TESCO TO COMPETE IN U.S. USING SMALL-FORMAT STORES

MARK HAMSTRA

LONDON - The British are coming after all.

Tesco, the global supermarket giant based here, last week said it would invest up to $435 million per year to introduce a new, small-format retail food concept in the United States. The company said the stores would draw from the Tesco Express convenience banner in the United Kingdom and will debut on the West Coast next year.

Although Tesco revealed few details about its plans, analysts said they envision stores in the neighborhood of 10,000 square feet that feature a heavy emphasis on prepared foods and heat-and-eat meals.

"I think this is much more important than people might think," said Neil Currie, an analyst with UBS Investment Bank, New York. "I think there are a couple of clues as to how serious Tesco is about this: Tesco has operations in several different countries, but this is the first time they have put a main board director in charge of it, on location. The second thing is the [investment] they are looking to put behind this. It is big."

Tesco said Tim Mason, the company's marketing and property director and a close aide to Terry Leahy, Tesco's chief executive officer, would run the operations in the U.S. while he remains on the board of Tesco. Officials at Tesco were not available for further comment.

The company, which with $59.5 billion in sales last year is about the same size as Cincinnati-based Kroger Co., had been reported to be eyeing acquisitions in the U.S. for the some time. Now that it has revealed its true plans, analysts said the idea of building a new format from scratch actually makes a lot more sense.

"Supermarkets in a way have become convenience stores in the U.S.," Currie said. "But if you had to start all over, would you build 40,000- to 50,000-square-foot convenience stores? I don't think so. So what Tesco is doing is starting with a blank sheet of paper."

The small-format food store - like Trader Joe's - is in what Currie described as an "embryonic stage" in the U.S., leaving leeway for Tesco to "create the blueprint" for a store that emphasizes freshness and convenience for fill-in trips between stock-up visits to big-box stores like Wal-Mart.

Mark Husson, an analyst with HSBC Securities, who, like Currie, hails from the U.K., said he thinks the concept Tesco opens in the U.S. will be a cross between its Express stores, which are suburban/rural convenience stores emphasizing fresh foods, and its Metro banner, which operates in urban markets and relies heavily on heat-and-eat meals and sandwiches.

"I think it will be value-added fresh food with no labor attached to it," Huson said. "In the U.K., you don't ask for three pounds of chicken wings - you buy a box of chicken wings, and it's Tesco's style to have the blue cheese sauce and chopped celery included right in the package."

He noted that the size of the investment Tesco is making - enough for more than 100 such stores, he estimated - indicates the company is likely to be considering multiple formats.

Neil Saunders, a consultant with Verdict Research, London, said Tesco is able to edit its assortment for small-format stores in the U.K. through rigorous analysis of its loyalty card data.

"One of the biggest questions in the U.S. is what range of product are they going to put in there and how is that range going to be composed," he said.

Husson suggested that Tesco might have learned a lot about U.S. consumer preferences through its partnership with Pleasanton, Calif.-based Safeway, through which Safeway offers a Web-based grocery service in several markets. That may also have been a factor in its decision to debut the new format in the West, he said, where Safeway has most of its Web business, in addition to the ready availability of land there for the organic growth Tesco said it is targeting.

Tesco projects the venture to be profitable by 2009.

One of the challenges, analysts pointed out, will be establishing the distribution infrastructure for the format. In the U.K., Husson said, Tesco buys custom-made products from manufacturers and then distributes them itself through its own warehouses. In the U.S., he said the company could either build its own distribution center or use a combination of third-party and direct store delivery.