January 2009

Sir Terry Leahy, Chief Executive, Tesco PLC

"Consumers, Competition and a Changing World"

Introduction

Good evening, thank you for inviting me and for the honour of giving this year’s City Food Lecture.

Many of you are members of the great City Livery companies. Depending on your point of view, the origins of those companies were either to protect consumers in the Middle Ages from shoddy workmanship, or they were a very early version of anti-competitive practices – something that the Competition Commission would no doubt launch an investigation into.

If Tesco had been around in the fourteenth century, I am not sure which of the great companies I would be a member of. We sell fish, clothes, wine, jewellery, beds – looking at the list of The Twelve Great Livery Companies, I could have made multiple applications.

The members of those companies in the Middle Ages shared one simple thing in common. Trade. Just like most of us here tonight, they sold things or services.

Today, that trade is becoming tougher. As we face into the cold wind of recession, I want to make a simple argument: our trust in consumers and our belief in free markets have created the food industry we see today, and delivered countless benefits to consumers and communities. Our industry needs to hold fast to those beliefs as we go through the recession. That is not merely the right course of action, but it is the only course of action if we are to rebuild our economy and prosper in the years ahead.

So this evening, I want to make the case for trusting consumers, and for the free market. I will spell out how competition benefits societies, and how the power of consumers can address some of the biggest challenges we face today. And I want to give some thoughts on what this means for our industry, those of us involved in food and retailing.

Fifty years of free trade, competition and consumer power

Let me start with something that may strike you as obvious, but in these dark days few people say. Since 1950, the world has seen one of the fastest and most sustained periods of economic growth in its history. 

The basis of that growth has been an economic and political system that safeguards private property and permits free trade in competitive markets. It is not laissez faire, or a complete free for all. It is a system in which individuals are free to pursue their own interests and compete, within a clear framework of law. And, thanks to that competition, this system delivers innumerable benefits to society - lower prices, greater choices, higher living standards and so on.

Yes, this system is called capitalism. And at its heart lies a fundamental belief: trust in people, not in governments. Those people are what the economist Ludwig von Mises called the “sovereign consumer”. Knowing what is best for them and their families, they are free to make decisions about their lives.

In the economic sphere, that means they are able to choose which goods and services to buy and own. And this in turn demands competition which, wrote Adam Smith, converts “the private interests of and passions of men” into consequences “most agreeable to the interests of the whole society”.

The “invisible hand”, the search for profit, benefits us all. No doubt thinking of us here tonight, Smith wrote “It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their interest. We address ourselves not to their self-love, and never talk to them of our own necessities, but of their advantages”.

These beliefs – belief in people, competition and the profit motive – broke down the dam of protectionism that was built in the 1930s. As a result, trade flowed more freely, spurring markets to innovate, create and invest. Average tariffs on goods are now at a record low. Today, there are more than 200 trade agreements and customs unions. 400 regional trade agreements could be in force by next year .

In my lifetime – and I will leave you to guess when I was born, but I am glad to say The Queen was on the throne – world trade has expanded at a much faster rate than in the first wave of globalisation in the nineteenth century .

The information revolution, the green revolution, the lower costs of transport – these changes have pumped up the muscles of the world economy. But it is belief in free trade, and in the power of consumers, that has created the conditions in which innovation could deliver immense benefits.

One round of world trade talks – the Uruguay Round – delivered a global tax cut estimated to be worth more than $200 billion a year . In the USA, where Tesco now has a thriving business, trade liberalisation has caused Americans’ annual income to increase by $1 trillion since 1945 . Closer to home, over the last 15 years the European Single Market has increased the EU's prosperity by more than 2 per cent of GDP. In 2006 alone this meant an overall increase of €240 billion - or €518 for every EU citizen .

Overall, between 1960 and 2003, global per capita GDP more than doubled . The greatest beneficiaries have been those countries that warmly embraced free trade, competition, and the freedoms that underpin a capitalist system. A recent study has found that economies rated “free” or “mostly free” enjoy incomes that are more than double the average levels in all other countries . Capitalism, free markets, trust in consumers – this has been a winning formula.

