Disclaimer: This interview is for informational purposes only and should not be relied upon as a basis for investment decisions. In Practise is an independent publisher and all opinions expressed by guests are solely their own opinions and do not reflect the opinion of In Practise.

{audio:0:01:21} I am a global investor and I currently manage a very concentrated portfolio. I find Poland to be exceptionally interesting, attractive as a country, as a people, as businesses and as economy, and increasingly I have been spending time learning more about Poland and Polish businesses. That is a little bit about me. I understand you have background in Tesco, which is exceedingly interesting for me. Let me stop there and I would love to hear a bit more about your background before we jump into the actual questions.

{audio:0:03:10} I have been working within the retail industry since 1999. I joined Tesco after a short period at a tech company called Comarch, which is a very well-known Polish company. It is one of the most successful Polish IT companies and also the biggest EDI provider in Poland. They also invest heavily in our market and are based in Krakow. I moved from them after four months to Tesco where I worked for 18 years in Asia and Europe, including the UK. I managed to get to know the entire group. I finished with Tesco in 2018 and moved to a pharmaceutical business in Poland called Dr. Max. It is the biggest pharmaceutical chain with 600 pharmacies in Poland, and is the biggest operator of pharmacies in Europe, operating in seven markets. It is owned by a private equity fund called Penta, which is one of the biggest Central European private equity funds of Czech origin.

{audio:0:04:42} I worked with them for two years then I was attracted by my current employer, MediaMarktSaturn who are the biggest consumer electronic retailer in Europe, operating in 12 markets. Poland is one of the biggest markets the company operates in and we are in the process of transforming the business to more of an omnichannel ecommerce business. That is nothing new but the company originated from a very traditional brick and mortar model, and is now transforming to a purely omnichannel business, which I am part of. I have been in retail since 1999, first food, then pharmaceutical and now electronics.

{audio:0:05:34} What functional role were you involved in when you were at Tesco?


{audio:0:05:44} In Tesco, I was the CFO for Central Europe, where I covered four markets: Poland, Czech Republic, Slovakia and Hungary. I was the only CFO for those markets because we clustered the four markets into one. It was not a coordinator job; it was a full CFO job for all four markets.

{audio:0:06:37} I am glad I am talking to you. Which city are you currently based in?


{audio:0:06:51} My life interests are in Krakow, which is the town I settled down after studies, but I am currently working in Warsaw. I used to commute to Wroclaw and, in Tesco, I used to commute mainly to Prague, but also to Budapest and occasionally Bratislava. I have commuted since 2011 when I moved internationally, from Krakow to many places.

{audio:0:07:28} Polish food retail is an attractive market which is why Tesco was there. Can you walk me through how Tesco got involved and their decision to pull out of Poland?


{audio:0:07:58} Technically, Tesco entered the market in 1995, but hardly anyone knows that because the first Tesco store was opened in 1999. But four years before, they took over a local chain of small stores in the south of Poland called Savia. This chain was originated from the town where I was born, so that is how I know it. They had 60 small format shops in the south of Poland – not hypermarkets at all – then Tesco started opening shops and the strategy was to open large shops of 12,000 square meters, which they successfully pursued for a decade. On the way, they acquired two companies. In 2002, they bought HIT from a German private owner. It was the first hypermarket chain which entered Poland after the communist break down. It was German owned and, at that time, was the biggest acquisition in the retail market in Europe, worth £500 million. I had the pleasure of managing the acquisition from a finance perspective.

{audio:0:09:47} In 2007, they acquired Leader Price which was owned by Casino Group, the French retailer. They left the market and sold their small stores to Tesco and their big stores to Metro Group. Since 2008, Tesco started moving more towards small stores but, at that time, the market was boosted by Jerónimo Martins, which is Biedronka, currently the biggest operator in Poland, who have a large market share in food retail. In a way, Tesco were trying to chase Biedronka with a quite ambitious opening plan of small shops.

{audio:0:10:45} Was all this in bigger cities or did it not matter which city they were in?


{audio:0:10:53} It did not matter much, but it was mainly smaller cities. It wasn't villages like Dino are doing. Unfortunately, at the same time, Lidl came to the game and they had ambitious plans for Poland. They are still active and the race is between Biedronka and Lidl, although Biedronka is still ahead. Lidl are still trying to take market share from Biedronka, which involved multiple price wars between them, where Tesco were not able to compete.

