Competitiveness and Investment Attractiveness of the South African Food Retail Industry - Essay Example

?Competitiveness and investment attractiveness of the South African food retail industry Module Word Count 3004 Table of Contents Introduction 1 2. Porter's National Diamond 1 3. Management Issues 6 4. Mode of Entry 8 5. Conclusion 9 References 11 Appendix 13 Introduction 1.1 Background The South African food retail industry (SAFRI) has been experiencing strong growth in recent years and is predicted to grow further (Datamonitor, 2012). The SAFRI was expected to generate total revenue of $73.9 billion in 2011 which amounts to compounded annual growth rate (CAGR) of 11 percent between 2007 and 2011. The most lucrative areas in food retailing are expected through hypermarkets, supermarkets and discounters in South Africa. By 2012, the SAFRI is expected to have a value of $98.1 billion which will be an increase of 32.7 percent over 2011 (Appendix A). While the above figures demonstrate the attractiveness of the market for investments, further evaluation would be conducted to determine the competitive advantage in investing in South Africa. This would be conducted through the extended model of Porter’s National Diamond. 2. Porter’s National Diamond The competitive advantage of an industry, according to Porter, derives from the national ‘diamond’. These four diamonds are the four determinants of competitive advantage created within the home base of the nation state – factor conditions, demand conditions, related and supporting industries, and firm strategy, structure and rivalry. The extended model of Porter’s National Diamond includes government and chance events. An important key feature of the model is that the determinants are supportive of each other and operate as a system (Clancy, O’Malley, O’Connell and Egeraat, 2001). This implies that there should be effective flow of information about needs, techniques and technology. Here geographic concentration is important because proximity facilitates flow of information. This concept is known as clustering and hence it would determine if South Africa has clustering in the retail sector. 2.1 Factor Conditions Factor conditions are basically inputs but these are not inherited; they have to be created, according to Porter. These factors would have to be upgraded from time to time. While the basic factors pertain to demographics, location and climate, the advanced factors include communications infrastructure, sophisticated skills and research facilities. South Africa’s population has surpassed 50 million and more than 90 percent of its population is non-white (Arisaig, 2012). Unemployment rate is 25.2 percent and the average life expectancy is only 57 years. Unequal distribution of wealth has resulted in the poorest ten percent earning just one percent of the total national income. Poor education system can be attributed to high rates in unemployment. However, the country has modern infrastructure and the retail sector is sophisticated although dominated by local products (Ntloedibe, 2012). The country also has a well developed communications network and electricity supply is also reliable. In addition, South Africa also has a network of merchant banks, brokers, and financial services specialists. Investments in technology and telecommunications are increasing which will enhance business infrastructure thereby enabling the companies to compete with the countries in the West (Maxwell, 2013). The southernmost country on the African continent, South Africa is one of the most economically prosperous nations in southern Africa due to its coastal location and presence of gold, diamonds and natural resources (Briney, 2012). However, climate change is prominent in South Africa and this impacts sourcing and transportation of agricultural products for retailers. One way to handle this is through adaptation by sourcing through several suppliers in vulnerable categories. Despite its coastal location, water is scarce and water security is a fundamental challenge faced by retailers. This requires the retailers to actively engage with suppliers for water management, both in supplier operations and in product design. Education level being low, the food retailers face shortage of skilled labour (Arisaig, 2012). This requires developing programs first to attract talent and then to train and develop, while also providing for career progression. 2.2 Demand Conditions Demand conditions influence the shaping of particular factor conditions. Home demand is determined by a mix of customer needs and wants, their scope and growth rate and the mechanism through which domestic preferences are transmitted to foreign markets. Legislative requirements and demand from the customers pose a challenge for waste management for the retailers (Arisaig, 2012). This is particularly with regard to packaging and water pollution. Since this poses risk to retailers and their suppliers, retailers need to take initiatives beyond their operations thereby including suppliers and customers. Sophisticated skills such as recycling and light weight packaging could help in managing waste. Building resilient supply chains is also critical to the retailers in South Africa and this involves working with supply chain partners to