Background

Tesco PLC is a British multinational grocery and general
merchandise retailer with headquarters situated in Hertfordshire, England. The
company was founded in 1919 by Jack Cohen who began buying surplus stock from
the British Army and selling it from his market stall in Hackney. In 1924,
Cohen purchased a shipment of tea from supplier T.E Stockwell and sold it as
his own-brand product. When choosing a name for his brand, Cohen decided to
take the initials of his supplier and combine them with the first two letters
of his surname to produce the name Tesco. The first Tesco store was opened in
1929 and by 1939 there were over 100 Tesco stores across the UK. Since then,
Tesco has experienced rapid growth and is now the 9th largest
retailer in the world in terms of revenue (Deloitte, 2017). The company operates
in a number of different countries all over the world, employing over 460’000
people across 6809 stores – 3739 of which are in the U.K. Tesco has a number of
subsidiaries including its online service Tesco.com and also Tesco Bank which
offers financial services to customers in the U.K. Many of Tesco’s stores are
now equipped with petrol stations which has led to Tesco establishing itself as
the U.K’s largest independent fuel retailer with the company reporting £6.05
billion in revenue from fuel sales in 2016/17 (Tesco Annual Report, 2017). The
majority of Tesco’s revenue, however, comes from its retail operations which
generated £48.8 billion in revenue in 2016/17.

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Retail Industry

The retail industry is the largest industry in the U.K and
is vital to the success of the country’s economy. In 2016 alone the retail
industry generated £358 billion in sales, accounting for 5% of the U.K’s total
GDP (Gross Domestic Product). The largest part of the retail industry is the
food and drink sector, which accounted for £171.1 billion of the total retail
sales in 2016. The industry employs over 3.9 million people in the U.K which is
14% of the entire U.K workforce. The food and drink sector is dominated by
supermarket chains with Tesco occupying 28.0% of the market share. Its main
competitors are Sainsbury’s (16.2%) and Asda (15.3%), however, German value
chains Aldi and Lidl have saw rapid growth in recent years, occupying 6.7% and
5.1%, respectively (Kantar Worldpanel, 2017). There are a number of external
forces which can affect the performance of companies within the retail sector
including economic factors such as unemployment levels; social factors such as
family size and political factors such as the political and legislative
conditions of the countries in which they operate. These factors can present a
number of risks to companies so it is important that they are addressed in both
the strategy setting and risk management processes. Failure to manage these
risks effectively can have devastating effects on a company’s financial health.

Tesco Accounting Scandal

In September 2014, Tesco released a statement admitting that
it had overstated its profits for the first-half of 2014 by £326 million. As a
result, Tesco’s share price dropped by over 50% in one year – wiping £2 billion
off its market value. The company set the record for the biggest ever loss
recorded by a retailer, recognising a £6.3 billion loss for the year. The
scandal resulted in Tesco being investigated by the Financial Conduct Authority
(FCA) and the Serious Fraud Office (SFO). The investigations came to an end in
March 2017 with Tesco agreeing to pay £235 million in a settlement deal. Tesco
were not the only organisation subject to investigation; after the scandal came
to light, the Financial Reporting Council launched an investigation into the
conduct of Tesco’s auditors – PricewaterhouseCooopers (PwC). However, the
investigation was later closed with the FRC’s executive council stating that
there was “not a realistic prospect that a tribunal would make an adverse
finding against PwC” (FRC, 2017). Deloitte later replaced PwC as Tesco’s
auditor in 2015.

Tesco has been on a long road to recovery since the
accounting scandal came to light and have been working tirelessly to regain
competitiveness, improve its balance sheet and rebuild trust in its brand
(Tesco Annual Report, 2017). The scandal was ultimately a risk management
failure as there should have been appropriate controls in place to prevent it
from happening. Accordingly, there have been extensive changes in the way risk
is managed throughout the organisation (Tesco Annual Report, 2015).

Oversight

The Tesco board has overall responsibility for ensuring that
there is an effective risk management structure throughout the organisation.
The board is responsible for setting the organisations risk appetite and is
directly involved in the risk assessment process. The board is also responsible
for conducting a yearly review to ensure the effectiveness of the
organisation’s risk management process and internal controls. There is clear
division of responsibility between the running of the board and the running of
the business. The chairman is responsible for the leadership of the board and
ensuring that it is operating effectively, whilst the responsibility of the
day-to-day management of the business has been delegated to the group chief
executive. The group chief executive is responsible for developing and
implementing the organisation’s strategy and has overall accountability for the
control and management of risk. The Group Chief Executive is supported by the
Executive Committee, which is responsible for making and implementing
operational decisions while running Tesco’s day-to-day business, and for making
recommendations to the Board.

