Capitalism and Argos

Introduction

This report sets out a case for the international expansion of Argos. It argues that, in light of the slowing UK retail market and rising labour costs, there is great opportunity for Argos to internationalise to exploit cheaper labour costs and access new and emerging markets where there is increasing demand for household goods. The structure of the report is as follows:

• Company overview and rational for international expansion
• Description of investment project
• Target Country business environment
• International market entry mode
• Challenges and difficulties that the company may face and how to overcome them
• Conclusion and recommendations

Company Overview

Argos is a part of the UK Home Retail Group (HRG), a FTSE 100 company. HRG is the UK’s leading home and general merchandise retailer with a 10% market share of the general merchandise and home enhancement market worth 58 billion sterling pounds per annum. As well as being a market leader in furniture retail, HRG holds the leading position in the horticulture, garden furniture and outdoor living markets and a wide range of consumer goods and merchandise. It has three distinct businesses, namely Argos, Homebase and financial services. Argos is the leading general merchandise retailer in the UK. It was established in 1973 and currently has 680 stores in the UK and Ireland. It employs 29,5000 workers.

It is the largest multi- channel retailer using catalogues, telephone, internet and stores, providing a variety of methods and convenience for its customers to shop for a large range of household goods. Homebase is the second largest home improvement retailer in the UK. It was established in 1981. Both Argos and Homebase were acquired by GUS Plc of Netherlands in 1998 and 2002 respectively but demerged from GUS Plc in 2006. HRG also offers financial services including credit through its store cards and insurance services including home, car and pet insurance.

HRG faces competition from many players in the market in different product categories including B&Q UK’s number one home improvement retailer, Curry’s and Comet in consumer electronics and domestic appliances, Woolworth in toys and general merchandise, H Samuel in jewellery and supermarkets such as Tesco, Asda and J Sainsbury’s in the non food and non clothing market. The following report focuses on Argos. 2. 1ARGOS Argos is a pioneer of catalogue retailing in the UK and has established a strong brand that focuses on choice, value and convenience.

About 17 million UK households, representing around two thirds of the population have an Argos catalogue at home at any point in time, serving over 130 million customers annually through its high street and out of town stores. The latest Argos catalogue has approximately 18,000 product lines with the number of core lines increasing to nearly 3 1,000 and the majority of stores stock around 10,800 lines for immediate collection. Argos is continuously adding new product lines. Recent product lines include pet care, technology, leisure and eco-friendly goods.

It has also recently launched a new premium own-brand homecare range of products – ‘Inspire’ collection in its HOME catalogue – as the next prong strategy to compete with department stores in their mid-market range of home products. This is intended to further strengthen its market position as the top retailer offering customers good value, budget and mid-market product ranges. Argos also competes on price. It has kept low level prices in each edition of its catalogues since 1999 and recently it has reduced overall prices by approximately 5% across 8,000 product lines.

This price reduction has been achieved through the development of supply chains in emerging markets such as China and India. Argos sells its products through stores, online and over the telephone with two-thirds of products now sold by telephone and online (www. argos.co.uk). The Argos website has become the second most popular e-commerce retail site in the UK. Consequently Argos has established One Network Command Centre to support the company and its suppliers with real-time, multi-party transaction solution for Argos collection services and its supporting booming Direct Import department.

Fully integrated multi-channel retailing using store, internet, telephone Market leader Opportunities Store expansion Increasing online sales Demand for household products Strong market position enables it to develop important long term relationship with suppliers Cost benefit and ability to source exclusive products at advantageous quantities Weaknesses Concentrated geographical operations Limited international exposure and experience Threats Slowing UK retail market Rising labour costs Intense competition Easy to imitate selling methods

International Expansion of Argos

“Internationalisation is understood as a step by step process of international business development whereby a firm becomes increasingly involved in international operations on both inward and outward side” (Welch and Luostarinen, 1988, p38). 3. 1The Need for International Expansion The SWOT analysis suggests that the slowing UK retail market, rising labour costs and intense competition particularly in the general merchandise and home improvement markets, are a threat to the long term sustainability and profitability of Argos. According to the 2007 HRG Annual report Argos has a long tract record of growth.

