Business Evaluation of Tesco
Table of contents:
1. Executive Summary 3
2. Introduction 4
3.1. Analysis of the structure of the UK Supermarket/Food Retailing Industry 5
3.2. Macro-Analysis of the Supermarket Sector 6
4.3.1 Political 6
4.3.2 Economical 6
4.3.3 Sociological 7
4.3.4 Technological 7
3.3. Porter’s 5 forces 8
4.3.1 Customers Power 8
4.3.2 Power of Supplier 8
4.3.3 Threat of new Entrants 8
4.3.4 Threat of Substitutes 9
4.3.4 Competitive Rivalry 9
3.4. Financial and Business performance of Tesco and Sainsbury 10
4.3.1 Profitability 11
4.3.2 Liquidity 11
4.3.3 Working Capital 11
4.3.4 Gearing 12
4.3.4 Investment Ratio 12
3.5. SWOT Analysis 13
4.4.3 Opportunities 13
4.4.4 Threats 14
4. Conclusions 15
5. Recommendations 16
6. Bibliography 17
7. Appendices 19
- Executive summary
The aim of this report is to analyse the past trends and events in relation to the present state of Tesco and the food Industry in order to understand and predict the future of the company. The research was conducted through the internet, e-journals, books and newspapers, evaluating statistics, figures and trends together with the information provided by other valuable sources.
The analysis of the structure of UK supermarket industry has identified four companies dominating the market and creating an oligopolistic market economy: Tesco (30%), Asda (17%), Sainsbury (16%), Morrison (12%). It also looks at the growth trend of these companies over the last 10 years.
A macro-analysis was conducted assessing the external factors affecting the supermarket industry focusing on the Political, Economical, Social/Cultural and Technological even that have been affecting this market over the last 5 years. The PEST analysis also evaluates current trends in order to estimate future developments.
The Porter’s 5 forces analyses has established an imbalance in this industry. It appears clear that although the top four chains are exerting a strong competition on each other, the power of customers and suppliers is very limited and almost nil. The same applies for new entrants that have very high barriers due to the oligopolistic market present at the moment.
The financial and business performance of Tesco have been analysed and compared with its biggest competitor Sainsbury. The outcome clearly shows a more favorable situation regarding Tesco.
The expansion into non-food market, overseas and the takeover of smaller shops have been identified as major opportunities. The price competition and the new investigation of the Office of Fair Trading (OFT) have been identified as main threats.
A conclusion is given to summarize the findings. Suggestions are made on the possible future of the market and the company and whether or not the client should invest in Tesco.
At present it is possible to notice Tesco in the headlines of newspapers and magazines with news and information regarding its dominance of the retailing market and its continuous improvements and expansion. It is clearly stated that Tesco owns about 30% of the UK market with a constant growth over the last ten years. Their expansion abroad has been very successful so far and it has a good prospective for the future. In order to achieve these goals, Tesco claims to have researched the market and tries to meet the consumers’ needs, including a policy of lowering prices. Among their strategies the company has expanded the services provided to non-food products and has opened different formats of shops, such as metro, express, extra, and superstore.
However, not all the news is in the favour of this company. There is a dispute going on about the negative impact that Tesco has been having on the economy, especially regarding smaller grocery shops, farmers and suppliers. It appears that the top four supermarkets have gained too much power that has been used to obtain more profit at the expense of the companies mentioned above, many of which went out of business. Although the structure of the market is oligopolistic, Tesco, having a much higher proportion of the market, can almost exercise a monopoly. The government and through the Office of Fair Trading (OFT) have taken consideration of this matter and are investigating the circumstances.
- Analysis of the structure of UK Supermarket/Food Retailing Industry
As shown in Graph 1 (Appendix A), there are four main operators that own and control the market: Tesco, Asda, Sainsbury, and Morrison. These four leading companies own around 75% of the food market and more than 60% of the grocery sales. (BBC, A, 2006)
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Graph 1 shows the trends that these four top companies have been developing over the last 10 years and their market size. Tesco has always been in first position since 1996 with a steady increase from 21.5% of the market to 30.4% in 2005. It is followed by Sainsbury and Asda which have opposite trends: Sainsbury has been having a continuous decline, from 19.7% in 1996 to 15.9% in 2005, while Asda has been having a stable rise from 11.8% in 1996 to 17%, overcoming Sainsbury in 2003. Morrison had a deep increase in 2002 as they took over Safeway.
