No prisoners: e-Commerce Uses Game Theory to Capture Consumer Share of Wallet thanks to Nash Equilibrium

It is that time of year again. Christmas shopping must be done and deals are flying in all consumers inboxes. Whilst reading ‘The Bargaining Problem‘ by one of my favourite Mathematician/economist, it got me thinking how we use the Game Theory on a regular basis in eCommerce reflecting on my Christmas shopping behaviour (both as a consumer and retailer). Indeed, the rise and rapid proliferation of technology has forced companies to adapt in order to stay relevant and competitive. Specifically, the consumer retail industry has recently navigated this changing landscape by utilising collected consumer data to make prices dynamic depending on seasonal factors, locations (international businesses) and even the strategies of their competitors. These companies are trying to harness the power of technology to achieve perfect price discrimination, where the seller knows every buyer’s willingness to pay and can therefore maximise retail prices without exceeding the buyer’s walk away price.

John Nash and the Equilibrium Point

John Forbes Nash Jr. (June 13, 1928 – May 23, 2015) was an American mathematician who made fundamental contributions to game theory, differential geometry, and the study of partial differential equations. Nash’s work has provided insight into the factors that govern chance and decision-making inside complex systems found in everyday life.

His theories are widely used in economics. Serving as a Senior Research Mathematician at Princeton University during the latter part of his life, he shared the 1994 Nobel Memorial Prize in Economic Sciences with game theorists Reinhard Selten and John Harsanyi. In 2015, he also shared the Abel Prize with Louis Nirenberg for his work on nonlinear partial differential equations.

John Nash is the only person to be awarded both the Nobel Memorial Prize in Economic Sciences and the Abel Prize.

Game theorists use the Nash equilibrium concept to analyse the outcome of the strategic interaction of several decision makers. In other words, it provides a way of predicting what will happen if several people or several institutions are making decisions at the same time, and if the outcome depends on the decisions of the others. The simple insight underlying John Nash’s idea is that one cannot predict the result of the choices of multiple decision makers if one analyses those decisions in isolation. Instead, one must ask what each player would do, taking into account the decision-making of the others.

 

Game theory applied to eCommerce

In the context of e-Commerce, the retailer and the consumer are the two players. A game theory graph would illustrate the company’s best response to the consumer’s willingness to pay and the consumer’s response to the retail price the company is offering for the product. There would be no dominant strategy in this game because of the availability of information about other sellers and the access to other sellers the customer has in addition to the connectivity to millions of buyers via the Internet the company has. Either party can forego engaging in this transaction and just find another customer/company to sell/buy to/from. This can be illustrated with the given example (I read couple of articles whilst researching) of how Amazon dropped prices on Black Friday of a Samsung TV from $350 to $250 and decided on this final price using collected data, which allowed them to surpass the competition. Amazon took this a step further by hiking the price of HDMI cables, a complementary product, knowing based on consumer data that people are less likely to shop around in pursuit of the lowest prices for smaller items than bigger ticket items. The customers’ willingness to pay was any price lower than what the competitors were offering, which turned out to be the $250 (implying that no other retailer offered prices that low).

The implications of this show how companies are controlling not only prices but consumers’ perception of prices, thereby using this data to surpass the competition by limiting how consumers perceive the choices they have in front of them. Furthermore, this serves as an illustration of another way we experience a loss of control in our lives. However, another side of the argument says that perfect price discrimination can positively impact consumers, since their prices will be individually tailored. At the same time, this constant changing of prices can end up overwhelming and deterring consumers from purchasing the item all together.

As of now, it is too soon to tell how and if this becomes a normalised practice that we all must adapt to. It definitely is interesting to consider the ripple effects it will have on consumer behaviour in the future in addition to potential consumer protection regulation, as we are operating within a rigged sandbox where companies hold all the cards in their favour through informational advantages.

Recommended reading: http://file.scirp.org/pdf/IB_2014122310482155.pdf

Happy Christmas Shopping and bargain hunting

Benoit Mercier

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What strategy for TESCO?

