New Retail Paradigm As Tesco Era Begins

ELLIOT ZWIEBACH

Los Angeles — Tesco's launch of Fresh & Easy Neighborhood Markets, scheduled for later this week, is likely to be the first step in a U.S. entry that could ultimately be national in scope — and influence — according to a range of industry observers.

“Tesco's entry into the United States will change the retailing paradigm,” said Mike Griswold, a Boise, Idaho-based analyst with AMR Research who previously worked for Shaw's and Albertsons. “Using advanced customer segmentation strategies, Tesco will provide a new shopping experience that forces food retailers to reexamine how they identify, define, interact with and satisfy their customers.”

London-based Tesco is scheduled to open its first Fresh & Easy units Thursday at six locations across Southern California, with five more in Las Vegas and one in San Diego due to open next week. The 10,000-square-foot stores will offer a mix of produce, ready meals, food to go and impulse snacks, supported by a limited core of groceries.

Tesco expects to have another 20 locations in operation in Southern California, Las Vegas and Phoenix by the end of the year, with 100 more stores scheduled to open during 2008.

“U.S. supermarket retailers should be concerned — very concerned,” said David McCarthy, managing director for Citigroup Global Markets, New York. “If Fresh & Easy does prove successful, it will lead to changes in the shopping patterns of U.S. consumers, with long-term ramifications for the entire U.S. food industry over the next 25 years.”

Tesco will generate behavioral and cultural changes among U.S. supermarket companies “[that] will be fascinating to watch,” predicted Mark Husson, managing director for HSBC Global Research, New York.

“If the early stages are successful, Tesco will probably be facing a squadron of look-alike competition from the majors within two to three years, [with] Kroger, Safeway, Supervalu, Stater Bros., Whole Foods, etc., all producing clones quite quickly in order to understand the competitive proposition.

“However, Tesco will have focus, a first-mover advantage and a head start in tons of locked-up sites, and so ought to do quite well.”

Observers said they expect the company to achieve sales of $2.3 billion to $2.7 billion by the end of next year and $4.5 billion by the end of 2009, with market shares in the Southwest ranging from 1% to 4% over that period.

The stores are likely to have a greater impact on restaurants, convenience stores and specialty food formats than on traditional supermarkets, observers noted, though that could change if Tesco's expansion broadens to include larger-format stores, they said.

If Tesco is unsuccessful, some suggested it could be because of too heavy a reliance on private label, the small store size or the pricing on some takeout foods.

One veteran industry executive, who said he has seen photos of Tesco's mockup prototype, told SN all products except bananas are in some type of packaging and only self-service checkouts are available — efforts to reduce and control expenses, he said.

Despite some misgivings, however, he said he expects Tesco to be successful, “though it may have to fine-tune its model for several years. The hardest part of what it must do will be matching demographics with economics, and those factors change dramatically from store to store.

Perry Caicco, an analyst with CIBC World Markets, Toronto, expressed more skepticism than most of his peers about Tesco's American prospects with small-format stores, though he said he likes its long-term chances if it moves to a larger format.

“Small-surface formats are much more difficult to operate than large conventional grocery stores, and if the selected site is anything less than perfect, it can bomb out quickly,” he pointed out.

If the small-format stores were to fail, Caicco said, “Tesco may decide to move immediately into more economically feasible larger-size formats, which would present a far more formidable challenge to existing players.”

Pricing on some items could be a problem, Husson indicated. “While many consumers are familiar with family and casual dining menus, some of Tesco's product is actually fine dining, [and] some meals will cost $6 to $7, which is more expensive than traditional U.S. supermarket meal solutions,” he explained.

Griswold said he expects Tesco to maintain a saturation strategy using smaller formats as it expands, “but as it gains a foothold in a given area and as the supply chain structure [falls into] place, you will start to see larger formats in surrounding locations.”

Tesco is likely to have a national footprint within 24 to 36 months, he added, “so I don't rule out an acquisition [that] would provide an infrastructure to enable it to expand.”

“Tesco could strike gold in the U.S.,” said Neil Currie, an analyst with UBS, New York. “A multipronged marketing platform based around convenience, range and price could be a significant threat to conventional supermarkets, which are stuck with oversized legacy real estate, designed for an increasingly bygone era when supermarkets were the food category killer.”

McCarthy said one edge Tesco has is its multitiered private-label offering, product-line enhancements rather than duplications and its emphasis on fresh rather than frozen — “advantages that have taken a generation to develop [that] cannot be replicated in a few months by a competitor.”

Meredith Adler, an analyst with Lehman Brothers, New York, said she has no reason to believe Tesco will fail, “[though] it has numerous challenges to overcome, [and] it would be naive to assume the Big 3 won't react in some way.”

Kroger has already begun segregating ready-to-serve meals at its stores in Las Vegas, she pointed out; Safeway has said it's ready to launch its own small-box format if consumers indicate they like the Fresh & Easy concept; “and Supervalu is likely to be equally prepared to react if necessary,” Adler pointed out.

Ritch Allison, a partner with Bain & Co. Retail Practice, a New York-based global strategy consulting firm, said the move toward smaller-format stores by Tesco — along with tests of express formats by Giant Eagle, A&P's Super Fresh and Whole Foods — “represents a renewed desire by grocers to innovate in an effort to find new ways to meet consumer needs. Convenience in one form or another has been around for years, and the entry by Tesco has brought it to the front burner for CEOs in the grocery business.

“This is a new battleground that will play out in the grocery space as retailers become more aggressive with takeouts.”

Tesco Completes $2B U.S. Bond Offering

NEW YORK — Fresh & Easy's arrival in the United States will accompany $2 billion raised in the U.S. debt markets by parent company Tesco.

The retailer last week completed its first U.S. bond offering — an effort, the company said, to introduce the company to bond investors here; to establish itself in a new market; and to diversify its investor base.

Tesco is expected to use the proceeds from the offering to refinance certain short-term indebtedness and for general corporate purposes. The bonds encompassed $850 million worth of 10-year notes, paying 5.5% interest and maturing in November 2017, and $1.15 billion of 30-year notes, paying $6.15% interest and maturing in November 2037. The bonds include a provision that would allow investors to sell them back at 101 cents on the dollar if there is a change of control at Tesco.
— E.Z.