The Macroeconomic Environment in Tesco - Essay Example

Investment Report: Tesco Plc The Company The foundations of Tesco can be traced back to a market stall from which its former owner Jack Cohen sold groceries in the East End of London in 1919. The company has grown to become an international company operating in 14 countries with over 500,000 employees serving millions of people on a daily basis (Tesco 2013). The name originates from the first own-brand product that Mr. Cohen sold and was created from the initials of a partner in a firm of tea suppliers – TES and the first two letters of Jack’s surname – CO in 1924. The company’s goals extend from a shopping experience that is second to none to getting things done in the ‘right’ manner for customer, employees and the communities that the company serves (Tesco 2013). Tesco is currently the world’s third largest retailer in the world measured by revenue and the second largest when measured by profits. The company is undoubtedly the largest in the retail industry in the UK, where it controls approximately 30% of the market. This places Tesco substantially ahead of ASDA its closest rival which is operated by Wal-Mart a U.S owned operation. However, BBC (2012) indicates that Tesco’s market share fell below 30% to 29.9% for the first time in seven years for the 12 week period to January 22, 2012. The company’s major competitors include Sainsbury which was number one until 1995, ASDA, Safeway and Morrison’s. Tesco’s size resulted from a series of acquisitions throughout the UK. The company is now an international group with operations in 14 countries – located in Asia, Europe, and the U.S. According to Tesco (2013) Tesco’s venture into the international arena started in 1995 when the company invested in Hungary. In 1998 the company entered Thailand under the Tesco Lotus brand and in 1999 though a partnership with Samsung made its entry into Korea where it now has 450 stores. The company took a break and continued its streak of expansion when it entered into a partnership with 30% stakeholder Darby in Malaysia. This was followed by the acquisition of the Kipa stores in Turkey in 2003 and entry into China in 2004 where the company established a network of over 100 stores in several Provinces along the Eastern Seaboard. The company entered the U.S in 2007 under the name Fresh & Easy and now has approximately 200 stores in several states including California. Tesco now has approximately 6,234 stores and is expected to continue growing as economic conditions improve. In fact, the company decided to reduce its planned investment in China as a result of uncertainties in the environment (Tesco 2012). The macroeconomic Environment in UK and Hong Kong An analysis of the macroeconomic environment of Tesco using PESTEL provides information about to opportunities and threats in the environment. In order to assess the impact of the environmental conditions of all these countries on Tesco’s, an environmental analysis needs to be done In the political environment the threat of terrorism is not as high as it was before. However, Tesco appears to be prepared as a major terrorist event would affect the company’s system and impact its ability to trade. The company has contingency plans in place as well as security systems and processes to deal with any such event (Tesco 2006). Tesco’s other international competitors - Wal-Mart and Carrefour face temporary price controls in Kunming, a southwestern Chinese city. (Bloomberg 2010; China Briefing 2010, CNNMoney 2010). However, incentives are being offered for investors to start business in the western region - the poorest region in China. The environment in the UK is getting better as the government has reduced the corporation tax rate for 2012/13 from 24 per to 23 percent. The rate is expected to be reduced to 22% in 2013/2014. The political environment in Hong Kong as it relates to business is different as the country is considered to be a tax haven with a corporate tax rate of 16.5%. The company does not have value added tax as it exists in the UK (LowTax 2013). This provides a less complex environment for businesses and is a good reason for Tesco to consider investing there. Additionally, it is on the South Coast of China and would definitely complement the company’s operations. In the Economic Environment, the recession in some parts of Europe is far from over but most countries are on the recovery path. The business is susceptible to economic downturn which generally affects discretionary income. Operations in the UK were affected by high price of petrol and falling real incomes that affected discretionary spending. China is expected to be an engine of growth but the company will speed up investments as it sees necessary as long