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Published on 30th November 2018

Tesco Felt the Squeeze as Accounting Scandal Unfolded

On September 19, 2014, former Tesco chairman Sir Richard Broadbent received a phone call that he likened to a “[Houston] . . . we have a problem” moment.

The call was from then CEO Dave Lewis, alerting Broadbent to a report that suggested employees of the grocery giant had improperly reported £250 million in income.

Indeed, the report had an astronomical impact. Three days later Tesco announced it would hire an outside auditor and suspend four executives. The company was forced to release its third profit warning in weeks, resulting in the stock price dropping 12 percent and wiping £2 billion from Tesco’s value.

Now, the employees at the center of the scandal are on trial as the British legal system attempts to understand how and why one of the world’s largest supermarket retailers overstated profits by millions of pounds.

Chris Bush, Tesco’s former UK managing director, and John Scouler, former UK commercial director, face charges of fraud by abuse of position and false accounting. Former UK finance director Carl Rogberg was also charged but is not currently standing trial due to a heart attack suffered last winter. Broadbent shared his memory of the phone call as part of his testimony at Southwark Crown Court this week.

All three have denied the charges. The defendants have yet to testify.

The ex-leadership on trial has been described by prosecutor Sasha Wass as “generals” who used their managerial authority to encourage employee “foot soldiers” to improperly report yet-to-be-earned income from suppliers in order to artificially inflate profits.

But pressures on the company’s financial performance emerged as soon as Sir Terry Leahy left the company in 2011, and Philip Clarke took over as chief executive.

Leahy had been at the helm of Tesco for 14 years, leaving a legacy as a dynamic leader who had grown Tesco from a second-tier grocer to a multinational food retail company. But with his global ambitions, he also stretched Tesco far from its UK roots even as this market accounted for around two-thirds of sales and profits.

There were signs of struggle abroad from the start. The grocer was late to the Chinese market among global retailers and a US brand called Fresh & Easy failed to catch on with American consumers. The economic downturn squeezed consumer spending worldwide, and operations in these countries failed to turn a profit.

The financial crisis and austerity hit British customers’ wallets as well. Money spent maintaining overseas businesses drew away investment from Tesco’s home stores, prompting service complaints. Competition from other low-cost retailers further chipped away at Tesco’s hold on the market. The company’s UK sales and market share steadily dropped.

While Leahy may have left behind a difficult situation, Clarke failed to lead effectively against outside encroachment, wrote Financial Times reporter Andrea Felsted.

“He dithered over the chance to cut prices at home, which would have crippled competitors such as J Sainsbury, and turned the tables on the advancing discount supermarkets such as Aldi and Lidl,” she explained.

Tesco issued its first profit warning in two decades in January 2012, when it became clear profit would be £450 million lower than expected. This sent shares down 16 percent.

Clarke announced a £1 billion plan to update stores and improve customer experience, but the pressures continued to mount through 2014.

In early 2013, an investigation found several supermarket-brand burgers—including Tesco’s—were partially made with horse meat, causing further consumer distrust in the grocer. In April 2013, the company sold its 199 US stores and wrote down £804 million in its UK property portfolio. In October, the company announced all nine of its international businesses were in sales decline. After poor Christmas sales, the company issued another profit warning at the beginning of 2014.

As sales decreased and costs related to overseas businesses grew, Tesco felt a margins squeeze. Operating profit margins, which had hovered around 6 percent from 2010 to 2012, nearly halved to 3.7 percent in 2013.

There was an internal pressure to achieve ambitious budgeted margin targets during this time, which led to Tesco being “unfair” to suppliers for their own financial gain, according to an investigation by the Groceries Code Adjudicator published in 2016.

The report, which covered June 2013 to February 2015, found that Tesco requested payments from suppliers whether or not growth targets were met. There was “widespread” accounting errors and duplicate invoicing that resulted in significantly delayed repayment. Investigator Christine Tacon found internal emails that suggested employees were deferring payments to suppliers in order to meet forecasted targets. One email suggested a strategy for making a half-year target was “not paying back money owed.”

“I found that Tesco knowingly delayed paying money to suppliers in order to improve its own financial position,” Tacon wrote.

Wass echoed this in court, suggesting the “obsession right from the top” that “budgets must be hit and targets must be hit” were what led to the improper accounting.

By spring of 2014, the internal tensions further rose to the surface.

Finance director Laurie McIlwee left the company in April, apparently over disagreements with Clarke. After yet another profit warning that summer, Clarke—who was set to celebrate four decades at the company—stepped down. Former Unilever executive Lewis was ushered into the role early, starting September 1, 2014.

19 days later, he made the call to Broadbent.

Lewis recalled “genuine shock” in learning about the overstatement, he told the courts this month.

“The level of what was implied in the paper was a way of operating I had not ever seen before,” he said.

Note: Story received top marks in Reporting Business course as part of my MA in Financial Journalism at City, University of London.