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British Intelligence On Tesco:
Three Areas Of Concern

As we have analyzed Tesco’s journey to America, we have acquired new correspondents from wherever Tesco has operations. This note came from a gentleman, still active in the industry, who supplied fresh produce to various multiples in the UK for many years. He has also been involved with some of the most prominent shippers in the US, so he has first-hand experience with both UK retailing and US production agriculture:

I saw the link to your site in Money Week in the UK. I have been in the produce business for 25 years both in the UK and the US. I have grown businesses with Tesco that have been from boom to bust…. so I may not be entirely dispassionate in what I have to say. However I feel the need to comment on your excellent observations and I don’t believe that I am alone.

I was recently in LA and visited a Fresh & Easy. I simply had to see what all the fuss was about? What did they have to offer the US consumer that others didn’t? I was very disappointed, the store was a ‘revamp’ and in a poor location. The offering was basic, which seemed to be seen as a positive!!?? The produce was over-packaged and very poor compared to the excellent offerings in nearby stores. There were very few customers, almost outnumbered by staff!! I had expected to see ready meals but there were few. I left feeling that I still couldn’t see what they were trying to achieve.

I have also talked to producers in California that Tesco wished to trade with. They were told that their standards weren’t up to scratch and they must supply in bulk for Tesco to repack. How can this work? These companies are world leaders and highly efficient. Surely repacking can only lead to more cost and wastage??? Their attitude was extraordinary… or was it?

The same attitude has been their way in the UK for some time now. It is beginning to show in the UK stores too.

Tesco’s rise over the last 10+ years began when they correctly saw the changing eco-social changes taking place in the UK. Tony Blair saw that everyone was becoming middle class or at least aspired to be, so did Tesco.

Very cleverly Tesco positioned its brand so anyone could feel comfortable shopping there… they were able to aim at 100% of the market, other stores were pitching at different social groups so, by definition, were restricted to smaller shares of the market, some at the top — Marks & Spencer, Waitrose, etc. — some at the bottom — Morrison’s, Aldi, ASDA, etc. — and the ones in the middle — Safeway, Somerfield — lost out every which way….

The growth was phenomenal, from less than 20% market share to greater than 40% today. But that has now happened. Customers now have a ‘love/hate’ relationship with Tesco. Many have no choice.

To achieve more growth, Tesco now has to move into more non-food and overseas. At the same time they have stopped listening and have started telling customers what they want. Something they started doing to suppliers 10 years ago.

This does not bode well for Tesco’s future. It may take years to show in the financials because of their size, momentum and huge property portfolio but you can begin to see changes in the UK stores now. There is none of the American service, no “can I help you”, no “have a good one”. By contrast other stores are improving all the time, Morrison’s especially.

I feel, like you, they are going to get their asses kicked, and it will start in the US unless they make some dramatic changes and soon. I’m selling their shares.

I will keep looking at your excellent articles.

We appreciate the kind words for the Pundit and appreciate the contribution of some British expertise to the site. The big problem in getting an accurate assessment as to the likelihood for success of Fresh & Easy out of London is that Tesco has been so successful for so long that you have a whole group of people — suppliers in the industry, analysts in The City, etc. — who have basically built careers betting on Tesco to succeed. And it mostly has.

But the nature of these things is that nobody rings a bell to tell everyone that the party is over and things have changed. It is just that, quite suddenly, all those bets on Tesco that always paid off in the past, go bad.

Our correspondent raises several important points:

  1. How well is Tesco actually doing in the UK today?

On this question much may depend. It is important to note that, contrary to reputation, not all British attempts to enter the US market have been business catastrophes. J. Sainsbury started with a $20-million investment in Shaw’s in 1983 — it exited the US market after 20 years, following several acquisitions, by selling New England’s second largest chain to Albertsons for almost $2.5 billion.

Although there had been several subsequent capital investments, there also had been much profit. The reason J. Sainsbury sold the division had nothing to do with bad performance in the US — it was problems back in the UK. Sainsbury had lost its market-leading position, was deeply concerned about both Tesco and ASDA and decided to concentrate on its home market.

That we could see the same happen with Tesco is unlikely, but not inconceivable. The latest numbers show, as our correspondent indicates, a rise in market share for Morrison’s:

The latest TNS Worldpanel grocery market share figures, published today for the 12 weeks ending January 27, 2008, show strengthening growth for Morrisons. Building on the recent results posted by the firm, sales have lifted a record 11% compared with the equivalent period a year ago. As a result their market share has grown from 11.0% to 11.5%. As we saw last period, this growth is the highest for any of the retailers measured. The relaunch advertising, featuring Lulu and Alan Hansen amongst others, together with strong promotions, has certainly borne fruit.

