The Emergence of the Discounters and Their Impact on Tescos Survival - Case Study Example

The Emergence of the Discounters and Their Impact on Tesco’s Survival Contents Contents 2 Introduction 3 Discussion 3 Structure-Conduct-Performance Model 3 PEST Analysis of Tesco Plc 4 Oligopoly in UK Supermarket Industry 6 Barriers to Entry and Economies of Scale 6 Suck Cost, Price and Non- Price Competition 7 Current Position of Tesco Plc in UK Supermarket Industry 8 Porter’s Five Force Model 9 Evaluation and Conclusion 11 Reference List 11 Introduction The Structure-Conduct-Performance (SCP) theory of Industrial Organizational Economics initiated and developed by Edward Chamberlin, Joan Robinson and Joe S. Bain explains the rationale behind a firm’s performance through economic conduct in incomplete markets. Markets for quasi public goods and merit goods are the perfect examples of imperfect market (Dwivedi, 2002). The characteristics of the UK retailing supermarket industry have changed overtime as a result of amalgamation among general merchandisers and evolution of high volume discounters. Rapid expansion of such formidable industry players coupled with changing demographics during post recession period have threatened the existence of big supermarkets such as Tesco Plc. Tesco is one of the largest retailing grocery and supermarket in the UK as well as in the whole world in terms of revenue and market share. As the retail supermarkets are not associated with producing tangible products and they only concentrate on bulk purchasing from manufacturers and supplying to consumers. Such industry is oligopolistically competitive and the market players always strive to satisfy consumers’ demand through an efficient inventory management and cost control (Ellickson, 2004). In this paper, analysis will be done on the emergence of discounters in the UK supermarket industry and their impact on the survival of long existing giant supermarkets such as Tesco Plc. For the purpose of analysis, the company specific Structure-Conduct-Performance model will be studied and the degree of barriers to entry in the UK retailing industry, the economies of scale enjoyed by the big players like Tesco, level of sunk cost as well as pricing and non pricing strategies of the company will be evaluated. Discussion Structure-Conduct-Performance Model The Structural Conduct Performance Model indicates that external environment keeps dominant influence on firm’s performance in which it operates. In this model, structural characteristics of the industry are regarded as the determining factors of conducts or strategies that lead to influence the business performance of the industry players. Structural characteristics include considerations such as customer specification and concentration, barriers to entry, degree of product differentiation among competitors, existence of substitute products in the market etc. According to this theory, success in business arises only when the firms choose to compete in a structurally attractive industry. Strategies are formulated in order to rectify the firm’s optimal position into the industry segment and to evolve as market leader over a period of time. Emphasis has been given on the analysis of the firm’s environment in which they are operating for assessing the overall economic profitability of the industry that has a major consideration on individual firm’s profit (W. G. Shepherd and J. M. Shepherd, 2003). Applying the Structural-Conduct-Performance Model in the UK retailing supermarket industry, it can be examined that in spite of the intense competition in this segment, the industry possesses huge potential of profitability mainly because of uniform or even, increasing demand of consumer goods, foods and beverages. However, product diversification and product development of other companies and emergence of a large number of discounters such as Aldi, Lidl and Poundland have expanded the alternatives available to the consumers and as a result Tesco Plc is experiencing an exit rate of its loyal customers (Irish News, 2014). Modification in pricing and promotional strategies has also failed to be proved advantageous for the company. In such circumstances, it is required to analyse the contemporary environment in which Tesco Plc is operating currently. The technique of strategic assessment, PEST (Political, Economic, Social and Technological) will be incorporated in the next segment for this purpose of analysis. PEST Analysis of Tesco Plc Political Factor As a result of operating in multiple provinces in the UK, the political considerations in terms of changes in tax rates and other policy regulations highly affect the performance of the UK supermarket industry. Being a significant part of the industry, business operations of Tesco is also affected by such deliberations. In recent times, the possibility of independence of Scotland has initiated issues like supply change inconsistency and added administrative costs which has resulted in higher prices of the goods sold in supermarkets. Increase in price level will lead the consumers to move towards the locally situated high street discounters where same products are available at a lower price. Hence, the supermarkets such as Tesco, ASDA are bound to experience a reduction in profitability. The only positive consideration is the availability of land and labour at a lower price in Scotland which may enhance business expansion and profitability of the supermarkets. Another consideration in this regard is the possibility of the United Kingdom leaving European Union. This indicates that the foreign countries exporting goods for the purpose of selling in the UK supermarkets will become reluctant to continue to do so due to the possible changes in tariff as a result of leaving the current trade zone (Metzger, 2014). Economic Factors The present economic scenario of the UK influences the business operations of the supermarket industry of the country. Though the economy was gradually recovering in the post recession period, steady increment in the price of food products, keeping at pace with the boosting per capita income, resulted in noteworthy food price inflation in 2013. Such inflation has outraged the wage growth which has become imperceptible for the UK supermarket industry and the households as well. Increase in fuel prices led the outskirts customers to shop from out-of-town stores in order to save the