Since acquisition by GUS PLC on 31st March 1999, sales have grown from 1. 9 billion to 4. 2 billion and operating profit has increased from 122 million to 325 million for the year to 3rd March 2007. However, the report also recognises that the UK market is undergoing a significant change. “This change is in part driven by the recent slow down in consumer spending, but is underpinned by an overall structural shift in favour of large scale retailers such as HRG. This has led to an increasingly competitive market where scale, value and cost management are believed to be the key determinants of success”(p14). Nevertheless, it is anticipated that market conditions in the UK will remain challenging for sometime, particularly in the high value or housing related product categories. Additionally, the UK government has announced annual increase in the National Minimum Wage (NMW) which will come into effect on 1st October 2008. From that date the adult rate will rise from 5. 52 to 5. 73. The rate for 18-21 year olds will increase from 4. 60 to 4. 77, and the 16-17 year old rate will rise from 3.40 to 3.53.

This rising labour cost is likely to adversely affect the profitability of Argos in the UK. The Board of HRG believe that with its strong brand name, wide choice across its wide product range, multichannel offerings, strong retail credit position and the ability to open new stores, HRG is in a strong position to trade through any continuing cyclical retail downturn. Nonetheless, based on the above factors and HRG strategy for growth, international expansion seems to be the most obvious and sensible option towards ensuring long term profitability and higher annual rate of growth. 3.

Strategy for Growth The 2007 annual report of HRG sets out the company’s strategy for growth as follows:

• Leverage extensive product portfolio, market leadership and purchasing scale Increase market share in targeted large product markets Expand Argos’ networks by opening 30 Argos Stores per year Extend and exploit multi-channel leadership
• The corporate objective of Home Retail Group is “to deliver sustainable returns for all its stakeholders. Our aim is to deliver growth in total shareholder return that at least matches the top quartile of comparable listed companies over the medium to long- term.
• Home Retail Group aims to achieve this by delivering sales and profit growth 5 throughout the group, supported by investment programmes that give returns in excess of our cost of capital”. Against this backdrop there is a tremendous opportunity for Argos to exploit its strong brand name, multi-channel selling technology, management know-how and experience as well as economies of scope to expand its retail outlets to an overseas market by opening at least 25% of the planned 30 new stores outside of UK and Ireland.

Proposed Investment Project

The objectives of the proposed investment project are:

• To open new stores abroad in search of new markets.
• To increase annual growth rates and profit margin through cheaper infrastructure and labour costs (efficiency seeking).
• To enhance the Argos brand name globally

Success Criteria

The success of this proposed international investment project depends on many factors. The key success factors are location of the project, the management of international relationships and networks and extensive prior market research. Choosing the right location is paramount.

According to the eclectic theory (Dunning, 1988), a firm must have three advantages for internationalisation to occur, namely Ownership, location and internalisation advantages commonly known as the OLI paradigm. “The extent to which a firm engages in foreign production will depend on the comparative ownership advantages vis-a-vis host country firms and the comparative location endowment of home and foreign countries”. While location- specific endowments are external to the enterprises that use them, ownership- specific endowments are internal to particular enterprises.

They consist of tangible and intangible resources, including technology, which itself dictate the efficiency of resource usage. Although the origin of many ownership endowments may be partly determined by the industry or country characteristics of enterprises they can be used anywhere. Argos has ownership advantage arising from size which can generate scale of economies and inhibit effective competition. It also has exclusive possession of intangible assets such as strong brand name, management skills and market power at home which is transferrable to an international market.

This ownership advantage needs to be complemented with a good choice of location. Secondly, the effective management of international relationships is crucial to the success of this project. This is more so because apart from Ireland, Argos has no international retail experience and presence. The company therefore has a very steep learning curve and to a large extent will depend on the knowledge of its international networks in order to succeed in an international context. Johansen and 6 Mattson (1988) allude to the importance of managing international relationships and the problems of trust, control, resources and

interdependencies companies may face in the process of internationalisation. This means that Argos must adopt an international business structure with robust control systems. Any partnerships and network arrangements should have clear contractual terms in order for Argos to maintain sufficient control over its international operations and subsidiaries. It is incumbent upon Argos to ensure that it develops an efficient inventory and logistics systems particularly with suppliers and delivery outlets in order to maintain and enhance its cost advantage.

Ohno Taiichi (1988) suggests the “Just In Time” (JIT) system for reducing the degree of unnecessary inventory. Finally, the importance of a comprehensive market research cannot be overemphasised particularly with regards consumer tastes and wants, pricing strategy and refund policy and more importantly customer preference for selling methods. Some modifications and adaptations may be necessary to satisfy local needs and consumer habits. In particular catalogue retail may not be particularly suited to certain international markets particularly those in the emerging economies.