{audio:0:11:53} At the same time, there was a strategy decision made by the Tesco group not to invest into international operations because there was a big threat of Lidl entering the UK market, hence the group focused primarily on the UK. That was the critical point which unfortunately led the company to decide to leave the market because while Biedronka and Lidl were growing, Dino came with a new format of proximity supermarkets. Żabka entered the convenience segment which was and still is growing very quickly. Customers were moving away from the big shops and Tesco were mainly relying on the old format of large hypermarkets which was slowing down. They started losing market share and became unprofitable. This stagnation in growth led to a difficult situation where the company was dragging down the entire group, and therefore, they decided to leave the market because it was simply not adding any value to its portfolio.

{audio:0:13:40} Through that evolution of opening up and increasing the number of stores, acquiring HIT and several others, then deciding to close, it looks like there was an exact overlap. As you said, Tesco actually entered in 1999; 1999 is when Dino seems to have opened up as well, so my question is, did you watch Dino from Tesco's viewpoint, grow and compete from a very different angle, not only with Tesco but Biedronka, Lidl, Stokrotka and everybody else?


{audio:0:14:39} Yes, at that time we were watching Biedronka who were a benchmark for pricing decisions because they had the best price perception in the market and still do, despite the fact that, technically, Biedronka are not the cheapest. If you look at the pricing analysis of the core product, they come across as cheaper but Biedronka managed to have a very strong price perception over the years which they still maintain. Because of their scale and visibility, Polish consumers believe they are the cheapest operator. For Tesco, Biedronka was a benchmark to match our prices to, to ensure we remained competitive.

{audio:0:15:36} Biedronka was everywhere, with over 3,000 shops across the market, and they had a very well-developed distribution network, which is crucial to make small format profitable. Tesco and other large format operators had distribution networks which were not designed to support small format stores. They need many depots across locations and the right fleet because you cannot deliver to small stores with big trucks. Small shops cannot be serviced by bigger warehouses because you have to pick by item, rather than by case or pallet, because it is too much for the store. Those companies and Tesco didn't have this capability and there was a limitation to make small format operations profitable. Before Biedronka was sold to Jerónimo Martins, it was setup by one of the biggest real estate owners in Poland, Mariusz Świtalski. They had quick and easy access to many locations in the country, and scaled up to almost 400 shops.

{audio:0:17:55} Dino, at that time, wasn't so much of a threat or a concern as it started relatively small. However, the concept was new and different, because Biedronka and Lidl were discounters, although Lidl is perceived to be a supermarket rather than a discounter, whereas Biedronka is still perceived to be a discounter. Dino was always perceived as a neighborhood or proximity supermarket. An average Dino has 5,000 SKUs whereas Biedronka or Lidl used to have 1,200 SKUs but have increased to 3,000 which is still less than Dino. The core thing in supermarkets like Lidl – and it is a strength of Dino – is fresh food, particularly fresh meat.

{audio:0:18:58} The Dino group owns a meat factory so it's vertically integrated which allows it to assure locally produced Polish meat and offer a deli counter as a service to customers. None of the discounters have that so it was a competitive advantage. They also have good quality fruit and vegetables, and in the core groceries, they focus more on brands than private label, which is maximum 4% of the turnover at Dino, whereas the private label at Lidl is 90% of turnover. Biedronka also have double digit participation of private label in their portfolio. Dino would rather offer good quality branded products than focus on their own brands.

{audio:0:20:03} How real is the fresh meat advantage and why did Tesco, Biedronka and Lidl not replicate a similar fresh meat program within their stores?


{audio:0:20:36} Biedronka and Lidl don't have counters and it is not something they would do because it's expensive to operate a service counter and it takes up space. The blueprint of the typical Lidl or Biedronka store cannot fit any fresh deli counter, so all their meat is pre-packed.

{audio:0:21:13} Pre-packed for the meat?


{audio:0:21:14} Yes, pre-packed. Tesco had a strong deli and meat counter and had their own meat production where they would buy half a pig or cow and work the carcasses and serve those. That was the model for hypermarkets for many years but it was unprofitable due to labor costs. It required expensive equipment and losses were incurred because not everything was sold. The model changed after several years and everybody stopped producing meat in-house and Tesco and the other big players signed agreements with big meat producers, such as Hilton, who are well-known and have factories in Poland.