fuel prices. Increasing value of real estate influenced major supermarkets like Tesco to shut their operations in loss-making outlets. Such actions taken by the company amplified the unemployment rate of the UK economy to 7.1% in 2013 as well. Such vicious circle impinged the consumer spending which in turn hurt the profitability of the supermarkets including Tesco (Joseph, 2008). Social Factors Economic impacts on the UK supermarket industry influence the consumer behaviour and such influences in turn changes social factors of the UK consumers such as purchasing patterns of consumers. Shopping habit and status symbols may restrict the consumers to shop from discounters such as Aldi and Lidl but such restrictions will be validated to a point till when the consumers have been able to derive value of their purchase from the high end supermarkets like Tesco. When Tesco started providing discount coupons and announced “Big Drop Sale” similar to those high street discounters, premium consumers did not found any status differences between the two and tend to shift their buying behaviour towards those stores where they will find the same products at a competitive price. However, increasing in fuel price positively impacted the online shopping behaviour of Tesco supermarkets (Metzger, 2014). Technological Factors Technological considerations are important for the UK supermarket as introducing innovative facilities in the outlets tend to attract large pool of customers. With the rapid development of technology orientation among the UK retail consumers, online shopping of foods and consumers products of large supermarkets such as Tesco, customer satisfaction has been established. Tesco’s effort to establish point of sales software and close circuit televisions to enhance shopping experience, customer satisfaction and establish customer loyalty has become successful in accelerating sales of the supermarket and the industry as a whole. Oligopoly in UK Supermarket Industry Barriers to Entry and Economies of Scale Supermarkets in this industry segment in the UK create oligopoly due to existence of huge competition among few but large firms. In the supermarket industry of the UK, four large firms such as Tesco Plc, Sainsbury’s, ASDA and Morrisons account for more than 75% of the revenue and market share. Naturally, the industry includes interdependence among these bug supermarkets to some extend and high barriers to entry in order to maintain the dominance of the existing firms. The firms’ reluctance to share its potential revenue, profitability, market share and customer loyalty also creates artificial trade barriers. As the aggregate supply of the market is concentrated in the hands of the above mentioned firms, the consumers are benefitted through providing a competitive price. In general, the firms involved in oligopolistic market tend to keep the price level so low so that no firms wish to enter in the industry as they won’t be able to incur profit due to the requirement of huge initial investments. However, the industry is experiencing entry of discounters such as Aldi and Lidl who are significantly capturing the market share of the UK supermarket industry, threatening the existence of big supermarkets like Tesco. These discounters are providing all the products available in Tesco and other big supermarkets but at a lower cost. It is hardly possible for these supermarkets to release the products at this price level, taking into consideration the infrastructural maintenance and technology involved (Geroski and Jacquemin, 2013). Figure 1: UK Supermarket Industry Share as on 2014 (Author’s Creation) Economies of scale prevail in the UK supermarket as the four firms derive huge profit due to overhead cost advantages as a result of operating in large scale. For these four super markets, an increase in sales by one percent leads to decrease in cost per unit, as the fixed cost are sized as a result of operating in this industry for a very long period of time. Well established supply chain network, easy access of required resource and exhausting set up cost also brings economies of scale for those participants in oligopolistic market. Hence, the scope for investing in research and development increases for the companies, making the supermarket industry highly technology oriented. Interdependence also exists as pricing or promotional strategy changes of one supermarket leads to influence the actions of others. For instance, if Tesco decides to announce a discount on the products during Christmas, such action taken by the company will influence Sainsbury’s or Morrisons to introduce the same. The collusion among the firms became evident as well, when nine firms of the UK supermarket industry including Tesco, Asda and Sainsbury’s were penalized in 2003 on the ground of fixing the price of milk and cheese. The horse meat scandal in 2014 further signifies the cut throat competition among the existing firms which is also a major characteristic of oligopolistic market (The Telegraph, 2014b). Suck Cost, Price and Non- Price Competition Sunk cost may be defined as the cost which has been incurred and cannot be recovered in future. Sunk costs are high in markets where the markets are characterised by strict entry and exit regulations. Such characteristic is most prominent in oligopoly market and hence, the level of suck cost is very high in the UK supermarket industry (Metzger, 2014). High level of sunk cost in Tesco and other companies again emphasises their propensity to invest in infrastructural and technological development as well as contribution in research and development. Price and non price competition also prevails in this industry segment (Sloman, 2004). Price competition is frequently experienced in this industry when price level is reduced by of one of the supermarkets, say Morrisons, as a result of reduction in prices level of Tesco. Non- price competition can be best exemplified by Tesco’s action of distributing “Tesco Loyalty Card” which bounds the customers to shop again and again from their superstores only, for acquiring the rewards associated with these cards. Tesco’s effort to introduce free home delivery system, discounts on petrol on purchase of a certain specified amount, 24hours shopping facilities etc are some of the foundations of price and non-price competition. All these criteria show a kinked industry demand curve, ascertaining the