Strategic advantage in competitive business environments

Strategic Advantage

Introduction and Description of the Problem

Tesco is the market leader in the UK supermarket industry, with a share of 28.8% as of the summer 2014 (Statista 2014). Other major firms in the industry are Asda, Sainsburys and Morrisons, but the industry overall is highly fragmented. Most firms in the industry compete in the mainstream segment of the market, including Tesco. Few major players operate with a premium platform. The industry has recently been characterized by the rise of discounters, including new market entrants from the continent in Aldi and Lidl, both of which compete in the discount segment, along with incumbent discounter Iceland.

The emergence of the discounters is a major strategic problem for Tesco. The discounters, well-financed and operationally sophisticated, have been able win market share in the UK with their low prices, and at this point are stealing share away from the more established companies. Tesco has seen its share of the UK market decline by 2% in the past couple of years, almost all of it going to the new discounters (The Economist, 2014). A new competitive threat is certainly within the category of a critical business issue.

The new competition raises other issues for Tesco. Discounters tend to leverage supply chain efficiencies and buying power. Tesco should have significant capabilities with respect to both of these elements, but the company needs to evaluate at this point if it does have a supply chain problem. In particular, Tesco needs to decide on the level of commitment it is willing to have to British producers, as the country's food self-sufficiency is declining in the face of price reductions owing to the supermarket wars (Rayner 2014). Tesco's commitment to British food producers could be marketed as a source of advantage, and it certainly is something that would be reflected in its corporate values. It is worth noting that the company does not express a commitment to British values in its current statement of values (Tesco 2014).

The third issue for Tesco is how to view the new UK competition in light of the company's disastrous forays into international markets. Tesco wants to succeed internationally, but has struggled and retreated from the major markets in China (The Observer 2013) and the U.S. (Kirka 2013). This leaves the company's international presence in minor markets like Hungary and Malaysia, which sound more like a distraction than anything else. According to the company's latest annual report, international markets are worth ?19.6 billion in revenue and ?930 million in trading profits. This is a 4.7% net margin, compared with 5.02% net margin on domestic sales. The company saw its profits decrease in all regions last year, however, and revenues declined in Europe while flatlining in the UK.

Thus, Tesco has three major strategic challenges. The first is to determine its response to the threat posed by discounters entering the domestic market. The second is to determine what its values are with respect to UK producers, and the third is that Tesco needs to determine what it needs to do about its international operations. Having lost the two largest international grocery markets, but still earning 27.6% of group revenue internationally, Tesco may find that losing money overseas is hurting its ability to defend the domestic market, so all of these three strategic issues tie in together.

Analysis

There are a number of analytical tools that can be used to help Tesco determine the strategy that it needs to adopt to address these different strategic issues. The purpose of using these analytical frameworks and diagnostic tools is to understand the different facets of the company's operating environment, both internal and external. Doing so will give Tesco management the perspective needed to develop better strategy. Among the tools and frameworks are PESTLE, Porter's Five Forces, the industry life cycle and the key success factors.

PESTLE

The PESTLE analysis covers the political, economic, social, technological, legal and environmental aspects of the macroenvironment. The political environment is moderately favourable for Tesco. While the emphasis on free trade has made it easy for foreign companies to enter the UK market, it has also allowed Tesco to pursue growth elsewhere in Europe. The political environment is otherwise fairly neutral once food safety concerns are met. The economic environment is moderately favourable for the grocery industry, at best. While demand for food is constant -- everybody needs to eat -- people will reduce the sterling value of their food purchases in response to poor economic conditions. While the UK has recently experienced an improvement in its GDP growth rates and the number of unemployed workers is lower than at any point since 2008, worker wages are still decreasing (BBC 2014; Monaghan 2014). It is the latter figure that is driving more Britons to the discount stores, so that their wages are stretched further. This affects the stores they used to patronize, of which Tesco is one.

