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The supermarket format is obsolete in America -- at least that's the way the United Kingdom's leading grocer, Tesco, sees the U.S. market. That's why the British retail powerhouse plans to colonize this new world with unconventional convenience-style food and general merchandise stores, according to an industry analyst who in a previous life helped Tesco probe the United States for growth opportunities.
While many domestic chains are scrambling to hold their ground against Wal-Mart and other challenges, Tesco considers the United States a low-risk market that should provide decades of growth, says David McCarthy, Citigroup European food-retailing analyst and former Tesco executive, who recently shared some of his insights in a conference call.
Putting to bed persistent rumors that it had its eye on any number of acquisitions in the States, Tesco finally said in February it would make its U.S. debut in 2007 in the state of California, the place where Wal-Mart's market presence is currently its weakest. The British firm will forgo building supermarkets precisely because it believes Wal-Mart has already effectively neutralized the format here. Tesco instead plans to appeal to a segment of cash-rich, time-poor customers in an easy-to-shop, small-format setting, offering fresh, ready-made products that are high-ticket and high-margin.
Based on its past history of building scale quickly in international markets, when Tesco comes to the United States, it's likely to roll out a significant number of stores immediately. McCarthy says that the retailer is likely to enter the United States with a "big bang" -- a large number of new store openings in the first year, followed by a continued rapid rollout.
McCarthy should have a fairly good clue as to what Tesco is likely to do in America. He previously served as the divisional director of business development at Tesco, where he conducted the company's first study of the U.S. market, back in the mid-1980s. He also worked in Tesco's Planning Group, peopled with the firm's top execs.
The analyst's knowledge of Tesco's modus operandi is worth plumbing for indications as to how it might undertake a U.S. expansion. With the equivalent of $65 billion in sales for the 2005-2006 fiscal year, Tesco is the United Kingdom's largest retailer. McCarthy says that the chain should also be considered the United Kingdom's most successful retailer in overseas markets, with $13 billion in sales generated from outside the country.
Tesco garnered pre-tax earnings of $4 billion, and a net profit of $3 billion, for the 2005-2006 period.
Tesco operates a number of different store formats ranging from 1,500 square feet to 150,000 square feet or more. McCarthy gives the chain a lot of credit for its retailing philosophy, which he describes as "inclusive": Tesco targets everyone, unlike many of its other U.K. counterparts, and it has had success with this strategy, thanks to its emphasis on what he calls "localization."
Says McCarthy, "Tesco is a sales-driven/market share-driven retailer, rather than a margin-driven retailer" -- the type of operator that's always looking to "sweat the assets hard" and constantly seeking improvements in sales per square foot.
Tesco's strategy points to a belief that market share is a long-term driver of profits. The retailer is currently focused on approximately a dozen markets, much fewer than French competitor Carrefour, for example, which has stores in 30 markets spread around the world.
Nearly twice the size of its nearest competitor in the United Kingdom, Tesco came from behind in the mid-1990s, primarily through organic growth rather than by acquisition. The company broke the billion-pound barrier for the first time in 2001, taking nearly 70 years to get there. However, Tesco reached its next milestone, the 2 billion pound-barrier, just four years later.
Additionally, it's no stranger to Wal-Mart's impact. Since the Bentonville behemoth purchased ASDA in 1999, Tesco has actually widened its market share advantage over ASDA by 2.5 percentage points. McCarthy says that Tesco did this by attacking ASDA on price -- thus negating ASDA's price advantage -- as well as by extending its nonfood assortments. At the same time, Tesco increased its food advantage in terms of depth of range, quality, perception, and other attributes.
Outside of the United Kingdom, Tesco's most powerful market presence among developed countries is in Ireland, while Thailand, South Korea, and Hungary are its strongest among emerging markets. In Eastern Europe, Tesco is looking to increase its positions in the Czech Republic and Slovakia, in addition to a healthy share of the market in Poland.
Brick-and-mortar stores are not Tesco's only forte, however. The company is also the world's leading Internet grocer, and it runs a highly successful financial services arm through a joint venture with the Royal Bank of Scotland. In contrast, despite several attempts, Wal-Mart has been unsuccessful at entering the banking business in the United States.
