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Perishable Pundit
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Produce Business

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Cheese Connoisseur

Tesco’s US Losses ‘Unnerving’

Our extensive analysis of Tesco’s journey to America continues as Tesco just announced its earnings, which included horrific results related to Fresh & Easy. J.P. Morgan in London summed the matter up this way:

The scale of the losses in the US is rather unnerving: $133m on sales of $212m in 2H08/9 after losing $118m on sales of $147m in the 1H. The company guides to a similar sized sterling loss in FY09/10 (implying an improvement in dollars from $250m to $200m), a year for which it originally envisaged themselves to breakeven.

Then elaborated on the point:

Tesco’s Fresh & Easy format in the US lost £82m on sales of £132m in 2H08/9 after losing £60m on sales of £76m in the 1H. The company guides to a similar sized loss in FY09/10, a year where they originally envisaged itself to breakeven (it now does not make any forecasts for when this point will be reached).

The scale of the losses in the US are … out of all proportion to what one would think reasonable. Working from the company’s guidance of c60 additional stores in FY09/10, we think $600m sales should be possible next year with sales densities perhaps advancing to over $9/sq ft per week by the end of the year.

The business was set up to operate with wage expenses equal to 4% of sales (based on perhaps $17/sq ft sales densities), so it is probably reasonable to assume double this in current conditions. Putting in these numbers would imply huge fixed costs, equivalent to c50% of sales next year on average: it is difficult for us to believe that Tesco would have devised such a cost structure when it knew that this was not going to be a $3-4bn sales business by 2010.

Table 3: Fresh & Easy, $ million

1H07/82H07/81H08/92H08/91H09/10e 2H09/10e
Average space260,000520,000636,500946,5001,156,5001,398,000
Sales/sq ft8.888.618.319.63
Gross profit29425070
Gross margin20.0%20.0%20.0%20.0%
% of sales8.1%8.4%8.7%7.5%
% of sale

% of sales80.4%62.6%45.8%24.5%

Source: Company data, J.P.Morgan estimates

Perhaps, alternatively and maybe more realistically, it is not the fixed costs that are high but rather the gross margins extraordinarily low. This would be consistent with the challenge of being a limited range discounter: the format has to offer prices far below those of regular supermarkets to get people in the store, but it lacks buying power to derive a decent margin on these sales. One response to such a situation is to increase the range, which Tesco is doing, but this will serve to undermine the discount business model trying to be achieved.

We have increased our estimated loss for 2009/10 from £100m to £140m, in line with company guidance.

In its report and associated briefings, Tesco tried to have it both ways. Sir Terry Leahy, Tesco’s CEO, pointed out that the recession was an opportunity for Tesco. Due to Tesco’s financial strength it could charge ahead when others, not as strong financially, had no choice but to pull back. In addition, the recession allowed Tesco to build new stores and distribution centers less expensively. Sir Terry Leahy specifically said that it was finding it could build things for 20% less than it was paying before the crash.

The logic of this, of course, is that if Tesco believes it has a winning format in the US, it should be pouring in the resources to ramp up its expansion. As Jack Welch said when asked how to approach competition during a recession, when it comes to competitors, now is the time to “Buy them or bury them.”

Yet, when it comes to America, somehow the same recession that is an “opportunity” for expansion elsewhere makes a rapid expansion along the lines Tesco had indicated it originally planned to be somehow “not yet prudent.”

Although Sir Terry Leahy points to the fact that former boomtowns such as Phoenix and Las Vegas are no longer booming, the scale back of Fresh & Easy has virtually nothing to do with those cities. The additional stores were heavily slated for northern California with a major new distribution center opening in Stockton. It is just smoke and mirrors to pretend that empty condos in Vegas are stopping construction of a DC in Stockton.

You have to really look to the numbers because so much of the verbiage Tesco officials spout is just spin. Sir Terry Leahy was explaining to analysts after the earnings release that when it comes to Fresh & Easy, “We built the business we wanted to create” — a bizarre thing to say unless the business Tesco wanted to create was one that loses a lot of money.