Tesco_UK_main

In the past few months we have read a lot of negative articles about TESCO, a giant UK retailer. It has awaken my curiosity, not that I would pretend that I could solve their strategic issues, but I amused myself this weekend at writing a strategy as if I was the TESCO CEO. Feel free to feedback.

Background

Tesco started in 1929 with one store. By 2006, Tesco had overtaken Sainsbury’s to become the UK’s largest grocery store, and by 2007 account for 31.8pc of the total UK grocery market and the world’s 2nd largest retailer (by sales), operating in 12 countries (UK representing two third of its sales). Tesco got there through diversification and spotting gaps in the market, especially in the field of consumer behaviour. In 1995, Tesco revolutionised how data was collected and used through the Tesco Clubcard.

However, in January 2012, Tesco released its first profit warning in 20 years, and by November 2014 the share price had dropped to less than half the value of its record high of 2007. Its share of the grocery market has dropped to 28.7% by October 2014.

tescofig1

Figure 1: Tesco market price 2007-2014

UK grocery market analysis

Overall UK grocery market:

* Worth £174.5 billion in 2014.

* The grocery market’s share accounts for 54.5p in every £1 of UK retail spending.

* By 2019, the UK will grow by 16.3% to £203bn, with the fastest growth sectors being convenience, discounters and online3.

tesco fig2.png
tescofig3
Figure 2: IGD UK Grocery: Market and channel forecasts 2014-2019

tescofig4.png

Figure 4 – UK grocery market by 2019

Internet UK grocery market:

* Worth £7.8bn in 2014 +98.5% since 2009

* Growing internet penetration (80%)

* Rise of m-commerce with smartphones (+51% yoy)

UK discounting grocery market:

* Worth £9.5bn +35% since 2009

* Aldi (+35%) and Lidl (+17%) witnessed their highest ever growth in sales and market share (3.4% to 4.6%) and (2.9% to 3.4%)

Tesco 3 C’s

Core Customer analysis

Geographic
Region
UK
Density
Rural and urban
   
 
 
Demographic
 
Age
All age categories
Gender
Males and females
Income
Low and middle income category
Occupation
Students, employees, professionals
Education
High school, technical, Bachelors,
Social status
Working class, skilled working class, lower middle class, middle class
Family size
Single individuals, nuclear and extended families
Psychographic
Lifestyle
Traditionalists, contended conformers
Personality
Easy-going, determined
   
Behavioural
Occasions
Regular
Benefits sought
Cost advantage, variety
User status
Active user
Attitude
Sceptical, positive

Table 1: Target customer for Tesco

Competencies

* Online expertise and multi-channel synergies.

* Large scale operations, multifaceted distribution network from supermarkets to convenience stores and online shopping.

* Customer focused (CRM) – Clubcard: significant data collection on consumer habits since 1995

* Large range of products from Tesco Value range to Tesco Finest with significant purchasing power against branded products and suppliers.

* Large store network and very good geographical network across the UK

* Strong financial services division for personnel insurance and banking.

* Designed and implemented supply systems that effectively link existing shops with Tesco.com

* Staff – large pool of talented employees nurtured through internal training facilities

Competition

tescofig5.png
Figure 5: UK supermarkets’ market share

The big 6 dominate the UK grocery market with a combined 85% share, but heavy discounters have started to gain market shares due to the weak growth in the sector, limited product differentiation and limited costs for consumers to switch suppliers.

 

Table 2: UK Grocery market competitors

Macro and micro environment analysis

PESTEL analysis

* Political factors – In the UK the key political factor is the competition commissions view point on market share.

* Economic factors – continued economic stagnation, and the fact consumers have less money to spend on groceries.

* Social Factors – changing consumer habits too ease of shopping, value, and online shopping.

* Technological – where changing consumer habits are requiring smarter technological improvements.

* Environmental – reducing energy usage, packaging and transportation.

* Legal – Government policies and legislations over competition, food safety, food labelling impact the legal environment.

