INNOVATION IN THE RETAIL SECTOR OF UK

By

Inisa Guha

(PRN: 11060242022) Assignment Submitted In the Partial Fulfilment of the Requirements for the Second Semester in M.Sc. Economics (2011 - 2013)

Symbiosis School of Economics

CONSTITUENT OF SYMBIOSIS INTERNATIONAL UNIVERSITY

(Established Under Section 3 Of The UGC Act 1956, By Notification No F9-12/2001-U.3 Of Government Of India)

CERTIFICATE

This is to certify that the project report entitled Innovation in the retail sector of UK is an original work carried out by Ms Inisa Guha (PRN:11060242022) under my guidance in partial fulfilment of the requirements in the second semester for the degree of M.Sc. in Economics at Symbiosis School of Economics under Symbiosis International University, Pune.

Place: Pune, Maharashtra, India Date: 12 March 2012

. Kalyan Shankar

STUDENTS DECLARATION

I , Inisa Guha, hereby declare that the project entitled Innovation in the retail sector of UK which we have submitted in partial fulfilment of the requirements for the degree of M.Sc. in Economics is an original work, the data and statistics have been duly acknowledged and do not form a basis for the award of any previous degree to anyone else.

Place: Pune, Maharashtra, India Date: 12 March 2012

Inisa Guha

ACKNOWLEDGEMENT

For this dissertation I would like to thank my Director, Dr. Jyoti Chandiramani, my mentor Mr. Kalyan Shankar and my professors for their guidance and constant supervision as well as for providing necessary information regarding the dissertation and also for their support in completing the dissertation. I would also like to thank my family and friends for their support during this dissertation.

INNOVATION IN THE RETAIL SECTOR OF UK

Introduction:
There is a broad consensus that innovation deals with the successful exploitation of ideas which leads to sustainable economic growth. However, the precise meanings, practices, measurements of and potential support for the innovative activities of firms largely depend on the context in which they occur. Retailing is considered to be a service but is, of course, a hybrid economic activity performing a bridging role between production and consumption, in which firms bring together assortments of goods relevant to the needs of consumers. Yet the nature of innovation in this important sector is often poorly understood and inadequately measured. Over the last forty years, UK retailers have become much more active in their own right within the value chain. Indeed, large, professionalised, organizations now run most of the retailing in western economies and are now coming to do so in emerging economies. In addition to being substantial commercial enterprises, such retailers have also become trusted brands with, in some cases, retailers own label brands being regarded as of similar or higher quality than those of branded manufacturers. Now retailing is the legitimate focus of business strategy, marketing, operations management and other conventional business disciplines.

The main retailing sectors in U.K:

Food retailers are by far the largest retailing group in the UK. Food retailing accounts for almost 38 per cent of UK retail sales, whilst the large grocery retailers alone account for 30 per cent of all UK retail sales. There are a relatively small number of large grocery retailers, each of which operate a large number of stores (on average the large grocers operate 113 stores each, compared to an average of 1.3 stores per retailer for the food sector as a whole), generating large per-store turnover. The top five large grocery retailers account for 48 per cent of all sales (although the actual figure will be substantially lower than this, since these retailers also sell many non-fooditems).

Technology and innovation in retailing:

Retailing has undergone a radical change over the last few decades. Not only have there been changes in the size and scope of retail outlets. There have also been significant changes in the way information technology is used to reduce costs of distribution and store operation. Retailers have also become more involved in upstream production of goods, or at least have started to influence directly what suppliers manufacture. In addition, there have been new forms of retailing that bypass the traditional shop and make use of telecommunications and information technology to facilitate transactions with customers. One of the most significant advances in the technology used by retailers is the use of electronic information technology. Bar-coding and electronic scanning of products is central to this technology. The increasing quantity of data that can now be collected and collated by retailers has improved their ability to judge how consumer preferences change over time. As a method of exploiting this new information advantage, many retailers have developed stronger relationships with suppliers (this has been seen in recent years in grocery and other retailing), and have become involved in product development. Marks and Spencer (M&S) are a good example. When they develop a new line, they involve themselves not only in the factors that affect the buying and distribution of the product, but in the details of how the product is made and the source and nature of the raw materials used to make it. An example of this is when M&S established its own textile laboratory in 1935 and developed a relationship with ICI in order to understand the nature of the raw materials used to manufacture its products. This involvement allows M&S to influence its manufacturers in its product specification.