(Fooddeserts.org, 2006). – Appendix A
With four top companies leading and controlling the market it is clear that the structure of the Supermarket and Food Retailing industry/market is an oligopoly. (Sloman, 2005)
- Macro-Analysis of the Supermarket Sector
As it is stated by Monbiot (The Guardian, 2006) over the past 25 years, the government and the OFT have not been able to control the supermarket industry and as a result the big chains have taken control. One of the first government actions that generated this failure was to interpret the public interest as the consumer interest with regulations that look mostly at prices and the competition among superstores. However, the OFT has started to investigate big chain dominance of the market and fair trading, especially regarding suppliers. (BBC, A, 2006)
As stated on the article of Friends of Earth (FOE, 2005), at present there is an alliance of 15 environmental organizations that are demanding the government to take action through the Department of Trade and Industry (DTI) to make changes to the Supermarket Code of Practice in order to stop the growing power of the big supermarket chains and protect suppliers and small retailers. The Federation for Small Businesses (FSB, 2006) is also putting pressure on the OFT in order to stop the growth of the monopoly of the top 4 supermarkets.
A Mintel report (2005), shows that the demand for food over the last five years is limited and the grocery market is growing very slowly compared with other sectors. It appears that people tend to switch to higher quality food rather than buying more of the same quality. Also, due to the high competition and price-cutting strategy that the top four supermarkets have adopted, food price inflation has been very low over the same period of time. Thus, as we can see from the graph 2, the expenditure on food has decreased since 2000 and it has a downward trend.
Another important economical trend that can affect this market is the unemployment rate. National Statistics (2006) has confirmed that the unemployment rate has increased to 5%, the highest peak over the last two years. This rise is primarily due to an increase in unemployed women.
As stated in Siegle (The Observer, 2006) article, trends about food products keep changing over time. In the past, people started to use more ready-made food due to working condition, especially with the increase of working women, and multicultural food, such as Italian, Chinese, Indian, Japanese, etc. For both trends, the entire supermarket sector has adapted to the demand by creating an adequate supply.
However, the recent trends for this sector are changing. People seem to have become more aware of the health problems that ready-made foods can cause in the long term due to the preservatives or high quantity of salt that they contain. The same applies for food called junk-food, which is food with high sugar, salt, fat and calories but is limited in nutrition content such as vitamins, proteins or carbohydrates. (Larsen, 2003)
Evidence suggests that old and new technology helped to improve the service in supermarkets, offering a more efficient pricing system and expanding the payment methods, including debit and credit cards which provided faster and more secure payment. Both customers and employees are gaining big advantages from technology which is becoming faster and more efficient. (FMI, 2006) There are also new automatic tills where customers can scan their goods and pay without help from a cashier.
It also appears from the BBC (C, 2005) that more people are using online shopping to purchase grocery, especially over the holidays. In 2005 most of the big supermarkets were not been able to cope with the demand of online grocery shopping.
- Porter’s 5 Forces
- Customer Power
Evidence from the BBC news (A 2006) suggests that customers have benefited from the high competition in the industry which kept driving down prices over the last 6 years. However, the 4 largest chains has built an industry were, due to the large amount of customer that they reach on regular basis, the power of consumers is very limited. It will not make any difference to them if one single person or a small group of people would switch to another competitor. (Guardian, 2006)
- Power of suppliers
From Monbiot debate (The Guardian, 2006) it appears that big supermarket chains have total control over the suppliers forcing them to operate under their conditions. The power of the suppliers in this sector is very limited and almost nil because the four top supermarket chains do not leave any alternative but to work for them. The suppliers of small shops have already reached the tipping point and many of them are going out of business. Furthermore, the big stores are imposing very difficult conditions on suppliers including discounts on products already bought, compensations and contributions. However, bigger supplier chains have been able to cope with the increasing demanding conditions of the big superstores. (BBC, B, 2006)
- Threat of new entrant
A document from the OFT (FT, 2005) states how high the barriers are for new entrants to the UK superstore market. Furthermore, a BBC article (B, 2006) notes that because of the large amount of money required to invest in this market to open a new shop and obtain planning approval it is extremely difficult for a new competitors to open a new big supermarket store and enter the market. Nevertheless, since 1995 the German company Lidl was able to enter the market and now has a few stores in the UK. (Fooddeserts, 2005) Although the market share of Lidl has steadily increased since its establishment ten years ago, its proportion of the market is 1.8% and it is too small to constitute a threat to Tesco.
