Can Tesco swing it in California? Or will its secretive, costly entry into the US ultimately prove damaging, asks Siân Harrington

Tesco’s admission last week that is to move into the US market via a convenience offer in California raised more questions than it answered, not least because of its secret squirrel approach.
No, it couldn’t comment on the size of the stores nor the name they would trade under; no, there were no further details on supply chain and sourcing issues; and no, any more insight into the number of stores it hoped to grow organically would not be forthcoming. Competitive reasons, don’t you know.
No wonder many in the investment community were left feeling cheated, particularly as a clever Sir Terry Leahy (left) had implied the US was off the radar, although closer analysis of his words left the way open for an organic growth entry rather than major acquisition. And while The Grocer was following events in the States over the course of last year, including the fact Tesco had embarked on a sourcing operation in California, other press reports concentrated on its ambitions in the emerging markets of China and India.
The lack of details has left some speculating that the UK’s largest retailer was rushed into making an announcement following the departure of Colin Smith to Somerfield. The former Tesco trading director, grocery, had been in the States for nine months and was tipped for the top job.
There are also rumours of a boardroom rift (The Grocer, December 10, p5). Finance director Andrew Higginson, who has made no bones about his desire for a wider management job, is rumoured to be furious at the appointment of marketing director Tim Mason to head the operation.
While the fact a crack team was over the pond looking for an entry point was a badly kept secret in the industry (The Grocer May 7, p4), Tesco did succeed in surprising the market with its convenience approach. It is clear it originally planned an acquisition but getting the right deal has proved difficult.
The background to the operation certainly sounds like a scene from a heist movie. According to online news site The Business, Tesco executives pretended to be Hollywood producers making a film located in a supermarket to cover up their research. They built a store in a warehouse to show to consumers, and executives bought groceries using cash stuffed in carrier bags rather than using Tesco company cards.
So is its strategy to grow via a new convenience format in 2007 using capital expenditure of up to £250m per year sound? Initial reaction among investors has been lukewarm to put it mildly. “Tesco’s announcement was the piece of news that many shareholders were dreading.
“We think the risk profile of owning Tesco has now worsened materially,” says Jonathan Pritchard at Oriel Securities.
Some US commentators are also bearish. “I think that Tesco’s announcement caught most people by surprise. While there has been endless speculation about the company entering the US, I don’t think anyone thought they would build organically and/or choose convenience,” says Neil Stern, senior partner at retail consultants McMillan Doolittle. “The US convenience market looks dramatically different from the UK. Part of this is based on a lack of, or different, type of innovation within the sector. Part has to do with a very different lifestyle of the consumer. While Tesco has said it doesn’t plan on just bringing Express here, it will need to be conscious of both as it opens up stores.”
“Our feeling on Tesco entering the world’s most developed and competitive market is not so optimistic,” adds Shushmul Maheshwari, chief executive of research consultancy RNCOS. There are some plus points, he concedes: Tesco will focus on ready to eat, which is the growing sector, and organic growth will help it gauge growth prospects better before committing excess financial resources.
But “existing players already have similar propositions and to gain market share it will have to be aggressive”.
However, Scott Annan, director at UK convenience specialist Srcg, believes Tesco will make it work. As a top ten global economy in its own right, California offers plenty of opportunity, he says. “There is a nice gap for Tesco in fresh. Existing operators, such as AMPM, Circle K and 7-11 are all about the same, other than the logo above the door,” he says.
Annan believes that the concept will take the best elements from a number of successful convenience fascias - Express, Simply Food, Fresh & Wild and HE Butt - but will not include fuel - “there is no retail fuel margin, the whole area sucks”, he says.
Brandon Barnholt, president and CEO of US convenience retailer White Hen Pantry, is also bullish. “We have been watching the UK retail food market for a number of years because, in our opinion, there are relevant similarities. We have tremendous respect for Tesco and believe its Express concept will work in the US in the right demographic situations,” he says. “This an example of the US retail market not adequately serving the true needs of a consumer interested in fresh foods that are easy and quick to prepare while delivering on taste and nutrition.
“That being said, distribution and market penetration seem like large hurdles to overcome. We will watch with great interest to see how they tackle these obstacles.”
One global supplier adds that Tesco is a big fan of Whole Foods Market so elements of this may make an appearance.
Certainly, with growth in the UK slowing, Tesco needs to move into a market cheaply, with an easy-to-export format to generate returns quickly. Sure, India and China offer massive growth potential but complex regulation and the cost involved in developing appropriate formats make this a longer-term strategy.
Tesco has said that it expects to break even in year two in the US. There is no doubt, also, that the retailer would have done its homework. It will have learned lessons from its joint venture with Safeway. Then there is the Dunnhumby connection. The Tesco-owned data company has been working with US chain Kroger for the past five years.
“It is highly unlikely that there is not some connection going on there. Tesco will have had a tremendous knowledge of the US retail market before it even put a foot in the water. It has the best part of five years’ market research in its pocket,” says Nigel Lawrence, a Lawrence Pritchard partner and former Dunnhumby employee.
Despite being approached by The Grocer numerous times, Tesco failed to field someone to answer any questions. So, given the lack of details, what can we surmise? Probably it will develop 200 or so stores along the bigger Express/Metro size. Possibly it will look to pull franchisees away from existing operators, such as AM/PM, in the long term. Certainly it must be thinking big.
“It ain’t going to go somewhere just to say ‘look at me, I am in the States’,” says Annan.
“It is highly unlikely that between now and 2007 they will be sitting on their hands,” adds a City analyst. “You have to ask if this is all they are going to do.”