More recently, M&S were involved in encouraging European manufacturers to adopt the US technology that M&S had studied, in order to supply Iceberg lettuce all year round to its stores. Such practices are commonplace among other major retailers in the UK.

The size and growth of the retail sector:

Retailers were once seen as downstream resellers of products, simply ciphers in manufacturers distribution channels, intermediaries whose only role was to enable the flow of goods and services between suppliers and consumers - and who were of themselves incapable of innovation. This conclusion could be attributed partly to the dominant nineteenth century view that manufacturing rather than services provided the primary motor of economic growth and partly to the fact that in many developed markets, until the early 1970s the retail industry was fragmented, mainly consisting of singlestore and smaller chain retailers. In the UK the sector represents 7% of total value-added and employs 2.6 million (10%) of the total working population (Burt, 2003). In 2006 general retailing was the UKs eighth biggest contributor to value added. Tesco is the biggest UK private employer (240,000 employees) (FT 500, 2001), the twelfth biggest individual contributor to value added and among the eight fastest growing UK companies (DTI, 2005; DTI, 2006). The contributions of retailing can be seen as economic, social and environmental in their nature. From an economic perspective, retailers make both: Direct contributions towards GDP, employment and the supply of vital products and services to the population which stimulates demand and economic growth. Indirect contributions, which are less easily recognised and work in the form of a multiplier effect. However, retailing has a role to play not only in economic but also in social terms. Some retail brands (not always the largest) perform as cultural innovators, creating or assisting in the creation of trends for new products and services; or making such products and services more widely available to larger sections of the population. For example clothing retailer Zaras quick response, vertically integrated business model made an opportunity of the transience of fashion to create distinctive competitive advantage, whilst Marks & Spencers growth of its Simply Food smaller format store was explicitly designed to bring convenience foods to more convenient locations. A retailer with strong brand equity will be able to convey clearer value to customers which in turn will provide a more rigorous basis for innovation within the firm.

Drivers of Change:
The retailing that we see today is the product of four main forces: economic, social, features arising from changing levels of competition and innovation (including technology), and those derived from evolving regulation. In some cases, these influences act as constraints, in some cases they provide real opportunities for experimentation and innovation.

Economic Drivers:
For much of the past fifteen years, the UK economys development has been underpinned by extensive growth in domestic consumption. The broad consequence of this has been the relatively untrammelled growth of retail businesses and an optimistic and entrepreneurial outlook towards experimentation and expansion in a variety of ways. Most recently, the Bank of England has sought to rein in consumer spending through a series of interest rate rises. This, in combination with concern over rising levels of personal debt and more general economic uncertainty, has led to growth in retail spending faltering. It has been argued that the combination of price deflation accompanied by cost inflation has led some retailers into an increasingly difficult financial position and focused attention upon some types of innovation (such as process-related innovation delivering productivity benefits) over others. Firms can put pressure on suppliers to reduce the cost of goods or can also accept a fall in margin; cut other costs, or persuade consumers to trade up to higher margin products within a category.

Demographic and Consumer Behavioural Drivers:

The paradox presented by consumers lack of appreciation of price falls in certain categories of consumer goods can be largely explained by the halo effect of price increases occurring in more obvious categories - such as household utilities and transport. Many consumers are already inclined to believe that the selling price of a product is substantially higher than its fair price would be. Greater sensitivity to price and greater wariness of retailers promises on price, together with the growth of greater price information availability as a result of the Internet, has led to a greater focus on value formats by retailers. An increasing number of sectors have gone to value.

Consumers have also begun to exert greater control within the buying process, not least in response to the non-price concerns expressed above, ranging from word of mouth effects to product boycotts. The National Consumer Councils Active Consumer Index, which tracks switching trends for six services markets, has risen 52% since 2000. Retailers have not been immune to this growing activism as it has extended into broader areas of social and environmental responsibility. Solutions for retailers run from choice editing in product range, to the use of environmental or social sustainability as a differentiator in the creation and design of formats, to a complete ethical makeover. There is a potential dilemma for some firms in that the pressure towards providing value for money formats pushes firms towards cheaper, and potentially less sustainable, procurement. Similarly a contrasting growth in demand for service and experience amongst some consumers can be seen as both an attractive non-price differentiator when set against online competitors, but also a potentially costly consideration in designing new formats in the light of what we have said already about the increasing cost of space and of retail labour.