The same report shows that others are also gaining share:

Aldi, Lidl, and Iceland post strong growth ahead of the market, but then so does Waitrose, indicating that both ends of the perceived price spectrum are continuing their robust performance.

None of this is good news for Tesco back home. Our best information is that the company is seeing small market share drops as a rebounding Morrison’s and Sainsbury combine with a pincher movement of Waitrose and entrants, such as Whole Foods, on the top and discounters, such as Aldi, Lidl and Iceland, on the bottom.

All that has to happen is for Wal-Mart to decide to push harder to open ASDA stores — perhaps with a competitor for Tesco’s Express stores — and Tesco may have other things to worry about than Fresh & Easy.

Of course, we have always been a bit skeptical about Tesco’s retail performance, noting here that Tesco’s earning were virtually all related to its ownership of real estate.

Still, Tesco’s stock is down almost 20% over the last couple of months. Wall Street will say that has nothing really to do with Fresh & Easy and, in a direct sense this is true. But indirectly, a focus on a new launch often drains talent and distracts management from its core business.

With Fresh & Easy having been launched by a dream team drawn from other Tesco operations, the implication is obvious: You can’t both put your best and brightest on a new launch and keep them at home.

And the leverage works in a crazy way. Tim Mason, who Tesco sent over to run its US division, is generally recognized as a truly extraordinary executive and a marketing genius. So let us assume he is so terrific that sales of the US stores are fully 10% higher than they would have been in his absence — what an achievement! Yet, if he was back home in the UK and his marketing savvy boosted Tesco’s UK sales by only 1% — that would be many multiples of what he is accomplishing in America — at least by measure of the company financials for the next several years.

As a leader in the UK, Tesco is always subject to a brain drain. Very possibly, by internally draining talent from Tesco’s core operation, Fresh & Easy may also be hurting UK performance.

  1. The wacky system for buying produce can’t work.

This is a big question. The other day, we ran a piece, Tesco Criticism of $5 Coupons And Hybrid Car Parking, in which a US grower shipper wrote this:

As a produce seller, there is ‘no opportunity’ to sell directly to Tesco. Because of their branded packaging concept, every item must go through a third party, and someone has to be responsible for the shrink in packaging ‘before’ the product is in its final form. It does not seem efficient and the expected value added was not there for many items (salad mix excepted).

Now our British supplier who knows US producers says this:

I have also talked to producers in California that Tesco wished to trade with. They were told that their standards weren’t up to scratch and they must supply in bulk for Tesco to repack. How can this work? These companies are world leaders and highly efficient. Surely repacking can only lead to more cost and wastage??? Their attitude was extraordinary… or was it?

This business of repacking perfectly good produce is bizarre — and unnecessary. It all derives from a British system developed to efficiently handle high volumes. It is not, per se, a bad idea; if Tesco opens Fresh & Easy stores in a place like Manhattan, these techniques that allow produce to be efficiently shipped, displayed and sold might be a winner.

But in the vast majority of the US, the population density is so much less than what Tesco is used to that the stores will simply never generate the sales velocity to need this system.

For example, Phoenix has a population density of around 2,937 people per square mile; London is about 12,331 people per square mile. Add in a much more liberal attitude toward new store openings than in the UK, a much more vibrant low- and medium-priced restaurant sector and Tesco will be lucky if it gets sales per square foot 10% of what they do in London.

So whatever its virtues, this system is designed to handle a velocity they will never need. They should switch mostly to bulk, kill the packaging, make the displays prettier, cut out unnecessary bureaucracy in procurement, and hire Dick Spezzano, Ed Odron or Ray Klocke — all ex-produce retail execs out in California — to tell them how to do it.

  1. Disrespect of Suppliers

This business of not listening and making demands on suppliers — as our correspondent explains, “….they have stopped listening and have started telling customers what they want. Something they started doing to suppliers 10 years ago.” — is very serious, more serious in the US than the UK. At least in the UK, Tesco is a dominant buyer dictating to suppliers — a national institution dictating to customers. Here Tesco is a stranger, a foreigner.

One of the buyers procuring for Fresh & Easy had questioned his suitability as a vendor. He took the insult quietly but then called us to vent at how ridiculous it was. For all its bluster, the actual orders Tesco placed were for pitifully small quantities — a few boxes here and there.

It is said that Tesco did enormous research, but maybe they forgot to read this once popular classic: How To Win Friends And Influence People

We appreciate our letter-writer from the United Kingdom and the opportunity he provides to discuss these important issues.

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