Economics of the Firm - IKEA - Term Paper Example

?ECONOMICS OF THE FIRM- IKEA INTRODUCTION IKEA is one of the largest home- furnishing retailers based in Sweden. of IKEA is based on the Acronymof the following:  I (Ingvar) - Founder’s first name   K (Kamprad) - Founder’s last name   E (Elmtaryd) - Farm where Ingvar Kamprad grew up   A (Agunnaryd) - Home village. IKEA is conducting business in more than 41 countries with (Ikea, 2012) and sales from stores worldwide generated 26 billion euro in 2011, and this figure has increased from 22.5 billion euro in 2008 and almost 24 billion euro in 2010 (LaFranco, 2012). At IKEA, the heart of every activity has goal to ensure the availability of well designed functional home furnishing products. It ensures to bring product within the buying capacity of as many people as possible. IKEA takes challenges to provide the best quality at low price. Hence, success of IKEA is based on the secret recipe of simple yet effective business model. This report is aimed at providing the detailed review of the economics of IKEA, giving insight about firm’s internal conduct as well as impact it receives from domestic and international events. NATURE OF PRODUCT OR SERVICE IKEA furniture nature can be classified as normal goods; between the broad categorization of normal and inferior goods. Technology has played an incredible role in determining the demand for furniture. At IKEA, technological development has ensured continuous innovation that facilitated furniture in a flat package that is also easy to assemble by self at home. Moreover, technological advancement enables firm to sell online, allowing people to devise their own set up using IKEA applications and reduce cost with maximum benefit with IKEA’s life improvement projects. IKEA ranks first on top 20 furniture retailers (Daten, 2011) due to low price among its main differentiating factors. (Daten, 2011) Furniture has high price elasticity that threatens sale in case of rising prices. On the other hand, prices of furniture are rising due to declining natural resources and rising price of furniture components such as steel, plastic, aluminum etc as presented in graph below (Daten, 2011). (Daten, 2011) Survey report has shown that more than 75 percent consumer keep an eye on price when buying price (Daten, 2011). Therefore, IKEA is benefitted for its low price where other competitors get hard hit due to price. Housing demand compliments furniture demand. Availability of widest range of home furnishing product at affordable price makes IKEA preferred choice. During economic downturn, IKEA has managed to carve profit with its low cost offering fetching sales for being growingly adopted as substitute for high cost offerings in home furnishing . IKEA sales grew by 6.9% and stores increased by 2.7% in the year 2011 (Ikea., 2011). Finished flats as main drivers of furniture demand still have sizeable market as projected for 2012, survey report shows: (Daten, 2011) MARKET TREND Being home item furniture is used by almost all family members; hence, there are large numbers of factors that affect its purchase. These aspects include personal, product, industry, availability and many other domain all putting equal pressure in driving consumer behavior. Survey results driving the furniture purchase from two perspectives as shown in the following figures (Microsoft, 2011): (Microsoft, 2011) Shopping behavior for furniture purchase is affected by following factors (Microsoft, 2011): (Microsoft, 2011) Keeping all these factors, the survey found IKEA is the most preferred furniture retailer as shown: (Microsoft, 2011) Survey results regarding reasons resulting in furniture buying is mentioned below: (Microsoft, 2011) Among many factors leading furniture buying, income and price are very important. At IKEA constant innovation reduces prices which in result drive sales. At an average IKEA reduces its sales price by 2-3 percent per year (Ikea, 2011). An indifference curve for furniture consumption with change in prices from IKEA has been developed showing the increase in furniture consumption with budget line rotating towards right: image 11 Demand for furniture is determined by many factors including slide in prices while some of which are mentioned in image titled reason for buying demand. Increase in input price is expected to increase the price of the final furniture product. Rise in price shall result decline in demand. At IKEA this factor is combated by applying various innovative techniques and bulk buying that result sizeable decline in variable cost per unit. Price reduction through innovation is transferred to customer resulting in increased consumption from point C to A in the graph above. Supply mechanism of IKEA is also one of the most efficient supply chains giving it competitive advantage over competitors. Poland being the second largest source centre for IKEA has COM.40 and Correct as the supply chain project leaders that control