Tesco PLC Finance Strategy - Example

Tesco PLC Finance Strategy Name Institution Course Date Table of Contents Table of Contents 2 1.0 Introduction 3 2.0 Common Business Financing Methods 3 2.1 Debt Financing 4 2.2 Equity Financing 4 3.0 Analysis of Tesco’s Sources of Finance 5 3.1 Gearing Position 5 4.0 Tesco International Operations in Context 6 4.1 Tesco’s Strategy on International Activity and Finance 7 4.2 Analysis of How Tesco Currently Treats International Issues 9 5.0 Recommendations 10 6.0 Conclusion 11 References 12 1.0 Introduction Tesco is a British multinational supermarket and the world’s second largest retailer after America’s Wal-Mart (Humby et al. 2008, p. 2). Tesco was incorporated in 1919 in England and has since grown to become a worldwide brand with operations in more than 13 nations across the globe (Taylor 2014, p. 3). The history of the company indicates that Tesco began as a grocer selling good and non-food products. However, to establish a strong position in the market, Tesco has diversified its product portfolio by introducing new products that include finance, mobile, insurance and hardware among others. Although Tesco has maintained a strong position in the retail market, the supermarket faces stiff competition from other well-established retailers such as Sainsbury, Morrison and Wal-Mart just to name but a few. In 2016, Tesco posted revenue totaling £55.92 million (Tesco 2017). This report begins by analyzing how Tesco is financed with a particular focus on the company’s gearing. The second part of the report will analyze Tesco’s strategy on international activity and finance with a focus on how the retailer treats international issues. The report will conclude with recommendations to the validity of Tesco’s approach. 2.0 Common Business Financing Methods Business financing is critical to the success of a company. For any business to succeed, it must be adequately financed to ensure that it has enough funds to invest in various projects and to ensure effective operations. There are several sources of finance that a business can use to finance its operations. However, Fridson and Alvarez (2011, p. 14) argue that choosing the right source of finance is critical as it ensures minimizes a company’s exposure to risks associated with poor financing such as high gearing that can make a company look risky from the creditor and investor points of view. Despite the existence of many sources of financing available for businesses, debt and equity financing are the two most common sources of financing for businesses (Jung-Senssfelder 2007, p. 32). These sources of financing have their pros and cons that any company uses them must take into consideration. 2.1 Debt Financing Debt financing is one of the most common methods of business financing and involves a company taking loan-term loans from financing institutions to finance business activities. Debt financing is commonly used by companies because it enables a company to finance its business operations before it can be able to earn the necessary funds. Robinson et al. (2012, p. 17) suggest that debt financing is a great way of financing business especially when a company is pursuing aggressive growth strategy. Additionally, debt financing has the advantage in the sense that it does not dilute the ownership of the company because banks and other financial institutions do not gain control or ownership of a company by financing it through loans (Jung-Senssfelder 2007, p. 36). Despite the advantages associated with debt financing, this method of business financing also has a share of its disadvantages that make it a risky source of financing. The first disadvantage associated with debt financing is the fact that the loan must be repaid plus all the interests that have accrued (Glen & Pinto 1994, p. p. 24). In case of a default, a company runs the risk of its properties and assets being repossessed by the financing institution to recover the money. Loan financing is also a risky form of financing because it interferes with a company’s cash flow, which consequently can stifle growth. Additionally, financing businesses with debts has the risk in that, when a company is financed by too much debt (highly geared), this makes investors and creditors consider the company risky investing in or doing business with, which is not good for the growth of a company. 