Why is Tesco getting all frothy about coffee?

In his diary Samuel Pepys wrote about two loveable characters called Harris and Hoole, who used to hang out with “all the wits of the town” in a coffee den in Covent Garden, where they engaged in a “witty and pleasant discourse”.

‘Witty’ and ‘pleasant’ are the last two words you would use to describe the opprobrium whipped up by the national media over the last few weeks when it was ‘revealed’ that the fast-growing artisan coffee chain Harris+Hoole was actually minority owned by Tesco.

The fact that the retailer announced it had taken a 49% stake in the artisan chain in August last year, when it was widely covered in the business pages, appears to have been lost on national newspaper newsdesks, who despatched journalists in their droves to visit Harris+Hoole outlets and report on how Tesco was pulling the wool over consumers’ eyes.

The media storm was so severe that Tesco boss Philip Clarke was forced to pen an entry on his blog in which he defended the retailer’s investment, countering the negative publicity with the words: “We’ve always been upfront about our investment in Harris+Hoole, and so have Harris+Hoole.”

But what got lost amid the cappuccino froth and moral indignation was a vital question. Why would Tesco want to branch out into high street coffee shops?

You don’t have to look far past the latest high street coffee market figures for the answer. The total UK coffee shop market grew by 7.5% in 2012 to £5.8bn, according to data from coffee shop sector consultancy Allegra Strategies, ProjectCafe 12, and is now 10 times the size it was 15 years ago. Although Harris+Hoole has only 10 units and a 0.1% market share, that’s 0.1% of a sector that’s already worth nearly £6bn and predicted to hit £8bn by 2017.

Better still, this growth, which will take the current number of coffee outlets in the UK from 15,723 to more than 20,000, is being driven by the branded coffee chain segment, namely the likes of Starbucks and Costa. The sector shot up 10% in 2012 to £2.3bn and over the next four years is expected to enjoy 6% compound annual growth taking the number of outlets to 7,000 outlets by 2017 (from today’s 5,225).

So owning part or all of an up-and-coming coffee brand sounds like a no brainer, especially if the brand in question is UK born and bred, has healthy growth prospects and is unsullied by the sort of controversy that US chain Starbucks found itself mired in with the whole tax avoidance saga.

Allegra MD Jeffrey Young believes Tesco’s move is a sign of things to come and that future growth will be fuelled by a new generation of corporate-backed coffee shops, such as Harris+Hoole and Greggs Moment (currently being trialled in Newcastle), as well as the conventional branded coffee chains and ‘non-specialist operators’ such as supermarket cafés currently driving growth. “The entry of Tesco signals a new era of competition is about to emerge, with quite possibly further M&A activity,” he says.

Not that the supermarkets will necessarily take the same path as Tesco. Waitrose was actually the first to express an interest in establishing a high street coffee shop/café presence when it came close to purchasing Eat a few years ago and Young sees the acquisition of a high street operator like Eat or Pret A Manger as a more likely route to market for rival supermarket groups than the launch of a pure play coffee chain.

“It was a bold move by Tesco and I think that it’s unlikely that others follow. But I’m not ruling it out completely,” he says.

Whether taking a partial or full stake or starting a chain from scratch, there’s clearly scope for the likes of Tesco to become a significant player in this highly profitable arena. Yet that’s not quite how Tesco sold its investment in the chain to the media. In his blog, Philip Clarke said the company took a punt on Harris+Hoole after being impressed by the “energy and enthusiasm” of founder Nick Tolley and his siblings Andrew and Laura, as if the investment were more of a philanthropic gesture than a meaningful strategic move.

“We thought customers would love the coffee and the warm, friendly atmosphere of their shops so we decided to invest,” he wrote. “We like backing great brands, helping them to grow and to realise their potential. Great ideas can find it hard to get backing these days so we are pleased to be in a position to help entrepreneurs achieve their vision.”

The key words here are ‘their vision’. Despite Tesco’s stakeholding, the Tolley family retains full control over the brand and the day-to-day running of Harris+Hoole, stresses Nick Tolley, who says it was just looking for financial support. “We wouldn’t have been able to get to where we are today without Tesco’s backing, and their investment in our business will be a big help in any further expansion Harris+Hoole undertakes,” he adds.

Tesco may be taking a hands-off approach, but it will still reap the financial rewards if Harris+Hoole is successful. The move is also part of a wider strategy being deployed by Tesco, believes Young, who sees parallels with its investment in Euphorium, an artisanal bakery business that now has a presence in the retailer’s Kensington store. “This is about Tesco exploring the future of the high street,” he contends. “I expect them to make different but similar-style investments in businesses and concepts that are destined to be a really important future of the high street.”