support the development of emerging farmers. This is part of food security and this contribution means offering a broad range of healthy food options while also providing information to consumers about such food options (Arisaig, 2012). Corruption in South Africa has been in practice for decades but the retailers have to ensure they deal with it effectively so as to protect their reputation in their home markets (Arisaig, 2012). Retailers investing in South Africa would have to bring in good governance practices. To protect their reputation, retailers would need to develop robust code of ethics for suppliers and ensure compliance with legislative requirements. The emerging middle-class does engage in high level of consumer spending which has contributed to the growth of the retail sector in South Africa (Arisaig, 2012). Disposable income has been increasing but to pressures in high cost of living, consumers have become price-conscious. However, the retailing sector in South Africa is still underdeveloped with the informal sector dominating the market as of now. 2.3 Related and Supporting Industries Related and supporting industries in the retail sector include the small and large suppliers to retailers and the farmers. In South Africa several small suppliers exist and several emerging farmers have been trying to make themselves sustainable. Retailers in South Africa would need to collaborate with farmers and implement sustainable farming programmes (Arisaig, 2012). Retailers would need to work in cohesion and collaboration to develop and drive sustainable farming practices, which can ensure successful supply chains in the future. Retailers also need to work in collaboration with other retailers to facilitate the growth of small businesses and emerging farmers in South Africa. This can lead to job creation and food security. Currently the retail suppliers are subject to heavy financial burden as they need to comply with legislative requirements and retail standards. The legislation demands individualized audits and compliance checks of the suppliers but if the retailers collaborate this can be reduced so that a common set of standards and audit regime would reduce the burden. The agricultural sector in South Africa is shrinking as over the next 15 years the total number of farmers is expected to reduce by 60 percent (Arisaig, 2012). This poses an opportunity for retailers to carefully consider the buying power they hold through their value chains. Instead of focusing on price competition, retailers would benefit by developing a sound supply base thereby also encouraging small businesses to serve their supply chain. 2.4 Firm Strategy, Structure and Rivalry The conditions in a country determine how companies are established, organized and managed. Culture aspects play a critical role because culture impacts management structure, working morale and even interactions between companies. All companies in South Africa have to comply with Broad-Based Black Economic Empowerment (B-BBEE) legislation. They need to ensure that they address societal issues through ‘corporate social investment’ while also taking initiatives that they employ local people in their own organization and the suppliers too, are of local origin (Arisaig, 2012). If B-BBEE compliance standards are below the prescribed norms, suppliers and service providers may not be willing to engage with such companies. The “big five” South African food retailers include Pick n Pay, Massmart, SPAR, Shoprite, and Woolworths. These are established players in the industry and together they have 60 percent share of the food retail market in South Africa (Arisaig, 2012). All of them also have non-food operations. Besides, many of their food retail operations stretch beyond South Africa. As of now only one major international retailer is planning to enter the South African market. Investments are permitted in almost all the industries and foreign investments are treated the same way as domestic investments. They are subject to the same trade regulations and offered the same incentives and tax allowances (Maxwell, 2013). South Africa was ranked 34th out of about 183 countries in 2010 by World Bank for ease of doing business (Lauter, 2012). A local partner is essential to set up business in South Africa although there is no limit to foreign investors’ stakes in the company. However, rivalry between players in the sector is fierce due to limited product differentiation and negligible switching costs by consumers (Datamonitor, 2012). This results in competitive pricing. Besides, the international retailers would have to compete with the informal trading sector that African consumers are accustomed to (ATKearney, 2012). 2.5 Government Support While the government permits foreign investment in almost all sectors, it is important for retailers to have proactive engagement with the government for long-term sustainability. The industry as a whole can collaborate with the government to drive the development of skills and small businesses such as small retail supply chains. The Retail Association (RA) and the Consumer Goods Council of South Africa (CGCSA) are proactive bodies that support the above goals (Arisaig, 2012). 