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

Kingston International Study Group Stable Block Kingston Hill Business Economics work The Emergence of the Discounters and Their Impact on Tesco’s Survival By Contents Page Acknowledgement 3 Introduction 4 Structure-Conduct-Performance Model 4 Barriers to entry and exit 5 Conduct- pricing and non-pricing strategies 7 PEST Analysis of Tesco Plc 11 Evaluation 13 Conclusion 13 Reference List 15 Acknowledgement I am indebted to my supervisor for constantly monitoring this coursework and providing constructive criticisms. I would also like to thank my classmates for their positive suggestions. Introduction The characteristics of UK supermarket industry have changed overtime as a result of amalgamation among general merchandisers and evolution of high volume discounters. The market leader is being constantly challenged and indeed, rapid growth of the discounters- which have consolidated their places as key players in that industry- and the economic downturn have threatened the existence of big supermarkets and one supermarket which has suffered the aftermath of this change is 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 (Lewis and Dart, 2014). However, it has recently announced the closure of 45 of its UK stores and this move will alter the market share and power of the supermarket. In this essay, an analysis will be conducted on the emergence of discounters in the UK supermarket industry and their impact on the survival of a market leader such as Tesco Plc. For the purpose of this analysis, the Structure-Conduct-Performance model will be used to explain the characteristics and changes in that industry and to understand the future prospects of the company, a PEST analysis will ensue. Structure-Conduct-Performance Model The Structure-Conduct-Performance (thereafter abridged, SCP) defines the rationale behind a firm’s performance through economic conduct in the market segment. The SCP 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 conduct or strategies that influence the business performance of the industry players. Market structure The supermarket industry is oligopolistic because it is dominated by few but powerful key players. W. G. Shepherd and J. M. Shepherd (2003) defined oligopoly as a market condition in which the industry is dominated by small number of large producers and sellers 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 (Metzger, 2014). However the small discounters such as Lidl, Aldi, 99p stores and Poundland have decreased the market shares of some of the leading supermarkets (The Telegraph, 2014a). Significant characteristics of oligopoly market can be presented in the following way. There exist a small number of firms in the market segment which are large enough as compared to the size of the whole industry. Therefore, all such firms tend to dominate the industry segment. Producers are engaged in producing almost identical or slightly differentiated products. Therefore, the producers drive for strong promotional activities and take advertisement initiatives for highlighting their products and services and making these more attractive to the target consumers. Most importantly, the industry is characterised by barriers to entry and exit. Such prerequisite helps the existing firms to enjoy economies of scale but as more than one dominating firms are always present in the industry; the firms are not eligible to incur supernormal profit (Dwivedi, 2002). Barriers to entry and exit The industry includes interdependence among these big supermarkets to some extent 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. For instance, initially the UK supermarket industry witnessed existence of a small number of large firms such as Tesco, Sainsbury’s, Morrisons and Asda. All these four big supermarkets used to form oligopoly in the supermarket industry and share profitability, source of supply and other business aspects among these. Products were differentiated on the basis of promotional drives such as putting advertisements and announcing discounts. However, emergence of discounters gradually changed the picture of this particular industry segment (Geroski and Jacquemin, 2013). As supply of the market is concentrated in the hands of few in an oligopoly, the consumers benefit from competitive prices. In general, firms in an oligopolistic market tend to engage in predatory pricing that is keeping prices so low so that no new entrants will wish to enter the industry as they will not be able to make profits. This predatory pricing will be discussed in the sub-section on the conduct of firms. Another barrier to entry is the existence of sunk costs due to the requirement of huge initial investments. Sunk cost may be defined as the cost which has been incurred and cannot be recovered in future. Sunk costs are high in industries where the markets are characterised by strict entry and exit regulations. Such characteristic is most prominent in oligopoly market and hence, the level of sunk cost is very high in the UK supermarket industry (Metzger, 2014). However, as mentioned before, the industry has experienced the entry of discounters who are significantly capturing the market share of the UK supermarket industry, threatening the survival of big supermarkets like Tesco (The Telegraph, 2014a). 