the supply side efficiently (Best Log, 2011). Supply chain of IKEA is as follows: (Best Log, 2011) Brief about the supply structure entails COM.40/Correct controlling the reliable deliveries from smaller suppliers and reports to IKEA regularly. IKEA takes transportation responsibility and shares risk and costs with COM.40/Correct on the basis of Free Carrier (FCA). Consequently, suppliers’ cooperation, consolidation and long distances shipments form determinants of low prices for IKEA. These factors result in continuous increase in the demand of IKEA furniture even in the hard times of economy. Projected market demand for furniture is expected to gain more momentum with economic recovery. Eurostat’s Official 2012 projections estimate GDP in Europe (17 countries) to remain stable (-0.3%). Also non-residential investments in Europe will slow to +1% in 2012, though these figures show slow growth but it will remain in a positive zone. Growth of India, China, Russia and Brazil mainly would drive demand (World Furniture, 2012). PRODUCTION SUPPLY PROCESS AND COST The production process of IKEA if decomposed can be categorized with the standardized production of product and on a later stage assembly of standardized parts is closely related to logistics and marketing. IKEA manages to keep cost down with control on these two activities by “DFM (Design For Manufacturability)” to “DFL (Design For Logistics)” (Li, Guo, Skibniewski, and Skitmore, 2008). (Li, Guo, Skibniewski, and Skitmore, 2008) Top 5 contributors of the main raw material i.e. wood are presented in image below, whereas rest contributors are Vietnam, Canada, Slovakia, Lithuania, Czech Republic and Ukraine. Control over production process is maintained by efficient supply chain an example as presented in image 12. This maintains the cost of input and transportation under control. (Ikea, 2011) Income statement presented above provides some concise information about the IKEA. Cost of input has risen from 52% in year 2010 to 54.7% in year 2011. This is presumed to be a result of constant increase in prices of raw material input prices. The operating cost accounts for 71% in 2010 whereas the similar title shares 68% in 2011. This can be verily connected to IKEA business model of constantly striving to reduce operating cost. For instance, replacing traditional wood pallets with newly designed paper pallets have reduced wood usage; currently 51 percent of energy used at IKEA is from renewable source and constant efforts are being made to reached 100% etc (Ikea, 2011). IKEA is operating in oligopolistic structure therefore, with increased input cost and alongside reducing price; IKEA manages its profit with efficient control over production and supply chain through strong bonds with suppliers and efficient systems. STRUCTURE OF THE INDUSTRY MARKET Furniture industry in general is having following features (Furniture Manufacturers, n.d.): Overall the world has industry segmentation in both organized and in organized formats. Labor force is a combination of skilled and unskilled labor. For instance, big firms to endeavor continuous innovation require highly skilled labor whereas unorganized segment employee unskilled. Part of the industry is automated utilizing machines and CAD/CAM for manufacturing and designing while segment of industry only utilized handcraft tools. Furniture industry nurture many industries in ally due to wide product range such as office, living room, bedroom, kitchen, garden, school furniture but also mattresses, furnishings, upholstery, parts of furniture etc. This gives boost to industries such as plastic, steel, cotton agriculture etc Worldwide furniture industry in developing countries like China, Southeast Asia (Philippines, Indonesia, Malaysia, Singapore, Thailand, Korea, Taiwan and India), Poland and Mexico have developed their production capacity and taken over 30 percent of industry share. European Union accounts for about half or approximately € 82 billion of the world furniture production capacity. Canadian furniture market is the fifth largest furniture exporter (Furniture Manufacturers, n.d.). Therefore, industry has concentration. This characterizes that the industry with oligopoly structure with IKEA being the main player. This position is determined based on the huge standing among retailers mainly furniture. IKEA website contains almost 12,000 articles while it is also the third largest consumer of wood after Home Depot and Lowe. Also strong supply chain network allows IKEA to set prices and sell products with constant innovation unlike other general furniture industry producers that is forced to increase price duo to increased input price. IKEA has differentiated its product with offerings at continuous innovation, functionality and low price with sustainability. Strong control over supply chain with cooperation of supplier such as strengthened bonds with Poland suppliers’ network creates strong barrier for firms