Retail – an engine of social mobility

Let me bring this economic revolution closer to home. Think back to the days when supermarkets sold just food, and that food was usually tinned; when choice consisted of a bruised apple or a soggy lettuce; when luxury was a bottle of rather dodgy Riesling – those days are gone.

Competition has led to an explosion of choice: in the first six years of this decade, the largest four grocery retailers each introduced, on average, three new products a day. Put that another way: consumer choice grew, on average, by a dozen new products a day, every day, for six years .

And it is not just choice of goods, but choice of stores. 95% of us have access to supermarkets of three or more different fascia within 15 minutes of where we live. That choice allows customers to shop around more. In a four week period, customers on average use three different supermarkets. And the value of consumers switching from one supermarket to another is now worth over £10 billion a year. 

These facts give you a taste of retail today: highly competitive, dynamic and relentless. It is as if we are fighting a general election every day, in which customers vote with their wallets, switch their loyalties and shop around. And the benefits of this competition ripple across society, and are felt far and wide.

At its most basic, competition has lowered the price of shopping, helping most those on low incomes.  The price of food fell by over 9 per cent in real terms between 1989 and 1999. It fell a further 8 per cent between 2000 and mid-2007.  Put another way, Tesco has saved the typical household almost £5,000 on its shopping bills in a decade – ten years in which other households bills rose.

Then there is job creation. Tesco has created one new job every 20 minutes for the last 10 years. We have given work to 4,000 long-term unemployed. Those people enjoy not just the self-respect that work brings, but also benefits such as share options, pensions and flexi-time working.

And as retailers have profited, so too has the Government’s coffers which fund our public services. In the last 10 years, Tesco has paid £3.5 billion in tax – enough to pay for 160 new secondary schools.

These are just the direct benefits – benefits that any retailer could point to. Now think who else benefits from a shopping trip. Next time you are standing at the checkout, think of the number of people who have helped get those items into your hands. Farmers, food processors, brewers, fishermen, small manufacturers, hauliers – the veins of the supply chain spread across regions, countries and continents.

Many of you here tonight contribute in some way to that supply chain. And, when you examine it from afar, it is a miracle. Billions of products are made, shipped and bought, not according to some government’s central plan or blueprint, but to reflect the individual tastes and demands of millions of customers.

When I joined Tesco in 1979, we sold just one tenth of the number of products we do today. We relied on just a handful of suppliers. Today, we have 3,500 direct suppliers – one thousand more than in 2000. Some are large firms, others small, and an increasing number are local. Our aim is to stock more local lines than any other UK retailer – we already stock 3,000.

That growth demands innovation, enterprise, risk taking. Companies like Tesco, and firms from the largest to the smallest suppliers, must never cease to ask themselves “What more can we do for our customers?” They must always look for ways to improve a product, or develop a new line. If they deliver what consumers want, the company will win new orders, which in turn means more revenue and more jobs.

This virtuous circle of demand improves the lives of people around the world. Like any international company, our goods are sourced globally. Families and communities in the developing world benefit from the trade we do. Consider Panorama, a company in Haryana in India with whom we’ve been working for four years, which stocks us with women’s and children’s wear, and now employs more than 1,200 people. Or Homegrown in Kenya, with whom we’ve been working for more than twenty years, who supply us with flowers and vegetables, and who now employ 8,000 people – who in turn support around 40,000 dependants.

Many of you here tonight trade globally, and could give other examples. And each example is a nail in the lie that global trade hurts the developing world. The reverse is the case.

As the Chairman of the US Federal Reserve has pointed out, developing countries that opened their doors to global trade saw their annual economic growth double between the 1970s and the 1990s, while absolute poverty declined. Those that kept the drawbridge up saw their growth halve .

Once again, this shows the power of the sovereign consumer. Be it here or abroad, retail has been an engine for social mobility, raising people out of poverty, giving them security, opportunity and prosperity.

