Tesco may just have turned in a bumper £2.2bn profit, but international expansion will be key to sustaining success in the decades ahead, writes Andrew Don.

Slippage in Tesco’s UK sales growth from 5.7% over Christmas to 4% in the seven weeks to the end of February should not unduly worry chief executive Terry Leahy.

But the astute Liverpudlian will be well aware that increased gas, electricity and petrol prices will hit Tesco customers’ disposable income in 2006-07. And rival Sainsbury’s is on a recovery curve.

The amount of new space the hungry retailer can capture in the UK could be severely restricted in an environment that is strangely hostile to business success stories. Leahy knows infilling with smaller convenience stores is not enough to keep this retail phenomenon breaking records.

That is why he has diversified the company into a range of sectors from financial services to telecommunications, and dipped a sizeable toe into international markets, spreading its risk over 12 countries, or 11 once Taiwan, subject to completion of an assets swap deal with Carrefour, is stripped out.

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Non-UK sales space accounts for 54% of the group’s sales floor space, or 21.9% of group sales. Operating profit accounts for slightly more than a quarter.

This is no insignificant amount and, as it gains economies of scale in the countries in which it opens, and continues to spread its risk, higher-performing individual markets will be able to offset its lower-performing markets.

But how it fares in the US will be crucial for two reasons: firstly it plans to invest up to GBP250m (US$446.4m) a year in developing a new convenience format beginning on the West Coast in 2007. Analysts believe Tesco would like to expand all over the US once it can prove it can hack it in “the land of the free”.

Secondly, it will be fighting Wal-Mart, which it has already whipped in the UK, on its home turf. Tesco is the world’s fifth-largest grocery retailer by sales behind Wal-Mart, Carrefour, Ahold and Metro. It could well prove to be Wal-Mart’s strongest competitor.

Make or break in the US will be significant psychologically, not just to Tesco, but in terms of market sentiment.

Tesco is likely to have some issues on buying terms initially: much of this will have to be done on a local basis in a market that knows little about the GBP41.8bn turnover group.

However, it would still be dealing with many of its existing international suppliers and new ones should be wise to the potential of trading with this giant.

Cost of entry in the US is far cheaper than in the UK but Tesco is used to higher profit margins of about 5.5% in the UK, which will make economies of scale in America critical.

Success here is by no means certain but Tesco is particularly skilled at exploring new markets and it has been researching the US for 20 years.

More important, the company has proved time and time again that it has the ability to turn that research into a strong proposition and in-depth understanding of its customers.