considering entry with same level. Hence, low cost leadership like IKEA is the least attainable by firm planning to enter the firm. GOVERNMENT RULE Sweden like most other EU countries was hard hit by financial crises of year 2007 but it rebound in year in 2010. Currently it is among in the upper range of EU. Government of Sweden has managed high level trade, sound public finances; overall international investor’s confidence on Sweden economy is high and the country is considered as a long term viable investment option after receiving shock from financial crises. The economy review of Sweden in a glance is as follows (Doing Business, 2012): (Doing Business, 2012) Sweden is part of European Union but it has maintained its own currency krona (crown). Country has a high tax rate but the money given to government is truly spent on public expenditure. With globalization characterizing the world with India and China taking lead in promoting labor intensive jobs, Sweden has taken much direct and indirect benefit. Direct benefit came from diverting labor intensive jobs to mentioned countries and diverting its labor to more technical jobs; while indirect gains to Swedish economy includes gain from savings and investments (Bjorvatn, Norman, and Orvedal, 2008). The projected benefit this globalization is expected to drive for Sweden is forecasted below: (Bjorvatn, Norman, and Orvedal, 2008) Monetary policy announced in July 2012, government of Sweden has cut interest rate to 1.25 percent in anticipation of events in 2013. It anticipates world economic growth of 4 percent despite euro debt crises; slow but continuing growth of US; and mainly for the faster than expected strengthened krona. GDP of Sweden is expected to increase by 1.5%, 1.9% and 2.8% in years 2012, 2013 and 2014 respectively. Fresh study regarding tax found that Sweden pays almost 70 percent of their income in taxes; however, Swedes people get this money back in one form or the other. Furthermore, Swedish government is getting millionaires into tax net resulting capital inflow in year 2011 grown in five-folds. The tax amount has risen from two to 10 billion kronas ($300 million - $1.5 billion) as a result of agreement Swedish tax agency conducted with many developed countries . An overview of the public financial management and projections is as follows: In recent times, Swedish government has announced plans to slash corporate tax rate to 22% from its current setting of 26.3% to gear up the economy and country's competitiveness . This attempt will benefit IKEA along with other businesses with increased profits to be reinvested ensuring the further less priced products available for people and increased sustainable growth. Efficient government management took Swedish rooted firms such as IKEA, H&M and Volvo worldwide and they are considered household names from Boston to Beijing. IN UK, however, IKEA has been accused of cutting its tax bill by half by using savvy accounting techniques and cutting tax amount by ?9.7million to UK exchequer (McDermott, 2012). BUSINESS ENVIRONMENT Swedish government undertook measures that made doing business environment in Sweden more attractive. Current status of Sweden in Doing business index is summarized for the year 2012-13 in image below: Though there has been a decline of five levels in Doing Business ranking, Sweden still ranks among the preferred place for investment. Government of Sweden is planning to further reduce corporate tax in year 2013. This will further improve conditions for business mainly for IKEA with more reserves in hand to increase its internationals presence. IKEA also receive impact from international business environment. It has planned to enter the attractive market of India with investment of approx 600 million Euros. The decision has recently been finalized after reaching on the verge of cancellation due to strict non-acceptable conditions of Indian Government such condition in supplier contract, no resale of used furniture etc . Moreover, Conditions in Russia have also constantly acquired attention of IKEA management as Russia accounts for its main supply centre. Main issues IKEA has to account for production expansion in Russia can be categorized in following heads Bureaucracy (main hurdle) Waste management (Underdeveloped, lack of awareness) Energy (low energy efficiency, lack of awareness) Logging (illegal, non-transparent supply chain etc) In addition to these, recent pressure of IMF on Russia to tighten monetary policy will increase the cost of IKEA and would ultimately affect its business operations. Hence, any fluctuation in economy of Russia has equal impact on IKEA. Similarly, Chinese monetary policy that is suggested to have more room for easing can drive the cost of IKEA further down. However, any attempt by Chinese government to tighten the growth can any time put pressure on IKEA as government of China is criticized to have left with no more option to invest in. Currently, IKEA