A mass movement in green consumption

The benefits of consumer power do not stop there. One of the greatest challenges we face today is climate change. I trust the science, and I believe that we do not have a choice whether to go green and cut carbon emissions. If we want long-term economic growth, we have to go green. Failure to act means climate change could cause massive economic and social disruption.

As Stern has made clear since he published his Review in 2006, climate change is happening faster and emissions need to be reduced more sharply. This means the costs of tackling climate change have doubled. So for every £2 we spend now on tackling climate change, we are saving future generations anywhere between £5 and £20 at today’s value.

Too often, the solution to climate change is seen as the responsibility of politicians or regulators, or bodies like the UN or G8.  Of course their role should not be downplayed, but if climate change is to be tackled successfully, we need a new framework in which governments, business and consumers each play their part.  Governments must understand that they, business and consumers are inter-dependent and are more powerful when they work together.

35. Consumers account directly and indirectly for 60% of carbon emissions.  Get the consumer on side and the task of tackling climate change becomes possible.  Imagine if the 30 million people who shop in our stores around the world each week, the 400,000 people who are employed by Tesco, and the hundreds of thousands of people who work to supply Tesco – imagine if all these people started to make decisions that cut carbon. If they bought more green goods, and used less energy, we would soon create a mass movement in green consumption.

This begins a virtuous circle. If consumers are able to purchase lower-carbon products and services, they will reward the businesses that produce these products.  This will encourage competition between businesses to produce more environmental alternatives to current products and services.  It will stimulate the research and development to bring forward even better products.  And we will begin to create a mass movement in green consumption.

This approach underpins our strategy at Tesco. First, we’re greening Tesco itself. Second, we’re helping turn the supply chain green. And third, we’re helping our customers make green choices easier and more affordable.

The results are already plain to see. In just over two years we have saved more than three billion plastic bags; in just one year we recycled over 340,000 tonnes – or 70 per cent – of our UK stores’ waste ; and in just one week recently we sold in the UK more energy efficient light bulbs than in the whole of 2006.

But if we are to avoid the calamity that Stern predicts, we need to go much further than this. In the UK, that means cutting our carbon emissions by 80 per cent by 2050. So at Tesco we are looking for new ways to cut carbon – which is why we have invested in the Sustainable Consumption Institute at the University of Manchester. We have, for example, opened a store that produces just a third of the carbon emissions of a standard store. So we are starting down the road, making progress, but still have some way to travel.

The recession and food retail

To recap, the free market and consumer power has delivered greater prosperity, better living standards, more social mobility, a dynamic and innovative approach to the challenges we face. Despite all this, the market economy still has its detractors. Well, it may not be perfect. But my defence is like Churchill’s defence of democracy. “Democracy”, he said, “is the worst form of government except all those other forms that have been tried from time to time”. The same is true for the market economy. Not perfect, but far better than any other system.

In light of this, what of the future? How are we to cope in the recession? Let me first talk about what, from my perspective, the recession means for food retailers. And then turn to how others, notably the Government, should respond.

In a recession, the temptation for any business is to think that the rules of the game have changed. They have not. The consumer is still sovereign. Let me quote von Mises again: consumers “are no easy bosses. They are full of whims and fancies, changeable and unpredictable. They care not a whit for past merit. As soon as something is offered to them they like better or that is cheaper, they desert their old purveyors.”

43. Retailers need to heed that warning. In a recession, striving for consumers’ satisfaction has to dictate everything each of us does. Retailers need to earn customers’ loyalty, not take it for granted. We have to go on creating value every day – tomorrow, next week, next month. If not, customers can change where they shop in an instant. Their behaviour changes far faster than any organisation. They don’t need to have a Board meeting, issue a statement to the Stock Exchange, or pass a resolution at an AGM. They simply walk into a store, and starting shopping.

44. That’s why successful retailers are those who change fast to reflect consumers’ whims and fancies. And in a recession, the ability to change fast is more important than ever.