2.2 Equity Financing Equity financing is a common source of business financing that involves seeking funds from investors. In equity financing, a company gets money from private investors in exchange of ownership in the company (Fridson & Alvarez 2011, p. 14). Equity financing like debt financing has its advantages and risks that any business that uses this form of financing has to take into account. First, equity financing is popular with companies because the money given by the investors is not repaid as is the case with debt financing. Once investors have given their money by buying shares or stock in the company, they become owners of the company and the money is not repaid. Equity financing is also favored because this financing can be easy to get by selling shares to the members of the public (Glen & Pinto 1994, p. 58). This is different from debt financing that is not only difficult to get, but also comes with preconditions. Additionally, heavily financing a company operations through equity lowers a company’s gearing position, which makes a company attractive to investors and creditors because low gearing implies less risk. However, equity financing also has its cons. The first major disadvantage of equity financing is the fact that it gives ownership of the company to the investors. In fact, large investors often insist on having their representative on the board and executive positions, thus resulting in loss of control (Robinson et al. 2012, p. 21). Equity financing is also not good for a company because the profits generated have to be shared with the investors in the form of dividends. Over time, the earnings distributed to the investors might exceed what a company could have repaid on loans (Petty et al. 2015, p. 9). Moreover, equity financing is disadvantageous because it can result in conflict in case there are differences between the managers and the shareholders over ownerships and management of the company. 3.0 Analysis of Tesco’s Sources of Finance Tesco is an example of a company that finances its operations using debt and equity financing. According to the company’s 2015 annual report, Tesco was financed by debt to the tune of £ 10.651 million (Tesco 2017). In 2016, the amount of borrowing from financial institutions went up to the tune of £ 10 .711 million (Tesco 2017). These borrowings were taken by the company to finance its operations. The company’s annual report also indicates that Tesco finances its operations through equity financing. As earlier described, equity financing is where a company finances its operations using money obtained from private investors. According to 2015 annual report, the total equity finance for Tesco was £7.071 million and the figure rose to £8.616 million in 2016 (Tesco 2017). 3.1 Gearing Position Gearing is a ratio that measures the degree to which a company is financed by long-term debts relative to equity financing. Mathematically, gearing is equal to long-term debts divided by total shareholders’ equity. Conventionally, a low gearing ratio of below 50% is preferred because it shows that the company is not highly geared. A gearing ratio of more than 50% is not good from the investors and creditors point of view because it indicates that a company is heavily financed by debt, thus susceptible to business cycles. Based on Tesco’s 2015 financial year report, the company’s gearing ratio is 10.651/7.071 = 150.6%. This ratio indicates that Tesco was highly geared in 2015 indicates that the retailer is highly leveraged. The high gearing position of the retailer in 2015 thus indicates high risk that Tesco was exposed to in the sense that any sudden increase in interest rates could plunge the retailer into a loan default or bankruptcy. Accordingly, in 2015, the financial structure of Tesco was good from the creditors and the investors’ point of view as it indicated that the company runs the risk of loan default and bankruptcy that could have adverse impacts on investors’ investments and creditors because of the risk of the company not paying their obligations when they fall due (Robinson et al. 2012, p. 25). In 2016, Tesco’s gearing was 10 .711/£8.616 = 124.3%. This implies that there was an improvement in the gearing position of the company that declined slightly because there was an increase in equity financing while the amount of long-term debts decreased. Although the fact that the company is still highly geared as it is financed more by debt than equity, the reduction in the gearing position of the company would be a good sign of reducing risk position of the retailer as far as creditors and investors are concerned. Overall, Tesco’s gearing position is bad and needs to be improved to make the company less risky for the investors and the creditors. As demonstrated above, the company has a high gearing ratio both in 2015 and 2016 which implies that it is highly leveraged. High leverage means that Tesco is paying a lot of interest on the money it has borrowed and this puts the company at risk of bankruptcy or loan default that might have serious implications of the operations of the retailer. For this reason, it would be important that the retailer reduce its gearing position by reducing the amount of debt financing while increasing equity as this would make the company less risky and attractive to investors and creditors. 4.0 Tesco International Operations in Context The history of Tesco PLC dates back to 1919 when the retailer opened its doors. However, the company has since grown to become a household brand in the United Kingdom. For close to a century, Tesco plaid second fiddle to Sainsbury until 1995 that Tesco overtook Sainsbury to emerge as the UK’s largest retailer (Humby et al. 2008, p. 2). Today, Tesco is also the second largest retailer in the world after Wal-Mart. To minimize the competitive pressure it faces from local firms, Tesco has been focusing on growth by looking at foreign markets that provides it with opportunity for growth. Today, the retailer operates in more than 13 countries with more than 2,000 stores found in Asia and Europe. Tesco also has operations in the United States, where a significant part of its revenue comes from today. 