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Tesco Uses Poor Economy As Excuse For Fresh & Easy Pullback

Jim Prevor’s Perishable Pundit, November 18, 2008

Every time there is a hurricane or natural disaster, there are people and businesses that are horribly impacted, but there are also plenty of people who use the event as an excuse for their own non-performance. So a hurricane hits the coast in North Carolina and that somehow explains why businesses 150 miles to the west didn’t mail out checks that had been promised.

We thought of this as we read news reports of Tesco’s decision to slow its US expansion. Steve Hawkes is a sharp guy who writes for The Times of London out of Los Angeles and he recently wrote a great piece. Our only problem with the story is that, most likely, someone back in London chose the headline Meltdown puts the Brakes on Tesco’s US Dream, which is accepting at face value the explanation given by Tim Mason, Chief Executive Officer of Fresh & Easy.

We have been writing about Tesco’s journey to America from the very start, and we would say the explanation makes absolutely no sense and that Tesco is using the economic situation to cover up the fact that the concept is troubled and its execution has been problematic. Here is an excerpt from the article:

Tim Mason, chief executive of Fresh & Easy, said yesterday that plans for the chain to expand into northern California could be put on hold because of the recession gripping the United States…

Tesco had hoped to have 200 Fresh & Easy stores, modeled on its Tesco Express format, operating across southern California, Arizona and Nevada by February next year. Mr. Mason said that now he hoped to reach this target by next November….

The group has talked of having 1,000 stores on the West Coast, stretching from Seattle to San Diego. However, a move into northern California would require huge capital investment because of the need for a new distribution centre.

Mr Mason said: “The industry is in a very different place than when we came out and did the feasibility research three years ago. Then the US consumer confidence index was at the highest level it had ever been. In October the US consumer confidence index was the lowest it has been since 1967, so it’s a big change. We will still open stores every week, but it’s prudent to slow things down a bit.

“There’s a big cost step for us when we open up northern California and we can be quite flexible about when we do that. As things get to a point that we like how it’s all coming together, we like the way the stores are growing into the second year, then we can accelerate. If the economy takes a turn for the worst, it would be unwise to accelerate.” …

There is no doubt that the economic situation has changed, but it does that. There are economic cycles, upturns and downturns, etc. It is inconceivable that Tesco entered the US market expecting that there would never be a recession. What if Tesco had started building a second distribution center and then the recession came? Would it just close up?

Note what isn’t being said: The issue is not that Tesco cannot raise the money to expand the division. It is not even that the world is offering such compelling opportunities elsewhere that Tesco prefers to invest elsewhere. It is that the stores right now are not performing sufficiently well to justify the investment required to support them:

“As things get to a point that we like how it’s all coming together, we like the way the stores are growing into the second year, then we can accelerate…”

In other words if Fresh & Easy maintains current sales and profits, it is a loser and Tesco doesn’t want to pour good money after bad. Not only that, but Tesco is not confident that year two will be sufficiently better to justify investing more in the concept.

Now this has virtually nothing to do with the economy. Yes, many retailers are struggling but those are typically retailers of discretionary products or high-end retailers of food, such as Marks & Spencer in the UK and Whole Foods in the US.

Wal-Mart’s CEO Lee Scott is going around crowing:

CEO and President Lee Scott recently told analysts “This is Wal–Mart time” at the company’s two day investment meeting in Bentonville. “It is clear in this environment that the customer is more cautious and more thoughtful about what they buy and they’re more thoughtful about when they buy it,” but that because the low price retailer has fared so well in previous times of economic downturn, “We see this as an opportunity to widen our moat.”

Since executives for Fresh & Easy have continuously claimed both that it is cheaper than American supermarket chains and that its private label products have won phenomenal acceptance, the idea that the recession is causing Fresh & Easy to pull back makes no sense. The poor economy should be helping a chain that is cheaper than everyone and has well accepted high quality private label products.

