Question : Why would Tesco decide to form a joint venture for entering the Chinese retail market? What are the advantages and disadvantages of this strategy?

1 Introduction To open a shop is easy; to keep it open is an artChinese proverb 20 July 2014Philip Clarke was staring out of the window of his office. The moment he had heard the news that morning an enormous weight had been lifted off his shoulders. The day had started like any other until that board meeting at 11 o clock. It was then that he was formally asked to resign from his position as Chief Executive. After 40 years his career at Tesco would abruptly come to an end. But back in his office, Clarke just could not understand why he was feeling so relieved. One month earlier Tesco announced to turn its unprofitable operations in China into a staterun company. By doing so, the supermarket chain became the latest retailer to give up on cracking China on its own. Besides relief Clarke felt somewhat powerless. He had just been given his second profit warning, and already was asked to leave the companythe company he had dedicated his life to for so many years. In trying to unravel the reason for Tescos failure in China, Clarke started to think back to where the story of Tesco started and what the reasons for entering the Chinese retail market had been in the first place. 2 Tescos History When Jack Cohen started to sell groceries in London in 1919, Tesco started life. Five years later in 1924, the Tesco brand first appeared when he bought a shipment of tea from Mr T.E. Stockwell. The initials were combined to form the name Tesco. In 1929, Mr Cohen opened its first flagship store in Burnt Oak in the Northern part of London. The brand continued to grow in 1930 when Mr Cohen built a headquarters and warehouse. In 1932, Tesco became a private limited company. Tesco quickly expanded as it started buying up rival shops. During the 1960s, the supermarket chain started to expand rapidly as it began to widen its product offering. Tesco revolutionized the way people managed their groceries in the UK. By the 1970s, it started with the building of a national store network to cover the whole of the UK. By 1979, total sales of the brand were 1bn, and by 1982 these numbers had doubled to more than 2bn. In the 1990s, Tesco started an aggressive marketing campaign in an attempt to overtake Sainsburys as the UKs leading grocery. In 1992, the company launched its slogan every little helps, which was followed by the launch of the Tesco Club card scheme, which helped Tesco to overtake its biggest competitor in the retail market. In 1996, Tesco expanded overseas opening shops in Poland, the Czech Republic, and Slovakia and appointed Sir Terry Leahy as chief executive in 1997 (Clark, 2014). In 2004, Tesco expanded operations to the worlds fastest growing retail marketChina, by acquiring a 140 million stake in a Chinese hypermarket chain named Hymall. The joint venture agreement with Ting Hsin was part of Tescos strategy to overtake Wal-Mart as the worlds largest supermarket operator. China is one of the largest economies in the world with tremendous forecast growth and a market we have researched extensively over the last three years, said former chief executive Terry Leahy. Tescos move to China was expected as the company was already present in South Korea, Japan, Taiwan and Thailand. At that time, Tesco was operating in 13 countries worldwide. 3 The Retail Environment in China Chinas 1.2 billion population has been of interest to many retailers and manufacturers of consumer products. Over the years, Chinese consumers started to afford better quality of life, which led to an increase in consumption of both necessary and luxury products (see Fig. 1). Average incomes rose, and Chinese citizens in urban areas started to earn an average annual income around 1.900. Since 1978, the country achieved an average 9.9 % annual GDP growth, and the International Monetary Fund (IMF) forecasts the Chinese economy to surpass the US by 2016. Although growth projections are lower for the upcoming 5 years, the annual growth rate still outpaces other BRIC countries (see Fig. 2). Income in China: urban vs rural Yuan, per person Fig. 1 Urban vs. rural disposable income. Source: Adapted from The Economist (2014) Currency: 1 1/4 9.55 BRIC GDP Growth 1992-2016 (US Trillion) Fig. 2 GDP growth. Source: Adapted from Prudential Real Estate Investors (2012) China lagged behind other BRIC countries with similar cultures in terms of household spending rates. Therefore, China still had significant unrealized upside potential. To get in line with Asian neighbours, household spending as a percentage of GDP could rise to around 50 % (see Fig. 3). In the beginning of 1990, consumption patterns in China increased to a level where distribution could no longer meet local demand. This increase incentivized the development of new supermarkets. In the search for globalization, many Western and Asian retailers explored opportunities in China in the hope of capturing market share. The predominant retailers were often owned and operated by state-owned enterprises. Chinese shoppers however, had recently gained interest in foreign and smaller-format retailers (see Fig. 4). As China was the second largest retail market, it was no wonder that some of the worlds leading retail chains including Wal-Mart, Carrefour and Tesco were exploring the market. Wal-Mart and Carrefour entered China in the mid-1990s. Tesco, however, waited until the regulatory environment became more favorable in 2004. Fig. 3 Household expenditures. Source: Adapted from Prudential Real Estate Investors (2012) Fig. 4 Timeline of changes in Chinese retail formats. Source: Adapted from Prudential Real Estate Investors (2012) 4 Tescos Expansion Tesco made its move to enter China in 2004, buying a stake in local hypermarket operator Hymall, which operates under the company Ting Hsin. The following 2 years Tesco opened 5 new outlets under the Hymall name and launched its own-label products in China. In 2006, Tesco paid its partner, the Taiwanese retailer Ting Hsin, 180 m to boost its share in Chinese venture Hymall from 50 to 90 %. Since September 2004 Tesco held a 50 % stake in the venture. The newly adopted strategy is to conquer China on its own. The deal, which is valued at around 180 million pounds, will allow the partnership to accelerate its growth in China whilst continuing to benefit from Ting Hsins invaluable local