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Tesco vs. Costco

Jim Prevor’s Perishable Pundit, February 28, 2007

We’ve run several pieces regarding Tesco’s move into the American market. In the last few days we’ve been studying a research report on Tesco done by Credit Suisse, first with a piece entitled, Tesco’s Success Course Far From Easy, and then with a piece entitled, Tesco In America: Foodservice vs. Prepared Foods. This report also analyzes the implication of Tesco opening in America for Costco:

With 20% of its store base in Tesco’s proposed U.S. markets (Southern California, Phoenix and Las Vegas), Costco is more exposed than any other mass merchant in our coverage. On a state wide basis, Costco operates 37% of its warehouse clubs in California, Arizona and Nevada.

While Costco’s warehouse club model differs dramatically from Tesco’s planned Fresh and Easy stores, there are similarities between the two retailers’ food offerings, especially in fresh and prepared foods. Food accounts for over 50% of Costco’s sales volume. Fresh food, including meat, dairy and bakery contributes up to 11% of its total sales volume. With an average ticket of $120-$130 for U.S. customers, Costco is certainly not centered around convenience. However, on a quick trip during the week or when buying in bulk on weekends, Costco customers often include a rotisserie chicken, fresh pizza or a meal ready to eat as well as a carton of milk or bunch of bananas with their purchase.

In our view, Tesco’s U.S. entrance may compel Costco to revisit its food-only concept store as a competitive response. Costco first tried to open a smaller format focused on high-end groceries in Manhattan in 2000, but the plan was derailed due to escalating construction costs and neighborhood opposition. In 2003, COST purchased a former 106,000 square foot Kmart with plans to open a food only location in Bellevue, Washington to develop and test new concepts for its existing warehouses. However, management decided to put the project on hold and instead focus solely on its existing warehouse club format.

Costco is open to new formats, as evidenced by its two specialty home/furniture stores and plans for a third this year. Costco was looking for sales of $40 million annually from its pilot furniture store in Kirkland, WA. According to Furniture Today, Costco’s two furniture stores brought in over $100 million in 2005.

Although generally the report has been insightful, on this point the analysts may be jumping the gun. If Tesco opens this concept and if it is successful, then Costco and every other retailer will respond.

In fact the biggest vulnerability for Tesco is how easily this concept can be duplicated. Because Tesco seems to have focused on a concept for which real estate is available, we would expect every supermarket and supercenter and warehouse club to look at the possibility of aping the concept — including players in the Arizona, Nevada and Southern California.

In contrast when Wal-Mart rolled out its supercenters, supermarkets couldn’t easily duplicate the concept: their distribution centers and buying operations couldn’t handle all the non-food items. It is not easy to find space and build from scratch 200,000 square foot stores.

Costco will react — it is a big market. But so will Safeway and Kroger and others — if Tesco’s stores are successful. And that “if” is a big one.

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