Arslan Ahmed

2017 Enterprise Risk Management Strategic Audit of Tesco PLC Contents Executive Summary ................................................................................................................. 2 Introduction .............................................................................................................................. 3 Overview of Tesco .................................................................................................................... 3 Risk Audit ................................................................................................................................. 3 Situation Analysis and Risk Profiling .................................................................................... 4 Critical Evaluation of Internal and External Risks .............................................................. 5 Risk Mitigation Strategies ....................................................................................................... 7 Conclusion ................................................................................................................................ 8 Recommendations .................................................................................................................... 8 References ............................................................................................................................... 10 Appendix ................................................................................. Error! Bookmark not defined. Executive Summary This assignment looks at the ERM framework at Tesco PLC. Tesco PLC uses a Group Risk Register for the recording of risks all over the company so that a risk audit can be done. It also has stated its principal risks and uncertainties in its report which we will discuss. Further, risk situation analysis will look at SWOT and PESTLE and risk profiling will consider important financial ratios to look at the overall position of the company now and in future in case its merger with Booker was to happen. It will be shown as company is in turnaround phase its future looks good overall. Next thing we will look at is one internal risk the company faces that of failure to listen and respond to customers and one external risk that of failure of Tesco’s business model to adapt to changes in external environment. Next, we will discuss the risk mitigating strategies pertaining to the two risks and conclusion and recommendations will be at the end. Introduction ERM according to the well recognized organization, COSO (the Committee of Sponsoring Organizations of the Treadway Commission), is: “…a process, effected by an entity’s board of directors, management and other personnel, applied in strategy setting across the enterprise, designed to identify potential events that may affect the entity, and manage risk to be within its risk appetite, to provide reasonable assurance regarding the achievement of entity objectives.” (UNIVERSITY OF CALIFORNIA). The assignment will begin with a brief introduction of the company, next look at the risk profile and situation analysis at Tesco and also look at one of the internal risks and one external risk that Tesco faces. Finally, the risk countering strategies will be discussed leading to a conclusion and recommendations for strengthening risk mitigation strategies at Tesco Group. Overview of Tesco Tesco is UK’s largest retailer dealing in food and groceries. It had 6902 shops in the world and 476,000 colleagues all over the world at 2016 business year end. Collectively, the Tesco retail business, Tesco Bank and Tesco dunnhumby, the customer insight and analytics business form the Tesco PLC Group. Tesco’s core purpose is: 'Serving Britain's shoppers a little better every day.' Tesco gives its customers the most importance and also makes sure they are never disappointed. Tesco forms part of the top four retailers in UK along with Sainsbury’s, Asda and Morrison’s. The current market share of Tesco has dropped down to 28.4 percent in the year 2016 as German retailers Lidl and Aldi have taken away some of their customers. Risk Audit Risk audit process at Tesco uses the Group Risk Register to record the key risks the company faces at any given time period. Each business unit of Tesco also develops risk registers. There are the CEO, business units and also committees involved in risk audit process. The leader/managers of individual business units identify risks while Group Audit and Advisory (GAA), an independent group supports