4.1 Tesco’s Strategy on International Activity and Finance As the business environments become more competitive and domestic markets of some companies become more saturated, internationalization has become a viable means of surviving for most companies. Today, the majority of big companies operate beyond their national borders as they seek to acquire new market opportunities and to make profits (Ryans 2013, p. 72). Nonetheless, choosing the correct internationalization strategy has never been easy for companies and the same applies to Tesco that has had to ensure that it understands the nature of the market which it intends to expand to before choosing the right strategy to adopt. However, analysis indicates that Tesco has always relied mainly on three internationalization strategies as it seeks to enter and conquer foreign markets. The strategies include Greenfield investments, acquisitions and joint ventures. To ensure success, the retailer adopts an entry mode based on the nature of the foreign market in terms of culture, legal issues and customer needs to prevent failure. Tesco currently has presence in many countries across the globe. The retailer’s global strategy has focused on expansion mainly to the emerging markets, such as Czech Republic, India, and Singapore while at the same time looking to exploit large consumer markets like the United States and China. The company has adopted different entry strategies as it seeks to enter the overseas markets. One of the strategies has been Greenfield/fully owned subsidiary (Morschett 2011, p. 101). Over the last few decades, Tesco has opened quiet a number of fully-owned subsidiaries in foreign market. In 2007, Tesco expanded to the United States by opening small grocers is Arizona and Nevada. The company has adopted the same strategy in many other foreign markets, such as China, Ireland, Scotland and Singapore, just to name but a few. Greenfield investments have proven appropriate for Tesco when entering a new unexploited market (Butler & Neville 2017). Despite the benefits that Tesco has gained through Greenfield investment, this strategy has had an effect on the retailer’s finances and cash flows because they are expensive as it means that Tesco has had to open stores and manage them on its own (Alexander & Doherty 2009, p. 34). In fact, most of the Greenfield investments that Tesco has engaged in foreign markets have failed to record good performance because they are not only costly, but also fail to meet market demands in foreign markets. Tesco also pursues international market through acquisitions. Acquisition is market entry strategy that involves one company called the predator acquiring another called the target (Sternquist & Witter 2011, p. 21). In acquisition deals, once the predator has acquired the target, the predator gain full control over the activities of the target, such as finances, resources, quality control and production and marketing. Although acquisitions are often very involving because of the bid process, Tesco has often used this strategy as a way of conquering the overseas markets (Taylor 2014, p. 34). The retailer has been pursuing this strategy because of the benefits attached to acquiring a foreign market, that include acquiring the resources, expertise and the market share owned by the target, as well as the fact that acquisitions makes it possible for Tesco to bypass the legal and cultural challenges associated with entering a foreign market (The Guardian 2013). For instance, Tesco expanded to the United States in 2006 by acquiring Fresh and Easy. Entering the U.S. market through acquisition of Fresh & Easy has made it simple of Tesco to penetrate the American retain market (Butler & Neville 2017). The same has been seen in Thailand, where the move by Tesco to acquire Lotus enabled the UK retailer to penetrate the Thai retail market easily and grow. Currently, Tesco is the market leader in Thailand retail industry as it has made significant investment into organic management. Additionally, Tesco has been involved in seeking joint venture partnerships as a way of conquering foreign markets. Joint venture is a market entry strategy where two or more companies come together to form a new company. In joint venture partnerships, both the companies that have come together share resources and management, as well as expertise (Sternquist & Witter 2011, p. 27). For instance, as part of Tesco’s strategy to enter the South Koreans market, the retailer formed a joint venture with Samsung Group to form a new company called Samsung and Tesco Home Plus (Taylor 2014, p. 13). The joint venture strategy was appropriate for Tesco when entering the Korean market as it enabled Tesco to bypass the cultural and legal barriers that would have made it difficult to enter Korea should it have opted to use Greenfield investment (Butler & Neville 2017). Additionally, forming a joint venture with Samsung Group has been beneficial to Tesco as it has enabled the UK retailer to take advantage of the expertise of Samsung Group in electronics industry. Furthermore, joint ventures have been appropriate for Tesco as it has enabled the retailer to build interpersonal relationship in foreign markets, thus ensuring the success of the retailer in the international markets, where it has used joint venture partnerships (Ryans 2013, p. 81). 