2.6 Culture Culture impacts the way information is processed and the way communication patterns are formed. Cultural differences can cause stress and could result in lack of cooperation between merged firms (Lin & Sun, 2010). Blending of diverse cultures can be challenging and create an obstacle to successful collaboration. The United Kingdom scores high on individualism and low on power index compared to South Africa (Geert Hofstede). This implies that the South African society represents a hierarchical society with inequalities. However, both the UK and South African societies are high on individualism scores although the UK is much higher. 2.7 Evaluation of Attractiveness The nation has modern infrastructure and a good retail sector although most of it is in the informal sector. Demand for food retailing in South Africa is high due to higher disposable income and an underdeveloped retail industry. Because of poor factor conditions, retailers would need to invest in robust employee engagement and training programmes. Natural resources and qualified human resources are scarce and hence these have to be factored in while deciding to invest in the retail sector in South Africa. The agricultural sector is shrinking in South Africa which is an opportunity to international retailers to invest in South Africa. The environment in South Africa appears to be conducive to investments in the retail sector although a local name is essential for foreigners to start business. Competition exists mainly from the local retailers and since the consumers demand foreign goods, opportunity for international retailers is immense. However, retailers investing in South Africa would have to ensure compliance with legislative requirements, which is a factor that would be applicable in case of all foreign and domestic investments. To gain competitive advantage, retailers should focus on product differentiation as this is a major demand in South Africa. Culturally, the two countries are not vey dissimilar and hence cultural adaptation would require minimal efforts. 3. Management Strategies While the business environment appears to be conducive to investments, international retailers should ensure two key management issues are in place before operations in the South African food retail industry. The first strategy should be to have some differentiation from the existing retailers to gain competitive advantage. An effective competitive strategy can help an organization find its industry niche and learn about its customers (Porter, 1980 cited in Allen and Helms, 2006). Porter (1985) posited that an organization should choose one of the three basic generic business strategies - differentiation, cost leadership, and focus (cited in Allen and Helms, 2006). Differentiation is a key business strategy and product differentiation fulfills customer need. In South Africa, product differentiation should be a competitive strategy because there is limited product differentiation offered by retailers. This strategy can be tailored to suit customer needs and would enable providing superior value to the customer. As of now the retailers are under pressure to reduce prices but product differentiation would enable the retailer to charge premium pricing because of the product characteristics. The South African consumers have become health conscious and increasingly seek wellness products, and health and convenience continue to be the key drivers (Ntloedibe, 2012). While domestic labels are available, consumers seek foreign brands in consumer goods. Hence, international retailers can seize this opportunity to create product differentiation. The second strategy should be to take up CSR as a strategy. This should not be limited to philanthropic activities such as educational scholarships and health programmes. It should stretch beyond and the effort should be to generate sources of income. The local legislation enforces adherence to B-BBEE. Besides, competitive business environment also exerts pressure on firms to discharge social responsibilities. However, it is not enough to project an image of being socially responsible under pressure. The international retailer should develop CSR strategies in alignment with business objectives as well. The activities should not merely be to fulfill regulations but to actually render service to the society. The retailer from the UK should integrate social and environmental concerns into its business operations (Perrini, 2007) and CSR should not be philanthropy at other people’s expense (Robins, 2008). Any deviation in maintaining morality in conducting business can adversely affect the brand image, customer retention, and overall business (Robinson, 2002). By adhering to socially responsible and ethical principles, the retailer would be able to capture a sizeable market share at lower operating costs (Labbai, 2007). Besides, long-term sustainability in the sector is dependent upon an efficient and resilient supply chain (Arisaig, 2012). Therefore, the business strategy of international retailer should be to fulfill the needs of the host country. As such, they should address the key issues such as climate change, water security, waste management and food security. Retailers in South Africa recognize the need to be seen as responsible corporate citizens and source products ethically and sustainably. Such a strategy would help strengthen the retailer’s brand while also building a strong reputation in the local communities. Therefore, the two key management issues that the international retailer should address in South Africa are product differentiation and implement CSR as a business strategy aligned with business objectives. 