In announcing its move into the US, Tesco has set itself a daunting challenge, one that has defeated other European retailers. Katy Humphries looks at what makes Tesco’s move different and why analysts expect the company may have a decent chance of success.

The news that Tesco has set its sights on the lucrative US market came as a surprise to many investors and analysts alike, despite relentless rumours linking the UK’s largest retailer with various US ventures.

Prior to the announcement, it was generally thought that the maturity and competitive nature of the US retail sector made it too daunting a prospect. But a market that, according to Tesco’s own estimates, is worth in excess of GBP343bn (US$600bn) and is expected to grow by 40% in the next five years, clearly represented a tempting prize to a company for whom international operations have become increasingly significant.

The surprise stemmed at least in part from the fact that Tesco had ruled out any major US acquisition this January, quelling speculation that it was pondering a move for the defunct Albertsons supermarket chain. Statements from CEO Terry Leahy seemed to indicate that the company had no imminent US acquisition plans. What pundits had not expected, however, was that Tesco would not look to buy an established business but instead launch a new convenience store format and develop organically.

There are pros and cons to this mode of expansion. Tesco will initially be risking less than if it were to take on a major acquisition – planned capital expenditure is GBP250m per year, with the company expecting to break even within two years. But as a completely new player in a market of established retail names, building up brand recognition, attracting customers, and establishing a distribution system will be no easy task.

However, that drawback could be seen as an opportunity, as Tesco would be bringing something new to the US market. Leahy naturally believes it has a concept that will appeal to US shoppers. “The United States is the largest economy in the world with strong forecast growth and a sophisticated retail market,” he said. “It is a market we have researched extensively for many years and over the last year we have committed serious resources to developing a format that we believe will be really popular with American consumers.”

Moreover, it is not as if the acquisitive route has proved successful for UK retailers in the US. Attempts by Sainsbury’s and Marks & Spencer to gain a foothold there through acquisition have foundered. Indeed, Neil Sanders of Verdict Research believes the organic approach could be the best option. “It is eminently sensible for Tesco to develop organically,” he said. “Tesco doesn’t want to be burdened by the problems of a company it takes over nor does it want to be encumbered by stores which are unsuited to its operation. Moreover, this route will allow the company to manage its capital expenditure and learn from experience as it expands store numbers.”

Tesco’s other tactical coup may be its choice of a convenience format rather than attempting to go head-to-head with some massive supermarket operators – including the biggest in the world Wal-Mart – in their own backyard.

Wal-Mart has taken some steps towards a smaller-format strategy with its Neighbourhood Markets. However, this evolution has been decidedly tentative, and US analysts have suggested Tesco could steal a march on its biggest competitor.

“Tesco is not just another Wal-Mart or another traditional competitor,” said Scott Langdoc, Nigel Montgomery and Robert Garf of AMR Research in a note. “It plays the market differently, and retailers that don’t take heed and act accordingly will have nothing but an uphill climb.”

In 2007, Tesco will open an unspecified number of stores on the West Coast, an area offering a dense affluent population base. It is also an area of relative weakness for Wal-Mart. The giant has only 266 stores in California, Oregon and Washington combined, compared with 415 in Texas alone.

The Tesco format will be loosely based on the Tesco Express model that has proven successful across five countries, with over 800 stores serving around 8m customers a week. The new concept will be specifically designed to appeal to US consumers, but Tesco declined to give further details regarding the name, design, store numbers and the merchandise they will be carrying at this stage.

If the stores mirror the European and Asian Tesco Express outlets, they will provide high-quality foods for a young, urban clientele. Tesco’s shops will likely be convenient stores rather than convenience stores in the traditional sense. Instead of hot dogs kept warm under lamps, nachos and microwave burritos, they will offer upscale groceries, including private label, fresh produce and prepared foods.

By starting with a small format and limited product range, Tesco will be able to focus its efforts and gauge success before thinking about further expansion Langdoc told just-food. “Probably the most difficult aspect of Tesco’s market entry is established US retail capacity, which is still growing without Tesco’s appearance,” he said. But overall Langdoc feels Tesco’s sophisticated retail approach could pay dividends in spite of the tough nature of the market. “Will Tesco be able to carve out a niche in a mature market when most of its recent market entries have been to developing countries like the Eastern Bloc and China? With time, we say it will. Those of us who follow the global retail market, and the UK grocery market in particular, have always been impressed with the forward thinking and thought leadership, in process and technology, that retailers like Tesco have broadly adopted more successfully then their US counterparts.”

Tesco typically enters new markets with a small investment in a single format before expanding into others. “While Tesco may have picked a specific format and geography to get started in next year, it has a broad portfolio of store models and market opportunities to explore,” the AMR researchers noted. “Once the base supply chain and management infrastructure is in place and initial consumer reaction to the Tesco brand is assessed, all bets are off as to how far Tesco may want to take its approach to American retailing.”

So if the US analysts have got it right, Tesco could bring a dynamic new approach to the US retail market that encourages innovation and invention, and in the process succeed where a number of its peers have failed.