Tesco faces battle in UK and end of US venture could free up resources

Tesco faces battle in UK and end of US venture could free up resources

When pondering why Tesco has decided to consider quitting the US, one must look at the UK retailer's challenges at home.

Tesco has faced questions over its US venture ever since it opened its first Fresh & Easy in 2007. However, the criticism has intensified since it became clear Tesco was struggling in its home market.

Of course, one must quantify what one means by "struggling". Tesco still accounts for around 30% of grocery sales in the UK, ahead of nearest rival Asda, which has 17% of the market. However, it is clear Tesco has come under pressure in recent years not just from Asda but a resurgent Sainsbury's, a growing Morrisons (up until recent quarters) and UK consumers' rising interest in discounters like Aldi.

At first glance, there is no doubt Tesco was unfortunate in the timing of Fresh & Easy's launch. The first store opened in November 2007. Ten months later, Lehman Brothers collapsed, sparking the financial crisis that plunged the West into recession.

"Not even the brightest economists in the world could foresee the unprecedented crisis in the markets about to engulf the world," Tesco CEO Philip Clarke said.

"But when it hit, it hit hard. And those states in the US where we were trying to build a presence – California, Nevada and Arizona – were particularly affected by the sub-prime crisis. Launching Fresh & Easy in the world’s most competitive retail market was never going to be easy, but the economic backdrop made the task twice as hard."

However, Tesco would be disingenuous to simply point at the economy for the under-performance of the still loss-making Fresh & Easy. Ahead of the opening of the first store, Tesco trumpeted the fact it had researchers spend time in the homes of consumers looking at shopping and cooking patterns.

"We literally went into their kitchens and looked in their refrigerators," Tim Mason, the Tesco veteran who became Fresh & Easy CEO, said in June 2007. "Based on our research, we are confident our stores will be a hit in every neighborhood we open in."

Nevertheless, even as the first store opened, there were questions over Tesco's Fresh & Easy strategy. One question mark over Tesco's strategy was the amount of own-label products sold in store. Initially, a Fresh & Easy outlets sold around 3,600 SKUs and of that around 50% is own-label, a proportion much higher than a typical US supermarket. Demand for own label has increased in recent years in the US but it still accounts for just 18% of total packaged food sales. Last month, SymphonyIRI questioned whether private label had reached a "glass ceiling" in the US.

As Tesco announced its "strategic review" of Fresh & Easy yesterday, there was also criticism of its over-use of self-service checkouts.

Bloggers from independent US-based Fresh & Easy Buzz said all but two of the 199 Fresh & Easy stores have only self-service checkouts. That, said Fresh & Easy Buzz, would be a "very major limiting factor" for Tesco selling the business. "As we've said before, no other chain in California, Nevada or Arizona does self-checkout only. So, any buyer must spent big $ replacing checkout stands," it wrote on Twitter.

Leaving to one side whether self-service tills could be a barrier to a sale of the business, the checkouts suggest a fundamental misunderstanding of US consumers.

Speaking to reporters yesterday, Clarke refused to pin-point why Fresh & Easy had not succeeded as Tesco had hoped. "My task is not to re-test the theory of entry but to test whether the time is right to exit. The journey to sustainable returns is going to take too long. Once that became clear, it was right that we act and we act quickly."

And, when analysing why Tesco could have felt it had to act quickly, one comes back to the UK. Like-for-like sales, though sequentially improving in the retailer's third quarter, are still falling. Successive quarters of sliding sales pushed Clarke into investing GBP1bn to revitalise its UK business from January and, although he yesterday pointed to improvement from its food business, sales are still down.

The UK, based on Tesco's results for its most recent full financial year, still accounts for almost two-thirds of the retailer's trading profits. With Tesco's UK business treading water and facing intense competition from a number of rivals, it is little surprise the retailer wants to divert its resources to a domestic business that still underpins the group. And with investor criticism of Fresh & Easy's ability to make a profit despite hefty investment, it is little surprise that Clarke concluded enough was enough.

"The last 18 months, we gave the business the best shot. We minimised the costs. We reduced the losses. I don't think there's any more we could have done but once it became clear, we had to act fast," Clarke said yesterday. "Sometimes you're able to change the dial. Sometimes you're not."

Reflecting on Tesco's third-quarter sales, Clarke said he was "really pleased" with the performance of its UK food business. "Although it's still early days, the offer is improving and the consumer is starting to respond," he said.

That said, the latest data from Kantar Worldpanel showed Tesco's share of grocery sales in the UK was down year-on-year in the 12 weeks to 25 November. Elsewhere, Tesco has faced challenges in non-food.

The City's view of Tesco's attempts to revitalise its UK business was qualified. "Stripping out the drag of general merchandise, Q3 food LFL was up 1.2% according to management though we suspect inflation has helped," Seymour Pierce analyst Kate Calvert said. "From a share price perspective even if Tesco does have a relatively good Christmas, there will still be no visibility on whether UK profits have bottomed until the second half of 2013."

Charles Stanly analyst Sam Hart added: "We are encouraged by the recent improvement in like-for-like sales in the UK food business, but it remains unclear at this stage whether a further downward rebasing of operating margin will be required in the UK over the medium term."

If Tesco's UK business was thriving and seeing off the competition perhaps Clarke may have persevered for a bit longer with Fresh & Easy. But Tesco still faces a battle in the UK and ultimately - and quite rightly - Clarke has decided the time is up for the retailer's American venture.