{audio:0:22:37} Hilton, like the hotels. They are able to provide good volumes for such a big chain, but they are not perceived to be a local Polish producer which is a problem because Polish consumers want locally produced Polish sausages. Meat produced by international operators is not perceived to be of the same quality as locally procured meat. Group Dino owns a local producer so they can influence and control the service quality.

{audio:0:23:41} Which country is Hilton meat from?


{audio:0:23:47} Hilton, I believe, is from Germany but they have a big factory in Southern Poland.

{audio:0:24:07} That is a true advantage and difficult to replicate by many other players.


{audio:0:24:22} The typical Dino shop is 400 to 500 square meters which is half that of a Lidl, Biedronka or a small format Tesco, which allows them to squeeze into small villages, where Biedronka cannot. These small rural areas are going to grow naturally because the trend is to live in these places with big houses and work in the nearby cities. In these rural areas, you can still buy land relatively cheaply and can even build a house for less than it costs to buy an apartment. If you look at their expansion plans, some stores are not as successful as they wanted, but overall, it works for them.

{audio:0:26:20} The profile of Dino customers is quite specific because they have 5,000 SKUs which fulfils the customer expectations and demand. They are not forced to travel further because they can find whatever they want locally. They also provide essentials for lower income groups with more constrained budgets. They also have some non-food essentials, similar to Lidl, with their non-food market in the middle of the shop offering DIY and random products, which they do to attract people, because there's always something new and interesting in their shop. Dino do not focus on WGIG, which is what's gone is gone, which means it comes, it is sold and never comes back. Dino stocks basic household items like a pair of scissors.

{audio:0:29:07} Tesco, Biedronka and the others all watched Dino going into small catchment areas over the past 20 years. Setting aside the fresh meat part, more from the strategy behind going after these small towns, clearly they have disclosed to the outside world that there is a market. Why didn't Biedronka, Tesco, Lidl and others go after the same market? I know Centrum have been attacking this market, but many big players seem to not be doing the same thing as Dino; am I missing something?


{audio:0:30:40} You are right, the bigger players are not doing that. They have not developed a good store model. The Tesco 1K shop which is 1,000 square meters, was not developed thinking about small towns. They were built in or surrounding cities with dense catchments. Nobody knew the habits of Poles would change and they would choose to live in small towns. Since the early 90s, and still from 2000 to 2010, cities were attracting people, but they wanted to go to Wroclaw, Poznan, Warsaw and Krakow. Whereas for the past 10 years, more people live 30km to 40km from the main town, mainly due to the affordability of property. They began to enjoy being away from big towns and not to experience the dark side of living in a big city.

{audio:0:32:45} You need to be well organized on the logistics side to efficiently deliver stock to those shops because they require expensive daily deliveries, which is what Dino does. You need to build your network with close docking stations to be efficient enough to optimize your routes. Tesco didn't have that and nor did Biedronka to some extent, therefore they could not enter those zones. Lidl wanted to lock the cities before moving further, and are still focused on bigger cities rather than small areas. The western part of Poland is more industrial and developed and much more affluent. The eastern part is more rural, less affluent, higher unemployment and has a smaller population. Dino are very dense on the western border and are more spread out in the east, which is very similar to others.

{audio:0:34:28} Dino are entering more into the eastern part which still has a lot of traditional trade. Many small shops are owned by private families and they also have moving shops which are small delivery vans which travel to villages. Every day the guy comes at the same time close to your house and you can buy basic products directly from the lorry. It is not great service but is convenient. Tesco were thinking about it but it did not resonate with the Tesco Group board. Biedronka trialed it but they gave up because they realized mobile shops would be unprofitable.

{audio:0:36:03} From my standpoint, competition is an important area I keep a close eye on.


{audio:0:36:20} The Polish market is 60% consolidated and 40% privately owned, whereas in Czech Republic, Slovakia and Hungary, 75% is consolidated and only 25% are corner shop retail.

{audio:0:36:56} Does consolidated mean controlled by Biedronka, Lidl or Dino?


{audio:0:37:04} Consolidated means it is managed by organized chains like Biedronka and Lidl. In Poland, 40% of shops are privately owned, whereas in other markets it is much lower, so there is still a bigger piece of cake to take over. 40% of the market could potentially be taken over by either organic growth or small acquisitions, so the Polish retail market remains very attractive. The Polish market is also consolidating quicker after several players left. Casino Group and Tesco sold their assets whereas the Czech Republic, Slovakia and Hungary still have the same number of competitors.

