Tesco Business Strategy - Report Example

Running Header: Economics for Business: Tesco Page Tesco Business Strategy APA style 10 April 2006 Introduction Economics is a social science whose concepts can be readily applied to any business organization. In fact, it is irrefutable that the operation of business entities is being strongly governed by the different economic principles, such as the law of supply and demand and concepts such as elasticity. These laws and concepts which can be used to look at the internal operations of the firm are contained in a field called microeconomics. Meanwhile, the dependency of businesses in the overall business climate is the topic of a more integrative field called macroeconomics. This field shows how business entities are affected and respond to external problems such as oil price increases and currency fluctuations. This report will analyse the operation of Tesco PLC using an economic point of view. The first section will apply microeconomic concepts of supply, demand, and elasticity. Afterwards, it will also expose three economic challenges which are faced by the company in short, medium, and long term as well as recommend possible solution to these problems. The paper will conclude with its findings. Tesco Business Overview "Our core purpose is, 'To create value for customers to earn their lifetime loyalty'. We deliver this through our values, 'No-one tries harder for customers', and 'Treat people how we like to be treated'." Tesco is an international supermarket chain based in the UK, specializing in a range of products including; clothes, consumer electronics, consumer financial services, internet services and consumer telecoms. For the end of the 2005 financial book year it generated a net income of 33.974 billion with a pre-tax profit of 1.962 billion. According to TNS Superpanel, Tesco owns 30.6% of the UK grocery market and that 1 out of every 8 spend in the UK on retail sales is spend at Tesco. Demand With Tesco supplying 30.6% of the UK grocery market, out of a population of +- 60.6 million (CIA, 2006 est) it is assumed they have a customer base of 18.5 million. Any change in the market environment will have a major effect on Tesco grocery sales due to its large share in the market it caters to. If for example there is an increase in the fuel price, which will result in subsequent increase in the cost for grocery distribution and delivery will adversely affect the prices of groceries. This will essentially cause a surge in total demand and will be felt by the company as a drop in revenue. Figure 1: Effects of Change in Demand Elasticity As can be seen from graph 2 a change in price will negatively influence the demand, this lower demand will result in lower level of sales and can also squeeze the net income of Tesco. For the large retailer, with its huge UK customer base this can result in a major loss of income, and due to the fact that they work on a very high amount of sales with a very marginal profit margin on each product, such a reduction in demand can seriously affect their bottom line. What can also be seen from the graph are the huge movement on the demand side with a small price increase. This implies that the general market of Tesco is very elastic or price sensitive. A lot of factors also contributed to the price elasticity of demand. One of which is the presence of competitors who can charge a lower price should Tesco choose to impose price increases. The rise in prices is always met by decreases in demand which reflects the customers' price sensitivity. Tesco recognize this as it established a product line which caters to highly price sensitive customers. This product line is called Value by the retail giant, indicative of what it offers to the buying public. A good illustration of how prices affect the buying behaviour of the public is the analysing the effect of a general rise in the prices of grocery items in Tesco. When grocery prices increase, ceteris paribus, people tend to buy less quantity of it as their disposable income can only purchase much or they tend to chooses to buy from retailers who can price more competitively. In should also be noted that as the price of grocery products increases, less luxury items are purchased. This will bring about a drop in the overall sales per person considerably as demand for essentials and non-essentials are elastic. Even essential products such as bread may show a marginal drop but much less than luxury items, and is said to be less elastic as people need it to survive and will pay higher prices to get it. This may also be one of the reasons Tesco management decided to diversify and include other services and products, such as mobile phone services and television broadcasting. And in addition expand there business into Central Europe, Ireland, East Asia and the USA. By spreading their investments over a wider range of products and covering other geographical regions, Tesco is insulated from local price fluctuations. Supply Lucy Farndon reports (2006) that the Forum of Private Business describes Tesco as the 'King Kong' of the High Street, a retailer which is 'too powerful, too greedy and too dominant'. This may be due to their continuous effort to reduce their product and service prices, deflation in Tesco stores run at 1.5% and they have even changed suppliers to push down prices. Of course this affects their supply curve, as the change of supply at a lower price will result in increased sales. Figure 2: Tesco's Supply Curve From Figure 2, it is possible to see what the result was of Tesco changing to cheaper suppliers. The supply curve itself have moved as the same products and services where supplied to Tesco at cheaper prices, meaning they could reduce their asking price, resulting in an increase in sales as the demand grew. The previous