The social environment is neither favourable nor unfavourable. Britons may favour discounters now, but that is more economic than social. There is little in the way of social positivity or backlash with respect to Tesco, at least none that would spur strategic action. The legal environment is moderately favourable, the environmental environment does not seem to affect competition in this industry.

The technological environment, however, has a few impacts on Tesco. Mobile technology is transforming not only the way that enterprise interacts with its customers, but it also creates opportunities for changing the way that people shop. Tesco is viewed as being behind the trends in technological innovation, and it is felt that this hurts the company (Kirka 2013).

Porter's Five Forces

Porter has outlined the five forces that shape strategy, because these are the five forces that determine the profitability of the industry. The forces are the bargaining power of buyers, bargaining power of supplies, the threat of new entrants, the threat of substitutes and the intensity of rivalry (Porter 2008). The bargaining power of suppliers is low, especially when they are dealing with the market leader in Tesco. This fact explains why British food producers are exiting their businesses - when supermarket companies demand lower prices this often removes profitability from the industry (Rayner 2014). This force is thus favourable to the supermarkets.

The bargaining power of buyers, however, is fairly strong. British shoppers will almost always have the choice between competitors. As the discounters open more stores, increasingly Tesco stores will face direct competition from a discounter. Many supermarket goods are staples, undifferentiated from store to store, and that invite direct price competition. The result is that consumers are willing to shop at a different store if they feel they can save a few pence. This force is unfavourable to supermarkets.

The threat of new entrants is high. There are no real barriers to entry, other than capital requirements and the knowledge of the industry. This means that any established supermarket operator can enter the industry. New entrants are the ones driving down prices in the UK supermarket industry, so this force is unfavourable (The Economist 2014).

The threat of substitutes is low. Supermarkets are difficult to substitute. There are restaurants and pubs, but they are weak substitute. You can have your own garden, but that is an even weaker substitute. Smaller stores are a limited substitute, but even with that Tesco and other supermarkets have utilized the small store format to build a presence on high streets around the UK. This force is favourable.

The intensity of rivalry in the industry is high. The new entrants from Germany are aggressively competing in order to win market share, so there is a lot at stake in the current supermarket environment. With the new entrants, there is overcapacity and existing companies need to compete to maintain their shares, or close stores in order to remain profitable. For Tesco, as the market leader, there are going to be some personal stakes, as the people who built Tesco into such a dominant force are now forced to defend that position. The intensity of rivalry is a strong unfavourable force in the UK supermarket industry, and not much better in other markets. Overall, the supermarket industry is a challenging one in which to operate. The new entrants have intensified the rivalry between the existing players, created overcapacity, placed pressure on domestic supply chains and reduce profitability, in part because they are leveraging the fact that real wages have been stagnant for years in the UK.

Industry Life Cycle

The supermarket industry is a mature business, with many of the companies having been long-established. Since everybody uses supermarkets, demand only grows at the rate of population growth, give or take a few percentage points. An industry in the mature stage of the life cycle therefore offers limited growth prospects, and market share gains will typically come against established players. This is why the new entrants are competing on price, and every point of share they gain come at the expense of Tesco or one of the other established industry leaders. For most firms in mature businesses, they must either find a way to differentiate into a niche (i.e. Waitrose) or they will inevitably compete on price, brand and location. Tesco is able to compete well on all three dimensions, but is finding itself challenged nevertheless. It is expected that the nature of competition in the industry will not change and price will continue to be a main determinant of consumer loyalties, as per Porter's generic strategies typology, which argues that mainstream firms that are poorly differentiated must compete on price -- firms caught in the middle will not succeed in the long run (Porter 1998). For Tesco, its brand and large number of locations are points of differentiation, but it remains at risk if it cannot meet the prices of the new entrants.