Avoiding heavyweight rivals
>>A wise entry into a fragmented convenience market, says IGD
There were 138,205 convenience stores in the US at the end of 2004 and the numbers are rising strongly, according to National Association of Convenience Stores research. Sales through these stores stood at $395bn including fuel.
Sales growth to December 2004 was 17% year-on-year but this was driven mainly by rising fuel prices. Two thirds of sales are from fuel compared with a third from grocery.
Sector profits were up 24% at $5bn while the average convenience store had sales of $3.3m, of which $2.4m was fuel. Cigarettes, soft drinks, foodservice, beer and other tobacco top the bestselling product categories and, together with salty snacks, confectionery, edible groceries and milk products, make up 87% of all food sales.
According to NACS, the West Coast in particular is notable for its fragmented convenience market. It has the three states with the highest percentage of one-store owners, including California with 77%.
“In choosing to enter the convenience sector rather than the supermarket sector, Tesco will avoid direct competition with powerful domestic and international rivals,” says James Walton, senior economic analyst with IGD.
He adds that the West Coast is at the forefront of a revolution in food culture, with increased interest in wellbeing and nutrition.
“Tesco may choose to take advantage of this, with a strong fresh produce presence and quality healthy foods. Local produce and ethnic foods may also be focuses.”

View from the States
>>Mike Duff, senior editor at US trade magazine DSN Retailing Today, gives his view
Food retailing analysts and observers in the US are discussing Tesco’s announcement with a bit of wide-eyed wonder, but they may pause to reconsider soon when they take a closer look at what the company is up against on the American West Coast.
After news of Tesco’s decision to open a new convenience format on the West Coast broke, Merrill Lynch analyst Patricia Baker wrote in a research note: “This pursuit can only be viewed as a negative for the conventional supermarket industry. The coming of Tesco represents the entry into the market of not only a new player, but one that is a quite accomplished retail entity with the ability to attack this market in a much more meaningful fashion over the long term, should it choose to do so.
“The design and product offering of its concept may force existing operators to take a hard look at their own operations.”
Tesco is already involved in US food retailing as minority owner of GroceryWorks, a partnership with the Pleasanton, California-based Safeway chain. Tesco’s research certainly included data derived from that operation, an internet delivery service under the Safeway banner. So Tesco has practical experience of US food retailing on the West Coast - where much of Safeway’s business is conducted.
Yet, competitively, supermarkets probably aren’t Tesco’s main concern. Entering the West Coast means Tesco will avoid rivalry with Wal-Mart, which is unrepresented there in convenience.
However, Tesco has walked right into the teeth of Aldi. The German company owns Trader Joe’s and operates more than 150 on the West Coast alone, concentrated in the affluent, professionally oriented neighborhoods that Tesco has served with Express in the UK.
Trader Joe’s features low-price, own label groceries and quick meals and is a big hit with urban, time-challenged women. Units are small by US standards, convenient to shop and are merchandised with take-out and microwavable items.
To a significant extent, what American and British consumers refer to when they mention convenience stores is dissimilar.
To Americans, a convenience store is a small shop, usually fronted by gas pumps, that primarily sells fast food and soft drinks, such as hot dogs and 7-Eleven’s famous Slurpee, as well as beer, cigarettes and snacks for a largely male and teenager clientèle. That will permit Tesco to differentiate, but convenience stores have had a decidedly mixed record selling what the US market regards as replacement meals, which Tesco does well in Express.
A Tesco Express variant will have more than standard convenience stores in the way of direct competition, though. In the US, drug chains function as convenience stores for women and stock quick preparation food, groceries, snacks, beverages and other consumables. CVS, among the most formidable drug store chain operators in the States, has just acquired about 350 units on the West Coast.
Yanks are also typically stock-up shoppers. Warehouse club operators including Costco and Wal-Mart, with Sam’s Club, know this and promote to the tendency. On top of that, California is the home of the drive through everything, and the rest of the Coast is almost as car-oriented. The drive through is the West Coast nip in. Tesco might consider a drive through in an Americanised Express.
Additionally, regular supermarkets have pumped big bucks into the West Coast, with new formats and merchandising.
Which brings us back to Aldi and Wal-Mart. Wal-Mart has already opened 50 stores in California, the overwhelming majority being supercenters or expanded food concepts, and plans to add lots more. The company is making a similar push in Washington and Oregon.
Wal-Mart could easily shift resources and begin opening up Neighborhood Markets, a convenience format that would take on Tesco’s c-store directly, to put pressure on Tesco while Aldi certainly won’t sit idly by and hand over its West Coast business to a European competitor.
By attacking Tesco’s start up, it could bleed off dollars Tesco might otherwise spend on cutting prices in the UK, where both Asda and Aldi want to expand market share.