In truth, the problems of Fresh & Easy remain as they always have been:

  1. A uniform merchandising offer across a diverse group of consumers with different incomes, ethnicities and geographies is a loser.
  2. The failure to accept checks and manufacturers’ coupons puts them outside of consumer expectations.
  3. With the exception of specialized upscale retailers, such as Whole Foods, and the exception of certain categories, such as pizza and rotisserie chicken, the whole “ready-meal” offering is a bust. Americans eat take-out from restaurants instead.
  4. The concept comes across to Americans as commissary-produced food — not “fresh” — because items such as sandwiches and rotisserie chicken are not made fresh on premises but are made roughly the way they would be made to be put in a vending machine.
  5. Small store formats are inconvenient — “not easy” — for most shoppers because these formats don’t carry enough assortment to fully meet the shopper’s desires and so they become just another stop to make.
  6. Fresh & Easy has no identity. People walk in with some seeking an experience similar to Whole Foods, others Trader Joe’s, still others Aldi, and a hundred other things. Even after visiting the store, it is unclear if the priority is to be a bargain or to be green, for example.
  7. There is not enough parking in most stores to support the volumes they need to succeed.
  8. In the rush to sign leases, Fresh & Easy is stuck with a lot of bad locations.
  9. The concept is mostly an urban concept with the most successful stores in more urbanized areas. The concept has little place in Las Vegas.
  10. The stores are too expensive. Our Wal-Mart Pricing Report in Los Angeles, which you can see here, clearly showed that despite all Tesco’s talk of Whole Foods quality at Wal-Mart prices — they couldn’t beat a chain such as Stater Bros. and Safeway — forget about Wal-Mart.
  11. The marketing has attracted the wrong customer. Nothing wrong with giving the consumer good value… in fact low prices make perfect sense. The fixed costs are paid for so any gross margin generated may help. However, instead of offering consistently the best prices in town, the strategy is to overcharge and then give coupons. But the coupons $5 off $20 purchases, $6 off $30 purchases, etc., have attracted a clientele that loves coupons more than they love Fresh & Easy. Every time they try and turn off the couponing, sales collapse.

These problems might be solvable. After all both Aldi and Trader Joe’s run successful small store formats in America. But Tesco has put itself in a bind:

By electing to open up with an enormous distribution center and to transplant British vendors and British management, Tesco created a ‘brilliant or bankrupt’ situation for Fresh & Easy. It had to roll out fast because the overhead was so high. But that fast roll out, in addition to meaning Tesco had to accept sub-par sites, also meant that it had no opportunity to tweak its concept. It is like trying to fix a car while you are driving it — almost impossible.

The there is the arrogance of the approach to America that has made many who could help them elect not to. We’ve written before about small things, such as Tesco’s refusal to join the produce trade association, both local and national. That type of behavior is representative. A company looking to be part of the American industry would pay a few thousand dollars in dues because Safeway, Kroger, SuperValu and Wal-Mart do and because their vendors would appreciate it. Instead Tesco elects to thumb its nose at these associations and at the way things are done in America. It seems, though, that the executives at Tesco are oblivious to the price their shareholders pay for their arrogance.

Tesco has a lot of money, and with the son-in-law of the former Chairman of Tesco running the Fresh & Easy division and Sir Terry Leahy’s prestige tied up in the rollout, they may kick this can down the road a bit and avoid dealing with reality. The truth, though, is that whatever happens in the future, hundreds of millions of dollars have been unnecessarily wasted.

End Of An Era At Wal-Mart

Fresh from Bentonville, here is a piece of news… Ron McCormick, longtime Vice President/DMM of Produce & Floral at Wal-Mart, has been reassigned to a new position focusing on local purchasing and sustainability.

We are not precisely sure what this new job will entail and no replacement has been named yet, though Wal-Mart has been hot on sustainability for some time and Ron has shown interest in the subject.

We ran a piece on a discussion he gave on Wal-Mart’s pursuit of “Heritage Agriculture” that you can read here.

We also have worked with Ron for several years as he chaired the PMA Packaging Council that supervised the PMA Impact Awards for Excellence in Packaging, on which we have been honored to serve as a judge. A not-insignificant portion of this competition focuses on sustainability issues.

Ron has from time to time tried to speak to the industry, as in this interview where he tried to clarify a reorganization of Wal-Mart’s produce procurement operation — though his public outreach became less frequent when there were management changes, and keeping the trade informed became less of a priority.