Porter 5 forces:

  • Rivalry among competitors – High. High concentration ratio with slow industry growth. Large number of local and global competitors. With the online boom smaller players are now able to compete with big players.
  • Threat of new entrants – Medium. High barriers of entry due to capital requirements, low product differentiation, low access to distribution channels and low switching cost.
  • Threat of substitutes – Low. They are a necessity only available from the industry.
  • Bargaining powers of suppliers – Low. No threat of forward integration, high threat of switching
  • Bargaining power of buyers – Medium. Relatively price sensitive, low switching costs, customers are becoming more knowledgeable about products and distributors.

Current strategy Challenges

Following an article given by Dave Lewis, I have identified 5 key challenges:

1. Tesco doesn’t know which shoppers to target. The supermarket is caught somewhere between the more upmarket offer of Sainsbury’s and Waitrose and the discounters Aldi and Lidl.9

2. The UK retail market is sluggish – Consumers have yet to feel the benefits of the country’s economic recover

3. Brand clarity and consistency is lacking

4. Tesco isn’t well loved – The supermarket has concentrated on high growth, fast expansion and cheap bargains rather than ‘softer’ notions of customer care or having good relationships with its suppliers

5. It lacks a clear management strategy10

Strategic Objectives

* To retain this year market share of around 28-30%. To regain market shares from discounters and upmarket competitors in the next 3 years to reach a 40% market share.

* To stay relevant to all customer segments through its Finest and Value ranges.

* To refresh the brand proposition in order to increase net promoter score.

* To increase store efficiencies and floor space to maximise returns from all stores

* To cut costs by divesting from non-profitable stores and reducing overheads

* To increase margins mix back to the 2014 levels (7.3%)

* To drive Every Day value prices through improved relationship with its subsidiaries to deliver over £300m savings

* To focus on complementary sectors outside of grocery such as children wear and financial services.

* To adapt to changing consumer habits and technological innovations

* To reinstate trust with employees, customers and shareholders

Proposed Strategy

Based on the above analysis, it is evident that the current strategy has not been working and meeting customers as well as shareholders expectations. Based on Tesco’s core competencies, I have developed a holistic new strategy:

1. Define a new brand positioning and segmentation 

Tesco doesn’t know which shoppers to target and its brand is not well loved in the UK. The supermarket is caught somewhere between the more upmarket offer of Sainsbury’s and Waitrose and the discounters Aldi and Lidl.

Our aim is to:

  • Increase revenue
  • Regain market shares by pushing out Aldi and Lidl and capturing some of Waitrose and M&S shares
  • Improve Tesco’s net promoter score

Brand/Marketing and distribution strategy

I propose to revamp the brand and distribution strategy on a cost neutral basis.

  • In terms of brand strategy, I propose to retain the Finest and Value range but to add a new brand “local”. See below.
  • In terms of distribution, I propose:
    • Hypermarkets and supermarkets: close non-profitable and refresh/modernise others
    • Metro/Express: Transform them into Tesco Finest and Tesco local stores based on their current locations and socio demographics catchment area

Based on research, Tesco customers feel they should get more and they feel their expectations are not met. But they want more (choice and quality) but by paying the same or less. Therefore, I would advise to be relevant with the target audience by having a new strapline “Expect more. Pay less”.

tescofig10.png

I recommend conducting a major customer research across all brands/sectors with a partner such as TNS, to better identify, define and segment customers. Also, I propose to appoint a marketing agency such as Saatchi & Saatchi to launch a new brand proposition based on the findings of the research.