- Threat of substitutes
The substitutes for big supermarkets are grocery, corner and high street shops. However, from the article of Monbiot (The Guardian,2006) the big chain stores have been competing by lowering prices for more than 10 years which has been driving a lot of grocery shops out of business. This is particularly the case with bakery products, such as bread, that were sold for less than the cost of production. A report from the OFT (2006) shows that over the last 5 years the number of independent shops has declined by 22%. Obviously, small shops cannot compete against big supermarket store and thus the threat of substitute products is very limited and low.
However, as specified in a report of Mintel (2005), online shopping is steadily increasing over the past few years, including the grocery market. Nevertheless, all the big supermarkets are already offering this new type of service.
- Level of current competition
Even if the threat of substitute products it is not very high, evidence suggests that the four biggest supermarket chains exercise a very high level of competition with each other. (Guardian, 2006) This is also confirmed from a BBC article (B, 2006) that states the effects of high competition among the top 4 store chains is the lowering of prices, increased selection, and improved product quality.
- Financial and Business performance of Tesco and Sainsbury
This part of the report compares the financial and business performance of Tesco with Sainsbury, which is one of its biggest competitors. The figures mentioned below are shown in Appendix B with the calculation of the ratios.
*Source: Figures have been collected from the Tesco Annual Report (2005) and Sainsbury Annual Report (2005).
The first point that stands out in the ratios is that all the Sainsbury ratios shows a decrease in profitability from 2004 to 2005 while Tesco has slightly increased its Gross and Net Profit and had a small decrease in the Return of Capital Employed (ROCE). The ROCE ratio is much higher for Tesco with a difference of 25.256% in 2005 and a large increase from the previous year. This ratio clearly shows that from 2004 to 05 Tesco was more profitable and employed the capital invested in a more efficient manner.
This is also confirmed in the Horizontal Analysis: Sainsbury made a loss in 2005 while Tesco had on average of 10.5% increase in Turnover, Gross and Net Profit from the previous year.
The liquidity ratios are concerned with the ability of the company to cope with the short-term financial obligations. Among the first point that stands out in the ratios is that all the Sainsbury ratios are slightly higher than Tesco but in general all the figures are below 1:1. Sainsbury shows a little improvement from 2004 while Tesco none.
Although those figures look very low, it is normal for this type of business because they hold mostly finished goods that are ready to be sold in a short time with a cash sale. (Auton, 2005) The Quick ratio does not take in consideration the stock which is the main source of profit for this type of retailing business.
However, as it is appear from the Horizontal analysis, Sainsbury has more Current Assets and less Current Liabilities than Tesco in both years.
- Working Capital
The stock turnover confirms the point regarding liquidity. Both companies on average sell their stock in approximately 2 weeks. There is little difference between the 2 companies, but Sainsbury has increased the speed of selling of its stock from the previous year while Tesco is roughly at the same pace.
Both companies need about 1 month to pay their debts. Thus they pay their suppliers in about 31 days, although Sainsbury has increased this period of time by 1 week compared with the previous year.
The gearing ratios show the proportion of money that the business is financed through borrowings. Usually the lower this ratio the less risk in investing in the company. Although, both companies have decreased their gearing in 2005 compared with the previous year, their gearing is still a bit high. However, in both years Sainsbury had a gearing ratio lower than Tesco by approximately 10%.
- Investment Ratio
Although the earning per share ratio gives a clear indication of the performance of the shares and the trend can be used to assess the investment potential of a company’s shares, it will not be helpful for the purposes of this report to compare the ratio of these two businesses due to the differences in capital structure and level of gearing. (Atrill, 2005) However, it is notable that the ratio of Tesco has increased by 17% from 2004 to 05 while the ratio for Sainsbury is almost halved over the same period. Graph 3 shows the trends of the share price of the two companies over the last five years. It is notable that the Tesco share price had a steady increase since 2003 while the Sainsbury share price has been fluctuating and has a much lower value.