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). Economies of scale can also be a barrier to entry and they prevail in the UK supermarket as the four firms derive profits due to overhead cost advantages as a result of operating in large scale. The supermarkets enjoy purchasing economies of scale because they are able to buy in bulk and reduce their cost per unit. These advantages can only be obtained when a company operates on a large scale. Moreover risk-bearing economies of scale can be reaped because large scale production allows the companies to spread their risks and in some cases, be innovative. Small businesses do not have that flexibility because they do not have the funds available to take a risk which might not pay off in the long-run. Banks offer favourable rates to big organisations as they are able to offer their assets as collateral security in case of default in repayments. Usually large companies are in better financial positions that small businesses which might not be able to raise the finance needed to compete with key players in the market. Other internal economies of scale stem from marketing and this is made possible because a company like Tesco can have just one marketing campaign which covers all its stores across the land. Therefore, marketing economies of scale act as a barrier to entry for potential new entrants. Management economies of scale deter small businesses from competing against large scale companies which can afford to recruit management specialists to work for them and this will lead to more efficiency which in turn will increase productivity. As far as external economies of scale are concerned, location can also be a barrier to entry as most supermarkets will benefit from being next to each other and knowing what their competitors are doing. The rents along a high street might be high for new comers. Therefore these aforementioned economies of scale act as barriers to entry for new entrants. Conduct- pricing and non-pricing strategies The supermarkets adopt various pricing and non-pricing strategies in order to compete. In an oligopoly, price war is prominent when price level is reduced by of one of the supermarkets, say Morrisons, as a result of reduction in prices level of Tesco. This will lead to all the supermarkets engaging in lowering their prices and compete on non-pricing strategies. In the short-run, in an oligopoly, firms can make super normal profits because there are few firms dominating the market. Due to the economies of scale, firms are able to reap advantages in terms of lower costs and this will help them to maximise their profits. Nonetheless, in the long-run, firms in an oligopoly will make only normal profits because the supernormal profits in the short-run will be eroded by new entrants. Due to this fact that there will be zero economic profits in the long-run, firms might collude in order to fix prices and become a cartel. A cartel acts as a monopoly in terms of output and prices but in the supermarket industry, it is not possible as the Competition Commission will investigate any collusion and the firms can be fined. 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). In order to avoid being fined, supermarkets will engage in cooperative competition. This idea can be explained using the kinked demand curve. Kinked demand curve According to the kinked demand curve, all the firms in an oligopoly will charge a price around the same level because any move by one player to increase price will not be followed by the others and this will make the firm lose customers and revenue as well. If a firm reduces its price, other firms will do the same thing and this will not lead to any increase in revenue and hence profits for all the firms involved. This is why, according to the kinked demand curve theory, firms will charge price at the kink because demand is elastic above the kink and inelastic below it. This can be graphically represented below. Figure 1: Kinked Demand Curve (Source: (Ellickson, 2004). The reason behind kinked demand curve in oligopoly marker such as in the UK supermarket industry can be attributed as the interdependence in decision making among the existing few firms. As in the oligopoly market, all the firms are aware about the strategy taken by other firms and change in price level of one firm tends to leave big impact on the prices of others, the demand curve becomes kinked. The same can be observed in the demand supply balance of the UK supermarket Non-price strategy Non- price competition can be best exemplified by Tesco’s action of distributing “Tesco Loyalty Card” which bounds the customers to shop 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, 24 hours shopping facilities are some of the foundations of price and non-price competition. Performance In the supermarket industry, Tesco experienced increase in profits from 2005-06 to 2010-11. However since the discounters have opened up new stores; Tesco’s profits have drastically fallen. This can be demonstrated by the curve below. Figure 2: 10 Years Profitability of Tesco Plc (MorningStar, 2015) Figure 3: UK Supermarket Industry Share as on 2014 (Source: MorningStar, 2015) 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 (Metzger, 2014). With the slogan of the company “Every Little Helps” indicates that the company tries to capture loyalty of every customer. However, continuous competitive pressure resulted in 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% in 2014, it is currently experiencing a continuous decline in market share (MorningStar, 2015). Figure 4: Death Sprial experienced by Tesco Plc (Source:The Guardian, 2014) Since 2010 the company has been experiencing considerable fluctuations in shareholders’ equity. 