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Tesco and Ocado: Competing Online Models Net Present Value (NPV) / MBA Resources

Introduction to Net Present Value (NPV) - What is Net Present Value (NPV) ? How it impacts financial decisions regarding project management?

NPV solution for Tesco and Ocado: Competing Online Models case study


At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Tesco and Ocado: Competing Online Models case study is a Harvard Business School (HBR) case study written by Ralf W. Seifert, Richard Markoff. The Tesco and Ocado: Competing Online Models (referred as “Ocado Grocery” from here on) case study provides evaluation & decision scenario in field of Technology & Operations. It also touches upon business topics such as - Value proposition, .

The net present value (NPV) of an investment proposal is the present value of the proposal’s net cash flows less the proposal’s initial cash outflow. If a project’s NPV is greater than or equal to zero, the project should be accepted.

NPV = Present Value of Future Cash Flows LESS Project’s Initial Investment






Case Description of Tesco and Ocado: Competing Online Models Case Study


The online grocery market in the UK is one of the largest in the world. It has many players, but two of the most dynamic are Tesco and Ocado. These two companies have taken markedly different approaches to executing and fulfilling online grocery orders from customers. Tesco has an extensive network of stores and primarily uses these stores as picking locations to prepare and ship customer orders. Ocado has no retail stores, and uses highly automated distribution centers to prepare and ship customer orders. This case describes the UK online grocery market and the two companies; it invites students to consider the differences in the approaches, in which ways they offer advantages to the company and to customers, and ultimately which one is better suited to the UK online grocery market. Learning objective: The objective of this case to develop an appreciation and understanding of the different benefits, costs and constraints of supply chain distribution models. By contrasting two companies that have very different supply chain approaches to competing in the same market, the case leads students to make connections between a company's supply chain strategy and its customer value proposition.


Case Authors : Ralf W. Seifert, Richard Markoff

Topic : Technology & Operations

Related Areas :




Calculating Net Present Value (NPV) at 6% for Tesco and Ocado: Competing Online Models Case Study


Years              Cash Flow     Net Cash Flow     Cumulative    
Cash Flow
Discount Rate
@ 6 %
Discounted
Cash Flows
Year 0 (10001944) -10001944 - -
Year 1 3465083 -6536861 3465083 0.9434 3268946
Year 2 3979608 -2557253 7444691 0.89 3541837
Year 3 3944753 1387500 11389444 0.8396 3312091
Year 4 3231424 4618924 14620868 0.7921 2559590
TOTAL 14620868 12682464




The Net Present Value at 6% discount rate is 2680520

In isolation the NPV number doesn't mean much but put in right context then it is one of the best method to evaluate project returns. In this article we will cover -

Different methods of capital budgeting


What is NPV & Formula of NPV,
How it is calculated,
How to use NPV number for project evaluation, and
Scenario Planning given risks and management priorities.




Capital Budgeting Approaches

Methods of Capital Budgeting


There are four types of capital budgeting techniques that are widely used in the corporate world –

1. Payback Period
2. Net Present Value
3. Profitability Index
4. Internal Rate of Return

Apart from the Payback period method which is an additive method, rest of the methods are based on Discounted Cash Flow technique. Even though cash flow can be calculated based on the nature of the project, for the simplicity of the article we are assuming that all the expected cash flows are realized at the end of the year.

Discounted Cash Flow approaches provide a more objective basis for evaluating and selecting investment projects. They take into consideration both –

1. Timing of the expected cash flows – stockholders of Ocado Grocery have higher preference for cash returns over 4-5 years rather than 10-15 years given the nature of the volatility in the industry.
2. Magnitude of both incoming and outgoing cash flows – Projects can be capital intensive, time intensive, or both. Ocado Grocery shareholders have preference for diversified projects investment rather than prospective high income from a single capital intensive project.






Formula and Steps to Calculate Net Present Value (NPV) of Tesco and Ocado: Competing Online Models

NPV = Net Cash In Flowt1 / (1+r)t1 + Net Cash In Flowt2 / (1+r)t2 + … Net Cash In Flowtn / (1+r)tn
Less Net Cash Out Flowt0 / (1+r)t0

Where t = time period, in this case year 1, year 2 and so on.
r = discount rate or return that could be earned using other safe proposition such as fixed deposit or treasury bond rate. Net Cash In Flow – What the firm will get each year.
Net Cash Out Flow – What the firm needs to invest initially in the project.