The board is supported by a number of committees, including
the audit committee which is responsible for overseeing and reviewing the
effectiveness of the organisation’s risk management process and systems of internal
control (Tesco Annual Report, 2017). They report the results of the review to
the board and provide them with recommendations for areas where action is
required.

The group compliance committee is responsible for monitoring
legal and compliance risks, ensuring that the organisation is adhering to all
regulation requirements.

Regulation

In the UK, all companies with a premium listing of equity
shares are required under the listing rules to report in their annual report
and accounts on how they have applied the UK Corporate Governance Code which is
published by the Financial Reporting Council (FRC, 2016).

In the context of risk management, the code states that the
board has ultimate responsibility for risk management and internal control,
including for the determination of the nature and extent of the principal risks
it is willing to take to achieve its strategic objectives and for ensuring that
an appropriate culture has been embedded throughout the organisation (FRC,
2016).

The corporate governance section of Tesco’s annual report
contains a statement from the board confirming that the company has applied the
main principles and complied with the relevant provisions set out in the UK
Corporate Governance Code.

 

 

 

 

 

Organisational Culture

The corporate governance section of Tesco’s annual report
contains a statement from the chairman of the board acknowledging
responsibility for ensuring that employees do the right things in the right way
by setting a tone from the top and leading by example (Tesco Annual Report,
2017).

Tesco have three main values:
– No one tries harder for customers
– We treat people how they want to be treated
– Every little help makes a big difference

These values are recognised across the organisation and have
become a vital part of Tesco’s culture. They help to align everyone to the same
objective and ensure that everyone at Tesco understands that customers are the
heart of the business. The values are instilled throughout the organisation
through numerous communication channels and are supported by Tesco’s Code of
Business Conduct which sets out the standards that are required throughout the
organisation. Colleagues must complete mandatory Code of Business Conduct
training and annually attest to compliance with the Code (Tesco Annual Report,
2017). Communication is an important part of the organisational culture at
Tesco (Tesco Annual Report, 2017). There are a number of ways for employees to
communicate to senior management such as team meetings, feedback forms and
Tesco’s employee intranet, ourtesco.com. The board recognise that feedback from
employees on ground level is important as it allows them to gain insight into
the real issues and make appropriate changes (Tesco Annual Report, 2017).

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Key Elements of Risk Management

Tesco has an
established risk management process which allows them to identify, assess and
monitor the principle risks that they face as a business (Tesco Annual Report,
2017). The organisation’s internal audit function conducts interviews with
business leaders as part of the risk identification process. A risk which can
impact the ability of the organisation to implement its strategy is termed a
principle risk. A risk assessment is then conducted to determine the potential
impact and likelihood of each risk, taking into account internal controls in
that are in place. A risk register is maintained containing all of the
principal risks faced by the organisation. This is cascaded down the
organisation and is considered and discussed during regular meetings with
senior management. Risks are managed on an ongoing basis and are regularly
subject to review to ensure relevance and completeness (Tesco Annual Report,
2017). The principal risks faced by the organisation are shown in the diagram
below:

 

 

 

 

 

 

 

 

 

 

 

Tesco’s 2017 annual report presents each of its principal
risks in a table which has three columns. The first column gives details
regarding each of the risks and how they relate to the business; this column
also contains a numbering system which links each risk to the organisation’s
strategic drivers:

1)     
Build a differentiated brand

2)     
Reduce operating costs by £1.5 billion

3)     
Generate £9 billion cash from operations

4)     
Maximise the mix to achieve a 3.5% – 4.0% group
margin

5)     
Maximise value from property

6)     
Innovation

The second column gives details regarding risk movement and
uses an arrowing system to state whether the risk has increased, decreased or
is the same as the previous year. The third column gives details of the key controls
that the company has in place to manage each risk.

