of innovations such as loyalty cards. Poor management of its supply chain also damaged its reputation for reliability in its customers' eyes.

But Tesco's problems today may be even worse than those of Sainsbury's 20 years ago. As the overall grocery market was expanding strongly in the 1990s, much of Sainsbury's decline in revenues was in relative rather than absolute terms. Tesco does not have that luxury today: like-for-like industry sales are now only inching up at a rate of 0.9% a year. And Tesco is much less well able to bear the costs of a turnaround than its orange-liveried competitor: its balance-sheet at the moment is simply in a much less healthy state. Whereas Sainsbury's in the 1990s had a minimal pensions deficit and owned over 90% of its stores freehold, Tesco today is in a much worse position, not least because of its £2.6 billion pension-fund deficit. And worse still, before the retailer's present problems came about, it had sold many of its stores on leaseback agreements, which lock it into renting them back at ever-increasing rents that it cannot escape.

Although analysts are still divided over whether entering these contracts was a good idea in the first place, what is certain is that they mean Tesco has much less flexibility to reorganise its store network to deal with rise of budget supermarkets than Sainsbury's had in the 1990s. Yet even without that disadvantage, it took well over a decade and a series of chief executives to turn Sainsbury's fortunes around. However deep the accounting problems Deloitte's newly-launched investigation eventually finds, reversing Tesco's decline will have no quick fix. Although Mr Lewis's mandate to change Tesco's strategy has been strengthened by the latest revelations, investors may need to wait years before they hear any good news, as happened with Sainsbury's. But in today's rapidly changing and uncertain retail climate, Mr Lewis may find them less patient today than they were in the past.