knowledge, Terry Leahy announced. We have seen exciting growth in China since announcing the joint venture two years ago and are looking forward to the partnership entering a new phase. Had we decided to enter the Chinese market on our own to soon? Philip Clarke thought to himself. In trying to pinpoint the moment where a wrong decision had been made, his thoughts paused for a moment. Clarke, who had not yet been appointed as chief executive, had watched from the sideline how Terry Leahy had made the decision to speed up the retail expansion. The reason for choosing a partner in the first place was to gain more knowledge of the retail market and consumer preferences. Perhaps we believed we had figured out the Chinese retail market too soon. When entering China, Tesco had taken a more conservative approach, compared to other retail competitors. The retail company only focused on the four main urban centers Shanghai, Tianjin, Guangzhou and Beijing. By doing so it had a long way to catch up in terms of establishing brand awareness and loyalty, as the retail company had been hiding behind Hymall and its Happy Shopper logo. This policy changed in September 2006, when the retail company announced it would introduce 500 products, including noodles, soap and napkins, under its own brand. Few British visitors would be able to recognize Tesco in China, as the merchandise could not have been more different from back home. In tradition of Asian wet market, the frogs, turtles, fish and silkworm grubs were freshly displayed. In January 2007, the first store operating under the Tesco name opened, in order to start developing brand awareness. The store, in Beijing, added to the total of 46 stores in the North, South and East region of the country (see Fig. 5 for a map of China). The company set out plans to open ten stores a year under the Tesco name. In February 2011, the retailer signed a joint venture to build three more shopping malls. Later that year Tescos full-year results showed an increase in sales with 5 %, but local operations failed to break-even in the second half of the year. Newly appointed Chief Executive Philip Clarke announced that Tesco would reduce its numbers of store openings in the country. He further mentioned that it had been more difficult than expected to get prime locations. In April 2012, the retailer announced its full-year results for 2012. Tesco reported a 4.1 % increase in sales in China. The retailer mentioned it has taken a more cautious stance on China, because of persistently high inflation and pressure on wag costs. By 2012, the retailer announced closure of four of its hypermarkets in China as it struggled with that it called the challenging environment in the country. Analysts argue whether the company had done enough in terms of building brand loyalty. In April 2013, the retailers annual numbers showed it sales had fallen 1.1 %. We still see an excess amount of new space being opened in the marketahead of customer demandand we have moderated our pace of development accordingly. We opened just 12 new stores this year and closed five underperforming stores as part of our increased focus on our three strongest regions. China remains a strategically important market for Tesco, Philip Clark says. We will focus our efforts on establishing and then pursuing a profitable approach to growth. In May 2013, reports emerged that Tesco had been looking for a partner in China. Tesco at that time declined to comment. By June 2013 sales in China fell 4.9 % in the first quarter of Tescos new financial year. Tesco said the whole sector had been affected by the bird flu outbreak and a food safety scare involving pork. China is a business we said we are going to focus much more on profitable sustainable growth, Clarke says. Fig. 5 Map of China. Source: CIA The World Factbook https://www.cia.gov/library/ publications/the-world-factbook/geos/ch.html [accessed 18 December, 2014] In August 2013, Tesco confirmed it was in negotiations to merge its Chinese operations with local retailer China Resource Enterprise (CRE), which is the subsidiary and listed company of China Resource Holdings. CRE focuses on retailing, beverage, food processing and distribution. 5 Consecutive Setbacks In 2013, Tesco announced it was in talks to team up with China Resources Enterprise Ltd (CRE), a move that followed decisions to abandon the United States and Japan and focus on investing in its British home market. Later that year, Tesco finalized the deal with CRE in order to create the largest food retailer in China. The joint venture would combine Tescos 131 outlets in the country with CREs almost 3000 stores. CRE would own 80 % of the new chain and Tesco would be left with 20 %. Tesco believed the merger would create combined sales of around 10bn. But the deal left a question mark over the future of the Tesco brand in China and would bring an end to the groups independent business in one of the worlds fastest growing retail markets. The partnership creates a strong platform in one of the worlds largest markets, Tesco chief executive Philip Clarke announced in a statement. We can now combine our strengths to build a profitable multichannel business, offering our customers in China the best of modern retail. Although Tesco claimed the merger followed a series of joint ventures struck between CRE and other multinational companies, it was seen as retrenchment strategy after declining sales. Retail analysts noted that the decision actually meant that Tesco had surrendered itself and was giving up, portraying the difficulty of foreign companies experience in negotiating with suppliers and regulators in fast-growing risky markets. The partnership would mean that the brand was left with a minority share in the partnership, and some analysts believe this option was the most favorable for the company. Tesco finally finds a big giant to salvage them, said Kenny Wu, an analyst at Society General Ji-Asian Hong Kong. One Hong-Kong based M&A banker told Reuters that Tesco, like Frances Carrefour, was eager to address the problems in its own home market. Tesco has been struggling in China and has been losing money. This may look win-win, but in reality, Tesco is saying: I cant figure out China, he said. Tesco is not alone in its inability to become successful in China. Earlier in 2013, media reported that global retail giants Wal-Mart and Carrefour were closing several of their underperforming stores in China