by keeping an eye on the work of the executive board, the CEO as well as the committees namely, Audit committee, Executive committee and the Group Compliance Committee. The Board looks after the risk mitigating strategies and their implementation, Audit committee assists the board and also ensures that correct risk framework is used while the CEO is held accountable if the downside of any risk were to occur. Meanwhile the Executive committee oversees the Group Compliance Committee to see that the work is done correctly. (TESCO PLC, 2016) The generic internal and external risks facing the Group and their respective mitigating strategies are given in table 3 in Appendix: Situation Analysis and Risk Profiling Situation Analysis is explained as: “The collection and systematic evaluation of present and past economic, social, political and technological data that is aimed at identifying both internal and external forces on an organization and assessing the organization’s future and current strengths, opportunities and weaknesses.” (LAW DICTIONARY) Both PESTLE and SWOT analysis are useful tools for situation analysis. Tesco’s Swot analysis is given in Table 1 in appendix. Risk profiling using financial ratios: Assumptions: 1. Merger with Booker will happen as announced probably by the end of the fiscal year 2017. 2. The merger will be positive and will improve company’s position. 3. There will be no recessionary phase the economy will enter. 4. There will be an increase in revenue in the year 2017 because of the turnaround. (THE GUARDIAN, 2017) The increase is kept at one percent to be reasonable as the previous year there was still a negative growth in revenue by minus five percent. 5. Turnover figures for 2017 onward will also increase as Booker will be merged and collective revenue will result. 6. Net profit figures will improve as it is expected that there will be savings worth GBP 200 million spread over five years 2017 onward. While there will be a negative effect too because of the costs of the merger which will also be spread over five years ahead of 2017. The net effect in net profit will be an increase by GBP 11 m. (CAHILL, Helen, 2017) 7. The forecast for total borrowing assumes that the merger will be funded by a combination of debt, company savings and also sales of redundant outlets. This will lead to a significant increase in long-term debts for the year 2017 and onward. 8. The assets will increase as Booker assets will become part of the balance sheet. Booker assets were estimated at GBP 1385.7 m at fiscal year 2016 end. (BENTLEY REDMAYNE STOCKBROKERS) This will mean improved asset turnover ratios. 9. ROCE will also improve as net profit will rise in proportion to capital investments. 10. Liquidity ratios apart from debt to equity will remain constant as in future the company expects the liquidity risk to be getting lower. (TESCO PLC, 2016) If merger goes well, in future the company will be in a good position as revealed by the figures and the ratios. As for its risk profiling it will be in a situation that it can face both upside and downsides of the risks. Also, the news items predict if the merger is successful there will be major advantages in future. (WILLIAMS-GRUT, Oscar, 2017) Critical Evaluation of Internal and External Risks Internal risk of failure to listen and respond to customers One internal risk which Tesco faces is the risk of failure to listen and respond effectively to its customers. (TESCO PLC, 2016) While another one which is external in nature is the failure of the economic model to respond to the changing marketscape or the market forces. Both of them are interlinked as failure to listen to the changing customer needs also means that the business model is outdated. We have countless examples of companies who said they were customer centric but could not become so. Take the example of Best Buy which was considered previously one of the best retailers had to take a downfall in 2012: Customers all over the country have taken to the blogosphere to rant about bad experiences with pushy or unhelpful employees, not to mention how the company failed to ship thousands of pre-ordered items that consumers planned to give as Christmas presents. (They also failed to give timely warnings, making it the Grinch of the season.) (CUSTOMER RETAIL EXPERIENCE, 2012) The effects of failing at customer service or not giving customers what they want can be drastically bad. It grows from one or two instances of bad service to more. Customers start sharing the bad experiences