We discovered this in the recession of the early 1990s, when we changed Tesco from head to toe to focus on customers. We learnt more when we set up our business in Asia in the 1997 Asian crisis. And on the basis of that experience, I make three observations about the current crisis.

First, with unemployment rising, and people concerned about their incomes falling, obviously the pressure is on price more than ever. For example, we are now Britain’s Biggest Discounter – the clearest possible demonstration of our strategy to follow consumers. Sales in our discount and value ranges are up by 65 per cent on the year. Now, a quarter of all our customers’ shopping baskets and trolleys include something from this range – which shows that customers see this range as offering great value.

Prices have been cut while inflation has been subsiding – which brings me to my second observation about the recession. Commodity prices are down over 50 per cent from their peak, and the price of a barrel of oil is down by about a hundred dollars from the giddy height it reached last year. These lower prices need to be fed into the supply chain, and passed on to consumers who are under growing financial pressure. We want to ensure that all our suppliers understand this, which is why we are going to great lengths to talk to them about the new pressures that consumers are under. This adjustment affects our entire industry. It will be difficult for some, but it is critical if consumers are to be given what they want. Think of the alternative: keeping prices as they are, and hoping against hope that consumers on tight incomes will buy our goods.

My third observation relates to climate change, to healthy eating, to local produce. Some say that in a recession all these things are luxuries, or that consumers no longer care about protecting the environment, eating healthily or buying local goods. All that matters is saving money.

This is a misleading argument. Consumers’ underlying values, fears and aspirations do not change in a recession. Their wish to protect the environment, to have a healthy diet, and to eat fresh, local produce has not diminished. They simply want more help in meeting their aspirations.

That means we need to make our offer more affordable. At Tesco, to help people go green, we have a new, good value home insulation service. To encourage healthy eating, we have ten offers on fruit and vegetables every week in 500 UK stores. To support local suppliers, we’re giving consumers a good choice of local produce, and sell on average over five and a half million pounds of market value produce each week. The point is simple: we have to change.

The Recession, Retail and Government

Those are some simple observations on what we, as an industry, can do as we enter what will be a tough year on the high street: but what of government?

As governments tackle the recession, they too must not forget the benefits that free trade and markets have delivered, and the power of consumers. Yes, there must be regulation to protect markets from abuse and to overcome market failure.  But the best markets are those where the consumer is king, and the best regulations are those which underpin, not replace, the consumer.  The problems we face today are not caused by too little regulation, but regulation that has been spread too widely and indiscriminately.

So Siren voices, calling for ever more regulation and intervention, must be ignored. That way lies the rocks, and the reason is simple enough. The more we regulate business, and the more that a government spends, the greater the burdens on the private sector – companies of all sizes that employ many millions of people, and whose taxes pay for public services.  The higher those taxes are, the less there is for companies to invest, the fewer jobs they can create, the longer and darker the recession will be.

So what should governments do? There is a clear difference between the banking crisis and the wider recession. Banks underpin economies. If banks collapse, people’s confidence in money evaporates.  Trade grinds to a halt as the economy’s engine seizes up. So government clearly has a role to prevent a banking collapse and the return to an age of barter. 

But beyond that, governments can help ease the pain of recession in a number of ways. Our Government rightly wants to get more people back to work, and keep them in work. That means two things.

For a start, every effort should be made to stop taxes going up. It would make good sense to freeze business rates this year, so that the tax burden on business does not rise.

Then there is regulation. Businesses must not be buried by a new avalanche of new paperwork from Whitehall. For example, the Competition Commission’s inquiry into supermarkets proposes a so-called competition test. This test assumes that, if you ban one company from investing in an area, another company will step into the breach. There is nothing to support that assumption, especially in today’s economy.

58. Furthermore, why hamper a highly competitive industry that the Commission itself acknowledged delivers value, choice, innovation and convenience? Why hinder new investment which create jobs? And does it really make sense to bring in such new measures, which will cost time and money, at this time?