as the economic outlook improves (Tesco 2013). The decision was taken to leave Japan in order to focus on the larger, more profitable and growing businesses in Asia. The economic situation is particularly difficult in Hungary and Ireland. Profits were also negatively affected by disruptions at the new distribution centre in Poland. The company’s international business increased profits by 18% and helped to compensate for the reduction in trading profit in the UK. With the exception of the horsemeat stories there were no major events in the grocery retailing business. In fact, Quinn (2013) indicates that in spite of the horsemeat scandal investors should hold Tesco shares as things have improved since the last annual report. Quinn (2013) also indicates that the company made some major investments since the start of the year in the UK. The social environment has its own share of problems. There are risks in the supply chain that could affect customers. Some years ago milk products from China were contaminated and this led to several deaths. This matter was dealt with in a sober manner and so it did not have a great impact on sales. The recent horse meat scandal is also another situation that the company had and is still dealing with in several markets – the latest being in the Czech Republic (Reuters 2013). Natural disasters can also have a negative impact on its operations, Flooding in Thailand caused stores to close (over 150) and all four distribution depots. However, the loss in profits was mitigated by insurance claims (Tesco 2012). As Tesco continues its expansion into the international marketplace, each market has its own culture and culture which has to be given due consideration. In fact, Tesco (2012) indicates that it has to do the right things for customers, employees and the community in which it operates. The technological environment has provided opportunities through which Tesco has increased the customers shopping experience – from long lines to more aesthetic appeal. Since the launch of its online shopping the company has introduced ‘Click & Collect’ at over 770 stores. Additionally, the company has dotcom only stores which fulfill 80% of orders in London (Tesco 2012). Furthermore, with the introduction of applications for cell phones customers are now able to shop on the go and not only from the comfort of their home. In the legal environment there are regulations both locally and internationally which will affect Tesco’s operations. This includes limits on mergers and acquisitions. Some years ago government regulations prevented Tesco from taking over Safeway and so Morrison’s was able to capitalise on that opportunity. In the last financial year trading profits were affected by crisis tax levied in Hungary on the company’s profits which reduced it from 22% to 18%. The cost to the company was ?38 million. Additionally, in South Korea a reduction in sales is expected as restrictions on trading hours for large retailers take effect. Tesco has made positive moves as it relates to the ecological environment. The company is committed to help prevent climate change by reducing energy use and the pollution of the environment. The company has introduced its Corporate Responsibility Management (CRM) systems to all its international operations (Tesco 2006). Since then there has been a 26% reduction in carbon emissions and the plan is to reduce this by 100% by 2050 (Tesco 2012).The company has a zero carbon supermarket in Cambridge UK which is the first of its kind in the world. It is also encouraging the use of reusable bags in its stores internationally. The company has waste bins to facilitate recycling at all its locations and seeks to educate customers by various means. Porter’s Five Forces framework Porter’s Five Forces model is very useful in analysing the competitive environment. Walton (1999) indicates that the more firms manipulate the forces in a way to favour their business, the more effective its strategy will be. Tesco’s strategy has proven to be effective. In fact, the company has seen some results in its latest move to focus on its investments in UK – its home base. The diagram in the appendix illustrates the model. The threat of substitute is a concern for all businesses. However, Tesco sells similar products with different brand names. This is just one of the ways the company has sought to differentiate its products from the competition. In addition to that the company is always finding new ways to improve the shopping experience for customers. The company has also made use of technology by being the first retailer to offer online shopping to its customers. Tesco.com is a major contributor to the company’s revenue now contributes significantly to Tesco’s PLC’s revenue. Barriers to entry