through word of mouth. The company’s image starts declining and many figures in the income statement are affected. Customers may switch to alternative stores or buying online and as a result company’s revenues start shrinking. With lower revenues and high expenses of retaining employees who create disgruntled customers the net profit figures are severely affected. The worst is the effect on the brand reputation as a blow to equity is the hardest to recover from. The grid below places the internal risk of failure to be customer centric for Tesco inside the box corresponding to low likelihood or probability while it keeps the the Impact or the effect of this risk high. At present Tesco need not worry too much about the likelihood of the downside of this risk as it is an example of a very good customer-centric company. After all it was one of the pioneers to use the dunnhumby for tracking the purchases of its customers to analyze the data gathered for better customer service. Also it focuses currently on giving its customers the best bargain as stated in the report that if a customer was not to get the right price at Tesco, Tesco will match the prices of any other store customer found lower prices at. However, in the past Tesco has suffered: Tesco was the exemplar of harnessing customer data through a loyalty program (Tesco club card), using data mining and predictive analytics to generate insights and then doing database driven marketing based on these insights…Today Tesco is on the floor. Why? Because Tesco’s management ended up doing what management teams do: exploiting customers to extract surplus profits for the Tops and Shareholders. (Invaluable Customer-Centricity Lessons from Tesco) Hence, as it now might enter a merger and expand its business Tesco needs to be very wary that in expansion phase it does not neglect its customer centricity and loses out on customers as a result. External Risk of failure to transform the business model In order to understand external risk, that of the failure to transform the business model in time for the market changes, a prime example of Nokia illuminates: …the people at Nokia were aware of the changes going on around them…Where they struggled was in converting awareness into action…The failure of big companies to adapt to changing circumstances is one of the fundamental puzzles in the world of business. Occasionally, a genuinely “disruptive” technology, such as digital imaging, comes along and wipes out an entire industry. But usually the sources of failure are more prosaic and avoidable -- a failure to implement technologies that have already been developed, an arrogant disregard for changing customer demands, a complacent attitude towards new competitors. (BIRKINSHAW, Juilian, 2013) In Tesco’s case, the company faced the brunt at 2014 fiscal year end of the failure to respond effectively to the changing competitive landscape as well as to the evolving customer needs wherein they preferred low prices and shopping through the internet. (SHEFFIELD, Hazel, 2015) The same year, Tesco experienced the worst loss in history. The risk of a failure to transform the business model has high likelihood especially as there is the possibility of the merger. This merger can bring about major shifts in the competitive reactions as well as the external forces affecting the company. In such a case if Tesco which will have become even larger by acquiring Booker, were to lag in transforming its business model then something terrible could result. As we know from Nokia’s example such failure could mean being thrown out of business. External Risk: Failure Figure 1. Impact and likelihood grid for Tesco. of economic model to High transform to changes in external environment Likelihood Internal risk: Failure to be customer centric. Low High Impact Low Risk Mitigation Strategies For dealing with risks of failure to be customer centric the company uses following mitigation strategies:  They have developed strategic plans to enhance understanding of their customer needs. Customer insight supports development of customer-focused strategies across each market.  Further they have developed strategic customer profiles which explain the needs and expectations of their target markets.  They have invested in the customer experience by increasing colleague hours on the shop floor and by providing customer service training for colleagues across all stores.  