Part of the problem may be that these claims are exaggerations. For example, when Pundit sister publication PRODUCE BUSINESS did its price comparison study on produce prices in Los Angeles, Fresh & Easy didn’t win. In fact it was beaten not only by Wal-Mart but by Stater Bros. and Vons — it was only traditionally pricey Ralph’s that it managed to beat.

There are, however, broader problems. The Times article continues:

Mr Mason conceded yesterday that the chain had found it harder than expected to crack America, not only because of the more mature nature of the market — “we are not filling a vacuum” — but also because of the economic slowdown.

Fresh & Easy has been unable to open some stores in Phoenix and Las Vegas because property developers decided to shelve plans for certain sites.

The loss of a few locations because developers abandoned plans is inconsequential compared to the thousands of sites now available because of the downturn in the economy. When it comes to real estate, the rise in vacancies is a big win for Tesco.

The phrase about “not filling a vacuum” is getting closer to the point. When Tesco announced its plans to expand to the US, many thought it invincible because it had been successful in most of its overseas forays. These efforts, though, were typically in markets such as Poland or Thailand without a well developed western food retailing scene.

It is not as if Tesco opened new stores in France, Germany, and the Netherlands and showed this enormous ability to beat its competitors. It really was good at finding places where it could “fill a vacuum.”

Now in the US, what Tesco is really finding is that small stores geared toward the middle of the market — that is, not discount, like Aldi, or foodie, like Trader Joe’s — are a skinny opportunity to begin with. It also is learning that whatever innovation it might bring to the market will be quickly vetted and, if worthwhile, copied by world — class competitors operating in their home market — Wal-Mart, Safeway, Kroger, Supervalu, Costco, Whole Foods, etc.

In other words — as Lee Scott’s comments allude to — it is not enough to simply be good; one must have unique competitive advantages that create a “moat” to insulate one from effective competition. The reason the Fresh & Easy idea was always problematic was there were only two options.

Either it would be very successful, in which case every retailer in America would open small footprint stores and have them open in Miami, Cincinnati, New York and Boston long before Tesco got there — leaving Tesco with a small beachhead in the west. The other option would be that this small scale store was not a real market. In either case, it would not be a big win.

One senses that reality is starting to seep in. When the Fresh & Easy concept was opening, Tim Mason struck down all hesitations by repeating the Tesco mantra about Fresh & Easy:

“This is a launch, not a trial,” said Mason, in one of the oft-repeated mantras spouted by the ruthlessly on-message Tesco team, all of them clad in LA-casual jeans.

Now, in The Times article, Tim Mason sounds contemplative, almost plaintive:

Mr Mason insisted that critics doubting the potential of Fresh & Easy would be proved wrong, adding that to go from no stores to 100 in a year was an “exceptional” achievement.

“We are absolutely thrilled with the customer response from those loyalists that have got it, and really loved what we do,” he said. “What retailer has better staff, better product quality and delighted customers and doesn’t make it?”

Opening 100 stores in a year is an achievement and it should be acknowledged. Though it should also be noted that Wal-Mart has been doing far more than that and with each store being 20 times the size for well over a decade. More importantly, opening stores is a matter of logistics; it speaks nothing to the success or failure of the business proposition. It just means Tesco had enough money to build stores and enough capabilities in real estate and construction to secure leases and build-out structures. It doesn’t even mean that the locations selected were good.

The truth is that Tim Mason’s reference to “loyalists” is telling. If Fresh & Easy had enough “delighted customers” that were willing to buy enough volume at a high enough margin to produce reasonable returns, Tesco would be pushing on the pedal to open more distribution centers and more stores. Its decision to sit tight is an outgrowth of the fact that it is losing money and doesn’t know how to change that. Blaming this problem on general economic conditions is an easy out.

It is sitting, waiting, trying a few changes, but, unwilling to fundamentally change the concept as we have advised. It sits hoping that time itself will right what is wrong.

Alas, surely all the British executives at Tesco must be aware, we had this war once and the loyalists lost. It is unlikely to turn out better for Britain’s largest retailer this time around.

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