Confirmation that Tesco is in joint venture talks with China Resources Enterprise highlights a mounting trend in the FMCG sector. International companies eyeing growth in the rapidly expanding Chinese market are seeking out local joint venture partners. If Tesco’s negotiations with CRE prove successful, a stronger business will emerge, Katy Askew suggests.

Tesco confirmed today (9 August) it has entered exclusive talks with China Resources Enterprise to establish a joint venture retail operation.

The move reflects Tesco’s increasingly prudent approach to its expansion in China, a market that it has operated in since 2004.

Tesco has argued that the retail space race in China has seen store openings outpacing demand in the country and, in 2012, the company “moderated its development accordingly”. During the fiscal Tesco scaled back its investment in China, opening just 12 outlets and closing five others as part of a drive focus on three regions in the east of the country.

Plagued by issues in its core domestic business, the UK retailer opted for a more conservative approach to capital allocation in China.

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Tesco has also seen Chinese sales deteriorate as a result of mounting competition in an increasingly saturated market that has – to an extent – been hit by the global economic slowdown. In its most recent trading update, Tesco conceded that like-for-like sales in the country dropped 4.9%.

Despite these challenges, Tesco has repeatedly insisted China remains “a strategically important market” for the company, downplaying any suggestion that the supermarket giant could look to withdraw from the country (as it intends to do in the US, if a buyer can be found for its Fresh & Easy format).

But something clearly needed to be done to improve the group’s performance in China.

In May, reports first emerged that Tesco was searching for a Chinese partner to help revitalise its business in the country, without the need to pour money into its operations there.

CRS would seem an ideal candidate. The state-backed firm is already a retail powerhouse in China. Alongside its food and brewing interests, CRE operates 2,986 stores in China and Hong Kong through its CR Vanguard unit, dwarfing Tesco 131-store strong network.

In one swoop, CRE’s geographic footprint offers Tesco access to Chinese consumers in faster growing, smaller Chinese cities. Currently, Tesco’s efforts are focused on the Shanghai, Tianjin and Liaoning provinces. CRE’s CR Vanguard stores cover 24 provinces which together have a population of approximately 1.1bn.

CR Vanguard also has an established national distribution network and, as Tesco termed it, “deep understanding” of local customers.

According to Shore Capital analyst Clive Black, if a deal does go through, this local insight is a clear benefit of teaming up with a local partner. “It may be welcome news, helping local insight in a market that pure Western plays struggle to effectively penetrate in our view,” he comments.

Beyond insight into Chinese consumers, CRE also offers an understanding of the Chinese regulatory landscape and well-developed connections with local suppliers.

For its part, Tesco brings to the table its global retail know-how, international sourcing scale and supply chain capabilities.

Tesco also has plans to develop multichannel operations in China and intends to launch an e-commerce business in Shanghai this year. Tesco’s experience in this field would likely prove invaluable to the potential JV company, which Tesco and CRE said would become “the leading multi-format retailer” in the country.

According to Jon Copestake, retail analyst at The Economist Intelligence Unit, a joint venture deal would be “win-win” for Tesco because it would allow the company to grow in China without diverting resources from the UK.

“Critics may see this as Tesco admitting defeat in attempts to tackle the difficult Chinese market on its own and spreading the risk also spreads the potential reward. But with the British retailer focussed on regaining share in the UK without losing out in a key emerging market like China, engaging with a partner like China Resources seems an obvious route to take,” he says.

It is also a well-trodden path for multinational FMCG companies targeting growth in the country. CRE already operates a successful joint venture with UK-listed SABMiller. Food giants including Nestle, Arla, Kellogg and BRF have also taken the joint venture route to grow their businesses in the country over the past year.

A joint venture company brings together the best of both worlds. Local know-how, distribution and logistics are combined with the supply management and internal structures that multinational groups have developed from years of experience of operating across multiple markets.

It would seem then that we could well see more of the growing trend for Chinese firms to team up with international giants in the coming months and years.