4. Mode of Entry The choice of foreign market entry mode is a strategic decision as it affects future performance in that market (Zhao & Decker, 2004). Traditionally the mode of entry was licensing, exports, joint ventures or wholly owned subsidiaries depending upon resource commitment and the level of control desired (Brouthers and Hennart, 2007). Today other factors such as manageable levels of cultural distance, growth opportunities, supply chain efficiencies and customer receptiveness influence the choice of entry. These factors can be challenging and serve as impediments in retail internationalization (Evans et al, 2008). Therefore the choice of entry mode depends upon internal and external business environment. South Africa being an underdeveloped economy, poses more challenges as it is difficult to anticipate consumer demand. Besides, cultural differences between the two nations also pose challenges. To overcome these challenges joint venture with a local partner appears to be the solution but international retailers can experience managerial and operational problems does not understand the retail business model (Owens & Quinn, 2007). The selection of an appropriate business partner along with host country assessment thus becomes critical to success in retail internationalization. A global retailer should not focus on culture and geographic location (Park & Sternquist, 2008). The country analysis based on Porter’s Diamond Model suggests that international competition is non-existent in South Africa and the sector is dominated by domestic retailers. It may be difficult to select a right partner for joint venture and the sector is not undergoing consolidation in South Africa. As such the sector, being underdeveloped in South Africa, does not offer acquisition opportunities. At the same time, evolution of hypermarkets in South Africa is a common phenomenon where they sell large quantities of all consumer goods on self-service basis. These hypermarkets tend to purchase directly from manufacturers, bypassing the wholesalers (Ntloedibe, 2012). Education levels are low due to which it is difficult to find suitable employees for the sector. Heavy investments would be required in training and development of people as retail is a service-oriented sector. Under the circumstances, the UK retailer is advised to enter initially through exports. Most South Africa retail chains have their in-house import departments or third party distributors/importers for importing goods (Ntloedibe, 2012). The UK retailer can thus deal directly with chain headquarters and who will then direct them to their third-party importers. Along with the strategy to enter through exports, the UK retailer should appoint an after-sales agent who should be an expatriate from the UK, to understand the local market, the consumer buying behavior and consumption. Once the products are accepted and recognized by the consumers, and once the UK retailer reaches a certain level of exports, it can plan a joint venture with a local partner. 5. Conclusion Based on Porter’s National Diamond an analysis of the food retail industry in South Africa reveals that the potential for growth is enormous. The sector is still underdeveloped and is currently dominated by domestic supermarket chains. Competition in the sector is thus only from local retail chains and the country is attractive for investments in the retail sector. The legislative requirements are not too stringent that cannot be adhered to. The reducing agricultural and farming activities are an opportunity for international retailers to enter the market. However, the analysis identified two management issues that should be addressed to remain sustainable – create product differentiation strategy and focus on CSR as a business strategy. The local standards also require retailers to focus on issues such as climate change, food security and waste management. Since the sector is still underdeveloped, and a local partner is essential, it would be best to enter the sector through exports initially. Expansion through joint ventures can take place at a later stage. References: Allen, RS., & Helms, MM. (2006). Linking strategic practices and organizational performance to Porter’s generic strategies. 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Why corporate social responsibility should be popularised but not imposed. CORPORATE GOVERNANCE, 8 (3), 330-341 Robinson, K., (2002). The importance of being good: the Enron scandal has put the spotlight back on ethics. Banks can no longer ignore the issue of social responsibility and those which do may not survive. 16(5). British Council Journals Database. Zhao, X., & Decker, R. (2004). Choice of Foreign Market Entry Mode. Retrieved from http://bieson.ub.uni-bielefeld.de/volltexte/2004/507/pdf/m_entry.pdf http://geert-hofstede.com/south-africa.html Appendix A South Africa Food Retail Industry Value Forecast 2011-2016 Source: Datamonitor (2012) Read More