EL SEGUNDO, Calif. — Tesco U.S. here said last week it expects to continue its rapid store expansion program, despite a U.S. District Court ruling that said it must do more work to satisfy environmental compliance issues at its distribution center.
The ruling (see story, Page 39) was issued the same day Cheshunt, England-based Tesco completed a three-day conference for British and American investors that included tours of stores, the distribution center and an adjacent central kitchen. Tesco now has 21 Fresh & Easy stores in operation in Southern California, Las Vegas and, as of last week, the first four in Phoenix. Another 30 locations are scheduled to open by late February.
Industry sources told SN the key points that came out of Tesco's meetings with analysts included:
'EPITOME OF CONVENIENCE'
Fresh & Easy stores have the potential to generate annual revenues of $7 million to $9 million per unit, with average tickets exceeding $25 and traffic counts of more than 500 customers a day.
Private-label products, which account for about 50% of each store's 3,500 stockkeeping units, constitute approximately 75% of revenues, with Fresh & Easy ketchup, for example, outselling the leading national brand by a 2-to-1 ratio.
Weekly sales per square foot are running between $14 and $22.50 — a range one analyst said could be low — compared with $8.10 at supercenters, $8.70 at supermarkets and $35 at Trader Joe's.
Fresh & Easy has 270 store sites in its pipeline, including locations in Northern California, and expects to have 50 opened by February 2008 and 200 a year later. Tesco also plans a second distribution center in Stockton, Calif.
The cost of opening each new store is about $1 million.
While customer surveys rated the stores higher than 90% on most attributes, they gave Fresh & Easy only a 74% positive response on in-stock conditions. The company said out-of-stocks in some perishables categories are the result of the positive reaction to the chain's fresh prepared-food offering.
The highly competitive nature of Fresh & Easy's everyday-low-pricing strategy could prompt traditional operators to invest more in price or in similar small-format stores.
The central kitchen at Tesco's Riverside facility has 10 packing lines that prepare almost all the fresh-processed private-label products sold at the stores, with products shipped within one day of production.
Tesco sources merchandise from only 29 suppliers, with only one supplier per category.
John Heinbockel, an analyst with Goldman Sachs, New York, called the opening of Fresh & Easy “the most important launch since Wal-Mart's supercenters,” adding that the stores offer “the epitome of physical convenience and a surprisingly strong EDLP effort.”
He said pricing was 13.1% lower than either Safeway or Kroger at one location and 15.7% lower than Safeway, Kroger or Albertsons at another.
While Fresh & Easy stores are intriguing, he noted, the threat they pose is manageable.
What's intriguing about them, Heinbockel explained, is that prices appeal to lower-income customers, while the offering of organics and other higher-price-point items will attract upscale shoppers.
The threat to traditional operators should be manageable, he said, “[though] virtually no one is immune from some impact,” he added, citing several reasons, including the ability of conventional operators to use promotional prices to blunt the market-basket spread and the consumer appeal of a broader assortment and service offerings at supermarkets.
According to Deborah Weinswig, an analyst with Citigroup Global Markets, New York, Fresh & Easy's EDLP strategy “has already driven strong initial traffic and will ultimately pressure traditional supermarkets to invest more in pricing.
“We also expect traditional supermarkets to reconsider small-format stores, even though these have historically been less profitable.”
James Anstead, a London-based Citigroup analyst, said he is encouraged by early data. “The fundamental differences between Fresh & Easy and the incumbent operators may mean that the U.S. consumer takes a little time to adapt, but the concept is strong enough to drive long-term market share gains,” he explained.
Although Tesco officials were reticent to discuss traffic levels, and Anstead said that “none of the stores we visited seemed especially busy,” he noted that “Fresh & Easy is clearly a very different format from anything the U.S. consumer is accustomed to, [and] the key may be to encourage nervous shoppers to give it a try.”
Regarding out-of-stocks, Anstead said, “Management admitted there have been some short-term availability issues, but these are being dealt with. Tim Mason [Fresh & Easy's chief executive officer] admitted the company has been ‘desperately chasing stock.’
“Quite fairly, he attributed this to the fact that ordering systems need a period of stability to build up a history.”
While the stores' self-checkouts may be a negative for some shoppers, “the flashing up of prices during the self-scanning process reinforces the low prices Fresh & Easy is charging,” Anstead pointed out.
He said Tesco had originally intended to limit store selection to 2,500 SKUs rather than the 3,500 it carries, but was persuaded by customer feedback during the development phase to expand the selection to incorporate some key brands and ethnic items.
Fresh & Easy might be willing to expand the selection slightly or alter it “if feedback suggests this would help,” Anstead said.
Commenting on the distribution center, Anstead said the facility does not use RFID technology, which he said “[seems to be] a reflection of the slow progress of RFID technology in the retail industry.”
Although a second distribution facility is planned for Stockton, in Northern California, Tesco said it could begin opening stores in San Francisco supplied from Riverside, Anstead indicated.
Perry Caicco, an analyst with CIBC World Markets, Toronto, called Fresh & Easy “a brilliant concept — and ‘sneaky’ brilliant, because [supermarket] competitors will be puzzled and dismissive of the concept and so will not feel compelled to respond, and probably couldn't if they tried.
“Fresh & Easy will be insulted and ignored by grocers, even as it quietly eats away at the supermarket business, because each Fresh & Easy is small-volume, each sells many products that are not obviously competitive, and they wouldn't know how to measure it anyway. And when conventional grocers wake up, there will be almost nothing they can do about it.”
The secret to Fresh & Easy's success, Caicco said, is the products, “which are fresher than anything in the market, largely healthy and very affordable. Over time, as customers discover they are holding fresher product than ever before, at prices the same as or lower than the supermarket, they will become a regular part of the weekly, or possibly daily, shopping habit.”
Bland, Yet Upscale
According to another analyst, “Tesco's ability to start with a clean slate in all areas of operations is a competitive advantage. Everything is well thought out, with a goal of minimizing costs while maintaining quality and control over product.”
However, the stores could confuse consumers, the analyst told SN, noting that they are “quite bland, with little visual appeal. The entire look stresses the low-price aspect of the business, yet the offering is quite upscale.
“Several people said they did not see it as a place to do a full shopping trip, especially if you have kids. And it's hard to imagine a consumer just walking in off the street and understanding the excellent quality-value relationship.”
Robert Summers, an analyst with Bear Stearns, New York, said he does not anticipate significant success for Tesco's U.S. venture. “Tesco's entry will be a modern-day Bunker Hill, with likely the same outcome as before,” he declared.
He said the stores are clean “but seem sterile and undifferentiated relative to offerings already in the marketplace. The SKU selection and atmosphere present an uncompelling offering that falls well short of revolutionizing the industry, [and] the overall ambience seems inferior to current market offerings.
“The concept appears to not be specialized enough and not deep enough to become a destination shop.”
As for the rapid store expansion that's projected, Summers said, “The speed at which Tesco is seeking to ramp up its unit openings to leverage the massive distribution center it has built has forced the company to compromise on its site-selection process.
“Ideally, Tesco would like to take Walgreens' locations — generally Main and Main corner locations, with ample parking for easy in-and-out access — and convert them into Fresh & Easy stores. The only problem is, Walgreens already has those locations.”