They spend to ensure that customers have an all time, wide range availability of goods and that the prices of those goods remain competitive. Their Feet on the floor program allows the colleagues who work outside the stores to spend a day inside stores in order to increase the understanding of customer focus throughout the company. For the risk of failure to transform the economic model, the company has the following mitigating measures and controls (TESCO PLC, 2016):  Significant transformation programs are being undertaken by the company across the Tesco Group, including organizational design, data strategy, reset of supplier relationships, cost reduction and people & capability.  There is an Executive Committee and Board overview of key strategic initiatives to improve sales and margin, and to reduce cost. Periodic sales margin planning and forecasting activity are reviewed by Group and local finance functions. Conclusion To conclude, it can be said that Tesco needs to be very wary of what could go wrong regarding their customer centricity and business model transformation especially when they seem ready to go into a merger. Although, if the merger was to do the good things that are predicted it will result in very good turnover and profit figures for the company as shown in financial ratio analysis. Recommendations a) It is important that Tesco should not only assess what their customers are currently buying through their software but to stay up to date should also conduct surveys for the changing needs and preferences of the customers. b) Tesco should also make sure that now while it is proposing to a merger it should plan in advance the intricacies of the merger and what the possible effects on the business model could be. It should try and make its business model adaptive and flexible now even more so as it becomes even larger a company by incorporating Booker Group. c) It should try and innovate quite often as innovative companies have good survival rates in today’s rapidly changing markets. d) It should ensure that it gives the customers what they value to be truly customercentric. Many companies though wishing to be customer centric have failed to be truly customer centric; their expansionary policies coupled with their sights held onto shareholder’s value made them fail to be customer centric. Bibliography BENTLEY REDMAYNE STOCKBROKERS. Booker Group. [online]. [Accessed 3 Apr 2017]. Available from World Wide Web: BIRKINSHAW, Juilian. 2013. Why corporate giants fail to change. [online]. [Accessed 3 Apr 2017]. Available from World Wide Web: CAHILL, Helen. 2017. Five numbers that explain the merger between Tesco and Londis owner Booker. [online]. [Accessed 3 Apr 2017]. Available from World Wide Web: CUSTOMER RETAIL EXPERIENCE. 2012. Where Best Buy went Wrong. [online]. Available from World Wide Web: Invaluable Customer-Centricity Lessons from Tesco. [online]. Available from World Wide Web: LAW DICTIONARY. Situation Analysis. [online]. Available from World Wide Web: SHEFFIELD, Hazel. 2015. Tesco results: the five reasons behind Tesco's Historic GBP 6.4 billion loss. [online]. [Accessed 3 Apr 2017]. Available from World Wide Web: TESCO PLC. 2016. Annual Report and Financial Statements 2016. THE GUARDIAN. 2017. Tesco hails Turnaround as Festive Sales Increase. [online]. [Accessed 3 Apr 17]. Available from World Wide Web: UNIVERSITY OF CALIFORNIA. Enterprise Risk Management. [online]. Available from World Wide Web: WILLIAMS-GRUT, Oscar. 2017. Tesco is buying wholesale food supplier Booker in a GBP3.7 billion deal. [online]. [Accessed 3 Apr 2017]. Available from World Wide Web: Appendix Table 1 Strengths Weaknesses 1. Leadership position in the UK 1. Weak financial performance 2. Effective online operations 2. Serious damage to the brand image due 3. Club card as an effective consumer to commercial income scandal in 2015 information tool 3. Reliance on the UK market 4. 4. Diminished employee morale Strong property portfolio Opportunities 1. Threats Pursuing international market expansion 1. Inability of the new leadership to turn strategy over the business 2. 2. Increasing presence in financial services Inability to sustain cost leadership industry competitive advantage 3. Increasing non-food retail range 3. Currency fluctuations 4. Enhancing the effectiveness of the 4. Emergence of new ethics-related marketing strategy problems Tesco SWOT analysis Source: Research Methodology, http://research-methodology.net/tesco-swot-analysis/ Table 2 Historical Trends Forecast Key financial 2013(f Per 2014( Per 2015( Per 2016( Per 2017( Per 2018( Per 2019( figures and igures cen figure cen figure cen figure cen figure cen figure cen figure ratios in t s in t s in t s in t s in t s in t s in millio cha millio cha millio cha millio cha millio cha millio cha millio ns) nge ns) nge ns) nge ns) nge ns) nge ns) nge ns) £ - £ 64,55 13 56,92 7 % 5 £ Turnover 63,40 2% 6 Net Profit Total Borrowing £ 91 £ 105 24 % 270 % £ 10,83 £ 3% 4 11,21 3 11 % -£ 5,766. 