Success and failure of two business models at Tesco

Case Study

Success and failure of two business models at TescoSample Page

Tesco’s expansion strategy
For reasons of market power, there are very few supermarket chains that have around 30 per cent of their home market. But that is the case with the UK supermarket retailer Tesco. The company has come to dominate the UK retail market with a wide range of stores across the country. Some stores are very large with up to 50,000 sq ft of shopping space. They carry a wide range of products from food items to electrical goods, from clothing to banking and insurance products. Other Tesco stores are much smaller and carry a limited range of local products. All Tesco’s stores are served by a sophisticated supply chain. This links sales data from computer checkout terminals to central stock holding and delivery vehicles that replace products overnight. Tesco has become so large that it has found it difficult to expand further in the UK – partly, at least, because its market dominance has made the British competition authorities keen to ensure that the retail market remains competitive and prices stay low. Consequently, in recent years, Tesco has been forced to seek expansion outside the UK. Tesco’s strategy has therefore been to develop major supermarket chains in such countries as Poland and the Czech Republic. As a result of this international expansion strategy, some 80 per cent of Tesco’s group capital expenditure in 2007 was on retail stores outside the UK. For example, it was moving steadily into China where it had some 50 hypermarkets and had acquired a controlling interest in its local partner, Tin Cao. At the time of writing, Tesco was also planning to develop further its Chinese hypermarkets. At the same time, Tesco was planning to open up a chain of new, small, convenience stores in the main Chinese cities. These convenience stores have a much smaller range of products and are located closer to shoppers’ homes – hence, the name ‘convenience’.

Tesco’s strategy in the USA
Although the USA is the world’s largest retail market, British retail companies have not traditionally had much success with store formats in the USA. Two of the UK’s leading retailers, Sainsbury and Marks & Spencer, sold their US outlets during the 1990s. This was partly, at least, due to a lack of profitability because the USA is a highly competitive retail market. Possibly the most successful US retailer is Wal-Mart: the company operates very large, highly efficient, low-price stores mainly located near major shopping malls that require car access. Wal-Mart is the world’s largest retailer by turnover and has expanded outside the USA into China and the UK, where it owns the ASDA supermarket chain.
In spite of this heavy competition, Tesco identified the USA as a market that it would like to enter. However, it needed to find a profitable strategy that would compete against companies like Wal-Mart. Tesco decided that its UK supermarket strategy could simply not compete against Wal-Mart – the American company was too efficient, too low-cost and too well-entrenched for Tesco to make headway. Tesco therefore needed another strategy.
After examining various possible approaches, Tesco decided that it would be best served by copying the strategy of two of its competitors in the UK: the German retailers Aldi and Lidl. When these two retailers decided to move into the UK in the early 1990s, they were faced with the large supermarket chains like Tesco, ASDA and others. In order to differentiate themselves, Aldi and Lidl brought their German retail strategies to the UK: small stores of around 5,000–10,000 sq ft, no frills or presentation, few if any major branded products and very low prices. They operated what is called the ‘hard-discount’ retail store concept. In effect, the two German chains offered a new concept in value for money to the British shopper. The result was that the two chains both had some real success, in spite of heavy competition from the major British retailers like Tesco. Given the evidence of this success, Tesco decided that it would launch the hard discount retail concept in the USA. In early 2008, it began rolling out the first of 50 ‘Fresh & Easy’ stores in California, USA. Tesco announced that it would be investing $500 million to develop a chain of 250 stores by the end of 2009. The chief executive of Tesco North America described this as a ‘transformational’ moment for the company. ‘It is clearly scaleable but you can’t push the pedal until you can convince shareholders it will work. We have got latitude to build a big business on the west coast before they hit the gas.’ There were outline plans for 1,000 stores each of around 5,000 sq ft.
To keep costs low, the Fresh & Easy stores mainly sold a big non-branded range from identical store formats. There were self-service checkouts without cashiers and shelf-ready packaging. The aim was to reduce the number of staff needed in each store. There was also one totally new initiative that was not copied from Aldi and Lidl: Fresh & Easy would sell fresh ready meals and, unlike anywhere else in the Tesco business, the company set up its own manufacturing plant in California to make the meals. Again, the strategy was to reduce the costs. ‘We could have asked one of our [UK] suppliers to come over and they would have jumped at it, but we felt we could do it ourselves,’ explained John Burry, Fresh & Easy’s chief commercial officer. ‘We have lots of experience in this and the [profit] margin is better. Why pay someone else to do this?’ The prepared food was going down so well with shoppers that there were availability problems in the first few weeks of operation. Although there had been some early success, the Fresh & Easy concept was still facing problems in early 2011. It was making a loss with the store opening schedule also being delayed as a result: the trading loss in 2010 was £165 million ($270 million) with only 30 store openings in 2010 to make a total of 145 stores.
After five years of losses, Tesco finally decided in 2013 that the Fresh & Easy business model was not working. American customers wanted more choice in store, more opportunities to handle fresh products, less Tesco own-branded products and more well-known national brands. The company announced that it was pulling out of the USA at a cost of over $200 million.
In addition, Tesco was also facing problems with its largestore UK model in 2014. Its large-scale stores were threatened by two competing retail grocery models: the grocery discounters like Aldi and Lidl and the upmarket grocers like Waitrose. Tesco needed to rethink its business models.

Case questions

1 What were the two main business models operated by Tesco described in this case? Why did the company develop a new model for the USA?

2 What are the benefits of defining a business model? And what are the problems?


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