Whilst not defined as a principal risk, Tesco’s annual
report also contains a section identifying the potential effects that Brexit
could have on the business. As there has been little agreed between the
negotiating teams of the U.K and the E.U, it is difficult to say what the
long-term effects of Brexit on the retail sector might be. However, CBI
(Confederation of British Industries, 2017) has identified a number of key
areas of importance to the retail sector:

–         
EU trade: tariffs and other barriers may
increase

–         
Migration: access to labour from the EU supports
growth in the retail sector

–         
Regulation: changes to the existing regulatory
environment presents a risk to stability which producers and consumers need

–         
Currency: the lower value of the pound may cause
prices to rise even further

Tesco recognise that these key areas could have an adverse
effect on the business and its operations. Tesco’s annual report states that
management will continue to monitor and assess the potential risks and impacts of
these on Tesco stakeholders.

Does Tesco Have Effective Risk Management?

The information provided in Tesco’s annual report provides
in-depth insight into how risk is managed throughout the organisation. From the
information provided, it is evident that Tesco make use of an enterprise-wide
approach to risk management. An enterprise-wide approach allows for enhanced
planning and performance, promotes information processing and communication,
improves accountability, and protects organizational and individual reputations
(Kleffner, 2003). The board of directors is responsible for ensuring that the
organisation has effective risk management in place and also for setting the
risk appetite. The risk appetite is defined amount of risk that the
organisation is willing to accept in pursuit of their strategic objectives
(Brown et al., 2009). It is executive committee’s responsibility to ensure
compliance with the risk appetite and also to promote the organisations risk
management philosophy and strategy throughout across the organisation (Beasley
et al., 2010). Tesco’s board is also supported by an audit committee, which Lloyd
& Fanning (2007) state is critical for organizational success in a dynamic
environment like the retail sector. Paape and Speklé (2012) indicated that
audit committees are essential in the oversight of risk management practices.

Tesco’s risk management process is effective because there
is a clear link between risk management and the organisation’s strategy. Each
of the principal risks detailed in the annual report are assigned to the
strategic drivers which they have the potential to affect. The primary goal of
enterprise risk management is to assist an organisation in achieving its
strategic objectives, therefore, ERM must be part of the strategic planning
process and the strategy execution process (Beasley et al, 2007). Considering
risk during strategic planning also allows organisations to identify risk
opportunities (Frigo, 2011). In some situations, ERM may highlight areas where
an organisation is being too risk averse or is ineffectively responding to
similar risks that exist across multiple silos of the organisation. In other
situations, ERM may identify risk opportunities which may create value for the
organisation (Fraser & Simkins, 2010). Greater awareness of risks and
opportunities faced by the organisation as a whole allows for more efficient
use of resources and promotes better decision making throughout the entire
organisation (Slywotzky, 2012).

Tesco also have a monitoring system for each of their
principal risks, documented in their annual report, which shows whether risks
have increased, decreased or stayed the same as the year before. This is
essential to ensure relevance and completeness of each principal risk. Risk is
dynamic in nature, so controls and risk management processes that work well now
may need to be improved in the future (Gordon et al, 2009).

Tesco has a strong organisational culture which is essential
for effective risk management. Executive management’s top-down communications help
to emphasize the organisation’s strategic direction and make sure every
employee from top to bottom knows exactly what is expected of them. The board
and senior management provide also employees with numerous platforms to communicate
what is going on within the business and what is happening in the external
environment. When everyone in the organisation is effectively communicating
information regarding risks and coordinating risk management activities, the
organisation will be better positioned to achieve its strategic goals (Nocco
& Stulz, 2006).

After Tesco’s accounting scandal came to light,
the company experienced a major dip in profits and a loss of reputation. Since
then, the organisation has been on a road to recovery with profits steadily increasing
each year. In 2015/16, the organisation’s operating profit was £985 million and
in 2016/17 the operating profit has increased by 24.9% to £1.28 billion. Sales
have also increased by 1.1% from 15/16, meaning customers are buying more
products, more often at Tesco. Cash flow has also increased by 9.1% from the
previous year. There has also been an increase in shareholder value in terms of
ROCE (Return on Capital Invested). After the accounting scandal, this plummeted
from 13.6% to 4.0% but has been increasing year on year – 6.2% in 2016 and 8.1%
in 2017. These performance measures suggest that Tesco is a company on its way
back to the top; it is with no doubt that this should be accredited to good
governance and effective risk management

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