Tesco thinks small to be big in America

The supermarket giant aims to succeed where others have failed by opening local convenience stores across the States. Tony Glover reports

It was without a hint of irony that Tesco, the giant supermarket chain, announced plans to conquer the US by opening stores that would trade on their small and friendly credentials.

The chain, which will cost £1.25bn to roll out, will consist of 50 fresh&easy Neighborhood Market stores by the end of next February. The investment is key to Tesco's hopes to launch a successful challenge to the likes of Safeway and Wal-Mart in their own backyard.

The UK group last week reported bumper interim results, with an 18 per cent rise in pre-tax profits to £1.29bn in the six months to August and a 9 per cent increase in sales underpinned by the company's growing international business.

Tesco, which also has plans to develop stores in India, has already captured significant market share in 12 countries including China, Japan, the Czech Republic, Malaysia, Korea, Thailand, Hungary, Poland, Slovakia and Turkey.

But taking on the US will be the greatest challenge in the company's 83-year history. The supermarket was invented in the US, and Tesco grew in the UK by copying the pile-it-high-sell-it-cheap strategy of retailers such as Wal-Mart. But it now claims that, after years of careful and secretive research, it can offer US shoppers something they do not already have: "Whole Foods quality at Wal-Mart prices", via local convenience stores. (The reference is to Whole Foods Market, the leading retailer of organic food.)

The initial rollout of the fresh&easy chain will be in Los Angeles, San Diego, Phoenix Arizona and Las Vegas. Tesco has earmarked an investment of around £250m a year for five years, roughly 7 per cent of the company's total capital expenditure, purely for US expansion. The £1.25bn question is whether it can succeed where rivals have failed. Other UK retailers, notably J Sainsbury, which finally quit the US market in 2004 after a 20-year campaign, were equally sure of their strategies. But City analysts appear to be convinced that Tesco has at least a fighting chance.

Lehman Brothers analyst Matthew Truman says: "Tesco's entry into the US is in stark contrast to previous UK retailers' attempts. While many have pursued acquisition-led growth in the hope of harbouring synergies through scale, Tesco has identified a niche product and format that will likely offer them first-mover advantage."

According to the investment bank Merrill Lynch: "Tesco has spotted a crack in the market it can exploit. They can exploit their world-leading box of cost-saving tricks – everything from centralised distribution to ready-for-shelf packaging."

Tesco is not trying to compete directly with the so-called "big box retailers", such as Safeway, Wal-Mart, Costco and Target, which operate huge, largely out-of-town supermarkets. Instead, it aims to supply a growing number of shoppers who are eschewing the traditional American weekly drive to a hypermarket in favour of more frequent trips to a local store.

According to Merrill Lynch: "Over the years social change has fragmented the food-led shopping trip. More smaller and single-person households, older couples, dual-income families and so on, all mean that there are more US food shopping trips than, say, 20 years ago."

Two years ago, Tesco sent a team of executives to the US to carry out its research. It also hired anthropologists to stay in the homes of 60 shoppers and built a mock-up store in Los Angeles, telling inquisitive bystanders it was a movie set.

As well as offering its own products with no artificial colours and flavours and no trans-fats, Tesco is positioning its chain as the "good guy" of US retailing. In an industry where leading players such as Wal-Mart have been heavily criticised for low pay and poor working conditions, it is offering staff benefits such as health insurance, pensions and paid holidays.

According to Tesco's chief executive, Sir Terry Leahy: "We've announced a very, very good employment package. We're going to be a very good employer."

Sir Terry is also keen to emphasise the company's green credentials. Every store will have a huge image of a family of polar bears as "a reminder for us to be careful about our impact on the environment". The company has invested in California's largest solar roof installation to help power its distribution centre. By such measures as using LED lighting in freezers, Tesco thinks it can reduce in-store energy use by 30 per cent.

But will additive-free foods and an eco-friendly attitude be enough to conquer a market that has eluded other UK contenders?

"The biggest market concern appears to be that Tesco's new concept of high-quality but affordable convenience stores may not appeal to US consumers, who regard convenience stores as places usually attached to gas stations where you buy cigarettes and magazines. The concept of quality, fresh ready meals is a new one in the US," says Mr Truman at Lehman Brothers.

While central to its future growth, the US represents only a part of Tesco's global footprint. The company now opens four times as much retail space overseas as in the UK. Unlike its UK rivals Morrisons and Sainsbury's, it sees long-term profits growth as driven by global expansion and is eyeing India as the next market after the US.

Tesco director Lucy Neville-Rolfe says: "We already have 3,000 support staff in India and are investigating the possibility of developing stores with a local partner, something foreign retailers are required to do under Indian law."

Ms Neville-Rolfe adds that Tesco is not in the business of creating a one-size-fits-all global brand, but rather stores that respond to national markets: "In China, for example, we build hypermarkets. But in the US we are opening convenience stores that are only a little larger than the Tesco Express stores in the UK."

Neither is Tesco interested in branding all its stores with a single logo. In Turkey, for example, it is known as Kipa; in the Far East, it favours hybrid names; in Thailand, the brand is Tesco Lotus and in China it is Tesco Le Gou, which translates as "Tesco happy shopping".

Analysts believe that Tesco's international business will outstrip its UK operations as emerging markets expand and the home market reaches saturation.

"In 10 years," says Mr Truman, "factoring in opportunities of China, the US and a possible entry into India, Tesco's international business will represent around 47 per cent of group sales and profits. To put our estimates in context, the international business already makes more profit than Sainsbury's or Morrisons, while also owning more real estate."

But Tesco's international strategy will be judged on its US performance. Success will establish it as one of the most significant retailers in the world. Failure will see Sir Terry lose his crown as king of the high street.