The Internet Grocery Market in UK

University Degree Business and Administrative studies

Economics and Business Finance in Context Internet Grocery Market in UK

Student: Magnús Helgason

Lecturer: Peter Bell and Khaled Soufani

Course: MSc Finance and Investment

Module: ECM02 – Economics and Business Finance in Context

Date Due in: 6th November 2008

Number of pages: 7

Word count: 2868

Internet Grocery Market in UK
‘...grocery shopping is a pain‘ (Butler, 2007)

Introduction

This assessment is part of Economics and Business Finance module in phase 1 in MSc Finance and Investment at University of Brighton 2008-2009. The main emphases of this assessment is to do a full analysis of a market of my own choice and write a report as if I was an analyst submitting a document to my professional colleagues in a finance house.

In the process of choosing the market I looked up in books to see the definition of a market. I found out that Sloman & Hinde (2007) define a market as the interaction between buyers and sellers. Knowing that, I logged into www.keynote.co.uk to find a market to make a report that was of my interest. After looking over different types of markets I decided to go ahead and make a report about the Internet grocery market in UK.

In a report I found on Key Note from 2007, „E-Commerce: The Internet Grocery Market“ (2007), the market has been divided into two main sectors: Supermarkets online; and niche and specialist suppliers. I‘m mainly going to analyse the market for supermarkets online, but these sectors are so related that inevatible the niche and specialist suppliers will come into the picture.

In this report I‘m mainly going to talk about the microeconomics aspect of the market though I will cover the macroeconomics part of it to some extent.

Background

In 1994 Tesco was the world‘s first retailer to open up a grocery store on the Internet. Take-up of the service was slow the first years. Mainly because people were unfamiliar with the Internet, Internet connections were slow, people hadn‘t been doing business over the Internet before and didn‘t know if it was safe. But with ever growing technology resulting in faster Internet connections and better online ordering systems the market picked up on the service and it started to expand, more grocers came into the market. Along with this and increasing ownership of home computers and people getting more familiar with shopping online the Internet grocery market has been growing year by year. The markets‘s sale increased from £660m in 2002 to £1,835m in 2006 at a current price in 2007, an increase of 278%. (Key Note, 2007)

Market definition and market participants

All markets on the internet are part of electronic commerce, usually referred as e-commerce. To see if the internet grocery market fits the definition of a market we have to look at the definition of the e-comerce. E-commercse is a general concept covering any form of business transaction or information exchange executed using information and communication technologies. E-Commerce takes place between firms, between firms and their customers, or between firms and public administrations. Electronic commerce includes electronic trading of goods, services and electronic material. So from that we can see that the Internet grocery market fits into the short description of the market, i.e. interaction between buyers and seller. (Whiteley, 1997)

The Internet grocery market in UK is where firms, i.e. supermarkets, niche and specialist grocery stores, use the Internet to distribute their services and products. Only business-to-consumer (B2C) part of the market is included in the report. (Key Note 2007)

The participants on the Internet grocery market are all the economic agents. Of course the households as the consumers trying to maximize their satisfaction by going online and order goods and services from the firms on the market. The firms participate on the market as the producers and try to maximize their profit by offering goods and services to the consumers.

Some members of the households are also workers or even owners of the firms on the market. Firms and households are therefore in a twin demand and supply relationship which is called the circular flow of income. (Sloman ...

This is a preview of the whole essay

Sloman and Hinde (2007, p24) describe the relationship in following way:

On the right-hand side of the diagram, households demand goods and services, ans firms supply goods and services. In the process, exchange takes place. In a money economy (as opposed to a barter economy), firms exchange goods and services for money. In other words, money flows from households to firms in the form of consumer expenditure, while goods and services flow the other way – from firms to househoulds. This coming together of buyers and sellers is known as a market.

At last, governments participate on the market by trying to maximize social welfare by amongst other things set the taxation level, which affects the consumer‘s income and therefore consumer‘s expenditure.

Market structure

Currently in UK there are estimated to be more than 100,000 traditional grocery stores. They are splitted into four sectors: supermarkets and superstores, convenience stores, independent grocers and other outlets. In 2006 supermarkets and superstores, such as Tesco, Sainsbury‘s, ASDA and Waitrose were dominating the Internet grocery market with £1,660m of £1,835m total sales at current value in 2007. (Key Note 2007)

Since there are so few big firms competing on the Internet grocery market the market is categorized as being oligopoly on the scale from perfect competition to monopoly.

