Tesco has failed to build Chinese business with staying power

Tesco has failed to build Chinese business with staying power

Nine years after Tesco, with high hopes, entered the Chinese market, the UK retailer is scaling back its presence in the country.

Tesco is in talks to merge its 131-store network with the operations of state-owned China Resources Enterprise, which runs almost 3,000 outlets in the country.

The two sides have signed an MoU and discussions continue but they have already outlined plans for CRE to own 80% of the venture, with Tesco taking 20%.

Shares in Tesco climbed on Friday in the wake of the news. With Tesco's Chinese business making operating losses and sales down, analysts welcomed what they saw as further evidence of the retailer's more disciplined use of capital, while still keeping a foothold in the market.

Analysts were keen to play up what both sides could bring to the venture, with Tesco's international "expertise" and "experience" being touted by some industry watchers.

However, amid the praise for the deal and the purported benefits for both sides, the proposed agreement should also act as a reminder of Tesco's, at best, patchy international record. Once flush with global ambitions, Tesco has, in the last year, quit Japan and set out a plan to leave the US. China is a market where the company still had high aspirations even as recently as 2011, when it launched a bond offer to fund expansion there.

The announcement of these talks should not be an occasion to simply pat Tesco on the back and say 'well done'. It may be heartening to some that Philip Clarke (whose role before CEO was as head of Tesco's international business) is looking to find a way forward for the retailer in China but one should still reflect that its foray into the country has hardly been a success. In 2004, when Tesco announced its first venture in China, it talked excitedly about the retailer's potential. It has, however, failed to build an independent business with staying power in the country.

"This cannot be the outcome Tesco had in mind when they entered the market," one industry analyst, who wished to remain anonymous, says. "However, they have been known to be struggling for a while, with a relatively smaller number of stores than other global players, and an over-emphasis on following UK/ global processes. I see this tie-up as a pragmatic and face-saving approach."

Tesco will reportedly face a fee to save face. The venture with CRE, while enabling Tesco to keep an interest in the country, will reportedly see the UK retailer pay its Chinese partner "hundreds of millions of pounds" for its stake.

The venture will, the companies say, have sales of around GBP10bn, compared to the GBP1.43bn Tesco's Chinese business generated on its own in the retailer's last financial year. Therefore, Tesco's initial 20% stake will only proportionately provide a small increase to its existing sales in the country. Moreover, Tesco's 20% shareholding also raises questions about how much influence it will have over the venture's operations.

Shore Capital analyst Clive Black said he "welcomed" Tesco's plan to join forces with CRE.

"There has been considerable ebbing & flowing in Tesco's strategy in China to our minds, which has disconcerted investors and ourselves. It is only three years ago that management was showing investors plans for a opco-propco development strategy that comprised up to 80m sq ft of real estate development and a major programme of free-standing hypermarket openings too. Within two years this plan was substantially scaled back."

However, he remained cautious about the prospects some hold out for the new partnership. "We concur with the view that Tesco could benefit from better market understanding in China with CRE as a partner. Furthermore, we see material potential benefits from utilising CRE's nationwide infrastructure from distribution and reach perspectives whilst longer-term Tesco may be able to contribute to the combined entity's progress if sourcing and operational processes can be applied to beneficial effect. Such matters, however, are a long way down the road and remain easier to write about than to deliver. We await to see how these discussions progress with interest."