may be high in the retailing industry. Tesco has increased barriers through various acquisitions. It has increased its presence in other complimentary businesses such as electrical equipment, clothing and apparel and furniture. The company also provides baked products for its customers. These are all aimed at generating more revenue. Rivalry in the industry had a major impact on profits in the UK as Tesco had to reduce its profit margins n order to stamp its dominance on the industry. In fact, the rivalry saw Tesco’s market share decline from 30% to 29.9% between December 2011 and January 2012. Tesco has expanded its operations both in the UK and internationally and this has made the company more competitive since it is no longer relying on one market. Tesco currently offers financial services and insurance products. The company has rescinded its partnership with Royal bank of Scotland and is in the process of introducing a full service bank – Tesco Bank. The company current competes internationally with Wal-Mart which is based in the US and Carrefour, out of France. The power of suppliers is weak as farmers and manufactures such as Proctor & Gamble and Uniliver have businesses in China. Tesco is a large buyer and the company has a large network of supermarkets and therefore it is able to wield its power over suppliers. The power of customers is strong since they determine Tesco’s survival. Customers are important to Tesco and so the company tries to please them at every step of the way. The company not only seek to provide them with more choices but also seeks to improve their shopping experience and to provide them with low prices. The main purpose of the company is the creation of value for customers in order to gain their loyalty (Tesco 2012; Tesco 2010) Competitive Strategies The company has employed a number of competitive strategies for organic investments to mergers and acquisitions to compete in the market. However, its main strategy is differentiation. This is facilitated by the use of various brand names for different income levels. The company uses marketing strategies such as market segmentation; differentiation; market share versus profit margin which was used in the UK to win customers. The company also uses various purchasing strategies. Analysis of the company’s operating exposure Operating exposure also referred to as economic exposure and it measures the change in the value of a company as a result of changes in future cash flows resulting from changes in the exchange rate (Eiteman et al 2007; Eun et al 2011). This suggests that there is the risk that future earnings and cash flows will be much less than anticipated (Brigham and Ehrhardt 2005). Tesco operates in 14 countries and so the company is exposed to varying conditions which have an impact on its operations. The company is exposed to foreign currency exchange and interest rate risk and inflation risk. Eiteman (2007) indicates that exchange rate changes are likely to increase Tesco’s competiveness in some countries while reducing it in others. Most of the groups operations are in the UK which accounted for 66 per cent of the group revenues in 2012 which totalled ?72 billion. This was followed by Asia with 17 per cent, Europe – 15 per cent, US – 1 per cent, and Tesco Bank with 2%. Despite growth in revenues in its UK operations there was a 1 per cent decline in trading profit. Asia and U.S. had growth in trading profits of 21.8 per cent and 17.7 per cent respectively. Despite the major contribution to group revenues by the UK operation, this was achieved by cutting costs in order to boost sales. The company’s financial statements are denominated in pound sterling and if only for consolidation purposes all currency have to be translated and so the business is exposed to both transactions and translation exposure. Tesco has to deal with more than 10 different currencies and for consolidation purposes each one has to translate their figures into pounds sterling. This requires the use of various hedging strategies in order to reduce its risk of exposure. Forward contracts and swaps are just two of the ways by which firms hedge their exposure (Brigham and Ehrhardt 2005). Tesco is also in the banking business and it is suggested that Tesco Bank diversify its loans by lending to businesses in different industries as well as in different geographical regions in the same way that the company has reduced its exposure by spreading its retail operations to Asia, Europe and the US. In fact Madura (2006) indicates that firms can diversify credit risk and therefore operating exposure by industry diversification, geographic diversification and international diversification. Madura (2006) also suggests that banks would not hedge individual transactions