Target Country Business Environment

One of the most important elements in the internalisation process is the choice of country of location. Johanson and Wiedersheim-Paul (1975) identify two main factors which influence the choice of location in the extension of activities to new markets. These are psychic distance and market size. Psychic distance is defined as “factors preventing or disturbing the flows of information between firms and market”, for example, differences in language, culture, political systems, level of education and level of industrial development.

Psychic distance is usually correlated with geographical distance. Secondly, from a business perspective, the most important consideration in international operations is the size of the potential market. This report analyses the political, economic, socio-cultural and technological (PEST) of two potential markets for international expansion of Argos retail operations, namely Spain and China (Tables 1 and 2). Both of these countries have favourable characteristics to attract foreign investment.

SPAIN

Spain is a developed country with a free market economy. It is located in mainland Europe and benefits from membership of the European Union, the common market, freedom of establishment, free movement of workers as well as geographical and cultural proximity to the UK. There are many similarities with the UK in terms of consumer tastes and preferences and standard of living. In addition, Spain is a popular destination for British holiday makers, and many British Citizens have second homes or holiday homes in Spain. These factors make Spain an attractive potential market for Argos.

However, there are also significant disadvantages including high cost of establishment, economic downtown across Europe generally, rising labour costs and a relatively small market size compared to China. 7

CHINA

In contrast to Spain, China is a developing country with a planned economy although this is moving towards a free market economy. There is a very large geographical and psychic distance and a myriad of regulatory and bureaucratic maze which presents a challenge for foreign firms wishing to establish in China. On the positive side, the potential market size is enormous with a very large population of over 1.3 billion people and an annual growth rate of around 11% in the last year. Labour costs are still significantly lower than in Europe but rising in some urban areas. Based on the PEST analysis, China appears to be the more suited for international expansion of Argos.

Political Factors China has become an important player in international trade since it began to open its doors to foreign investors in 1978. Over the last three decades under a relatively stable political environment, the Chinese government has been attracting and utilising foreign investment to facilitate its economic growth. Many countries have established bilateral trade relationship with China. However, stringent government policies and excessive laws and regulations have hindered foreign investment. Since 1992, the Department of Commerce, State Council, the National Development and Reform Commission, and the Ministry of Commerce have issued a multitude of regulations which are not conducive for doing business. To overcome this problem the government has introduced privileges and tax incentives in order to attract foreign investment. At the same time, it has decentralised power to some extent in an attempt to reduce onerous bureaucracy and obstacles to doing business. Another important aspect of government policy has been environmental protection, conservation of natural resources, environmentally friendly production and protection of ecological resources (Hong Kong Trade Development Council, 2007).

Business Indicators Spain China

Ease of doing business 38 83 Starting a business 118 135 Dealing with licences 46 175 Employing workers 154 86 Registering property 42 29 Getting credit 13 84 Protecting investors 83 83 Paying taxes 93 168 Trading across borders 47 42 Enforcing contracts 55 20 Closing a business 17 57 8 4. 2. 2 Media activities and publications are also restricted. The Chinese government encourages foreign direct investment and development of small-medium size enterprises (SMEs). It has also reduced the scale of state-owned enterprises through privatisation in order to improve efficiency.

Cultural and trade conventions are held inside and outside of China to encourage international trade relations. Since joining the World Trade Organisation (WTO) in 2001 trade barriers between China and other countries have narrowed. China is also a party to regional trading agreements such as ASEAN and APEC. Economic Factors Table 2:A Comparison of the Business Environments in Spain and China The world’s attention has focused on the recent rapid economic growth in China. According to Okushima and Uchimura (2006), average annual growth rate was 9% during the 1990s.

By 2007 GDP rose to 11. 5% but this is expected to fall to 11% in 2008 (The World Bank Report, 2007). The economic system in China is gradually transforming from a planned economy to market economy. The size of the Chinese market has aroused interest in foreign enterprises and economists alike. China has built infrastructure to support foreign direct investment (FDI) and has created economic zones and tax incentives for foreign companies to invest without little additional costs to them thereby driving China’s exports to $974 billion and per capita income to $2000 per annum.

Factors that influence foreign direct investment (FDI) in China include currency exchange rates, cheaper labour costs (although this is rising in some urban areas) and availability of raw materials. The Chinese consumer market is also buoyant and provides opportunities for development. The investment bank, Credit Suisse, predicts that the consumer market in China is likely to become the second largest market in the world by 2015 (China Daily, 2007). Argos is well placed to take advantage of these developments.