Ron’s departure from his position is really the end of an era. Ron was brought in by Bruce Peterson, who knew him from their days together at Meijer and — although in recent years the two had only sporadic contact, and many vendors felt they were very different people with different philosophies and attitudes — symbolically at least Ron’s presence was a lineal connection to Bruce Peterson, the man who built the produce operation at Wal-Mart from virtually nothing to the biggest in the world.

We, of course, wish Ron well in his new endeavors and now we have a new question for the industry to ponder: Who ought to sit in what is arguably the single most important produce-specific position on the planet earth?

Tracing Of Foodborne Illnesses
Falls Under A Patchwork Of Poorly-run, Under-resourced State Labs

We’ve been writing about it for years, but finally The New York Times has picked up on the food safety problem caused by incompetent and under-resourced state labs. Gardiner Harris wrote a piece titled, Ill From Food? Investigations Vary By State:

In just about every major contaminated food scare, Minnesotans become sick by the dozens while few people in Kentucky and other states are counted among the ill.

Contaminated peanuts? Forty-two Minnesotans were reported sick compared with three Kentuckians. Jalapeno peppers last year? Thirty-one in Minnesota and two in Kentucky became ill. The different numbers arise because health officials in Kentucky and many other states fail to investigate many complaints of food-related sickness while those in Minnesota do so diligently, safeguarding not only Minnesotans but much of the rest of the country, as well.

In fact what state one is in can make a big difference in the way an individual experiences the government reaction to a foodborne illness:

Take the case of Lauren Threlkeld, who went to a Kroger grocery store in Lexington, Ky., in August 2007 and bought a bag of Dole baby spinach contaminated with E. coli O157. She became violently ill with bloody diarrhea and was hospitalized for nearly a week.

When Ms. Threlkeld finally went home to recuperate in Madisonville, Ky., a county health worker called only to verify that she had fallen ill in another county. No one asked about the foods she had eaten or what might have made her so ill, she said. Later efforts by her lawyer pinpointed the source of her illness — far too late to help others avoid similar fates.

Dr. William D. Hacker, the public health commissioner in Kentucky, blamed tight budgets. “We have had a historically poor record of reporting” food-borne illnesses, Dr. Hacker said. “We are working hard to change our culture even with limited resources.”

In Minnesota and a few other states, victims of food-related illnesses tell very different stories. Sarah Kirchner of Belle Plaine, Minn., said health workers called her three separate times and spent hours discussing her children’sdiet almost immediately after a laboratory test verified that one had fallen ill with salmonella. Officials in Minnesota traced the outbreak to peanut butter in part because of Ms. Kirchner’s responses.

Many states are very limited in terms of laboratory capacity:

In Utah, for instance, only 18 of the state’s 1,388 medical laboratories process stool tests, said Dr. Pat Luedtke, director of the Utah public health laboratory.

There also are other barriers to gathering the needed information:

Well-meaning doctors who wish to send stool samples sometimes must pay the postage because insurers often refuse to pay for a test that largely serves a public health function; many doctors do not bother.

This New York Times reporter caught this key insight:

Congress and the Obama administration have said that more inspections and new food production rules are needed to prevent food-related diseases, but far less attention has been paid to fixing the fractured system by which officials detect and stop ongoing outbreaks. Right now, uncovering which foods have been contaminated is left to a patchwork of more than 3,000 federal, state and local health departments that are, for the most part, poorly financed, poorly trained and disconnected, officials said.

The truth is that hiring inspectors to stand around plants in the hope they will see invisible pathogens is an enormous waste of money. In contrast, bringing every state lab and public health service up to the level of Minnesota would be a wise and transformational investment in food safety.

Pundit’s Mailbag —
Guest Worker Programs

We have written a great deal about immigration. Our recent piece, Will US Citizens Harvest Crops? brought some interesting mail:

Regarding your piece on immigration and the more specific question of what the AFL/Change to Win Coalition position is on AgJOBS. As Co-chair for the Agricultural Coalition for Immigration Reform (ACIR), which represents the diversity of those supporting AgJOBS, I must point out that the opinion expressed regarding general union opposition to guest workers, including AgJOBS, is inaccurate and needs to be corrected.