{audio:0:38:43} Dino seem to be acquiring agricultural land from farmers in small towns?


{audio:0:39:17} Dino is organic and their standard blueprint shop is a very efficient investment. The average Dino shop costs $600,000 which was much lower compared to Tesco. Dino are very efficient on the capital side and the land they buy is normally fields of potatoes or rye. Their acquisition model is well developed which is how they are able to open 250 shops a year.

{audio:0:40:18} When you were at Tesco were there specific metrics for evaluating the operating performance of stores, like sales or revenue per square feet or square meter, and did you have a view on how Dino was performing, relative to the larger market?


{audio:0:40:58} The key metric was like for like sales and we looked at the sales per square meter. We used to call it store productivity, and in this matter, we also looked at property costs, because we had a mix of leasehold and freehold stores. Dino and Lidl had similar metrics but their productivity, compared to an average Tesco shop, was twice as much per square meter. Their like for like growth was close to double digits, whereas Tesco had a maximum of a few percentage points. We never exceeded like for like of 10% in Poland, where those small operators had years where they exceeded those levels. Looking at property costs in relation to turnover, depreciation was almost 2% of turnover for Tesco, whereas Dino was less than 1%. That allows us to make twice the investment for an average shop compared to Dino or Lidl. There were many operational measures such as stock losses versus turnover. Our benchmark was not to exceed 2% of turnover otherwise it became problematic to manage your P&L.

{audio:0:43:23} Is the store loss based on wastage of inventory?


{audio:0:43:28} Yes, wastage of inventory and inventory differences. The Tesco benchmark was not to be over 2%, but it differed by department. In fresh food you had more, and in non-food you had less. Tesco had a very high level compared to Dino or other small operators who had between 1.2% and 1.3%. Not everybody discloses but it is often reported in official statements but we know those levels from other sources.

{audio:0:44:26} When Tesco opened a new store it cost them double than for Dino; how long did it take for the store to break even? I assume you looked at something else as well in a new store you had recently opened. What was that and what should it be?


{audio:0:45:04} We expected the store to break even after two to two and a half years. The assumption was that the store achieves maturity of sales and builds catchments after four years, and would expect pay back within five years. That was the guidance given to investors. Often you would make exceptions in strategic locations but when a store had both measures below those benchmarks, we had to justify why that location was good and had potential. Żabka have a strategy where they consciously build a store to cannibalize their other stores, which prevents others from entering the market. You see five Żabka stores on one street, which is deliberate. Sometimes you need to look holistically rather than at single locations. Tesco would look at an unprofitable store in isolation, but after looking at the catchment, would realize the store was protecting other stores nearby from Biedronka or Lidl entering.

{audio:0:47:53} That is an interesting strategy. As you look at Dino over the next five years, what would be the reasons why Dino could fail?


{audio:0:48:33} They would fail if they stopped expanding. There is potential to grow by 1,500 shops to 3,000. There is still space in Poland for exactly those supermarkets. Several players tried doing that and failed because they tried to create something which was too up market. Alma supermarkets were unfortunately too posh and affluent which created the perception of being expensive places, where Dino has the sweet spot because they look like a modern shop, but have good brands at affordable prices. Others who tried to play in the supermarket area either exaggerated and over invested into their range by bringing in too many expensive lines and the waste level was too high, or their prices were high and consumers believed they were expensive. They didn't have enough traffic whereas Dino does because they followed the trend and opened proximity shops which consumers appreciate.

{audio:0:50:27} The exact same applies in consumer electronics where, in my company, we now compete with other players who open up small convenient shops in villages, because that way they cut off consumers from our shops. At Tesco we observed customers through our loyalty program and noticed that where we had more stores and were strongly present as a brand, online orders increased. Those consumers would buy much more from Tesco compared to the average customer in the market.

{audio:0:51:47} Online sales for current Dino customers in small towns isn't attractive?


{audio:0:52:01} No, it would not be attractive; it would be more of a distraction from the good strategy which they currently have and would definitely bring complexity to the business. Dino do not have an efficient model because pickers would pick the product and manually deliver. I cannot imagine having online pickers in a 400 square meter shop; it simply would not work.

{audio:0:52:48} You said they would fail if they stopped growing but you also said they have room to grow to take it up to 3,000 stores. They currently have 1,700 stores so what happens after they hit 3,000 stores in the next five years? They seem to be reinvesting their earnings into opening new stores, distribution centers and meat processing. Would they then start going into bigger cities or adjoining countries?