Investments of this nature give Tesco the opportunity to learn about different sectors and apply these lessons to its own business, argues Young. “It has a lot of venues with cafés already, so who knows what it could or could not do in the future with its own cafés?”

The supermarket threat

One plan already touted by Clarke in his blog is to eventually open Harris+Hoole outlets in some Tesco stores “when the Tolleys are ready”. Tolley confirms that while there is currently “no fixed timeline for opening Harris+Hoole outlets in Tesco stores… this is something we would like to do when we are ready”.

How that development will affect the retailer’s relationships with rival branded coffee chains that it already works with remains to be seen. For the time being, at least, the chains remain unfazed.

“The Tesco investment in Harris+Hoole does not affect our relationship with the supermarket chain,” maintains a Costa spokeswoman. “We have over 130 stores within Tesco, which are all trading strongly and will continue to expand. There obviously is demand for coffee shops within supermarkets. However, the majority of supermarket cafés and coffee shops offer a very different product and experience to Costa so we do not view these as direct competitors.”

Starbucks agrees there’s scope for more players in the market. “The trend for better coffee in the UK market continues to grow,” says its UK spokesperson. “Customers see premium coffee increasingly as part of their daily routine. That means that they expect great coffee wherever they are, which has led to opportunities in new places like roads, on trains and in planes, in universities, offices and even hospitals - as well as in supermarkets and down the grocery aisle.”

Caffè Nero, which does not operate any outlets in Tesco, is equally sanguine about the wider impact of the supermarkets. “Costa and Starbucks have previously had concessions within a number of supermarkets and Caffè Nero has continued to open and be successful alongside these,” says a spokeswoman. “We have no reason to believe this will be any different in the future.”

Before Tesco announced its investment in Harris+Hoole, the retailer was lagging well behind its supermarket rivals with its in-store café/coffee shop offer. Research conducted by The Grocer in September last year found that just 15% of Tesco’s 3,000 outlets had a café/coffee shop - as well as its Costa cafés, Tesco has installed more than 180 Costa coffee machines in Express outlets.

Morrisons has the most coffee shops percentage-wise, with 360 or 75% of its 475 stores boasting cafés. M&S comes next with cafés in 40% of its 731-strong estate, including c-stores and Sainsbury’s, which claims to have opened the first supermarket café over 40 years ago, has cafés in 30% of its stores. Asda did not respond to requests for details.

Not all the chains were prepared to share their future expansion plans for their café offer, but they’re all currently playing with formats and concepts to see what sticks. M&S has big plans for its ‘tasting café’ format, for instance. More than 140 have been launched to date and it eventually aims to roll them out to all its larger stores. Tesco is also “busily exploring new concepts” in addition to its Harris+Hoole investment.

Asda has upped the ante by introducing speed-dating evenings and mother and baby coffee mornings at some of its cafés, Morrisons plans to open about 10 Kiddicare stores all with their own cafés, and Waitrose is also looking to get in on the act. The chain has a rule of thumb that stores of around 30,000 sq ft and above include a café, although smaller stores may also have them because customers and, on occasion, local councils, insist on them - which is no bad thing, says Waitrose. “Our research shows that having a café in-store enhances the overall shopping experience for our customers and they now expect to be able to enjoy a coffee with us,” says a spokesperson.

With the wider retail market growing at 1%-2% over the past four or five years while the coffee chains enjoyed like-for-like sales growth of 3.5% last year [Allegra], it clearly benefits retailers too. And far from being saturated, as some commentators claim, the market still has plenty of scope for growth, insist coffee brands. The Costa spokeswoman points to Tesco’s backing of Harris+Hoole as evidence. “This demonstrates the demand for coffee shops in the UK and the room for new players within the market,” she says.

Tolley is similarly bullish and suggests the omens are particularly good for those offering something a cut above the rest. “We believe there is a growing demand for high-quality coffee on the high street and we want to make this more widely available in a friendly environment,” he says. “By doing so, we think there is a great opportunity to grow in the UK.”

However, some of the supermarkets may have to rethink their coffee shop offerings, certainly in-store, if they want to cash in, warns Young. While he singles out M&S for praise, for the rest it’s a case of ‘could do better’.

“They’re going to have to move with the times of the café world,” he says. “You can only stay so long with the cup of tea and biscuits, fish and chips and fizzy drinks model that some of the supermarket cafés operate. They can be pretty dire places.”

Not the sort of place you’d find Pepys’ Harris and Hoole engaging in witty repartee - but don’t be surprised if you see something akin to their coffee chain namesake heading to a supermarket near you soon.