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 at Aldi, Lild, Poundland and 99p stores. 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). PEST Analysis of Tesco Plc In order to evaluate present scenario of UK supermarket industry and how entry of a number of discounters have affected the business operations of large supermarkets such as Tesco Plc, strategic analytical tool PEST (Political, Economic, Social and Technological) Analysis will be incorporated. Political Factor As a result of operating in UK, the political considerations in terms of changes in tax rates and other policy regulations highly affected the performance of the UK supermarket industry. Business operations of Tesco are also affected by such deliberations. Increase in price level in supermarkets led 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 are bound to experience a reduction in profitability. 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 is on the road to recovery, 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 (Metzger, 2014). Increase in fuel prices compelled the outskirts customers to shop from out-of-town stores for saving 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. Status symbols may restrict the consumers to shop from discounters such as Aldi and Lidl but such restrictions can be nullified 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. Many customers avoided visiting Tesco outlets on account of saving the (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 (FitzRoy, Hulbert, Ghobadian and OShannassy, 2012). Evaluation Applying the SCP model in the UK retailing supermarket industry, it was seen that in spite of the intense competition, the industry still possesses potential of profitability mainly because of the increasing demand of consumer goods, foods and beverages (Irish News, 2014). 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 Conclusion From the above discussion it is evident that Tesco, along with the UK supermarket industry is experiencing difficulties due to emergence of the discounters that has resulted in a substantial decrease in the demand of the company’s products. Thus, the company must take corrective actions in order to secure its position in the industry market share. In this regard, the first initiative Tesco should take is to scrap its Clubcard as it accounts for a cost of £500m per annum (Lewis and Dart, 2014). Product lines should also be radically cut down based on the market research and industry analysis reports. 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. Ellickson, P. B., 2004. Supermarkets as a Natural Oligopoly. [PDf] Retrieved from: < http://www.goodfoodworld.com/wp-content/uploads/2012/05/SupermarketsAsNO.pdf> FitzRoy, P., Hulbert, J., Ghobadian, A. and OShannassy, T., 2012. Strategic Management: The Challenge of Creating Value. London: Routledge. Geroski, P. G. and Jacquemin, A., 2013. Barriers to Entry and Strategic Competition. London: Taylor & Francis. Irish News, 2014. Six steps to save Tesco. [Online] Retrieved from: < http://www.independent.ie/irish-news/six-steps-to-save-tesco-30566116.html> Joseph, N. G., 2008. Principles of Business Economics. Lewis, R. and Dart, M., 2014. The New Rules of Retail: Competing in the Worlds Toughest Marketplace. Basingstoke: Palgrave Macmillan. Metzger, K., 2014. Business Analysis of UK Supermarket Industry. MorningStar, 2015. Tesco PLC ADR TSCDY. [Online] Retrieved from: < http://financials.morningstar.com/ratios/r.html?t=TSCDY> [23 February 2015]. Shepherd, W. G. and Shepherd, J. M., 2003. The Economics of Industrial Organization. Illinois: Waveland Press. Sloman, 2004. Economics for Business. New Delhi: Pearson Education India. The Guardian, 2014. One in five UK supermarkets must close to restore profit growth, say analysts. [Online] Retrieved from: < http://www.theguardian.com/business/2014/nov/17/tesco-uk-supermarkets-closure-industry-profit-growth-goldman-sachs> The Telegraph, 2014a. Cuts threaten survival of supermarket suppliers. [Online] Retrieved from: < http://www.telegraph.co.uk/finance/newsbysector/retailandconsumer/11314806/Cuts-threaten-survival-of-supermarket-suppliers.html The Telegraph, 2014b. Five predictions for Britains battered supermarket industry in 2015. [Online] Retrieved from: http://www.telegraph.co.uk/finance/newsbysector/retailandconsumer/11302478/Five-predictions-for-Britains-battered-supermarket-industry-in-2015.html Read More