4.2 Analysis of How Tesco Currently Treats International Issues Although Tesco remains the world’s second largest retailer, the company has been struggling in some of the foreign markets due to international issues, such as culture and high operation cost. Culture is regarded as one of the major challenges facing multinational companies operating in foreign markets. According to Hofstede cultural dimensions, every society has its unique culture that manifests in five different dimensions, namely power distance, uncertainty avoidance, individualism, masculinity, long-term orientation and indulgence. The national culture of a given country determines how businesses are conducted and how consumers respond to foreign products and services. Tesco’s main issue in the international market has been culture (Butler & Neville 2017). The company has been finding it difficult penetrating come of the international markets, where it has expanded to because of cultural issues. A classical case in point is Japan, where Tesco struggled in beginning 2004 after investing an estimated £250 million (Wolfestone 2012). Despite such a huge investment, Tesco ended up failing in this market after gaining only about 1% of the Japanese grocery market share. The main reason for the failure of Tesco in Japan has been the failure of the retailer to consider the cultural differences between the Britain and Japan. For instance, it has been established that, unlike the UK, Japan has a unique culture as the retail market is characterized my several family-owned and long-established grocers which creates a hub of the community and are loved for the personal touch they offer (Krafft & Mantrala 2010, p. 46). Additionally, Japanese consumers put a lot of emphasis on quality of the products they buy and prefer excellent customer service whenever they shop. Unfortunately, Tesco stores are generally large in size making it difficult for the retailer to deliver high level of services to all shoppers. To respond to the cultural issues it faces in the foreign markets, Tesco has in some instances decided to cease operations. For instance, the retailer decided to cease operations in Japan in 2011 after realizing that most of its stores were making huge losses, with only half of its about half of its 129 stores in Japan making profits (Wolfestone 2012). Besides ceasing operations where it faces cultural challenges, Tesco is trying to ensure that it adopts the right market entry strategy. For instance, the retailer has increased its focus on joint ventures and acquisitions when entering foreign markets that are culturally different from the UK to overcome the cultural challenges (The Guardian 2013). High operation cost is another issue that Tesco faces in the international market. In countries like Japan, Scotland, Ireland and the United States, Tesco has been facing serious challenges because of high operation costs that make it difficult for the retailer to break even upon venturing into these foreign markets (Butler 2015). In response to high costs, Tesco is trying to respond by seeking to lower the costs by negotiating low prices when sourcing its products, and addressing labor cost by hiring only few staff to deliver the services to customers. 5.0 Recommendations From the analysis, it has emerged that Tesco is facing a number of issues with its internationalization strategies as it seek to expand into the overseas markets. First, to succeed in foreign market, it is recommended that Tesco refrain from using Greenfield investment because the strategy has proved costly for Tesco in most of the markets. For instance, Tesco’s problems in Taiwan, Japan and the United States are linked to the fact that the company adopted Greenfield investment. Instead, Tesco should focus on expanding its market reach through acquisitions and joint ventures. Joint ventures and acquisitions would be appropriate as it would enable Tesco to overcome legal and cultural barriers in foreign markets (McLoughlin & Aaker 2010, p. 112). Second, the retailer needs to ensure that its business practices, such as operation and human resource practices are aligned to the business environment of the foreign countries where it has expanded its operations (Seth & Randall 2011, p. 54). Customizing the business and HR practices to suit the local market in foreign countries will enable the company to penetrate the markets easily. It has been observed that, Tesco has been assuming that the UK’s business culture and practices are similar to those of markets like the United States and as a result has been exporting its UK practices into foreign markets and this has been a major shortcoming for the retailer. Therefore, to penetrate and succeed in foreign markets, Tesco should ensure that it aligns it practices to suit the local market business practices (Hitt et al. 2008, p. 62). Additionally, the analysis has found that high operation cost has been a major issue for Tesco in foreign markets. Therefore, going forward, Tesco should consider trying focusing on lowering its cost of production by adoption low cost strategy (Ryans 2013, p. 94). This will ensure that the company keeps its operation costs low, which in turn will ensure high profitability in the international markets. 