Step 1 – Understand the nature of the project and calculate cash flow for each year.
Step 2 – Discount those cash flow based on the discount rate.
Step 3 – Add all the discounted cash flow.
Step 4 – Selection of the project

Why Technology & Operations Managers need to know Financial Tools such as Net Present Value (NPV)?

In our daily workplace we often come across people and colleagues who are just focused on their core competency and targets they have to deliver. For example marketing managers at Ocado Grocery often design programs whose objective is to drive brand awareness and customer reach. But how that 30 point increase in brand awareness or 10 point increase in customer touch points will result into shareholders’ value is not specified.

To overcome such scenarios managers at Ocado Grocery needs to not only know the financial aspect of project management but also needs to have tools to integrate them into part of the project development and monitoring plan.

Calculating Net Present Value (NPV) at 15%

After working through various assumptions we reached a conclusion that risk is far higher than 6%. In a reasonably stable industry with weak competition - 15% discount rate can be a good benchmark.



Years              Cash Flow     Net Cash Flow     Cumulative    
Cash Flow
Discount Rate
@ 15 %
Discounted
Cash Flows
Year 0 (10001944) -10001944 - -
Year 1 3465083 -6536861 3465083 0.8696 3013116
Year 2 3979608 -2557253 7444691 0.7561 3009155
Year 3 3944753 1387500 11389444 0.6575 2593739
Year 4 3231424 4618924 14620868 0.5718 1847577
TOTAL 10463587


The Net NPV after 4 years is 461643

(10463587 - 10001944 )








Calculating Net Present Value (NPV) at 20%


If the risk component is high in the industry then we should go for a higher hurdle rate / discount rate of 20%.

Years              Cash Flow     Net Cash Flow     Cumulative    
Cash Flow
Discount Rate
@ 20 %
Discounted
Cash Flows
Year 0 (10001944) -10001944 - -
Year 1 3465083 -6536861 3465083 0.8333 2887569
Year 2 3979608 -2557253 7444691 0.6944 2763617
Year 3 3944753 1387500 11389444 0.5787 2282843
Year 4 3231424 4618924 14620868 0.4823 1558364
TOTAL 9492393


The Net NPV after 4 years is -509551

At 20% discount rate the NPV is negative (9492393 - 10001944 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Ocado Grocery to discount cash flow at lower discount rates such as 15%.





Acceptance Criteria of a Project based on NPV

Simplest Approach – If the investment project of Ocado Grocery has a NPV value higher than Zero then finance managers at Ocado Grocery can ACCEPT the project, otherwise they can reject the project. This means that project will deliver higher returns over the period of time than any alternate investment strategy.

In theory if the required rate of return or discount rate is chosen correctly by finance managers at Ocado Grocery, then the stock price of the Ocado Grocery should change by same amount of the NPV. In real world we know that share price also reflects various other factors that can be related to both macro and micro environment.

In the same vein – accepting the project with zero NPV should result in stagnant share price. Finance managers use discount rates as a measure of risk components in the project execution process.

Sensitivity Analysis

Project selection is often a far more complex decision than just choosing it based on the NPV number. Finance managers at Ocado Grocery should conduct a sensitivity analysis to better understand not only the inherent risk of the projects but also how those risks can be either factored in or mitigated during the project execution. Sensitivity analysis helps in –

Understanding of risks involved in the project.

What will be a multi year spillover effect of various taxation regulations.

What are the key aspects of the projects that need to be monitored, refined, and retuned for continuous delivery of projected cash flows.

What are the uncertainties surrounding the project Initial Cash Outlay (ICO’s). ICO’s often have several different components such as land, machinery, building, and other equipment.

What can impact the cash flow of the project.

Some of the assumptions while using the Discounted Cash Flow Methods –

Projects are assumed to be Mutually Exclusive – This is seldom the came in modern day giant organizations where projects are often inter-related and rejecting a project solely based on NPV can result in sunk cost from a related project.

Independent projects have independent cash flows – As explained in the marketing project – though the project may look independent but in reality it is not as the brand awareness project can be closely associated with the spending on sales promotions and product specific advertising.






Negotiation Strategy of Tesco and Ocado: Competing Online Models

References & Further Readings

Ralf W. Seifert, Richard Markoff (2018), "Tesco and Ocado: Competing Online Models Harvard Business Review Case Study. Published by HBR Publications.


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