but will instead net out exposure. Managing operating exposure The economic climate has not had much of a negative impact for the company as it has for some countries in the European Union. The company took the opportunity to grow its China business, although to a lesser extent than planned. Tesco’s size allowed it to reduce the impact of the competition, especially in the UK where the company experienced a negative growth in profits. The company faces various risks in the international business environment. In addition to diversifying its operations it has operations for which transactions are denominated in other currencies. Additionally, these countries experience different interest and inflation rates. The investment in Hong Kong will not be much of a challenge economically as the currency – the Hong Kong dollar is the eighth most traded currency in the world (BIS 2010). Hong Kong also has one of the highest per capita incomes in the world (UNDP 2009). Tesco’s operations are also affected by changes in the inflation rate as well as the interest rate. The company hedges its international business by borrowing in matching currencies. Loans to non-UK subsidiaries are hedged in foreign currency transactions. However, there are several approaches to the management of operating exposure. They include: matching currency cash flows; risk-sharing agreements; back-to-back or parallel loans; currency swaps; leads and lags; re-invoicing centre (Bodnar n.d.; Eiteman et al 2007; Eun et al 2011). Tesco is already matching currency cash flows. However, some other methods like risk sharing agreements with suppliers could be entered into where they would agree to share the risk resulting from changes in exchange rates. Tesco has enough power to get suppliers to agree to that. The company’s sheer size and volume of goods that it purchases provides it with a level of negotiating power that is comparable to companies like Wal-Mart. In terms of parallel loans the company could borrow in the other firm’s currency while the other firm borrows in ?’s the same amount at the spot rate. Both would repay each other when the loan matures. In a currency swap the dealer and Tesco could agree to exchange equal amounts of two different currencies say HKD and ? for a specified time period. For example, when amounts are due to repay loans. It helps the company to avoid both translation and operating exposure and lowers the risk of Tesco holding certain currencies. There are still other strategies that Tesco could use since a hedge is not perfect especially when a devaluation of the currency in another market is to buy products in that country if prices are competitive to offset the effects of the devaluation on the pound sterling (?). In fact, studies carried out by Nguyen and Faff (2003) found information in Australia to support the view that liquidity is a substitute for hedging. Purchasing could be shifted to the country with the devalued currency and this would reduce prices in the countries in which products are to be sold. In terms of marketing management geographic diversification means that when sales weaken in one country it may strengthen in another or remain stable. Product differentiation is often used to make the product less sensitive to a change in price. Additionally, market segmentation separates the market into luxury and economy. In terms of financial management financing may be arranged so that a reduction in sales from a weaker currency can be offset by debt service costs that are cheaper. Summary and Conclusion In spite of the various threats in the macro-environment Tesco has used its strong position to turn them into opportunities and the company is expected to do well in Hong Kong which has a favourable business climate. A growth rate of 2.6 and 4.1 is expected for 2012 and 2013 respectively (IMF 2012). The countries current account balance is expected to decline while consumer prices are expected to decline from 7.4% in 2012 to 7.0% in 2013. Tesco is currently managing its operating exposures very well and there is no cause for alarm. However, empirical studies have found that the use currency derivatives for hedging reduces their exchange rate exposure significantly (Allayannis and Ofek 2001). In fact, Crabb (2002) states that previous findings of insignificant exchange rate exposure in relation to large corporations like Tesco are due to the hedging activities that they engage in. Previous findings suggest that these activities are not very effective in eliminating risk (for example Shin and Soenen 1999). However, this may be location sensitive. Faff and Marshall (2005) found that that there is a positive relationship between multinational corporations such as Tesco, that have foreign operations and their level