Furthermore, Argos is in an advantageous position because it already has supply chains in Shanghai, Shenzhen and Hong Kong. This should ease its entry into the Chinese market.

Business Indicators

Economic system

Free market Economy EU member state

Consumption habits vary across social structures and gender differences. Although there is a relatively large cultural distance between developed countries in the West and Japan and China, most Chinese people are accustomed to consuming foreign products and services. They believe that foreign products and services are of high quality. For example, they prefer to buy electronic products from Japan and cosmetics from France. With rising standards of living and higher levels of disposable income, demand for house hold goods, leisure and sporting products is growing in China.

Western educated young people are adopting western culture and style of living. This influences their spending patterns particularly on sports, leisure and entertainment. While the older generation spend more on health improvement, and women spend more on beauty products, and household goods. Argos is well placed to meet these growing demands in life style changes. However, some modification to products and selling methods may be necessary to meet local needs, consumer tastes and preferences while maintaining the foreign feel and quality.

It is suggested that Argos starts with a smaller range of products than provided in the UK and this should take account of gender, age range and income levels of the Chinese consumer.

 Technological Factors

One of the positive effects of foreign investment on host countries is technology spillover. Most developing countries welcome foreign investment from the triad countries (Europe, USA and Japan) because of the potential technology spillover effect this could have on local firms and helping them to compete effectively with foreign companies.

Argos can bring management know-how and experience in retail services to China, particularly through its multi-channel retail strategy which is difficult to imitate. It can also take advantage of the rising number of people with access to telephone and internet to expand its telephone and online retail services to China without recourse to a substantial capital outlay. In 2007, users of immobile and mobile telephone rose to more than 910 million and 210 million people used the internet (netizens) during the same period1. Netizens read news, magazines, e- books and run e-commerce on the internet. Online and telephone shopping are very popular.

International Market Entry Mode

According to the stage theory (Johansen and Weidersheim-Paul, 1975), the process of internationalisation usually follows a sequential pattern of market entry mode, type of goods/services and geographical location. Hill (2006) identifies several market entry modes. These are: export, franchising, licensing, joint venture and wholly owned subsidiaries. Each entry modes has its advantages and disadvantages. When a global firm internationalises its business in overseas market, it is vital for them to choose the most appropriate market entry mode based on the company’s core competencies. The most appropriate entry mode for Argos into China is the joint venture. This is in part dictated by government policy in China which restricts the scale of activities of foreign investors.

Since the commencement of economic reforms in 1992, most overseas companies wishing to expand their operations to China must choose joint venture normally with a state owned enterprise (Davies, 1994). In the retail sector foreign investors may maximize their stake at 65:35 to local firms. Besides this requirement, it makes sense for Argos to enter the Chinese market through a joint venture with a local partner, in any case, because this would reduce the risk of investment and any political risk is then spread across the partnership especially where a state enterprise is involved.

Furthermore, a joint venture would allow Argos to tap into local knowledge and networks thereby reducing the liability of foreignness while at the same time enhancing the Argos brand name through the millions of netizens in China. In summary, this report recommends that Argos should open new stores in major cities of China including Beijing, Shanghai, Tianjin and Chongqing, Shenzhen and Guangzhou. Shenzhen in particular would be the preferred point of entry into China because it is one of the Special Economic Zones (SEZs) with excellent retail experience.

Currently, only three international retailers have so far located their stores in Shenzhen (Zhang et al, 2006). As far as a joint venture partner is concerned there are 15 potential retailers who are ranked in the top 100 enterprises of China (Feng, 2005). Among them is HuaRun Wanjia, one of the major retailers. It would be a suitable potential partner for Argo and has a strong performance record in Shenzhen.

Challenges of International Expansion to China and How to Overcome Them

It is inevitable that Argos will face enormous challenges and difficulties in its bid to enter the Chinese market. Cuervo-Cazurra et al (2007) identify three main difficulties associated with internationalisation: loss of an advantage which occurs when resources lose their advantageous nature when transferred to a new country; creation of a disadvantage which occurs when resources generate a disadvantage when transferred to a new country; and lack of complementary resources required to operate in the new country. The most difficult challenge for Argos will be the lack of complementary resources required to operate in China.