is enjoying exponential growth in China. Overall growth prospects are also high as growth projections worldwide are positive as given below: FIRM INDUSTRY LOCATION To successfully follow the goal of IKEA of low cost, it has been very considerate about the location factor as it greatly influence the entire cost structure. Recently IKEA has refused to continue its plans to open a store in Somerville nearly 15 years. Another city Burlington, is making constant efforts to retain IKEA that is considering to move the set up if the city is unable to meet its requirement of well set up infra structure. Next to land location, the entire flat pack store has located products in a strategic manner that does not let person escape from buying anything. These decisions are necessary subject to maintain optimal firm performance that is a road way to cost leadership. Attempt to perform at optimum, 33 studied IKEA strategies of combining place-related features that micro, meso and macro-spaces impose on resources such as products, facilities and units and also in business relation. IIKEA also achieves this goal by diluting too much spatial friction by relating itself in all three levels on both short run and long run effective tactics. Moreover, with globalization where India and China are taking lead in labor intensive industry Sweden is also taking considerable advantage. Sweden has taken dual indirect gains with both generating higher economic growth. The aforesaid gains are motivating saving and investment (i) and second being shifting Swedish resources into knowledge-intensive activities by shifting labor intensive jobs to India and China (ii) (Bjorvatn, Norman, and Orvedal, 2008). (i) (ii) (Bjorvatn, Norman, and Orvedal, 2008) Such knowledge intensive industrialization leads to agglomeration effect. However, IKEA product being labor intensive with processes more standardized; product and market clear; and having higher level of competition, the effect of agglomeration is less likely to effect. Therefore, localization being resulting impact of agglomeration does not result in and with IKEA structure and business model (Bjorvatn, Norman, and Orvedal, 2008). BUSINESS AND PRICING STRATEGY In growingly difficult business environment where the cost of every product in increasing IKEA stands firmly and profitably on its low priced product range. IKEA self states the strategy in achieving its goal in ten points which are as follows: Recycling AS-IS (placing products on sale to fetch revenue that would have been otherwise lost) Waste Reduction Automatic selling (effective product arrangement that require less staff assistance leading to reduce staffing cost) Thriftiness (saving each penny possible) In-house design (saving huge design commissions payable to outside contractors) Economies of Scale Transportation (only by cargo container or trailer and no usage of expensive air transport) Strategic Placement (placements on high visibility, high traffic areas) Minimal packaging (using brown packaging material, putting label for product identification, wordless instruction to save cost of translation etc) All these are guiding principles for IKEA to keep muscular control over cost. However, despite of selling similar products all round its worldwide destinations IKEA does not follow the law of one price (LOP). Microsoft (2011) conducted an extensive study regarding the price differential of IKEA products. It pointed price differential exists even after diffusing the impact of transportation cost, trade barriers, and taxes. Study further mentions that price differential receive impact from following three sources: special market strategies designed for different countries; impact of transportation cost and tariff exists while this impact cannot be accounted in quantitative ways; and linear relationship between country‘s productivity and the price variations i.e the higher the countries productivity higher will be price of the products available. Business strategy of IKEA had to face failure in Japan on its first round while the company redefined its strategy in second round which brought success to it. In the initial strategy IKEA underestimated psychic distance caused by cultural differences; market knowledge and learning; entry time and strategy; and degree of adaptation. While before entering second time, IKEA spent 5 years in market research. The economic conditions of country supported which also reduced the level of uncertainty. Finally, marketing mix accounting more adaption to Japanese lifestyle supported the second entry round. Hence, in reference with Japanese example it can also be concluded that IKEA is justified in maintaining the differential in strategies (which includes price as component of 4P’s) in order to be successful in strategies. To meet the new trends, IKEA and Ideabox have now come up with $86,000 flat-pack DIY home. ENTREPRENEURIAL ABILITY OF MANAGER All products at IKEA constantly have undergone