Micro-Economic Impacts on Tesco Plc

In this essay we are going to evaluate the micro economic factors on the activities and performance of Tesco. Tesco Plc (2011) states, that the retail industry is a highly competitive environment. Tesco competes with a wide variety of retailers of varying sizes and faces increased competition from UK retailers as well as international operators in the UK and overseas. Failure to compete with competitors on areas including price, product range, quality and service could have an adverse effect on the organisations financial results.Tesco aims to have a broad appeal on price, range and store format in a way that allows them to compete in different markets. There is a risk that Tesco may not deliver their stated strategy in full, particularly since, like all retailers; the business is susceptible to economic downturn that could affect consumer spending. 2. 0 The Extent of Competition in the Market Tesco is a multi-national grocery and general merchandising retailer. By revenue, Tesco is the fourth largest retailer in the world after Wal-Mart, Carrefour and Metro.With 4,811 across 14 countries in regards to profit, Tesco is the second largest retailer in the world. In the UK, Tesco operates in an oligopolistic market competing against three major retailers; Asda, Morrisons and Sainsbury’s. Oligopolistic markets are those which are dominated by a small group of larger firms with several smaller firms also competing in the market with minority market share. The concentration ratio of the retail market is 4:76. 2. Figure 2. 0. 1: Comparing the Grocery Market (Preston, 2008) Preston (2008) states, Tesco are the market leader with 31. % with Asda, Sainsbury’s and Morrison’s having a market share of 16. 9%, 16. 4%, 11. 5%.This means theoretically Tesco have monopoly power within the market but due to the intense competition which is apparent, they are not able to exploit their market power and discriminate against other firms as well as customers. How ever, there are still allegations that the major players within the market collude with one another to cause higher levels of barriers of entry and keep prices at a level which benefits all of the major firms. This protects their position within the market and allows them to set rices at any desirable level.With this happening these major players make it extremely difficult for start-up businesses to enter the market. 3. 0 Market Dominance In 1998 the market share for the grocery market showed that Tesco had 21. 8% of the market share. Asda had a market share of 12. 1% with Sainsbury’s share at 19. 9%. Morrisons and Safeway controlled 13. 3%. This gave a concentration ratio of 4:66. 1. However in figure 2. 0. 1, it shows that Tesco started to dominate the market and saw a rise in their market share from 21. 8% to 31. 4%.Presumably, within these 10 years Tesco’s used its economies of scale to gain this extra market share. With Tesco having a great majority of the market share they operate in, it allows them to possibly price discriminate. The way in which Tesco could do this is by having such a high market share they are capable of forcing competitors out of business and therefore, leaving only them to provide the products or services within that area. In addition to this, Tesco can under-price its products and services as with a greater market share they can reach economies of scale.Economies of scale arise when cost per unit falls as output increases. With having economies of scale Tesco’s can then be more productive than its competitors and supply more to its customers at better prices. For example if Tesco reach economies of scale they can get more from their suppliers with bulk buying allowing them to supply at lowers prices. By doing this poses a threat to smaller businesses that can be undercut by the competition. With a 30. 1% of the market share Tesco definitely do have some market dominance within the market via the instruments st ated above such as the potential to undercut competitors.However, they are not a monopoly and therefore, cannot fully price discriminate and set prices. As with doing this its custom see going to other companies within this market as the products and services they supply are similar. 4. 0 Economies of Scale Economies of scale are when higher output leads to lower average costs; such the average cost of production is reduced due to the increase in total output. Tesco has a very large scale business, opening new stores daily. There are currently more than 4,811 stores of Tesco worldwide.Since they are opening new stores regularly, they have to produce more. So as the volume of production increases, their average cost per unit has decreased. This has given Tesco a huge advantage over the other supermarkets especially those that are smaller in size. The large size of the firm means that it can benefit from further economies of scale in areas such as bulk buying, transportation, distribu tion, marketing and technology. A feature of their sales strategy is that they encourage customers to buy in bulk.They have special offers for that, such as buy one get one half price etc. These offers compel customers to buy more quantity, which in turn gives Tesco the advantage of selling more and consequently buying more, which in turn gives them a lower average cost. In an oligopolistic market, although it is difficult to prove, the likelihood is that the firms with majority market share collude with one another for the benefit of themselves. They will do so to maximise their profits as well as create higher levels of barriers of entry for new firms trying to enter the market.This has now become illegal in the UK by the 1965 Restrictive Trade Practices Act. 5. 