6.0 Conclusion Tesco is currently the largest retailer in the UK and the second largest in the world. The success of the company is attributed to effective strategies that the company has adopted over the years. However, it has come out from the analysis of the company’s financing strategy that Tesco relies majorly on two types of financing sources, namely debt and equity financing. Using 2015 and 2016 annual reports, it emerged that Tesco was financed by long-term debt to the tune of 10.651 million in 2015 and £ 10 .711 million in 2016. During the same periods, the retailer was financed by equity to the tune of £7.071 million and £8.616 million in 2015 and 2016 respectively. Based on the analysis, of the financing structure of the retailer, it emerged that Tesco is highly geared which paints a bad picture from the viewpoint of investors and creditors as high leverage means high business risk. This pints the need for the retailer to minimize its debt financing while increasing equity financing to make the retailer more attractive to creditors and investors. Additionally, the analysis discovered that Tesco internationalization strategy is based on Greenfield investment, joint ventures and acquisitions. However, considering the cultural and cost issues that the retailer faces in foreign markets, is its suggested that Tesco consider abandoning Greenfield investment and concentrate on foreign market expansion through acquisitions and joint ventures. Additionally, the retailer needs to focus on low cost strategy to remain competitive and survive the highly competitive global retail industry. References Alexander, N., & Doherty, A. M 2009, International retailing. Oxford University Press, Oxford. Butler, S 2015, Tesco beyond Britain: how supermarket is faring abroad, viewed 14 June 2017 https://www.theguardian.com/business/2015/apr/22/tesco-supermarket-abroad-china-asia-ireland Butler, S., & Neville, S 2017, Tesco's empire: expansion checked in UK and beyond, viewed 14 June 2017 https://www.theguardian.com/business/2013/apr/18/tesco-empire-uk-and-beyond Fridson, M. S., & Alvarez, F 2011, Financial statement analysis: a practitioner's guide. John Wiley & Sons, Upper Saddle River. Glen, J. D., & Pinto, B 1994, Debt Or equity?: How firms in developing countries choose, volume 63. World Bank Publications, Washington DC. Hitt, M. A., Ireland, R. D., & Hoskisson, R. E 2008, Strategic management: Competitiveness and globalization. South-Western, Mason, OH. Humby, C., Hunt, T., & Phillips, T 2008, Scoring points: how Tesco continues to win customer loyalty. Kogan Page Publishers, London. Jung-Senssfelder, K 2007, Equity financing and covenants in venture capital: An augmented contracting approach to optimal German contract design. Springer Science & Business Media, Berlin. Krafft, M., & Mantrala, M. K 2010, Retailing in the 21st century: Current and future trends. Springer, Heidelberg. McLoughlin, D., & Aaker, D. A 2010, Strategic market management: Global perspectives. Wiley, Hoboken, NJ. Morschett, D 2011, European retail research: Volume 25, Issue I. Gabler Verlag, Wiesbaden. Petty, J. W., Titman, S., Keown, A. J., Martin, P., Martin, J. D., & Burrow, M 2015, Financial management: principles and applications. Pearson Higher Education AU, Sydney. Robinson, T. R., Henry, E., Pirie, W. L., & Broihahn, M. A 2012, International financial statement analysis. John Wiley & Sons, Upper Saddle River. Ryans, A 2013, Beating low cost competition: How premium brands can respond to cut-price rivals. Wiley. Hoboken, NJ. Seth, A., & Randall, G. 2011, The grocers: The rise and rise of the supermarket chains. Kogan Page, London. Sternquist, B., & Witter, G 2011, Retail strategic international expansion (SIRE²) theory and cases. BSC Publisher, Haslett, MI. Taylor, M 2014, The success of Tesco’s international expansion in South Korean market. Examination and analysis of key factors. GRIN Verlag, Berlin. Tesco 2017, Annual report and financial statements 2016, viewed 14 June 2017 https://www.tescoplc.com/media/264194/annual-report-2016.pdf The Guardian 2013, Tesco on the retreat as overseas expansion turns in rotten returns, viewed 14 June 2017 https://www.theguardian.com/business/2013/aug/11/tesco-retreat-overseas-rotten-returns Wolfestone 2012, Tesco: International marketing gone wrong, viewed 14 June 2017 http://www.wolfestone.co.uk/blog/tesco-international-marketing-gone-wrong/ Read More