equilibrium point E1 would have moved to the right to point E2 as the consumers demand increased due to the reduction in price. Costs As with other business organizations, the cost structure of Tesco is comprised of fixed and variable costs. The company's fixed cost includes its investments on facilities like retail shops, shopping centres, land, labour, capital, and administrative expenses. Variable costs, on the other hand are expenses which directly varies with the retailer's operations such as the costs of merchandises and delivery expenses. The cost curves of Tesco are shown in Figure 3. Figure 3: Tesco's Costs Curves Economic Challenges Facing Tesco With Tesco serving a third of the UK market, employing 250,000 employees and in the process of expanding globally there are many challenges facing the company on a daily basis, most that will have an economical impact. Currently pressure groups within UK are trying to highlight the fact that Tesco is a monopoly in the UK, and that it have a negative effect on farmers, suppliers and smaller competitions. One the "Friends of the Earth" is using logo's to draw focus to this, and to put pressure on Tesco. Logo 1: Friends of the Earth action logo against Tesco Then in UK businesses that own more than 25% of the market are usually blocked from expanding or buying other companies in that sector by the "Office of Fair Trading". But Tesco's current expansion is focusing on convenience stores and is not seen by the office as in the same sector than supermarkets. But this is currently being contested by the smaller retailers and challenged by the Association of Convenience Stores. By expanding Tesco increases its market share of UK customers, but it also increases its dominance and this is creating a lot of resistance from competitors and pressure groups within the society. Tesco serving a major market in the UK and continuously expanding, needs an extensive transport system to distribute and deliver their goods to shops and customers, which uses a lot of fossil fuel, leading to bad customer relations with increasingly green customers. With fuel prices hikes that will affect Tesco's ability to keep their prices low and this will negatively impact their sales. Lastly proposed Government legislation to ban sales of alcohol in shops and supermarkets to over 21's will definitely influence Tesco's income from sales of these beverages. This legislation has been pushed by organisations against alcohol for a long time, and it seems imminent that it will be imposed within the near future. Possible Solutions to Tesco's Economic challenges Any business that functions within an environment will be influenced by changes or issues within that environment. Even more so if the business owns a major share of the market, and is seen as a monopoly by government, competitors, smaller businesses and pressure groups. This any change in legislation, fuel price, customer opinion, trade laws, supply or labour issues will affect the Tesco's income. Looking at the above mentioned challenges it is possible to divide them into short, medium and long-term challenges. The banning of alcohol can be seen as a short term challenge and will need pre-empted or immediate action from Tesco management. The fossil fuel issue is more a medium term challenge as it will take some time to evaluate options and implement actions. Pressure from social groups, competitors and governmental departments is long term challenges, as it will always be there due to Tesco's prominent presence in the market. To effectively meet the short term challenge of the proposed legislation on the banning of alcohol Tesco can prematurely remove these products from there shelves and promote the company's stance against alcohol misuse and sales. This may put the company in a positive light not only with the pressure groups, but also their customers. It will ensure Tesco's compliance to legislation as soon as it is implemented. The medium term challenge of reducing their use of fossil fuels within their transport network can be used as an opportunity to expand their services and sales even more. By changing their transport network from fossil to a alternative energy source such as hydrogen over a period of five years, and building the hydrogen conversion and supply facilities. Tesco will not only win the favour and support of the green organisations and customers. It will then be in a position to sell this energy to other businesses and customers who then want to change their transport to the cleaner fuel. The long term challenges of meeting and managing the pressure from the UK government, organizations and competitors due to the market monopoly it has, is a complex issue. Tesco is already expanding their operations globally have realized this and is implementing a well crafted strategy. By increasing their presence in other countries, they expand their operations, increase their income and reduce their dependability on the UK market. This is a long term goal as currently overseas sales only contribute to 20% of Tesco's net income. By increasing this to 50% they will be able to reduce their UK monopoly if and when forced to do so by pressure groups in the UK, without any loss to the company. Reference Page 1. Wikimedia. Tesco. Accessed 09 April 2006. http://www.answers.com/topic/tesco 2. CIA World Fact Book. United Kingdom. 2006. Accessed 9 April 2006. http://www.cia.gov/cia/publications/factbook/geos/uk.html 3. Lucy Farndon. The rise and rise of Tesco. 18 January 2006. Daily Mail. Accessed 10 April 2006. http://www.thisismoney.co.uk/news/special-report/article.htmlin_page_id=108&in_article_id=406335 4. SWOT Analyses for Tesco. 321books. Accessed 11 April 2006. http://www.321books.co.uk/catalog/tesco/swot-analysis.htm 5. Tesco Homepage. Accessed 11 April 2006. http://www.tesco.com/ Read More