innovations in order to make them easy to handle, cost effective and quality representative. Annual report 2011 of IKEA contains the story of IKEA’s EKTORP- sofa undergoing up-gradation since year 1996 to year 2010. Attempt to make it more customer friendly have resulted breaking it down to be flat packed and self assembly pieces. This also has reduced cost of sofa. The entire IKEA’s story is full of such constant innovations (Ikea, 2011). At IKEA values are followed that made it preference of employees and IKEA named as “Most Attractive Employer of year 2011” (Ikea, 2011). People at IKEA follow “IKEA spirit” value driven competence and leadership development mechanism. Sustainability is integrated in entire IKEA business model; in every function from product design to supply change. It is made the core element of long term strategy at IKEA. IKEA in an endeavor to ensure its product range growingly sustainable are rated on a unique score board of IKEA. Currently, 51 percent of energy used at IKEA is from renewable source. It has goal of managing 100 percent energy from renewable source and expects to manage it 70 to 80 percent by 2015. The share of FSC (Forestry Stewardship Council) certified solid wood in IKEA has increased from 15.8% in 2010 to 16.2% in year 2011. Similarly, sustainably grown cotton usage at IKEA has increased from 13% in 2010 to 24% in 2011. All these are examples of constantly striving co-workers (as employees are called at IKEA) to get product that meet all furniture related demand of customer from aesthetic as well as pocket perspective. CONCLUSION IKEA being among the largest retailers is also among the continuous success stories. The firm having roots in Sweden but stands in many parts of world. Currently IKEA is planning to double store numbers and slash prices only in Australia alone with expansion in India and China also. The success of business model is based on its most efficient system; constantly reducing prices; and on top of list is involving customer in conducting the portion of job that brings the final product in their hand. Understanding the customer psyche that over valuing products they build themselves has brought manifold benefits to IKEA. These on one side results in cost reduction while on the other side increase sales to the point that the firm remained profitable in hard economic crises. Overall economics of the firm witness that it has sound business plan that fetches customers to its store than glamorous attraction offered by businesses resulting in its sustainability in time when most of rest facing tough competition. References Best Log. (2011). Reconfiguration of the Supply Chain Structure. European Commission, Retrieved October 25, 2012 from http://www.elabestlog.org/sites/default/files/cases/Ikea%20Reconfiguration%20Supply%20Chain.pdf Bjorvatn, K., Norman, V., and Orvedal, L. (2008). On the Road to Samarkand Globalisation and the Swedish economy. Expert report no. 21 to Sweden’s Globalisation Council. Retrieved October 25, 2012 from http://www.regeringen.se/content/1/c6/11/32/24/f4d9dafc.pdf Daten, Z. (2011). Statistics For The Furniture Industry And Trade. Retrieved October 25, 2012 from http://www.smartcebuproject.com/downloads/11_9a_Statistics-Germany.pdf Doing Business. (2012). Sweden. The International Bank for Reconstruction and Development. Retrieved October 25, 2012 from http://www.doingbusiness.org/~/media/giawb/doing%20business/documents/profiles/country/SWE.pdf Furniture Manufacturers. (n.d.). World Furniture Industry. Retrieved October 25, 2012 from http://www.furnituremanufacturers.net/world-furniture-industry.html Ikea. (2011). Welcome Inside 2011. Retrieved October 25, 2012 from http://www.ikea.com/ms/en_CN/pdf/yearly_summary/Welcome_inside_2011.pdf Ikea. (2012). Facts & Figures. Retrieved October 25, 2012 from http://www.ikea.com/ms/en_CN/about_ikea/facts_and_figures/facts_figures.html LaFranco, R. (2012). Secret IKEA Fortune Put in the Spotlight With Rights Sale. Bloomberg, Retrieved October 25, 2012 from http://www.bloomberg.com/news/2012-08-13/secret-ikea-fortune-put-in-the-spotlight-with-rights-sale.html Li, H., Guo, H., Skibniewski, J. and Skitmore, M. (2008). Using the IKEA model and virtual prototyping technology to improve construction process management. Construction Management and Economics, 26 (9), pp. 991-1000. McDermott, K. (2012). eBay avoids ?50m corporation tax bill by channelling payments through Luxembourg. Daily Mail, Retrieved October 25, 2012 from http://www.dailymail.co.uk/news/article-2220907/eBay-avoids-50m-corporation-tax-channelling-payments-Luxembourg.html Microsoft. (2011). Retail: Furniture Insights. Retrieved October 25, 2012 from http://advertising.microsoft.com/uk/WWDocs/User/en-uk/ForAdvertisers/Retail%20Furniture%20Insights_March%202011_external.pdf World Furniture. (2012). International Market Review. Retrieved October 25, 2012 from http://www.worldfurnitureonline.com/PDF/WFR-Magazine.pdf Read More