00 £ -5% 1% 3 54,97 £ 8% 7 59,37 6 10 % £ 65,31 3 457 £ 17 £ 13 £ 14 £ 0% 129 % 155 % 178 % 207 £ 12,65 54,43 £ £ 6% 9 13,53 7 20 % £ 17,00 £ 8% 0 18,50 £ 8% 0 20,00 0 Profitabiliy Ratios Operating Profit Margin Gross profit Margin Return on Capital Employed Asset Turnover Net Profit Margins 3.76% 6.55% 14.50 % 1.26 0.04% 8% -4% -7% 8% 91 % 4.08% 6.31% 13.60 % 1.37 0.42% 140 % 10.17 % 687 % 263 - 174 % 3.87% % 240 4.00% % -6% 104 % - % 31 % -3% 437 4% 1.73% 9% 1.90% 31 1.45% % 5.24% 17 % 6.31% 5.80% 3% 6.00% 1.25 3% 1.28 0.24% 16 % 0% 14 % 9% 45 1.00% % 6.31% 7.00% 1.41 0% 13 % 11 % 6.31% 8.00% 1.58 0.28% -8% 0.26% 44 0.18% % Liquidity Ratios Current Ratio 0.69 5% 0.73 22 0.60 % Acid test Ratio Inventory Days 0.44 -2% 0.43 22.06 2% 22.43 -2% 21 0.42 18.51 20 % 29 % 3% 0.75 0% 0.75 0% 0.75 0% 0.75 0.59 0% 0.59 0% 0.59 0% 0.59 19.06 0% 19.06 0% 19.06 0% 19.06 % Debt/Equity Gearing Ratio Interest Cover 87% 0.65 4.80 9% 15 % 17 % 0.76 5.76 EBIT 2382 Interest £ Expense 496 Short-Term £ 60 £ Debts 766 % 1,910 Long-Term Debts Shareholder's Equity 9% 95% -9% £ 10,06 -8% 8 2631 61 % 57 % 161 % 145 % 245% 1.79 -9.51 -5792 457 % 609 9,303 % £ - £ - 16,66 13 14,72 108 1 % 2 % 124% 0% 124% 0% 124% 1.57 0% 1.57 0% 1.57 1.14 9% 1.25 9% 1.38 9% 1059 9% 1165 % 14 1.57 0% % £ 13 46 - 25 £ 181% % £ 5% 36 - 525 % 714 % 44 % 2.24 % 944 2% 963 £ 50 £ 422 % 844 £ 29 £ 2,008 % 2,826 £ 10,65 £ 1% 1 96 10,71 1 6% 23 % £ 18 £ 43 7,071 % 8,616 % 0% £ 844 0% £ 844 £ 14 £ 13 £ 3,000 % 3,500 % 4,000 £ 14,00 £ 7% 15,00 £ 6% 16,00 0 0 0 £ £ £ 15,00 0 6% 15,89 0 5% 16,65 0 Table 3- Risks and their mitigating factors regarding Tesco Plc. Primary Risks Mitigating Factors 1. Customer proposition-Failure to listen Investment in understanding and building to customers and their changing customer profiles and training colleagues to respond to customers’ needs. needs. 2. The economic model- the model does There are significant transformation not respond to changes in external programs being undertaken across the Group. economic environment and does not soon enough increase operating profit margin resulting in low cash inflow in future. 3. Liquidity-situation of cash to cover There is a funding plan to oversee the operations worsens. liquidity risk lowering requirements such as forecasting is done to predict future cash flows. 4. Competition-There is no effective Marketing scanning and competitor analysis response to competitors. provide knowledge about the possible risks from competition. 5. Brand equity loss-The brand loses its There are company-wide clear rules for name, recognition and trust with upholding the right practices for the brand. customers. 6. Technology-IT system failure or other There technological failure. is a technology strategy and technology leadership team to oversee the policies regarding technology. 7. Data privacy and security-The risk of IT security is monitored through access losing customer’s or company’s data controls testing and a review of security or losing face by inadvertently using policies. customer’s personal information without telling them. 8. Regulatory and compliance-failure to A code of business conduct exists which is fulfill compliance and regulations refreshed with clauses protecting against resulting in fines and reputational risks such as acts that may harm the UK damage. Bribery Act. 9. Safety-workplace safety guidelines Group safety policies and procedures exist are not met resulting in death, illness and there is mechanism to report directly to or injury. the CEO in case any untoward incidents or breaches happen. 10. People-colleagues (employees) are There are standardized recruitment and not trained well enough and retention selection procedures and retention is a major does not happen, leading to loss in priority of the HR function. meeting business objectives. 11. Tesco Bank- Tesco Bank has to see There is a Bank Board that reports to the restricted liquidity and cash owing to Audit responses regulations. in frequently Committee regarding regulatory shifting framework changes. The bank also has a measurement system to gauge the risk appetite it can take. Source: Principal risks and uncertainties, Strategic Report, Tesco Plc, 2016