of foreign exchange exposure in the UK – MNC’s with greater foreign operations have a larger magnitude of foreign exchange exposure. This was not the same for US and Asia where there was a negative relationship and no relationship respectively. Sometimes a company wins and at other times it loses but this should net off to Tesco’s benefit if managed well. Appendix References Allayannis, G and Ofek, E. (2001). Exchange rate exposure, hedging, and the use of foreign currency derivatives. Journal of International Money & Finance, 20(2), p. 273 - 296 BBC (2012). Tesco market share dips below 30%. [Online] Available at http://www.bbc.co.uk/news/business-16817254. [Accessed 19 March 2013] BIS (2010). Triennial Central Bank Survey: Report on global Foreign exchange market activity in 2010. [Online] Available http://www.bis.org/publ/rpfxf10t.pdf. [Accessed 19th March 2013] Bloomberg. (2010). China Inflation `Fight' May Widen as Growth Withstands Tightening Measures. [Online] Available at http://www.bloomberg.com/news/2010-12-11/china-s-inflation-tops-5-adding-pressure-for-wen-to-raise-interest-rates.html. [Accessed 18th March 2013] Bodnar, G (n.d.). Techniques for Managing Exchange Rate Exposure. [Online] Available at http://finance.wharton.upenn.edu/~bodnarg/courses/readings/hedging.pdf. [Accessed 18th March 2013] Brigham, E.F and Ehrhardt, M.C. (2005). Financial Management: Theory and Practice. 11th edition. USA: Thomson South-Western China Briefing. (2010). China Imposes Price Controls on Regional Retailers to Counter Inflation. [Online] Available at http://www.china-briefing.com/news/2010/12/10/china-imposes-price-controls-on-regional-retailers-to-counter-inflation.html. [Accessed 18 March 2013] CNNMoney. (2010). China imposes price Controls to Stave off Inflation. [Online] http://money.cnn.com/2010/11/17/news/international/china_inflation_price_controls/index.htm. [Accessed 19th March 2013] Crabb, P. (2002). Multinational corporations and hedging exchange rate exposure. International Review of Economics & Finance, 11(3), p. 299 – 314 Eiteman, D.K., Stonehill, A.I., Moffett, M.H. (2007) Multinational Business Finance. 11th ed. Boston, MA: Pearson Education Eun, C.S., Resnick, B.G., Sabherwal, S. (2011). International Finance. Global Edition. US: McGraw-Hill Higher Education Faff, R.W and Marshall, A. (2005). International evidence on the determinants of foreign exchange rate exposure of multinational corporations. Journal of International Business Studies, 36, p. 539 – 558 IMF (2012). World Economic Outlook: Growth Resuming, Danger Remain. [Online] Available at http://www.imf.org/external/pubs/ft/weo/2012/01/pdf/text.pdf. [Accessed 18th March 2013] IMF. (2013). Gradual Upturn in Global Growth During 2013. [Online] Available at http://www.imf.org/external/pubs/ft/weo/2013/update/01/pdf/0113.pdf. [Accessed 18 March 2013] LowTax (2013). Hong Kong: Taxation. [Online] Available at http://www.lowtax.net/lowtax/html/hongkong/jhktax.html. [Accessed 17th March 2013] Madura, J. (2006). Financial Markets and Institutions. 7th edition. USA: Thomson South Western Nguyen, H and Faff, R. (2003). Can the use of foreign currency derivatives explain the use of foreign exchange exposure?: Evidence from Australian Companies. Journal of Multinational Financial Management, 13(3), p. 193 - 215 Quinn, J. (2013). Questor share tip: Keep Tesco in your shopping basket. [Online] Available at http://uk.finance.yahoo.com/news/questor-share-tip-keep-tesco-060006404.html [accessed 19th March 2013] Reuters (2013). Tesco withdraws Czech salami containing horsemeat. [Online] Available at http://uk.finance.yahoo.com/news/tesco-withdraws-czech-salami-containing-174242519.html. [Accessed 20th March 2013] Shin, H and Soenen, L. (1999). Exposure to currency risk by U.S. multinational corporations. Journal of Multinational Financial Management, 9(2), p. 195 – 207 Tesco (2006). Tesco: Annual Report and Financial Statements 2006. [Online} Available at http://www.tescoplc.com/files/pdf/reports/annual_report_2006.pdf. [Accessed 18 March 2013] Tesco (2010). Tesco 2010 Annual Report. [Online] Available at http://www.tescocorp.com/data/1/rec_docs/713_2010%20Annual%20Report_LoRes.pdf. {Accessed 19 March 2013] Tesco (2012) Tesco Annual Report 2012. [Online] Available at http://www.tescoplc.com/files/pdf/reports/tesco_annual_report_2012.pdf. [Accessed 17th March Tesco plc (2013). About us. [Online] Available at http://www.tescoplc.com/index.asp?pageid=6. [Accessed 17 March 2013] UNDP (2009). Human Development Report 2009: Overcoming Barriers- Human mobility and development.[Online] Available at http://hdr.undp.org/en/media/HDR_2009_EN_Complete.pdf. Accessed 18th March 2013] Walton, J 1999, Strategic Human Resource Development, Pearson Prentice Hall, UK. Read More