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Tesco’s Success Course Far From Easy

It may be fresh, but it won’t be easy.

We’ve dealt with Tesco and its plans in America both here and here. Wall Street has also gotten into the game, and some clever analysts at Credit Suisse entitled their report: It May Be Fresh, But It Won’t Be Easy.

The research analysts at Credit Suisse are by the names of Michael Exstein, Edward J. Kelly, Andrew Kasoulis, Jay Carlington, Matthew Gardner and Tom Roller, and the highlight points of the report are as follows:


  • Tesco’s pending entry into the U.S. could represent one of the major structural changes to face the retail industry in some time. We estimate that Fresh & Easy, Tesco’s upcoming U.S. format, could generate $1 billion in sales within three years and capture 2-6% of the local market share in five years, potentially making it one of the few retailers to ever achieve that type of volume growth so quickly.
  • But it is important to keep in mind that the U.S. retail market is ultracompetitive and Tesco will need to navigate the complexities of the market while at the same time ensuring it can build an economically feasible and scalable model that offers a truly differentiated offering relative to existing formats. As our title suggests, while Tesco may introduce a fresh format/concept, executing on its strategy will not be easy
  • Mass market format tying fresh food and convenience with low prices. We believe Fresh & Easy will be a hybrid model which tries to bridge the gap between traditional (Kroger, Safeway) and specialty supermarkets (Whole Foods, Trader Joe’s) with mass market appeal (Costco, Target, Wal-Mart).
  • Initial implications for U.S. retailers will likely be minimal, as it will take time for Tesco to test and perfect its model before it expands into geographies beyond its initial targets (Southern California, Phoenix, and Las Vegas). However, we believe retail competitors and investors need to consider the ramifications now as Tesco’s growth will likely accelerate after year two and could include acquisitions in order to gain control of real estate. In addition, we believe some retailers are already working on potential competitive responses including new box formats and/or upgrades to existing formats.
  • It’s too early to short supermarket stocks. Near-term supermarket earnings should remain solid, Tesco will not have meaningful scale for at least two years, and success is by no means guaranteed. That being said, investors with a longer term time horizon should not overlook this potentially large negative catalyst.
  • Costco has the most exposure in mass merchant space. While Fresh & Easy may not be viewed as a direct competitor to the mass merchants, Costco’s large store base on the West Coast and high food penetration creates large overlap. Target and Wal-Mart’s growing food presence in these areas should also not be overlooked. Fresh & Easy will ultimately compete for fill-in grocery trips which the mass merchants are already having a difficult time holding onto.

The report also identifies the key executive team:

  • CEO, Tim Mason. Mason is very well known to most observers. He has been a Tesco main board director for 12 years and, as well as his US role, retains responsibility for group marketing. He has 25 years’ service at Tesco and has a wide range of experience at all levels — buying, marketing and retail operations. We think he has particular strengths in marketing, and specifically areas relating to understanding customers (for example, along with Terry Leahy, we think he deserves a lot of credit for the huge success of Tesco Clubcard). We also think he has strong diplomacy skills and gravitas (we regard him currently as a natural Number 2 to Leahy), which are likely to prove invaluable in navigating the various issues that Tesco is bound to face in the US.
  • CFO, Remko Waller. Waller is not a Tesco ‘lifer’ as far as we know. However, his recent experience as CFO of Tesco South Korea makes him well qualified in our view. We think South Korea is the only Tesco market outside the UK/Ireland that has very similar attributes to the US — high GDP per head, a relatively ‘modern’ economy/consumer, high real estate prices (so, very capital intensive), and high concentrations of urban population. Importantly, Korea has also been a hugely successful market for Tesco, and one where it has competed very well with Wal- Mart and Carrefour (both of which exited Korea in recent months). Over recent years, Tesco has proved adept at managing very rapid growth while generating high/increasing returns in Korea. As such, Waller’s track record in managing that growth should prove invaluable in the US.
  • Retail operations, Brian Pugh. Pugh joined Tesco in 1998 when it bought its entry-vehicle (13 Lotus hypermarkets) in Thailand. He is a US national and originally worked for Wal-Mart, which he left to set up the Lotus business with one other ex-Wal-Mart executive (Jeff Adams, now CEO of Tesco’s Thai business). After the Tesco acquisition, Pugh stayed on in Thailand where he became COO. We think the combination of his US nationality and Wal-Mart/International/operations experience make him ideally qualified for his new role.
  • Marketing, Simon Uwins. Uwin’s has been at Tesco for 23 years, during which time he has held various buying and marketing positions, latterly as director of marketing for Tesco’s UK business. He joined Tesco from market research agency AC Nielsen and, in his recent UK marketing role, represented Tesco on Dunnhumby’s Board (Tesco’s Clubcard data partner). We regard him as one of Tesco’s best qualified marketing executives. He is obviously very well placed to bring Clubcard and Tesco’s other marketing expertise to the US.
  • Commercial (Buying), John Burry. Although only around 40, Burry already has around 20 years’ experience at Tesco and has a similar buying/commercial background as Mason/Uwins. Most recently he was head of prepared fresh foods in the UK, which we think will be particularly appropriate for the likely offer in the US stores. He also has international experience — he was the Commercial Director of Tesco’s Czech business. We regard him as one of Tesco’s strongest up-and-coming commercial executives.
  • property, Tony Eggs. Eggs too has vast experience at Tesco. He has for many years been a prominent senior member of Tesco’s highly successful UK property team, latterly as Property Director. Property is likely to be a key challenge/opportunity in the US, and Eggs will bring with him the knowledge and know-how that Tesco has developed in the UK over the last two decades. With the UK planning regime relatively tight and Tesco omnipresent, we suspect the more liberal US laws and ‘greenfield’ opportunity present Eggs with the chance to almost start again with another Tesco expansion plan.

It is a long report and not in the public domain but we’ve read it and, between the report and what else we have seen, what we notice is five key things:

  1. Tesco may have misidentified convenience in America’s car-based culture. Although local stores are nearby, if they add an extra stop to a shopping expedition, they are not that convenient. In this sense, a Wal-Mart or Target supercenter may be a little further away, yet still be very convenient as consumers can get everything on one trip.
  2. The decision to not sell gasoline has condemned the concept to secondary locations. The stores will have to be draws themselves and that is not easy for a 10,000-square-foot food concept.
  3. The high prepared foods component depends on very high volume. Neither the population density nor the secondary locations in the launch markets are likely to sustain that volume.
  4. The concept does not seem to have strong barriers to entry. If it is successful, it is not clear why Safeway or Kroger couldn’t duplicate it, much less why HEB, Publix, etc., couldn’t duplicate it in their markets before Tesco gets there.
  5. In a rush to open a critical mass of stores, Tesco seems to have signed leases for marginal locations. This won’t make its job easier.

The problem may be that Tesco desperately wants a place in the US market, but any concept that requires prime real estate requires a very slow rollout.

So Tesco has convinced itself that small stores in neighborhoods will, if merchandised the Tesco way, be a big success.

If Tesco is correct, they will steal the crucial fill-in business from supermarkets, and with warehouse clubs and supercenters doing the big shopping trips and Tesco or Tesco-like concepts doing the fill ins, supermarkets will be in real trouble.

But the Tesco concept seems to depend on a revolutionary change in consumer shopping habits. If that revolution doesn’t occur, we may have to add Tesco to Marks & Spencer and Sainsbury’s on the list of British retailers whose plan to retake the colonies didn’t pan out as hoped.

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