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...

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…