This is a firm specific disadvantage and is derived from the liability of newness and the lack of foreign market knowledge to compete in a new environment such as China. Argos has no foreign experience. The Chinese market is particularly alien to Argos owing both to geographical and cultural distance. Johanson and Wiedersheim-Paul (1975) note that the most important obstacles to internationalisation are lack of foreign knowledge and resources. They suggest that these obstacles are reduced through incremental decision making and learning about the foreign markets and operations.

It is suggested that Argos commissions reputable consultants, including a local Chinese business consultancy, to advice on local market conditions, effective international business structures and potential partners for a joint venture. Sharp (1995) notes that consultants and other outside experts can be used to complement in-house strengths and fill gaps where the local capability is lacking or 12 missing particularly in new subsidiaries. They can also be used to provide validation of information inputs, bringing an independent external perspective which can be shared and discussed with local management.

Additionally, consultants can be used to assist with analyses of international issues, which transcend countries and regions. A consultant with sufficient expertise and experience in multinational company organisation and related international issues such as joint venture structuring and management would also be useful to provide a creative support in the continuous improvement and development of the internationalisation process. Finally, in addition to regular consultants, country experts can provide important validation and their reputation can

often get the message across more easily to top management even though they may not necessarily bring any thing new or different. The second most difficult challenge will be the liability of foreignness and similarly the lack of complementary resources needed to operate in a new institutional environment. This problem can be overcome by capitalising on local knowledge through a joint venture with a similarly large and reputable Chinese retailer such as HuaRun Wanjia. The knowledge of the local partner will help Argos to get around the excessive regulation and red tape depicted in Table 1 above.

Collaboration initiatives such as joint ventures have become one of the most popular means of entering new international markets (Osborn & Hagedoorn, 1997). But despite their popularity a significant number fail. Slocum &Lei (1993) note that partners come with certain expectations and objectives. Thus it is critical for managers to identify and understand effective partner selection criteria prior to entering into joint ventures especially in an international setting where differences in culture, infrastructure, economic development and government policies increase the complexity of the context in which the alliance is embedded.

Argos should also be mindful of the fact that potential partners are also competitors. Hamel et al (1989) observe that many western companies entering strategic alliances give away more than they gain because they enter partnerships without knowing what it takes to win. They note that companies that benefit most from competitive collaborations adhere to a set of four simple principles. Firstly, they need to recognise that collaboration is competition in a different form. Secondly, harmony is not the most important measure of success.

Thirdly, cooperation has limits and companies must defend against competitive compromise and finally, learning from partners is paramount. Successful companies view each alliance as a window on their partner’s broad capabilities. They use the alliance to build skills in areas outside the formal agreement and systematically diffuse new knowledge throughout their organisations. Furthermore, the cultural distance between the UK and Chinese joint venture partners will present a problem. Hoftstede (1980) defines culture as “the collective programming of the mind which distinguishes the members of one human group from another”.

Multinational companies are communication intensive and relationship dependent and cannot function well if they are internally divided by substantial cultural barriers. Cultural distance can create conflict if not managed well and this can lead to serious breakdown of communication and cross border integration. It is suggested that some of these problems could be overcome by clear and comprehensive contractual terms of the joint venture, the extent of the cooperation and a clear exit strategy. However, China does not have the same legal 13

infrastructure as the UK and reliance on legal agreements rarely works especially against a state party as aptly demonstrated by the McDonalds case in Beijing. Instead, personal power and relationships or connections, rather than the rule of law, have always been the key to getting things done in China. This is commonly known as Guanxi – meaning relationships. McDonalds lost its lease in central Beijing because it lacked the guanxi available to the powerful Li Ka-shing. The concept of Guanxi is deeply rooted in Chinese Culture, particularly the Confucian philosophy of valuing social hierarchy and reciprocal obligations.

“The most important factor in doing business in China is the people one knows when you are working your way through the bureaucracy”. Argos will need to develop a network of people in order to find an effective Guanxi. However, they must beware that this Confucian philosophy is often open to abuse by unscrupulous consultants and corrupt government officials which can add a huge transaction cost to doing business in China. The corruption perception index places China at the bottom third of the ratings with a grade of only 3. 2 out of 10. Nevertheless, this problem has not had much effect in deterring foreign companies from investing in China. The third challenge facing Argos may be loss of advantage due to different consumer tastes, standard of living and the amount of disposable income in China. Consumers in China may not be accustomed to Argos’s selling methods and may therefore not trust products they cannot see prior to purchase. In order to address this problem, Argos needs to develop trust and confidence through its joint venture partners and ex.