- Threats and Opportunities
* Source: Datamonitor, 2004 – Fooddeserts, 2003
Tesco has opened new stores with space for non-foods which has been successful over the last 2 years. (Datamonitor, 2004) The food retailing market is very competitive and the big supermarkets are expanding into non-food sales. (Fooddeserts, 2006)
The biggest stores have also been able to expand their non-food growth into the health and beauty industry with a very significant fast increase over the last few years. (Datamonitor,2004)
In 2003 Tesco bought many small-store chains and rebranded them with the name of Tesco Metro stores. (Fooddeserts, 2006)
Tesco has expanded to six European countries and five Asian countries with a continuous growth that saw sales multiply by ten times over seven years. They have recently entered the US market and the Chinese market, which has one of the fastest growing economies in the world. (Datamonitor, 2004)
Two of the biggest competitors, Sainsbury and Morrison, are going to decrease their prices thus creating greater competition for Tesco. Tesco has a price agreement with its competitor Asda and has lost part of its control over pricing. (Datamonitor, 2004)
Although there are good prospects investing overseas and in the European market, this international expansion has required heavy financing, including the expenses of advertising and marketing a new brand name. It is a risky investment because economic conditions could suddenly change or they are exposed toan unexpected reaction of the competition. (Datamonitor, 2004)
The biggest stores have also been able to expand their non-food growth into the health and beauty industry with a very significant increase over the last few years. (Datamonitor, 2004)
The competitor Asda has continuously increased its market shares and it overtook Sainsbury in 2003. They are adopting new marketing strategies to expand their competition and acquire more market power over the customers. (Datamonitor, 2004)
Many small grocery shops have not been able to cope with the increasing competition of big supermarket chains and have had to close. (FT, 2006). Under the pressure of small grocery retailers, the OFT is considering the possibility of unifying the grocery market to the food retailers. Under this circumstance, their proportion of the market is already too high, with a 31% share of the market equivalent to a monopoly, and it would require a reduction and restriction of its expansion. (Fooddeserts, 2006) Tesco’s share of the grocery market has grown from 15% to 31% since 2001. This new proportion of market share is already too high and it could almost constitute a monopoly. (FT, 2006) An article in the Guardian (Finch, 2006) states that the future of Tesco is in jeopardy as the investigation of the OFT of the top 4 superstore has started. Tesco may have to reduce its market share by selling off some of its stores in order to reduce its monopoly.
To summarise the food retailer sector is an oligopolistic market with four bigger superstore’s chains that own around 75% of the market, of which 30% is owned by Tesco. Although most of them had increased their market share over the last ten years, Tesco has maintained and strengthened its first position.
Political events over the last few years have shown that the OFT has been investigating the situation of the actual market in order to stop the growing power of superstores. Economic factors show that this market is growing at a slow rate and that the food price inflation over the last five years has been very low due to the high competition and price reduction strategy operated by the big chains. The increase in unemployment is also not a good influence on the retail industry. Social trends towards food have changed over the last five years, from ready-made and international foods to organic and healthy foods. This is due to a greater awareness of the long term bad health effects of eating junk-food. Technology has increased the efficiency of the environment for the employees and improved the service for customers. This includes self-service checkouts, online shopping systems and improved electronic payment methods.
The Porter’s 5 Forces analysis has shown that there is an imbalance between the forces. The customer’s power is very limited, most of the suppliers cannot exercise any power, barriers for new entrants are high, the threat of substitute products by corner shop is very weak and competition among the top 4 chains is strong.
Analysis and comparison of the financial and business performance indicates that Tesco has had a better management and greater performance overtime compared with its competitor Sainsbury. This is also underlined by the share price and profitability ratios.
Tesco continues to expand into the non-food market and grow internationally. It has also increased its market share by taking over small stores in the UK. However, pricing pressure and the challenge of competition is a threat for the company. Besides, the OFT is investigating Tesco and the company’s international expansion may not continue to grow.
After analyzing the market shares, the environment, the supermarket industry and the opportunities and threats of Tesco, I do not recommend investing in this company for the long term. Although graph X is showing a fluctuating upward trend for the share price and the company has a high proportion of the market, the overall growth stability of the company seems to have reached a peak. The company has gained a very large portion of the market and the share price is strong at the moment, however, the forecast for the long term is not as confident about the possibility of maintaining growth. They are probably at a stationary point from which could follow a recession.
Furthermore, a possible consequence of the investigation of the OFT is that Tesco may have to reduce its market share as it is already a monopoly within the grocery market sector. This will have a negative impact on the share price with a sudden drop or the start of a downward trend.
The economic trends relating to food retailing have not shown any increase or positive signs, including the low food price inflation rate and increased unemployment. Although there are high barriers to entering this market the threat of substitutes is low, the powers of suppliers and customers are very limited, the competition exercised from the other three big competitors is very high, and Tesco has had to keep lowering prices.
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Simone Antonuccio ID Number: 1016826 4MBS450 - Theory & Practice of Business CW2: Report on Tesco