Characteristics of oligopoly are that there are few big competitors who share large proportion of the market, they are the price makers and the entry barriers are really high. „For major retailers considering becoming involved in the Internet grocery market, there are some formidable barriers to entry. These include high start-up costs, efficient stock-picking and replenishment systems, comprehensive delivery networks and user-friendly website design.“ (Key Note, 2007, p1) I totally agree on this statement and in addtion, the firms that are dominating the Internet grocery market are the same as are dominating the „normal“ grocery market, so with this entry barrier it‘s a really hard work for those who are going to enter the market and compete with the big players. But there should be easier for niche and specialist grocery retailers to come into the market because the firms that are competing on that area of the market do not have such a market power.

Demand curves for firms on oligopoly market, and therefor on the internet grocery market , ususally tend to be downward sloping, relatively inelastic and companies are usually hugely interdependant on each other changes in prices and amount of their advertising. (Sloman and Hinde 2007)

As we can see in figure 3, price is inelastic to demand on a oligopoly market. That means when price is changed the quantity demanded changes of relatively small amount. The relationship between the responsiveness of quantity demanded to a change in price is called price elasticity of demand::

(Sloman and Hinde, 2007)

Considering the products that are sold on the Internet grocery market, they are mostly necessity goods and necessity goods are inelastic. If we just think that in general, if a price of a necessity good changes in price the demand won‘t be affected a lot. It‘s other way around if it was luxury good, they are said to be elastic, i.e. the demand will be affected when the price is changed.

Market conduct and market performance

The goals of the firms on the market are providing their customers with excellect services and productions and maximize their shareholders wealth. They have been doing that in recent years and amongst other things the sales from the online part of the grocery stores have helped them reaching their goals.

The phenomenon of e-commerce has gained acknowledgement all over the world, as it has enabled retailers to provide customers more effective and efficient services as it has helped many retailers to reduce costs, enhance business transaction, encourage trading across boundaries, directly linked buyers and sellers, allowed digital information exchange between buyer and seller, etc. (Quader & Quader, 2008, p177)

Like was mentioned before the price decisions are mainly dependant on the competitors on the market, i.e. if one of the competitors on the market changes its price the others do. But theres‘s a theory of non-collusive oligopoly market, which I assume the Internet grocery market to be. It is kinked demand theory, which explains how it is even when there is no collusion at all between oligopolists, prices can nevertheless remain stable. The theory is based on two assymetrical assumptions:

If a firm lower its price, its rivals will do the same to prevent losing customers to the firm that lowered the price.
If a firm raises its price, its rivals will not do the same to try to gain customers from the firm that raised the price.

On these assumptions, each firm has demand curve that is kinked at the current price and output, see figure 4. A rise in price will result in large fall in sales because the customers shift to the firm‘s rivals. Firms will thus be reluctant to raise its price because the demand is relatively elastic above the kink. On the other hand, a fall in price will result in small increase in demand since the competitor will also lower its price. Firms will thus be reluctant to lower its price because the demand is relatively inelastic below the kink. The effect of this theory is that the price is stabil because firms are reluctant to change its price at all. (Sloman and Hinde, 2007)

Market‘s supply and demand

Consumer demand for online sales has been growing steadily and expanding range of companies are responding to the demand. That counts for the Internet grocery market as other markets. ‘The amount of groceries sold over the Internet is expected to double in the next five years, according to new research that suggests that one in ten shoppers will no longer visit a supermarket by 2012.’ (Butler, 2007) If this forecast proves right, the sale will go up to £5 billion in four years‘ time. Although £5 billion is a quite an amount, it will only be 3 per cent of expected £156 billion of the total grocery market. ’Expansion of the Internet grocery market is dependent on a number of related factors, including household ownership levels of computers, access to the Internet by households, the length of time spent by households on the Internet and the spread of broadband usage.‘ (Key Note, 2007, p14)

The main force in increasing demand of the Internet grocery market is people‘s rapidly growing access to the Internet. In a report from the Office for National Statistics (2008) released in August 2008 it shows that 16.46 million households in UK had Internet access, i.e. 65% of all households.

People will always need the goods from this market, i.e. food and other necessity goods, and with ever increasing use of the Internet and reported safer alternatives to do business over the Internet there is highly likely that demand will increase over the years to come.

Other factors that could affect demand for this market to some or little extent is oil price and transportation cost . People might rather want to get goods delivered home instead of traveling in its own vehicles or using public transportation.

In order to meet the demand companies will increase its postcode coverage for their delivery to be able to satisfy the customer‘s demand. In 2007 Tesco covered around 98% of UK postcodes, Sainsbury‘s around 83% and ASDA around 60%. (Key Note, 2007) Companies have started to increase its postcode coverage for example Tesco has plans to increase online sales by opening online-only stores, small depots that will be base for deliveries of goods that have been ordered over the Internet.