59. Meanwhile, governments must act together globally, and redouble their efforts to secure new free trade agreements and stop new barriers being erected. According to the United Nations, a quarter of all new Foreign Direct Investment laws brought in since 2005 are unfavourable to trade . Some nations are already raising tariffs on goods like steel, meat, soybeans and cars.

This trend is the very last thing we need, given the World Bank already forecasts that global trade will shrink by over 2 per cent this year – the first decline since 1982 . Instead of erecting new barriers, nations need to form a united front against protection. And, in the long term, they need to agree upon the Doha proposals to cap tariffs on goods at 6 per cent. Without that cap, governments could raise those tariffs to 10 per cent – more than double today’s average.

The recession is, rightly, the main priority of governments around the world. But we must not allow other pressing, global challenges to slip out of sight. Consider this one fact: the world’s population is forecast to grow by 2.5 billion between now and 2050.  To put that in perspective, 2.5 billion was the size of the entire world’s population in 1950.

This growth means that we need to double the world’s food production by 2050. The demand for certain foodstuffs will soar. Since 1970, for example, the per capita consumption of calories in China and India has leapt by over 25%, the demand for meat threefold. These changes in diet will increase agriculture’s demand for water. And all of this is against the backdrop of climate change, and the need to cut emissions, which I mentioned earlier. 

What can governments do? Once again, I would argue for more open markets, and more trade. Farm subsidies are still too high. Support to producers in high income countries was estimated to be $268 billion in 2006, accounting for an enormous 27 per cent of farm receipts . These subsidies displace and reduce the efficiency of agriculture production globally, particularly in the developing world, and keep food prices in protected markets artificially high, often at the expense of the developing world. So they hinder our attempt to feed the world’s growing population.

Action is needed, but extreme caution is required. All these problems are interconnected. Trying to tackle one problem – climate change, for example – can compound other problems.

The recent expansion of biofuels is a case in point. A few years ago, governments offered subsidies to encourage farmers to plant biofuels, as a means of cutting carbon emissions. But by turning thousands of acres over to growing biofuels, forests were cleared and less land was available for other crops. The biofuels bonanza is estimated to account for 70 per cent of increase in corn prices and 40 per cent of the increase in soybean prices .

Worse still, much of the biofuels grown went to produce corn based ethanol. This is more costly to produce - in energy-equivalent terms - than sugarcane ethanol, and the environmental benefits relative to gasoline are small .

What conclusions can we draw from this episode? Not that we should do nothing, but that we should think things through before acting, so that we do not suffer from unintended consequences. We need research of the kind being undertaken at the Sustainable Consumption Institute that I mentioned earlier, so that we break out of the old way of thinking about problems, and think afresh.

68. Governments alone cannot solve the challenges we face alone. Official plans, blueprints, diktats – this is not the way to overcome problems that affect the entire world. Of course Governments have a role to play, but that role must acknowledge the interdependency of companies, consumers and governments themselves. For the best way to tackle many of today’s challenges is to act together to harness the dynamism of the market and the power of the consumer.

Conclusion

And that brings me back to where I began – the power of the consumer. Global, unforgiving and forever changing, the invisible hand of the consumer has created not just our industry, but it has delivered untold benefits of prosperity across the world.

Now, in a recession, we must not forget or ignore the lessons of the last few decades. We must not overlook the benefits that the free market and consumer power have brought.

Let me end by quoting Vaclav Havel, the First President of the Czech Republic. He wrote “I have always known that the only economic system that works is a market economy. This is the only natural economy, the only kind that makes sense, the only one that leads to prosperity, because it is the only one that reflects the nature of life itself. The essence of life is infinitely and mysteriously multiform, and therefore it cannot be contained or planned for, in its fullness and variability, by any central intelligence” .

These are words we cannot forget, written by someone who saw how planning and centralisation failed. My advice tonight is simple: trust the consumer. Only by following the consumer we will regain our prosperity. It is a lesson we took decades to learn. We forget it at our peril.

Thank you for listening.