Tesco Committed to Long-Term Success of Fresh & Easy

ELLIOT ZWIEBACH

Fresh & Easy Neighborhood Market appears committed to long-term growth and could someday have thousands of stores across the U.S., if Tesco's enthusiasm can be translated into more sales and profits.

“I already know Fresh & Easy will be a success. It is just a question of how big a success it will be,” said Sir Terry Leahy, chief executive officer of Fresh & Easy's London-based parent company, Tesco. “It might be a very nice chain of several hundred stores. We have to wait until the economy recovers to see whether it could be thousands, but I believe it can be.

“Customers love the stores, and it's gotten great reviews from people young and old, affluent and on limited incomes and across all ethnicities. Though it's a niche format, it's a big niche that has big appeal across communities.”

Industry observers, some of whom doubted the viability of Fresh & Easy when it began opening its small-format stores in late 2007, told SN they now see the chain as an ongoing entity that's here to stay — though they said they doubt it will have much impact on supermarkets until its stores are more densely situated or until Tesco decides to open full-line supermarkets.

Mike Griswold, a Boise, Idaho-based consultant with AMR Research, Boston, said he can see Fresh & Easy operating hundreds of stores — though not thousands, “unless it makes an acquisition or changes its supply chain infrastructure.”

“I think Fresh & Easy came into the U.S. believing it could be a one-stop shop for a full week's worth of groceries, but it's clear that would be difficult.

“In some areas, however, Fresh & Easy's smaller size could have an impact on traditional supermarkets if Tesco surrounded the market with hundreds of the smaller stores; or else it could make a bigger impact with a combination of 300 small-format and full-line supermarkets.”

Griswold said he believes Tesco was overly optimistic when it first opened, but that it recognized the challenges and “is making changes that are giving it longevity.”

“Tesco is a quick-learning company, and if it had any thoughts of abandoning its U.S. operation, it probably would have used the economic slowdown as an excuse for getting out.”

Suzanne Long, retail practice leader for SSA & Co., a New York-based consulting firm, said she believes Tesco is satisfied with the Fresh & Easy business model, “and it will probably stick with that model for the foreseeable future, though Tesco is always looking for the next opportunity and if it can find something else in the U.S. that appeals to it, it could go after it.”

She said Fresh & Easy seems to have found the most resonance with Hispanic shoppers, “who are able to find the fresh foods and varieties they need, which is one reason the chain has had the success it is having.”

George Whalin, principal at Retail Management Consultants, Carlsbad, Calif., said he doesn't believe Fresh & Easy, with 159 spread-out locations, has enough stores yet to have much impact on supermarkets. “The stores are probably having more impact on convenience stores, and it will require more Fresh & Easy locations in closer proximity to each other to have any impact on conventional supermarkets,” he pointed out.

But he isn't counting Fresh & Easy out. “Tesco is a formidable retailer that is very good at what it does, and it doesn't make a lot of mistakes. It's grown in markets around the world because it's so well run.

“But we in the U.S. have the twisted idea that no one can do it better than we can, which is nonsense,” Whalin said. “Tesco opened the Fresh & Easy concept with the idea it would have to be tweaked and modified, and there's no reason it can't grow into a very formidable competitor.”

David Bishop, managing partner at Balvor, Barrington, Ill., said most of Fresh & Easy's volume seems to come from fill-in trips, “because it's an easier in-and-out than the supermarket. But I'm not sure fill-in shoppers will evolve into full-time shoppers because of the one-stop-shopping advantages the larger stores offer.”

A larger Tesco format is “always a possibility,” Bishop added, “especially with so much underserved capacity, because Tesco is an adaptive company and moves quickly to take advantage of opportunities.”

Griswold offered a similar opinion. “At this point, most consumers at Fresh & Easy are there to top off their needs. You don't see many people viewing it as the place to do the bulk of their weekly shopping, because the range and choices are too limited.”

Asked whether Tesco has aspirations to open conventional supermarkets, Griswold said, “That's the $64,000 question. Tesco has used the small express format to enter other markets around the world and then begin to open larger supermarkets, and I think we should get an answer in the next nine to 12 months on whether that is its plan in the U.S.

“The challenges are supply chain and real estate. Right now Tesco is used to making smaller deliveries more often, but a larger store would require different economies of scale, and while a company like Tesco is capable of dealing with that change intellectually, I'm not sure it could do it physically at this point.

“We're at a point now where the Fresh & Easy name is becoming more established and the customer base is growing, and with the drop in the real estate market and more empty properties, there might be an opportunity in the next few months for Tesco to launch another format that's more traditional.

“If Tesco wants to find larger properties, this may be the best time — or else it may be too late.”