Tough price fighter
Comparing the U.K. and U.S. markets, McCarthy believes that, in many ways, the United Kingdom is a tougher market than the United States. The United Kingdom, he contends, is significantly ahead of America in terms of systems, distribution, and replenishment, for example.
McCarthy also considers competing with Tesco in the United Kingdom to be harder than competing with Wal-Mart in the United States. Most companies today aim for a certain demographic segment in the market, particularly in the United Kingdom. Sainsbury's, for example, targets the middle-to-upper-income customer, while ASDA aims for the lower-to-middle-income customer. Tesco, stands alone, however, and remains committed to a broader reach.
In terms of store formats, Tesco's hypermarket business is twice the size of ASDA's, which had been the large-format store market leader, and Tesco now attributes a larger proportion of its sales to large-format stores than ASDA does, which wasn't the case five years ago, says McCarthy.
Despite an increase in average store size, Tesco has been able to improve the sales productivity of its stores. From UK 69 pounds in 2003, Tesco's sales per square foot increased to UK 21.28 pounds in 2004 and UK 22.09 pounds in 2005.
Although Wal-Mart plays a leading role in the use of radio frequency identification (RFID) technology in the United States, ASDA trails Tesco in use of these systems that track inventory, cut costs, and improve staff and supply chain efficiency. ASDA plans to begin testing RFID later this year.
ASDA also recently set off a price war by announcing it would have the lowest prices -- period. Since Tesco won't be undersold, "the plot thickens in the U.K., where competition is already brutal," says Michael Bergdahl, a retail consultant and author who was the keynote speaker at a Tesco supplier conference held January in San Francisco. "Sainsbury's and Morrisons will have to hunker down and try to avoid the inevitable trampling they will receive as the two retail heavyweights duke it out for U.K. retailing supremacy," adds Bergdahl.
Further, ASDA plans to combat its slipping market share by opening six small-format stores, called ASDA Essentials, this year. They will measure 8,000 square feet, about four times the size of an average 7-Eleven convenience store, but less than a quarter of the size of Wal-Mart's smaller Neighborhood Market grocery stores in the United States.
Marriage of convenience
Tesco entered the U.K. convenience market with the Express format in 1995. The company then took its time with the rollout of the concept. In 1999, after refining the format, Tesco began opening a new generation of Express units, which included some prefabricated facilities (stores that were prebuilt and simply lowered onto the site by crane). In 2003 Tesco bought the T&S chain, picking up about 2,000 convenience outlets. Although it later sold some, it converted many others to the Express banner.
Currently Tesco is moving away from just opening convenience stores on gas station sites, toward freestanding Express units that are approximately 3,000 square feet.
By the end of 2005, Tesco had about 500 Express stores, with another 100 slated to open by the end of 2006. According to McCarthy, Express has a higher return on investment than other Tesco formats, driven by sales densities as high as UK 30 pounds per square foot per week.
Tesco's strategy to enter the U.S. market is supported by close scrutiny of small discount stores around the world (so-called "hard discounters" ranging in size up to 5,000 square feet, regardless of product offering). Since the company needs a large number of small units to justify the investments in centralized distribution, McCarthy believes that Tesco will follow up the opening of its distribution center in the United States with as many as 20 stores in the first week, 50 stores in a month, and perhaps 100 stores by the end of 2007. Rapid rollout beyond that would be expected as well.
McCarthy additionally believes that Tesco's new U.S. stores will place a big emphasis on fresh foods, quality foods, and value-added products, since these items are high-ticket and high-margin. The product offering will likely consist of a high percentage of private label, since Tesco has invested deeply in developing such products.
In the United Kingdom, Tesco Express stocks fresh meats, salads, vegetables, and a range of cooked meats. It also has an in-store bakery and a beer, wine, and spirits department.
Additionally, the company could adapt itself to the U.S. market by offering ready meals/prepared foods, and will likely lease its facilities, unlike in the United Kingdom, where Tesco owns 85 percent of its properties. In another departure, gas stations aren't expected to be an essential part of the concept.
McCarthy estimates that in time, Tesco could have 10,000 stores in the United States, generating $25 billion in sales.