I would recommend the following statement:

“Considerable media attention has been given to statements released this past week by the AFL-CIO and Change to Win Coalition regarding the conditions for their support for comprehensive immigration reform legislation. While media reports indicate that major national labor unions do not support expanded guest worker programs but would consider a Commission to study the need for future guest worker programs as part of comprehensive immigration reform legislation, there is no doubt that the guest worker policy positions of these labor organizations do not include the H-2A guest worker reform provisions of AgJOBS. This union support has been communicated by representatives of the United Farm Workers Union to leaders of the national agricultural coalition spearheading efforts to pass AgJOBS this Congress. To the contrary, these labor organizations have and continue to support AgJOBs, including its H-2A guest worker reform provisions, as part of comprehensive immigration reform. It is important that this accurate message be communicated to the grower and farm worker communities.”

Thank You for the opportunity to clarify this very important information.

— Luawanna Hallstrom
Co-chair, ACIR

We appreciate Luawanna’s letter. She certainly works hard for the industry. Her day job is in the family business as she is Chief Operations Officer and General Manager for Harry Singh & Sons and Business Manager for Oceanside Produce. She is also Western Vice President for the National Council of Agricultural Employers and still manages to co-chair ACIR in her spare time. So we thank her for her service to the trade.

On the specifics of what the AFL-CIO and Change to Win Coalition actually endorse at this point, we find it difficult to say for sure. The new position paper does leave a little wiggle room:

Improvement, Not Expansion, of Temporary Worker Programs
The United States must improve the administration of existing temporary worker programs, but should not adopt a new “indentured” or “guest worker” initiative. Our country has long recognized that it is not good policy for a democracy to admit large numbers of workers with limited civil and employment rights.

AgJOBS requires that existing illegal immigrants who have worked in agriculture can be granted temporary residence status. Then they must continue to work in agriculture to earn an adjustment of status to permanent resident status. The United Farm Workers Union would like that as it creates a source of new members, whether the national labor federations will see that as an “indentured” initiative we are uncertain.

Certainly, as Luawanna points out, the United Farm Workers of America has endorsed AgJOBS, so has Change to Win, though we can find no official position by the AFL-CIO on the topic. Still, now there is a new mechanism, a commission, and it is hard to see how ag won’t get included in that process; certainly nothing was said at the press conference about an exclusion of agriculture from the commission and it is not in the position paper. It is also noticeable that nobody from the labor federations themselves wrote to correct us, although we know we have many readers in the labor movement.

One wonders if “deals” that were made last year won’t come undone with a new administration and a new attitude in the country. If AgJOBS is to pass, the passive support of these national federations may not be sufficient. So the question is not what they technically endorse, it is what are they prepared to fight for. We will soon find out.

Many thanks to Luawanna Hallstrom and ACIR for clarifying this important subject.

We also received a thoughtful comment from one not favorably disposed to guest worker programs:

It has been my experience that Guest Worker Programs, in the past, were nothing more than government-sponsored slavery. Workers were taken advantage of in many ways. Overcharged for food and shelter, physically and sexually abused by growers and labor contractors and often used as scabs in labor disputes.

These abuses in the Guest Worker Program are well documented and available to anyone interested in reporting all sides of the issue. Having been raised in California’s San Joaquin Valley to a family whose business was food retail and wholesale, I have seen these abuses first hand and challenge the view that guest workers are the answer to the “immigration issue”.

If abuses in California don’t do it for you…… check out Florida.

I very much enjoy your column but do have an issue with your Hannity-like swipes at President Obama… you should save those swipes for when you become a talent at Fox News.

— Michael Angelo
Director National Sales
Calavo Growers Inc.
Santa Paula, California

We thank Mike for being so blunt and sharing his personal experience with the broader industry. It is not easy to stand up against the official position of many industry organizations, but it is only through the courage of people like Mike that we can have an honest discussion on such issues.

At the same time, although we appreciate his frankness, we wouldn’t write using such strong language unless we were prepared to do the work to back up such assertions. And that is tougher than it sounds. Not only do we have to prove that people were held as slaves but we have to quantify it.

