The billion pound grocer

by BBC News Online's Orla Ryan

Supermarket chain Tesco confirmed its position as one of the UK's most profitable retailers when it unveiled its results on Tuesday.

Profits came in at £1.07bn, exactly in line with expectations.

In the "sorry" world that is the UK retail sector, Tesco appears to have come up trumps.

But even as it basks in the glory of its success, Tesco still has one problem to consider - where does it go from here?

Supermarket woes

The UK supermarket sector has become increasingly competitive, with the large chains slashing prices to increase sales.

Many of the traditionally big names, such as Sainsbury's, have found it difficult to retain customer loyalty in this new competitive environment.

Retailing generally is in a "sorry state", according to the latest report from consultancy Verdict and it is companies such as Tesco, Ikea, B&Q and Asda that sell a wide range of goods cheaply that will fare well.

If you can't be as cheap as Tesco or Ikea, then you need to have a good reason for customers to choose you and for niche players such as Harvey Nichols and Selfridges, this could be the standard of service.

Tesco's road to profit

It is clear which route Tesco has taken.

"Customers have told us in detail how they want prices to get lower and lower and we've listened carefully," Tesco executive John Gildersleeve has said.

While prices have been going down, Tesco has managed to sell more goods, allowing its profits to grow.

It has consistently put money back into the business and while shareholders have suffered smaller dividends, this has meant increased efficiencies as, for example, Tesco has upgraded its computer systems.

"Lackluster competition has made its task easier," David Stoddard, retail analyst at Teather & Greenwood added. "Sainsbury has languished for a while. It has made it much easier for Tesco to pick up market share."

But given that it is unlikely that its competitors will take their foot off the price pedal, Tesco remains under pressure to find new ways to grow its business and its profits.

Going global

The increasingly mature UK market and the difficulty in getting planning permission for new sites means that all supermarkets are looking for ways of making more money and many of them are looking overseas.

But there are few successful global retail brands - even retail giant Wal Mart has found it difficult to export its brand to Europe and Asia.

"The case for globalisation of food retailing is still unproven," Teather & Greenwood's Stoddart said.

Indeed fears about the performance of Tesco's overseas stores have hit its share price.

"The market is conscious of potential problems in Poland (excess competition) and Asia (far from ideal economics) and it will be interesting to see if Tesco comments on either of these issues," a note from UBS Warburg said.

"The biggest concern about Tesco's long-term strategy is its exposure to overseas markets, the far east and eastern Europe," Kien Tan, retail analyst at Credit Lyonnais Securities said.

Not just food

But one clear way forward is to sell products other than food.

With consumer spending on food increasing very slowly, supermarkets are looking to make money from other goods.

Tesco saw strong growth of non-food sales in the past year.

In the seven weeks to 6 January, Tesco sold about 14,000 DVD players and 8,000 widescreen televisions, a record period for non-food sales.

Many of Tesco's new stores devote about 40% of their shelf space to non-grocery products.

It isn't the only retailer to have taken this route.

Grocers are expanding into health and beauty, clothing and footwear, homewares, electricals, books and music and videos and already they have increased their share of these markets from 39% to 45%.

Log on to Tesco.com

Tesco has also pinned some of its hopes for future profit on internet shopping.

Tesco has been one of the most successful online retailers

Their internet grocery model is seen as one of the most successful in the world, largely because it has piggybacked its internet businesses on its supermarket stores.

But Tesco.com proved to be a cloud on Tesco's results, posting a loss of £9m.

Moves to broaden the range of goods on offer are in part what hit the company's bottom line.

Analysts agree there is room for increased efficiency at Tesco.com.

The key indicator of success is the profit margin per drop - and Tesco could be making a lot more money on each doorstep delivery. The customer that orders groceries and a book from Tesco, will have the groceries delivered to his door and the book delivered by post - both could be delivered together.

"There is clearly no distribution efficiency there," David Stoddart, retail analyst at Teather & Greenwood said.