Key Success Factors

It is also worth considering the key success factors in the industry. Supermarkets are considered to be downstream operations, since they conduct their business on a B2C basis. Key success factors in the downstream industry are considered to be consolidation, backwards integration, private labels, product variation and supply chain management (Matthyssens 2008). Supply chain management and operational excellence are essential to delivering lower prices, and therefore competing as a low cost supplier in the industry. Tesco has some supply chain excellence, and it also competes on the basis of broad variation. This strategy is essentially trying to be everything to everyone, and while it has served Tesco well in the past, the strategy has also left Tesco vulnerable to specialists, especially those who may have greater supply chain excellence than Tesco does. Thus, the company is being challenged on its key success factors, the same factors that allowed it to emerge as the market leader in the first place.

The strategic question for Tesco is how to approach this issue of key success factors. The implication of the model is that Tesco needs to focus on supply china, backwards integration and private label in order to become a full-on discounter, but the competitive reality is more complex. The company has succeeded by combining these key success factors with product variation. The result is that Tesco is not strictly a discounter, but does offer low prices on my goods. The company's real estate hint at offering a larger product variety -- it has the space to. Can Tesco survive or restore its thriving status by adjusting some key success factors, and if so, which ones?

Blue Ocean

Kim and Mauborgne's Blue Ocean Strategy, as described in the text, argues that businesses can also succeed if they are able to enter an area of the business that is presently underserved. Tesco has done this successfully when it put small stores on high streets to reach the urban audience. So there is the possibility that Tesco can generate a creative solution that will counteract the gains made by the discounters. Predicting innovation, however, is difficult to do, especially in an otherwise slow-moving mature industry. Thus, Blue Ocean cannot be plausibly recommended as a strategic approach unless there is reason to believe that Tesco has a game-changing innovation imminent.

Analysis and Recommendations

The above strategic models do not necessarily account for Tesco's past success in the supermarket industry. The major players have always competed by combining elements of price leadership with differentiation. Looking at the current positioning of firms within the industry, Waitrose has premium positioning to a degree that the other players do not, so it should be insulated more than most competitors from the threat posed by the new entrants. That Aldi and Lidl have been able to gain so much market share to this point highlights the predictive nature of Porter's generic strategies, which argues that companies need to specialize in something -- either differentiation or cost leadership in order to survive. Tesco straddles the middle. Tesco has not lost as much share as some of the smaller competitors, which indicates that on the basis of branding and locations, Tesco at least has some differentiation. Management needs to determine how it should address the discounters -- by assuming that they are simply siphoning off their natural share of the market, mostly by outperforming established discounters like Iceland. Such a hypothesis would assume that market share losses for Tesco will be limited, because its points of differentiation are relatively strong compared with other industry players. The underlying assumption is that that limited selection and rather austere atmosphere of Lidl and Aldi will preclude too many Tesco shoppers from switching. This hypothesis, while plausible, is also risky.

In order to guard against the genuine possibility that average British food buyer is more price sensitive that Tesco may have once believed, Tesco should adopt a strategy that seeks to grow its market directly vs. The competitors. This strategy is based on the prior industry analysis, when viewed through the framework of the Ansoff Matrix. The Ansoff Matrix posits that firms can either service existing markets through market penetration strategies or product development, or that they can service new markets via market development or diversification.

Going back to the issue of internationalization, Tesco still has lot of resources tied up in its international operations. These have been struggling of late. Tesco left China and the U.S., which should have been the lynchpins of global supermarket expansion, and the company is witnessing declining sales in the mature European market. Tesco still earns profit internationally, but the growth prospects are minimal and there is a real possibility that international markets are proving to be distracting, something that has opened up the door for new competitors to threaten Tesco on the domestic market. The company has to consider further retrenchment of its global positions, or at least reducing the amount of financial and human capital that is dedicated to international markets. The UK market is twice the size of all of its international markets combined. Thus, the Ansoff Matrix strategy of focusing on existing markets is recommended. Further to this, market penetration is critical because the current supermarket wars are about share.