Competition and Innovation drivers:

In general terms, levels of competition ultimately determine the mix and range of retailing on offer to consumers and the extent to which continual innovation is required to build a switching barrier between, say, one retail format and another. With increased levels of competition amongst larger scale retailers, achieving that differentiation on a sustainable basis is costly and requires retailers to make choices. One driver of domestic format innovation comes of course from continually growing international activity within the UK. Estimates made in 2005 suggested that over 500 non-UK retailers currently trade in the UK, numbers which have been rising over the past twenty years, with high proportions of operators in clothing, footwear and accessories, health & beauty, toys and games and department & variety store retailing.

Regulatory drivers:
Regulation is often seen by retailers as an unnecessary cost to the business, but regulation can work to direct and focus innovation in unanticipated and otherwise unexplored ways, in seeking to attain specific social, economic and environmental goals.

Regulation can affect retailers in two ways in relation to innovation. The overall economic viability of any retail business model might be adversely affected or constrained. Additionally, however, because of the nature of retail business, regulation also influences the possible locations available for a particular retail format and the costs of servicing those locations.

Distinctive characteristics of Retail innovation:

Data recording factors such as R&D intensity3 and patent citation, suggests that retailing on a global scale scores relatively lowly compared to sectors such as pharmaceuticals, biotechnology or technology hardware and equipment. The Community Innovation Survey, a four-yearly pan-European examination of innovation activity, was extended to include services and retailing for the first time during its recent iteration in 2005. The survey suggested that: UK retailers report lower levels of innovation than all sectors in the UK as a whole: 40% of firms are innovation active, compared with 57% in the economy as a whole. The sector scores below the all sector average for every category of innovative activity but one; and is apparently significantly lower, for example, in terms of process innovation. Retailing did score highly on new to market product innovations (suggesting high levels of competition in the industry and/or constant search for new business streams and markets). Innovation-related expenditure of retailers is lower than the average; it looks as though this smaller number of innovations was both cheaper and had greater impact than on average. There was also evidence that in low innovation sectors such as oil production, construction or retail banking, large proportion of innovation is to a lesser extent technological, involving organisational and market change or melding technologies in delivering innovative services. This type of innovation remains largely hidden under the radar of the traditional measures of innovation. One other major indicator of the level of innovation within UK firms is the regularly conducted R&D Scoreboard (DIUS, 2007). The 17th annual Edition was published in 2007 and shows that Tesco and Marks & Spencer are amongst the UKs R&D leaders and fastest growing R&D spenders respectively8. In relation to the sector as a whole, however, there are significant deficiencies in the Scoreboard (including significant omissions, misallocation of firms including pharmaceutical suppliers - to the retail sector and some evidence of double-counting).

Whether this is as a result of non-response by major firms, the growth of private equity in the sector, a lack of an R&D line in public company accounts (or other accounting complexities arising from a firms diversified activities), or their not falling into the top 850 UK firms (or top 1,250 global firms), is unclear. For whatever reasons, however, the Scoreboard cannot therefore be regarded as a reliable indicator of retailing R&D. Retailers as innovation hubs: First, retailers are increasingly innovating by acting as intermediaries well beyond their core retail propositions. They do this through what we can call a two-way diffusion process (see Figure 3.3) comprising supply diffusion - which conventionally aggregates, augments and defuses new products, services and technologies from suppliers downstream to consumers - and demand diffusion - a relatively new feature in which the retailer deciphers existing or impending market/consumer needs and communicates them upstream, thus initiating and often co-creating innovations with suppliers. This innovation broadening role of modern retailers suggests that many of them are in the position to act as innovation hubs within their supply chains. The low appropriability of the retail environment: Secondly, the retail environment is one in which innovations can be easily copied. There are environmental factors external to innovating firms which affect an innovators ability to extract profits from their innovation. Such regimes can comprise the availability of legal instruments for protecting innovations like patents or copyrights, alongside technological conditions including production cycles or codified and tacit knowledge. In retailing there are low barriers to protecting intellectual property and thus high risk of not being able to extract profit from innovation. Predominance of non-technical innovation: Thirdly, retail innovation for the most part appears to comprise nontechnological, customer facing activities which are driven by social-economic rather than technological forces. Hybrid characteristics of innovation: Fourthly, some vertically integrated retailers have their own production units or design facilities, such as Zara (Spain) part of Inditex, Migros (Switzerland), Tchibo (Germany), the S-Group (Finland) For instance Migros, the largest Swiss retailer is the second biggest chocolate producer in Switzerland (Hristov, 2004). Others consider themselves manufacturers without factories in the sense that they exert significant upstream influence over suppliers.

