A Strategic Game Between Tesco and Asda in the UK

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Price Wars in the U.K. Grocery Market:

Price wars are a phenomenon that occurs across companies in various industries throughout the global economic system. In an oligopolistic market structure, players closely monitor the prices of each player and respond to any price cuts. This paper seeks to explore the strategic business methods being employed in the British grocery oligopoly and determine its effects on the economy using a game theoretical model. I will conclude that such price wars will drive independent retailers out of business, leading to a consolidated industry dominated by no more than four U.K. grocery chains.

By definition, price wars indicate a state of intense competitive rivalry accompanied by a multilateral series of price reductions. In the short run, price wars can be ‘good’ for consumers due to a lower price structure in existing product offerings, and ‘bad’ for competing companies due to a decrease in profit margins as well as potential threats to its survival. In the long run, dominant firms in the industry could benefit as smaller, marginalized firms are unable to compete and shut down. However, it could be bad for consumers as the remaining firms may agree to increase prices, possibly colluding even beyond the price set prior to the price wars.

Major Players – Tesco and Asda:

In the U.K. grocery industry, both Tesco and Asda have utilized similar discounting strategies to gain market share. Prices at both stores are largely the same, as of the spring of 2005. Tesco’s market share as of 2002 was 27.1% and Asda’s was 16.9%, according to a study by BusinessWeek magazine. Sainsbury, an upscale grocery chain which in 1995 was the U.K.’s largest grocery chain, has fallen behind to third place with 16.1%. Safeway has a small foothold in the market with a 12.4% market share. The dominant players in this market are Tesco and Asda, and both are committed to price reductions – especially with nonfood items. Both Tesco and Asda have a goal of opening 10-12 new stores per year throughout the U.K.

Tesco was founded in 1924 in North London by Sir Jack Cohen with proceeds he earned from Army services in WWI. By 2005, the company is an international grocery and retail chain with 2,365 stores around the world and a staff of approximately 367,000 employees. Tesco has had consistent growth in profit and sales over the past five years through 2005, and ten million visits per week take place by customers to its stores. Tesco has four key businesses; their core U.K. business, nonfood business, retailing services, and its international business. Tesco’s core market is in the U.K.

Asda was acquired by Wal-Mart in June 1999. There are 265 supercenters and 19 depots across the U.K. and approximately 122,000 employees across the company’s operations. The Grocer magazine named Asda “Britain’s best value supermarket” five years in a row through 2005. Since 1999, there have been over $915M in price cuts (adjusted from British pound sterling to U.S. dollars). Growth in nonfood items have exceeded expectation, as 5,000 new general merchandise lines have been added since 2002, including specialty items in pharmacies, opticians, jewelry, and photo departments.

Game Theory – “Hawk-Dove” Strategic Game:

It appears that both players in the U.K. grocery market are engaged in a strategic game that is similar to the Hawk-Dove Game, devised and named by Maynard Smith and Price (1976). This game has been a very important tool for understanding the role of aggression among players in economic systems. The Hawk-Dove game has been studied in many scenarios across various academic disciplines and has been instrumental in the are area of evolutionary game theory.

The idea here is that the Hawk is a very aggressive player, always fighting for some resource; the Dove is a pacifist, never fighting over that same resource. The goal of this game is to choose between the two strategies in order to determine how to share a common resource.

Other assumptions in the Hawk-Dove game are as follows: (1) fights between Hawks are brutal; (2) the loser is the first one to sustain injury; and (3) the winner takes sole possession of the resource. Each Hawk has a 50% chance of winning over another Hawk. The Dove withdraws in any conflict with a Hawk and, thus always loses. When two Doves interact, both share the resource.

This game has two pure-strategy Nash equilibrium, which determines the dominant strategy: One chooses to be a Hawk and the other chooses to be a Dove. There is also a mixed-strategy equilibrium, in which each animal chooses Hawk with a probability of one-third and Dove with probability of two-thirds. This is indicative of a distribution of strategies in a population in which Hawk is played one-third of the time and Dove is played two-thirds of the time. In other words, playing only Hawk or Dove exclusively, or in any other proportion, would be evolutionarily unstable.

In reality, Tesco and Asda have both been playing the Hawk strategy. Why would this occur when it is not an equilibria of the game and, in fact, is the most suboptimal outcome? It is possible that neither company is aware that they are playing this game. A more likely explanation is that the companies are both willing to sacrifice short-term profits in order to be the dominant players in the U.K. grocery industry in the long run. Public records demonstrate that executives at Tesco see Asda as a big threat, even though the quarterly sales at Tesco are 1.5 times that of Asda. Tesco is very focused in this price-war environment, and the company has even displayed on their grocery shelves the listing prices for their goods vis-a-vis Asda and Boots, a drug chain in the U.K.

This defense has seemingly paid off for Tesco, as it is still the market leader in terms of U.K. market share and net income. Furthermore, the company has been pursuing a unique marketing strategy based on a rich database of ten million customer surveys, customer panels, and mailed questionnaires with the goal of engaging the consumers in being empowered to redesign Tesco to best meet their needs and expectations.

Asda has been growing at 10% per annum, in the meantime, and is a viable competitor for Tesco. Another player, Sainsbury, has been in continual market-share decline since 1995 due to its unsuccessful execution of a high-priced alternative. Safeway, yet another major player and household name in the U.K. grocery marketplace, filed for bankruptcy in 2005 and subsequently merged with William Morrison. These four players in aggregate represent 72.5% of the industry, as of 2005.

Concluding Thoughts:

Price wars in the British grocery oligopoly market have affected more than just Tesco and Asda. Both companies have been playing a Hawk-Dove strategic game, whereby both players are acting as Hawks. Their resulting actions have damaged the business prospects for independent retailers, such as local grocers and food shops, many of which have shut down as a result. Furthermore, local businesses across the value chain of the U.K. grocery industry, such as suppliers and distributors, have been negatively impacted as well.

Tesco and Asda have been following this strategy since Asda entered the market space in June 1999. Such actions will likely result in the continued consolidation within the U.K. grocery industry, with no more than four dominant players in this space – with the largest market share going to Tesco and Asda.

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Source by David J Stone