Discount stores

Tesco discount stores – The challenge of reinvention

The UK retail sector is currently undergoing one of its biggest transformations in decades. This is evident in a number of high-profile administrations or CVA cases, such as Poundworld and Mothercare, and in the massive store closings announced by Marks & Spencer and House of Fraser.

The transformation of the UK retail landscape is also driven by the aggressive growth of discount stores like Aldi and Lidl which are eroding the market shares of grocers like Sainsbury’s, Asda, Morrisons and Tesco. The transformation of the industry puts considerable pressure on retailers to reinvent themselves and strengthen their competitive position, especially on the price sensitive spectrum of the market.

UK retailers have mainly used acquisitions to meet this challenge. The best example is the acquisition of Argos and Homebase by Sainsbury and the merger of Tesco with the convenience wholesaler and retailer Booker. There is also the recently announced merger plan between Sainsbury’s and Asda.

However, Tesco, the UK’s largest retailer, now appears to be adopting an entirely different strategy. She plans to develop a new store format that would allow them to compete with discounters like Aldi and Lidl.

This is an interesting decision – and one that could involve substantial risks. If Tesco were to compete with players like Aldi and Lidl, they would also compete with themselves. Economist Josef Schumpeter used the term “creative destruction” in his 1942 book to describe the need to “replace the old with the new”.

But the launch of new, competing businesses in response to substantial industry-level changes is not unique to retailers. There is actually a general tendency for this to occur in a variety of highly competitive industries.

Take the aviation industry for example. Domestic airlines such as British Airways and Lufthansa have faced stiff competition from low-cost airlines such as Ryanair and Easyjet. In response, Lufthansa now operates its own low-cost airline, Eurowings, after the company used the Airberlin collapse to expand its low-cost offering. It is important to note that, in addition to offering more competitive rates to customers, Eurowings employees are also paid less than comparable Lufthansa personnel.

Similar movements have occurred in broadband space. BT acquired Plusnet in 2007 with the aim of strengthening its broadband capacity, but still operates it as a separate business. Rather than integrating Plusnet, BT offers its customers broadband services through its BT and Plusnet brands. Plusnet is positioned as an affordable offering, with BT using higher upload and download speeds to justify higher prices.

Volkswagen recently launched MOIA, a separate company focused on the future of urban mobility. Again, this new organization has a mission that contrasts sharply with – and perhaps even competes with – Volkswagen’s traditional strategy. Even this statement on the MOIA webpage tries to set itself apart from the automaker: “This independent company based in Berlin, Hamburg and Helsinki does not see itself as an outright car manufacturer or car-sharing provider, but rather aims to become one of the world’s leading providers of mobility services by 2025.

Tesco’s announced launch of a new store concept has three important parallels with these examples:

  • The new company is created to target a segment of the market currently served by other players, but which also threatens to erode the current business.
  • Tapping into this segment of the market may require a different configuration of the value chain and a different cost base. Tesco has already indicated that the new staff will not be employed under current Tesco conditions.
  • The new business enjoys autonomy and is managed as a separate business. This is important because the dominance of the existing business can create challenges for any new innovative format.

So what does Tesco have to consider for the future?

The Big 4 retailer needs to separate the new business in order to run it in a significantly different way and (potentially) achieve a lower cost base. However, to take full advantage of it, Tesco must also carefully manage the integration of the two companies.

Tesco’s task will be to maximize economies of scale in overlapping product lines while launching a separate format that does not cannibalize its existing store formats. However, despite all efforts, such cannibalization could be inevitable and could even have positive effects. Recent research suggests that in similar cases, internal competition between two competing formats can become the engine of radical transformation – the complete reinvention of a business.

With the changing retail landscape, the Tesco that its customers know and love is likely to transform. However, the time seems right. Tesco announced a sharp increase in annual profits in April this year and is therefore in a good position to make the new format a success.

Professor Martin Friesl is an expert in strategic management at Lancaster University Management School

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