{audio:0:53:47} Moving to the bigger cities would be more challenging for them because the big cities are currently occupied by Lidl, Biedronka and Żabka. Żabka is aggressive and opens three to five shops daily, and Carrefour are also trying to make a convenience play with their model. Dino could possibly export this concept to other markets such as the eastern border which is still not developed. Their strategy could easily be replicated with the Czech model. I also expect some further consolidation in big cities because there are market rumors saying that the Polish market could be for sale. Eurocash Group are one of the biggest wholesalers in the market and also run retail chains which are not that successful, but they have good locations. That might be a good opportunity to take over and build something similar to Dino, but in the big cities, because they have locations which are unprofitable because they cannot run retail. I expect them to sell it.

{audio:0:55:55} There were rumors that Stokrotka was considering a sale so I expect big cities will consolidate and move closer to the UK model where you have five big players controlling the market. Lidl and Aldi managed to successfully break through that by adapting to the UK market, but Poland will go in that direction. Dino should become number one in supermarkets. Żabka is the absolute leader in convenience. The big fight will be between Biedronka and Lidl, who will ultimately dominate the semi-discounting zone. I believe hypermarkets are dying and there remains a big question around what happens with Carrefour because Poland is a lonely island for Europe and it will be difficult for them to sell. Auchan operates in a niche and have loyal customers. They are cheap but suffer from their model because they are 12,000 to 15,000 square meters. They are trying to do what others are doing by optimizing and right sizing their shops to be more efficient, because the cities are not as high as they would like and they are burdened.

{audio:0:58:34} If you ran Dino today, what would you do that they are currently not doing?


{audio:0:58:52} Apart from expansion, I would extend the non-food offering which is still small. Before the modern trade entered the market, there was a well-known state-owned brand called Społem, which still exists. These were the shops where you could find everything. Dino could consider extending their non-food offering. I see a threat from Netto, the discounter owned by the Danish Salling Group, who acquired Tesco small shops and are now building a completely new concept of Netto which is no longer a discounter. They have a nice-looking supermarket with an extended health food range. After acquiring Tesco, they have 800 shops in Poland and are still converting the Tesco shops into their own format by completely refitting all stores into modern looking supermarkets. I would look into how strong Dino is in terms of providing health foods from their core proposition because it is a strong trend in the Polish market which will continue going forward.

{audio:1:01:41} You said you would probably expand their non-food offering, which is currently only 12% to 13% of their total revenue. Their dominant piece is dry food and beverages which account for 50%, fresh food which includes meat is 40% and the balance is non-food; do you know where Dino's margin is higher versus lower?


{audio:1:02:24} The margin enhancer in their portfolio is all the groceries products. Personal care and homecare have margins up to 30%. Fresh food always drives margins down because fruit and vegetables is always below 10% and meat is 12% at best. Those products are meant to drive traffic to your shops, but you make margins of 30% to 40% from bakery, if you have a baker. Also, all the personal and homecare products are at 30% plus margins. Some lines in the food groups are margin enhancing, for example sweets and snacks. Alcohol is also lower margin because it is more regulated.

{audio:1:03:56} Particularly in the areas with high margins, such as grocery non-food and personal healthcare or homecare, there is a gray market which is evolving quickly in the Polish market. You can deal directly with big producers like Proctor and Gamble or Unilever and buy in bulk. They allocate well-known branded products, such as Colgate, towards gray market areas, which is basically their surplus. There is a chain of supermarkets called Dealz, which grew over the last two years and only sells those products. They tried to be disruptive in this area by selling branded personal and homecare products at lower prices compared to supermarkets. They source from the gray market area which is legal but you have very short payment terms because they want to liquidate their stock quickly. That is also a potential opportunity for Dino, because the market is clearly growing here.

{audio:1:05:56} This is exceptionally helpful; we didn't talk about the numbers but there is so much to learn about different strategies. I greatly appreciate your time. If it works out, I will come back to you through In Practise and we can pick up where we left off. I sincerely appreciate your time.


Dino Polska, Tesco, and Polish Food Retail

Former CFO of Tesco Central Europe

inpractise.com/articles/tesco-poland-dino-and-polish-food-retail

Dino Polska, Tesco, and Polish Food Retail(December 8, 2021)

Former CFO of Tesco Central Europe

Interview Transcript

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