New companies will enter the market, but like I have already mentioned it will be difficult to compete with the big players on the market but niche and specialist suppliers should have easier entry to the market because those players do not have such a big market power as the big supermarkets, Tesco, Sainsbury‘s and ASDA.

Broader perspective

’Britain is now in recession after the banking system came closer to collapse than at any time since the beginning of the First World War, according to the Governor of the Bank of England.’ (Wolf, 2008)

„The economy is heading into recession and may face a slump on the scale of the early 1990s“ (Smith, 2008)

Those are the headlines hitting the news every day. There‘s no coincidence that these headlines are knocking on our door every day. The world economy is in crisis because of the financial crisis which started in 2007 because of the sub-prime mortgages in USA. This crisis has resulted in collapse of some of the biggest financial institutions in the world, like Lehmann Brothers. Some countries have also had real troubles and are on the edge of a bankruptcy. The British economy isn‘t excluded from the trouble. Most specialists say that Britain is heading into „technical recession“, which is two or more consecutive quarters of declining gross domestic product. In a press release, „The great crash of 2008“, from the National Institute of Economic and Social Research (2008) released 22 October 2008 is said: ‘The British economy will suffer next year as it experiences the worst setback among the G7 countries. This reflects an especially pronounced reverse to consumer spending, which will fall by 3.4 per cent in 2009, easily the biggest decline among the G7.’

This will affect the Internet grocery market like any other market. Because of the nature of the market it won‘t hit it as hard as other markets, that‘s because the Internet grocery market offers goods that are necessary to people. People won‘t survive if it doesn‘t get its food. But, because consumers will have less to spend they will diminsh their consumption of convenience goods, which the companies on the Internet grocery market have been heading into. This will result in diminishing revenues for the companies on the market which will have to react by reducing cost and to do that they will have to dismiss people from their job.

Market‘s future

That‘s quite clear that with growing consumer demand for online sales facilites the market will expand in coming years. Despite the fact that the British economy is heading into recession the market will probably grow enormously in the long run, perhaps not quite as fast as forecasts are predicting and have been mentioned in this report.

Further update of broadband technology will help the market to grow. Faster broadband speeds will enable quicker and easier access to Internet sites and that should allow grocery retailers to develop their online sales facilities.

With the possible grow on the market it‘s highly likely that some new players will enter the market, though it‘s more likely to be niche and specialist grocery stores. There have though been speculation about Marks and Spencer entering the internet grocery market but they have always rejected that.

With the recession in the economy knocking on our door it‘s likely that some of the big companies on the market will try to integrate horziontally by merging with or acquire some of the niche and specialist grocery stores. It‘s one clear thing, that there are interesting times ahead on the Internet grocery market in UK.

References

Butler, S., (2007) ’Online sales grociers are predicted to double over next five years‘, The Times, 17 October 2007 [Online] < http://business.timesonline.co.uk/tol/business/industry_sectors/retailing/article2673561.ece > [Accessed 02 November 2008]

Key Note, (2007) E-Commerce: The Internet Grocery Market. [Online] <Url N/A>[accessed 02 November 2008]

National Institute of Economic and Social Research, (2008) The Great Crash Of 2008 [The UK economy] 22 October 2008, London: NIESR [Online] < http://www.niesr.ac.uk/pdf/Press/NIESR%20press%20release%2020%20October%202008%20a.pdf> [Accessed 03 November 2008]

Office for National Statistics, (2008) Internet Access 2008. [First release] 26 August 2008, Newport: Office for National Statistics [Online] available at <http://www.statistics.gov.uk/pdfdir/iahi0808.pdf> [Accessed 02 November 2008]

Quader, M.R. and Quader, M.S., (2008) ‘The utilization of e-commerce by traditional supermarkets in the UK through strategic alliances with internet based companies’. Journal of Services Research, [Online] Vol 8 (Issue 1), p. 177. Abstract from Business Source Premier database, http://search.ebscohost.com.ezproxy.brighton.ac.uk [Accessed on 03 November 2008]

Sloman, J. and Hinde, K., (2007) Economics for Business. 4th ed, Harlow: Pearson Education Limited

Smith, D., (2008) ’Warning that UK economy is heading into recession‘, Times Online, 27 July 2008 [Online] http://business.timesonline.co.uk/tol/business/economics/article4407544.ece [Accessed on 02 November 2008]

Whiteley, D., (2000) e-Commerce Strategy, Tecnologies and Applications. Cambridge: David Hatter

Wolf, M., (2008) ‘Britain is entering into recession, says King‘, Financial Times, 22 October 2008 [Online] http://specials.ft.com/vtf_pdf/221008_FRONT1_LON.pdf [Accessed 01 November 2008]