0 Barriers to Entry Barriers to entry are the means by which Tesco’s potential competitors are blocked out. Due to Tesco’s monopolistic characteristics, Tesco will be able to enjoy higher profits in the long run as rivals have not diluted market share. Three barriers of entry are: Patents are legal property rights to prevent the entry of rivals. They are generally valid for an average of 20 years and give Tesco the right to prevent competitors from using patented products.Tesco can sell licences to competitors for a stated fee. Using Advertising and Marketing Tesco have developed customer loyalty; their club card has played a pivotal role in their customer loyalty. Thus making demand less sensitive to price; due to advertising leading to an outward shift in demand. Tesco engage in brand proliferation, as it is a firm which sells a vast range of products, this may portray Tesco differently to consumers. This is common barriers to entry in these types of markets as it is non-price competitions for household good. 6. 0 Porter’s Five ForcesIn order to evaluate the competitive environment surrounding Tesco, I shall utilise Porter’s five forces model illustrated in figure 2. Fig ure 6. 0. 1: Porter’s Five Forces Model (Zanthus, 2011) 6. 1 Bargaining Power of Buyers 0 The bargaining power of buyers is fairly high. 1 Products that have a slight differentiation; more standardised, the switching cost is considerably low, allowing the buyers to switch from one brand to another easily. 2 Prices are forced down by buyer’s power. For example, if bread is too expensive in Tesco, buyers will use their power and move to Asda.Supermarkets have a disciplined approach to price setting, stopping them from destroying each other in a profit/price war. 6. 2 Bargaining Power of Suppliers 3 The bargaining power of suppliers is fairly low. 4 Suppliers fear losing contracts with major supermarkets, hence putting retailers like Tesco in a dominating position. Negotiations are therefore positive in order to get the lowest price achievable from the suppliers. 6. 3 Competitive Rivalry 5 The amount of competitive rivalry in the food and grocery retail industry is extrem ely high. 6 Tesco faces extreme competition from its key competitors; Asda, Sainsbury’s and Morrisons.Organisations are competing with each other over price, products and promotions sporadically. 7 Discount superstores such as Aldi and Lidl have taken over the market in current economic times, due to the recession. Keynote (2010) states, that during 2008, they recorded sales of over 25%. 6. 4 Threat of New Entrants 8 The threat of new entrants into the food retail industry is low. 9 Tesco and other supermarket chains put up considerable barriers to entry. Starting a new supermarket chain has barriers imposed on it, implicitly or explicitly, by the existing organisations.0 According to Mintel (2010) Tesco, Asda, Sainsbury’s and Morrisons account for 80% of all shopping carried out in the UK. 11 In order for new entrants to establish themselves they will have to produce something at an exceptionally low price and/or high quality. 6. 5 Threat of Substitute Products and Se rvices 12 The threat of substitutes in the grocery retail market is considerably low for food items whereas it’s medium to high for non-food items. 13 The substitutes for these major supermarkets are smaller firms such as convenience stores; but these are not seen as a threat to Tesco who offer high quality items at low prices.Tesco is however overcoming this threat by opening ‘Express’ stores in small towns and city centres, in effort of becoming an obstacle for substitutes hoping to enter the market. 14 In current economic times, customers will be drawn towards discounted prices, thus Tesco is a threat towards specialist shops. Due to the rivalry between these supermarket chains, a highly competitive environment can be maintained, and one that facilitates consumers a greater deal than a proliferation of small independent shopkeepers. 7. 0 Game Theory and Interdependence Game theory and interdependence are both linked together.Interdependence is when decisions o f two (or more) businesses have an effect on the other firm’s profits. Then when looking into interdependence the investigation into what happens is game theory. As Tesco has the highest share of the oligopoly it in theory has the most power of the market. However a competitor such as Sainsbury’s could easily affect the percentage share of the market Tesco has. This could be by Sainsbury’s lowering the prices of certain products and then with the decision that Tesco has to make, Tesco could end up losing either their percentage of share in the market or their profits.For example if Tesco decides to keep the price the same of an item which is on sale at Sainsbury’s then customers will decide to get the product from Sainsbury’s, thus Tesco lose money. However Tesco may also decide to lower the price of the item for sale at Sainsbury’s, however Tesco may not advertise the sale item as well as Sainsbury’s so again they may incur a loss as not many people know that the item is for sale. Many other examples could be used for interdependence for Tesco’s.If a competitor of Tesco such as Sainsbury’s decided to save costs because of the recession then Tesco could unexpectedly make more profits as a result. This is because Sainsbury’s could decide to save costs by cutting down the number of jobs and stop selling less profitable items. The effect this would have on Tesco’s would be positive. This would be due to the downturn in popularity of Sainsbury’s as a result of job losses around the country to save money. As big money companies cutting jobs is always very unpopular, as a resultSainsbury’s customers may well go to its competitors such as Tesco and thus Tesco gaining more money from more customers. With Sainsbury’s losing customers in this example, the demand curve for Tesco would shift to the right and as a result of more money being made the price level would be increa sed because of the increase in demand. 8. 0 Conclusion and Recommendations From the above analysis, it can be said that Tesco maintains to embrace its leading position in the highly competitive retail industry; in which organisations must follow both differentiated strategies and cost leadership.The core competencies of Tesco are aligned with the competitive operating environment, therefore highlighting a positive future outlook for the organisation. The company must constantly adapt to the fast changing circumstances. Strategy formulation should therefore be regarded as a process of continuous learning, which includes learning about the goals, the effect of possible actions towards these goals and how to implement and execute these actions.