Tesco recently said the cost of building a store has fallen by 20%.

Fresh & Easy, based in El Segundo, Calif., opened its first U.S. stores in November 2007. It currently operates its 159 stores of approximately 15,000 square feet each in three states: 98 in California, from San Diego north through Los Angeles to Fresno; 34 in Arizona, primarily in the Phoenix market; and 27 in Nevada, primarily in the Las Vegas area.

turning losses into profits

For the fiscal year that ended Feb. 27, losses at Fresh & Easy hit $253.9 million (U.S.), up from $208.5 million in 2008. According to Leahy, “Though we do not expect losses to be much lower [this year], we believe they have now peaked.

“The stores are terrific and really, really popular, and we've been able to keep expanding despite a pretty terrible recession in that part of the U.S., but as the economy improves and we increase the rate of expansion, we will turn those losses into profits.”

Sales at Fresh & Easy jumped 78.4% to $544.7 million at 145 stores, compared with $305.4 million at 115 stores a year earlier, while same-store sales increased 5%. On an average basis, sales per store were $3.8 million last year, compared with $1.8 million in the prior year, although many of the 2009 stores opened in the second half of the year.

The company said the combination of organic sales growth and new units could boost sales more than 50% this year.

Observers also say consumers may be warming to the chain’s pre-packaged produce offerings.

Leahy said his enthusiasm for Fresh & Easy's prospects is based on his belief the small format “appeals across economic groups and age groups. Until we see the [Southwest] become more stable, we just don't know how many places [we could open stores] because we don't know the possible density of the store network.”

Tesco said it will open new Fresh & Easy locations at the rate of approximately one per week through 2010, “with a focus on areas where the local economy has been less severely hit and where we are seeing substantially stronger sales performance,” though the company declined to pinpoint any of those locations..

The company has previously announced plans for 37 stores in Northern California, including 18 in the San Francisco Bay area and 19 in the Sacramento area — stores originally slated to open in 2009 but which were delayed because of the recession — though it has not disclosed when it might begin opening those locations, nor has it confirmed that construction is under way on a distribution center in Stockton, Calif., to service them.

Whalin said he expects Fresh & Easy to spend more money on store growth this year “because the company is seeing very positive results.” He expects it to open between 50 and 75 stores, plus the Stockton distribution center, “and it will definitely move into Northern California sometime during the year,” he speculated.

moving east

Tesco has also reportedly looked at potential expansion sites in Chicago, but Whalin suggested the company is more likely to continue to fill in locations between existing stores before moving beyond the West.

Griswold told SN “it probably won't be too long” before Fresh & Easy enters a market outside the Western U.S. — “possibly sometime after 2011.”

He said he believes Chicago would be a good expansion city. “Chicago could really use a format like Fresh & Easy because it has a huge population, with a good-sized Hispanic population that Fresh & Easy likes, given the good job it's done serving that segment in Southern California and Phoenix. And Chicago is the kind of market where it could put in a lot of stores and achieve market penetration very quickly.”

Bishop said he believes Tesco will expand Fresh & Easy gradually by following population growth over the next 20 or 30 years.

“Tesco is well aware of where the growth markets are, but it will probably grow from its existing base rather than jumping around — using a hub-and-spoke system, with each new distribution center able to accommodate stores in a 400- to 500-mile area.”

Long said she also thinks Fresh & Easy should grow outward from its West Coast base “into parts of the country where the name is already known, especially given the large Hispanic population there. Expanding into new areas where its name is not known would mean the chain would have to keep reestablishing the brand rather than building on it.”

According to Griswold, “Denver, Salt Lake City and Albuquerque or Santa Fe, N.M., would be good expansion locales because they have younger demographics and the kind of consumers that would be attracted to Fresh & Easy. Putting up a distribution center in the Denver or Salt Lake area would open up a large chunk of the U.S. for Fresh & Easy expansion.”

The time may be right for Fresh & Easy to begin making inroads in the inner city, Griswold added. “The early feedback is that the stores have the ability to diversify and vary their range to meet the needs of local communities, and given what it has already learned in the U.S., Fresh & Easy is in a good position to serve more inner-city markets,” he explained.

Having been in London last week, Griswold said he was fascinated by the number of small stores serving a city of 8 million to 10 million, “and that compares very favorably to places like New York, Chicago and other urban locations where Fresh & Easy doesn't operate.”

“Tesco originally talked about putting its U.S. stores in underserved urban locations, though we haven't seen much of that yet. So to get the kind of growth the company is talking about could mean Tesco would have to make significant investments in the inner city. The format is a good one, and it would resonate in those kinds of areas.”