I decided to let my creativity flow as to what I would do

Brands Tesco Finest New – Tesco Local Tesco Everyday Value
Logo tescofig11.png  TESCOFIG15  TESCOFIG16
Strategy Growth strategy Product differentiation strategy Predator pricing strategy
Positioning Premium range. This range is about high quality ready meals, products and service. Healthy and organic range. This range is about bringing local producers’ healthy and organic products to local consumers. Supporting the local economy. Value/low budget range but with good quality.
Slogan Expect more Premium. Pay less Expect more Organic. Pay less Expect more Value. Pay less
Competitors Waitrose, Marks & Spencer Sainsburys, ASDA, Morrisons Aldi, Asda
Consumer typology Age: 30-70 years old
Lifestyle: Busy lives, work and lots going on outside of work. Enjoy eating great food and going to restaurant but as little time to cook.
Age: 25-60 years old
Lifestyle: family oriented. Love walks and the nature. Strong engagement within the local community
Age: 18-50 years old
Lifestyle: little revenue and always looking for bargains and spending little on grocery in order to maximise their savings
Core Target Segmentation A, B, C1 – White collars B, C1, C2, D social demographics grades – Blue collars

B2B customer base

C2, D, E social demographics grades. Students, working class, unemployed.
Product 1,500 high quality products and packaging 1,000 local products. 2,000 products
Price Premium pricing strategy but remain slightly cheaper than competitors Status quo pricing strategy Aggressive low price strategy. Always cheapest
Place New – launch of Tesco Finest stores – these are small stores in market towns and upmarket locations. They do not range any other products. They have a finest restaurant and café also available. Visual merchandising is optimized.

Hypermarkets and supermarkets – all Finest products are visually merchandised separately from the other products in the aisle. Also, a Finest section is created to create a unique premium experience

New – Convenient stores – these are reconverted Express stores located in the heart of the local communities

Hypermarkets and supermarkets – all local products are visually merchandised separately from the other products in the aisle.

New – launch of Tesco Value stores – these are reconverted Express stores located in popular locations. They do not range any other products. Visual merchandising is done in bulk.

These products are also available in hypermarkets and supermarkets

Promotion Use a combination of above-the-line and below-the-line promotions with a focus on its quality and service Use a combination local below-the-line promotions with a focus on its local products and local activity Use a combination of above-the-line and below-the-line promotions with a focus on its prices and brands

2. Create a new product strategy for each segment 

I suggest to retain but revamp the Finest and Value range but also to add a new brand called “Tesco local” in the grocery division. The aim is to increase ROI and margins through reviewing the number and quantity of brands carried. Focus back on volume through reduced diversity. Allows Tesco to exert purchasing powers on suppliers to increase margins. Finally, like ASDA, there is a need to invest into low prices through improved relationship with its subsidiaries to generate further savings.

3. Streamline the store network

In terms of hypermarkets and supermarkets I propose to not open new stores; close non-profitable and refresh/modernise others and review cannibalisation of stores where too many exist within a 1km radius and determine whether some should be closed.

In terms of Metro/Express, I recommend transforming them into Tesco Finest and Tesco value (no frills approach to compete with discounters) as well as Tesco local stores based on their current locations and socio demographics catchment area

4. Utilise linear space more efficiently

Re-design hyper and super markets to promote value products and high end brands in better designed sections of the store. Make the stores warmer and more interesting to shop, and allow customers a much easier experience to shop quickly and efficiently. I also recommend to maximise hyper and super stores existing space, through strategic partnerships with external partners such as travel companies, gym operators, and other services where that location can accommodate such a change.

5. Define a new set of promotions

Establish better in store promotions of the value ranges giving them a more dynamic feel and identify to promote quality and value. The aim is to ensure customers trust “white label” brands as much as “branded”.

6. Develop strategic alliances

Tesco should consider getting into a strategic alliance with Kuoni or Virgin travel and offer those travel agents shop space with discounted travel possibly 2.5-5% off holidays for Clubcard owners.

7. Restoring investor confidence

The company’s overstatement of profit is clouding the company at the moment. After recent events, they need to take very strong action to try and ensure that they don’t fall out of favour with the people who are investing them. The recent dividend may have short term ramifications however long term benefits as they are signalling restructure.

8. Invest in innovation and new technologies to gain a competitive advantage

Recommend investing more in the online platform by creating a responsive design that will allow m-commerce to grow significantly. Also need to roll out click and collect to all stores and invest further

As I mentioned at the beginning this is factive work but a worthwhile exercise for any company to do when setting up its strategy.

Benoit Mercier