These characteristics have specific consequences in terms of innovation. We might expect such retailers to exhibit many characteristics in common with manufacturers, such as a focus on step-wise rather than continuous innovation. On the other hand, all retailers provide services of various kinds and we might expect innovation here to be different from the predominantly linear innovation patterns of manufacturing. Therefore retail innovation displays hybrid characteristics which are consistent with the complex nature of retail output. For instance, in the introduction of certain new product lines, there may be obligations on retailers to undertake scientific and quasiscientific tests and trials. Retailers reverse innovation cycle: Finally, retailing can experience a reverse innovation cycle (where financial and organizational costs are incurred at the end of the innovation process rather than at the beginning). This has also been observed in the financial services sector.

Retailers views on innovation:

From the feedback received from retailers on innovation a distinction was found between those innovations that were strategic and these which were more operational in character. Strategic Retail innovation: Although retail innovation tends to follow a pattern of a continuous change mode rather than the more pronounced manufacturing pattern of series of step changes between periods of stability, there is evidence that more radical innovations are often qualified as strategic in the sense that they are guided by corporate strategy. Strategic innovations might involve the development of new retail formats for international markets, in the case of Tescos new Fresh and Easy concept for the US market. Operational Retail innovation: At an operational level there seems to be a broad consensus that innovation is associated with new products, ideas or ways of operating. The predominant view suggests that operational retail innovations are mainly continuous, incremental and with a cost or value-added focus. They often involve planning, management sponsorship or resource allocation and have short innovation cycles of between 3 to 18 months. For example, one typical approach to innovation is experimentation through test or lab stores or through continuous store trials.

The retail innovation pyramid: What traditional innovation literature does not explore or explain at any length are the typical application areas in which retail innovation occurs. Our research has identified three such areas: (1) offer-related innovations, (2) support-related innovations and (3) organisation-related innovations. Offer-related areas of innovation include innovations in product, service, category format, channel and market, etc. For example Tescos innovations in non-food categories including stationery, entertainment, house wares, clothing, electronics, financial services, telecoms and convenience store. Support-related areas of innovation: On the other hand, support-related areas of innovation encompass innovations in technology, systems and the supply chain, etc. Examples of these are the development of extranet capabilities in terms of electronic stock control, payment, invoicing and delivery systems, similarly sharpening customer focus through the introduction of customer databases and loyalty schemes or innovating in in-store technologies in terms of sustainable energy consumption, shelf-management or payment systems. Organization-related innovations comprise the third area, which includes innovations with strategic or operational significance that provide management and delivery frameworks for the previous two - such as innovations in the retail model, in administrative processes, cross-functional teams or in new activities which require coherent management mechanisms such as in the case of CSR, sustainability and ecology.

Conclusion:
This paper includes analysis of innovation in the retail sector of U.K. Retailing is the eighth biggest sector of the world economy in terms of total market value and accounts for 7% of total value-added and 10% of the UKs working population. The retail sector makes direct contributions to GDP and employment, but also makes indirect contributions to demand and economic growth through its work with suppliers and business service firms, as well as to the UKs social and environmental performance. Innovation by retailers plays a critical role in allowing the sector to make these contributions. The 17th annual edition of the UKs R&D Scorecard notes that Tesco and Marks & Spencer are amongst the UKs R&D leaders and fastest growing R&D spenders respectively.

References:
Latchezar Hristov and Dr. Jonathan Reynolds(2007);Innovation in the UK retail sector. (1997)Competition in Retailing.