Nearly 2½ years after beginning to open its U.S. store base, Fresh & Easy continues to be flexible and willing to alter programs that don't work, the observers noted.

Changes it's made in the past year include:

“Everything we've done is a natural extension of what we've been doing all along,” said Brendan Wonnacott, the chain's communications director.

“As we approached 150 stores, it made sense financially to make a large-scale effort to move beyond fliers and in-store efforts to make people over a larger geography aware of what we are doing.”

building volume

Asked what Fresh & Easy needs to do to boost its volume and turn profitable, Long said it needs to stick with the store design it has and build on that. “It began opening stores and then invested quite a bit of capital in redesigning all of them to make them less sterile. Now that it's done that, it needs to make sure it doesn't have to redo the entire chain again.”

Griswold said Fresh & Easy needs to do more in terms of promotions, “particularly to raise awareness it is out there. It needs to make sure it doesn't lose touch with consumers and that consumers know who it is and where its stores are located — and it also needs to talk more about price because that's still the major determinant of where people shop.

“But it has already started to learn the importance of offering hotter prices and promotions.”

The key to boosting store volume, Griswold added, is understanding the consumer. “Tesco seems to have made a conscious decision not to use its loyalty card program, but it does seem to be making some merchandise differentiation on a local basis.”

According to Whalin, “It must become a better marketer and find ways to be more aggressive in advertising and promotions. It's beginning to do that, and it has to do it more, including considering TV advertising.

“Fresh & Easy has already made several changes at store level to meet consumer needs, and that's impressed customers. It began adapting within six or seven months of initially opening stores in terms of a willingness to change the merchandise mix and be more responsive to what the market wanted.”

Bishop said Fresh & Easy learned very early that the research it had done in the U.S. prior to opening stores was not complete or at least that its understanding of the U.S. shopper was not complete, and it's been willing to refine its operations ever since.

The refinements so far include changing the design and layouts of the stores, along with some of the product selection, “all of which has been driven by shopper feedback,” Bishop explained. “Fresh & Easy takes a program, tests it, evaluates it and addresses the opportunity gap.”

Whalin also said Fresh & Easy has been willing to change to accommodate U.S. tastes “in terms of the values it offers, primarily because of the state of the economy, which forced it to offer consumers more for their money.

“Fresh & Easy has a good selection of top-quality private label, priced at a good value, plus it offers a pleasant shopping experience. And while I'm not crazy about the self-checkouts, they work for a store of that size — and what's most important is, customers love them.”

For Griswold, Americans are willing to buy private-label brands, “though I'm not sure they are at the point of buying as much as Fresh & Easy is offering.”

Griswold said he sees the self-checkout, or assisted checkout as Fresh & Easy refers to it, as one area the chain needs to change, “especially if it hopes to grow basket size. Maybe it could start with one or two manned checkstands.”

However, he said pre-packaged produce is not the issue it once was. “People are getting used to it, and we're seeing more packaged produce in traditional supermarkets, so that's becoming more the norm.”

Jonathan Ziegler, an analyst with PUPS Investment Management Co., Santa Barbara, Calif., said he's been impressed by the attentiveness of the Fresh & Easy staff.

One of his complaints, however, is the stores' continued use of fixtures with deep shelves. “While I understand that means the stores require fewer deliveries and saves the company money on transportation and logistics, Fresh & Easy is paying full rents for retail space, and I believe it's wasting a lot of that space because not all products turn at the same rate and most items stocked deep are not generating the turns.”

On the other hand, Ziegler said he likes the gravity-fed refrigerated fixtures, “and the sell-by dates on fresh products are very large and easy to read, which is very consumer-friendly.”

However, with most fresh products carrying that day's date as the expiration, “it may confuse people who may think it's really not fresh if it expires the same day.”

One questionable policy that Bishop said bothers him is a holdover from Great Britain: Fresh & Easy's inventory system, which allows displays of fresh and prepared foods to sell down during the day before the company will restock for the next day.

“As a result, some shelves look pretty sparse late in the day, which raises questions about product freshness for American consumers, whereas British shoppers recognize and accept that practice.”

Long said she likes the “manageable size” of the stores and the ready-to-eat varieties it offers for consumers who don't want to cook or go out to eat.

“And I like the fact it's playing its own game and not trying to be something it isn't but is trying to create its own strategy and working with consumers to find out what they want and what they don't.”

AT A GLANCE

FRESH & EASY

U.S. debut: November 2007

U.S. headquarters: El Segundo, Calif.

Annual sales (FY ended Feb. 27): $544.7M

Annual profit (loss): ($253.9M)

Number of stores: 159