oligopolistic behaviour of the UK supermarket industry (Ellickson, 2004). Current Position of Tesco Plc in UK Supermarket Industry Though Tesco has maintained its leading market share in the UK supermarket industry, the sales, revenue and profitability of the superstore company has experienced substantial downward trend in the last three years and eventually it is losing the ground in the UK retailing market as a result of cut throat competition due to entry of discounters. With the slogan of the company “Every Little Helps” clearly indicated that the company tried to capture loyalty of every customer segments. Such horizontal diversification approach was adopted by the company in order to attain cost leadership in the industry. However, continuous competitive pressure resulted Tesco to experience a threat in terms of profitability when the annual profit of the company decreased by 93% in 2014 (FitzRoy, Hulbert, Ghobadian and OShannassy, 2012). Though Tesco has been able to secure a market share of 30.1% even in 2014, it is experiencing a continuous decline in market share compared to its own past records. This has indicated a “perfect storm” situation for the suppliers of Tesco as well (The Telegraph, 2014a). In August 2014, the market capitalization of Tesco Plc was £18.88 billion. Figure 2: Death Sprial experienced by Tesco Plc (The Guardian, 2014) However, since 2010 the company is experiencing considerable fluctuations in shareholders’ equity holding as a result of broken confidence of investors and accordingly Tesco encountered with a death spiral due to bubble burst. Excessive merger and acquisitions, unjustified business expansion, uncalculated promotional and pricing activities dragged the company to congregate a crumple its profitability to a 20years low of 28.6%. The shopping preferences of premium consumers are substantially shifting towards other sources of groceries, foods and beverages where all the products available at Tesco can be obtained at a lower price. Tesco’s initiative to introduce big discounts created bewilderment among high end consumers. The mid-ranged consumers also failed to establish the value of money as they have noticed the company’s strategy to keep the price of the products low in mainstream superstores and keeping price of the same goods comparatively higher in small countryside outlets. As an immediate result, Tesco closed down 3 loss-making stores and called off their plan for establishing 49 brand new supermarkets in multiple locations of the UK. The company also laid off 2000 redundant staffs in 2014 as a measure of cost cutting activity in order to ensure existence of the company in the market segment (The Telegraph, 2014a). Porter’s Five Force Model The five dimensions of Porter’s model reveal the true position of Tesco in the current UK Supermarket industry. Figure 3: Porter’s Five Force Model of Tesco Plc (Lewis and Dart, 2014) Evaluating the Porter’s Five Force model, it is evident that the company is experiencing considerable threats from newly entered high street discounters. Bargaining power of buyers is continuously increasing as they can have the access of the same product at a lower price in the outlets of such discounters. With a lowering in the demand of Tesco products, it has created a threat for the long established suppliers of the company as well and the suppliers are also looking for new business partners in order to keep the health of their own business unchanged (Lewis and Dart, 2014). The industry segment was always characterised by cutthroat competition among the few existing firms such as Tesco, Asda, Sainsbury’s and Morrison. However, entrance of the discounters combined with other industry effects has created serious risk for the existence of Tesco Plc. Evaluation and Conclusion From the above discussion it is evident that Tesco, along with the UK supermarket industry is experiencing serious anxiety regarding its existence due to emergence of the discounters that has resulted in a substantial decrease in the demand of the company’s products. Hence, the company must take corrective actions in order to secure its position in the industry as well as regain its lost market share and profitability. In this regard, the first initiative Tesco should take is to scrap its Clubcard as it alone accounts for a cost of £500m. Such huge investment did not even provided the company with a specific shopping behaviour of the consumers of Tesco. Product lines should also be radically cut down based on the market research and industry analysis reports. For instance, Tesco should analyse the some of the most purchased variety of yogurts and eliminate all other types of yogurts in order to save on costs. Unprofitable overseas subsidiaries should also be sold so that the company can generate sufficient cash for further investments in the supermarket business (The Guardian, 2014). Extensive importance should be given on online platform in order to reduce establishment cost and gear up sales depending on online business strategy. Consumer movement towards low priced products of the discounters signifies that wherever quality products are available at a competitive rate, the consumers will tend to shift their buying behaviour to that direction only (Irish News, 2014). Finally, the company should understand that be it premium customer segment or economic customers, pricing of products always matters the most. Adopting all these corrective actions in terms of cost cutting and rectifying its pricing strategy, keeping in mind the existing price level of all competitors irrespective of their size, will enable Tesco Plc to confirm its existence in the UK supermarket industry in near future. Reference List Dwivedi, D. N., 2002. Microeconomics: Theory and Applications. New Delhi: Pearson Education India. (https://books.google.co.in/books?id=IbvULY0ojiEC&printsec=frontcover&dq=Dwivedi,+D.+N.,+2002.+Microeconomics:+Theory+and+Applications.+New+Delhi:+Pearson+Education+India&hl=en&sa=X&ei=WlXcVKPACcWzuASqr4HYDw&ved=0CBwQ6AEwAA#v=onepage&q=Dwivedi%2C%20D.%20N.%2C%202002.%20Microeconomics%3A%20Theory%20and%20Applications.%20New%20Delhi%3A%20Pearson%20Education%20India&f=false) Ellickson, P. B., 2004. Supermarkets as a Natural Oligopoly. [PDf] Retrieved from: < http://www.goodfoodworld.com/wp-content/uploads/2012/05/SupermarketsAsNO.pdf> [Accessed 10 February 2015]. 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