Slavery is a specific word with a specific meaning — what percentage of people in, say, the Bracero program were actually held in a condition that would be appropriate to call slavery? And how does that compare to how illegal immigrants are treated? After all, the recent allegations of “slavery” in Florida did not apply to a guest worker program… they referred to illegal immigrants. Still, it is worth noting that othersshare many of Mike’s concerns.

Just recently Jason L. Riley wrote in The Wall Street Journal a piece titled, Obama and the ‘Amnesty’ Trap, which was subtitled, “The Immigration Bottom Line: We Need More Legal Avenues” that argued for such programs:

The nation’s two largest labor groups, the AFL-CIO and Change to Win, have already announced that they will oppose any new guest-worker initiatives and any significant expansion of temporary work programs already in place. Democrats and advocacy groups, who tend to see immigration as a humanitarian issue more than an economic one, will likely side with labor. But history suggests that such programs are effective in reducing illegal entries. Past experience shows that economic migrants have no desire to be here illegally. They will use the front door if it’s available to them, which reduces pressure on the border and frees up homeland security resources to target drug dealers, gang members, potential terrorists, and other real threats.

Nearly seven decades ago, the U.S. faced labor shortages in agriculture stemming from World War II, and growers turned to the Roosevelt administration for help. The result was the Bracero program, which allowed hundreds of thousands of Mexican farm workers to enter the country legally as seasonal laborers. In place from 1942 to 1964, the program was jointly operated by the departments of Justice, State and Labor. As the program was expanded after World War II to meet the labor needs of a growing U.S. economy, illegal border crossings fell by 95%. A 1980 Congressional Research Service report concluded that, “without question,” the program was “instrumental in ending the illegal alien problem of the mid-1940s and 1950s.” Apparently, the law of supply and demand doesn’t stop at the Rio Grande.

Beginning in 1960, the program was phased out after it faced opposition from labor unions. And since nothing comparable emerged to replace it, illegal entries began to rise again. The point isn’t that we need to resurrect the Bracero program, or that guest-worker programs alone will stop illegal immigration from Mexico. But a Bracero-like program with the proper worker protections ought to be the template. And expanding legal immigration ought to be where the Obama administration channels its energies.

Still, one doesn’t have to believe that guest worker programs lead to slavery or abuse to find them problematic.

The most interesting academic work in this field has been done by Philip Martin, a professor at UC Davis. You can look at a slideshow he developed on the subject of guest workers.

A key insight he develops is that temporary workers almost always become permanent. He attributes this phenomenon to “distortion and dependence.”

By distortion, he means that the availability of guest workers distorts the economy. In other words, if there is no labor to pick produce in a given area, nobody will plant trees there. But if there is a guest worker program, the trees get planted and if you try and end the guest worker program, the tree owner screams bloody murder that he will be put out of business. For political and economic reasons, the system will likely provide workers — legally or winked at.

By dependence, he means that the developing countries that send labor become dependent on remittances and ending a program can cause tremendous social unrest, revolution, etc., so we won’t really send the workers back.

Now, if the migrant program is not really going to be temporary, then why not just allow in more immigrants?

In our mind this brings us to the really key point. Simply letting in more immigrants or legalizing the ones who are here doesn’t actually solve the problem for agriculture. Because if you give people green cards, they find other jobs.

Now we have no delusions about making harvesting fun. But a lot of people take a lot of jobs that are very difficult: outdoor construction work, etc. Surely we can find a way to make harvesting work competitively with these other difficult jobs.

As far as Mike’s comments on our “Hannity-like swipes at President Obama,” although we suspect Sean would be insulted by the comparison, we actually try to swipe without fear or favor. If you read our discussion of the financial crisis, you will see we weren’t all that happy with President Bush and his administration either.

And as far as becoming a “talent” on Fox goes, well, we appreciate the thought and we have done quite a few pieces with Stuart Varney on the Fox Business Channel. We wonder what Rupert Murdoch would think?

Still, our roots are deep in the produce industry, and we are lucky enough to have a chance to make a difference doing something we enjoy. So you are probably stuck with us for some time to come.

Many thanks to both Luawanna Hallstrom and Michael Angelo for helping us address this important issue.

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