Opening More Stores as a Profit Strategy (Sheng Siong)

Question

Even as many businesses were battered by the pandemic, the low-frills homegrown supermarket chain Sheng Siong did well financially. It is aiming to open three to five stores annually in the next three to five years.

Discuss whether opening more stores is the best strategy for Sheng Siong to increase its profits. [15]

Answer

Thesis. A firm raises profit by increasing revenue, cutting cost, or both. This essay argues that, for Sheng Siong, opening more stores is the best strategy to increase profit — but only after weighing it against the risk of overexpansion and against the alternatives of product and process innovation, since the verdict depends on the firm’s scale, time horizon and budget.

How opening more stores raises profit. Opening more stores expands Sheng Siong’s scale of production and so lets it reap greater internal economies of scale. Through marketing economies it can buy supplies in larger bulk, gaining bargaining power and a lower price per unit. Through administrative and managerial economies, fixed overheads rise less than proportionately to the number of outlets, so cost per unit of output falls. Both lower average and marginal cost. On the revenue side, more stores in new areas raise accessibility, drawing in more customers and so raising revenue. With cost of production falling and revenue rising together, profit increases.

Anti-thesis (i) — overexpansion can lower profit. This holds only up to the minimum efficient scale. If Sheng Siong expands output beyond it, it begins to suffer internal diseconomies of scale. As outlets multiply, effective communication and coordination become harder, breeding managerial inefficiency and delays that raise unit cost. Rising average cost can then partly offset, or even exceed, the gain in revenue, lowering overall profit.

Anti-thesis (ii) — product innovation as an alternative. Sheng Siong could instead pursue product innovation to differentiate itself — bringing in unique or premium brands, or improving the customer experience through free delivery or an online-shopping app. If successful, demand rises and becomes more price-inelastic as the offering becomes less substitutable, lifting revenue and profit. The limitation is uncertainty: tastes are hard to predict, so the upfront investment may not yield higher revenue — for instance, a shopping app fails if customers are not tech-savvy.

Anti-thesis (iii) — process innovation as an alternative. Alternatively, process innovation — automated self-checkout, warehouse automation of the kind Amazon uses — raises the efficiency of the production process and lowers cost. With average and marginal cost falling, profit rises if revenue is unchanged; and because supermarket goods have inelastic demand, any resulting price fall brings a more-than-proportionate rise in quantity demanded, raising total revenue too. The limitation is the high upfront cost, which can depress profit in the short run.

Evaluation and judgement. On balance, opening more stores is Sheng Siong’s best strategy, on five grounds. First, time horizon: opening stores raises profit in the short run, whereas innovation is a long-drawn process with time lags. Second, budget constraint: R&D demands large financial capital that may be beyond Sheng Siong’s means, limiting the alternatives. Third, combined effect: opening stores both cuts cost (via economies of scale) and raises revenue (via accessibility), whereas process innovation typically only cuts cost and product innovation typically only raises revenue. Fourth, context: Sheng Siong produces a smaller output than rivals such as NTUC FairPrice, which suggests it has not yet reached minimum efficient scale, so further internal economies of scale remain to be reaped — the overexpansion risk is not yet binding. The reasoned verdict is therefore that opening more stores is Sheng Siong’s best strategy. The recommendation that follows is to reinvest the short-run profits it generates into R&D, so the firm secures short-run gains from expansion while building the long-run revenue growth and cost reductions that innovation eventually delivers.