The publication this week of Tesco's first-half results underlined yet again the retailer's dominance of the UK grocery sector. But, writes Katy Humphries, sustaining such impressive growth demands continued innovation, and hinges on the success of the retailer's ambitious international expansion plans.

The growth of Tesco into a retail powerhouse is a business success story to rival any. But such success can create its own problems. Tesco is faced with the task of sustaining fairly remarkable growth, something it is attempting to achieve through innovation at home and international expansion, while the market leader's dominance has been the principal catalyst for a Competition Commission investigation into the grocery sector.

It is little wonder that Tesco's dominance has raised concerns. The numbers are truly staggering. The UK's largest supermarket chain posted pre-tax profits of GBP1.15bn (US$2.15bn) for the first half of the year. According to the latest figures from TNS Worldpanel, Tesco controls 31.4% of the UK grocery market - a share that is almost double the size of its nearest competitors, Sainsbury's and Asda.

In its core UK business, first-half same-store sales increased by 6.5%. Store openings boosted total sales, which increased by 10.2%. The company said it expects to add 7.6% to its UK selling space during the current financial year, following the opening of 36 new Tesco Express sites during the first half.

In the face of strong opposition and criticism regarding the retailer's dominance of the UK retail market, Tesco invested GBP200m in lowering grocery prices, driving the cost of shopping at Tesco down by an average of 0.4%. Discussing the group's UK results, Tesco chief executive Sir Terry Leahy commented: "It hasn't been easy but it has gone well for the simple reason that we have been on good form operationally."

However, the resurgence of other grocery retailers - evident in the first-half results of both Sainsbury's and Morrisons - has led some analysts to question how sustainable Tesco's UK growth is. The mature UK market has undergone considerable retail consolidation. Couple this with the Competition Commission's investigation into the grocery sector, and it seems that Tesco's future growth in its home market could be facing some significant stumbling blocks.

To combat this, Tesco has developed a number of new products, routes to market and formats.

Shorecap retail analyst Clive Black believes these initiatives have given Tesco room for growth in the UK. "Tesco's strategy over the past ten years has been to add additional product categories, moving into non-food products and services," Black told just-food. "This means that Tesco still has room for growth in its home market."

Tesco has clearly established itself as a fashion retailer with H1 clothing sales growing by 19%, while consumer electronics sales increased by 36%. The company is currently trialling its Homeplus non-food stores, while over 8,000 non-food products will be available through Tesco Direct, which operates through a catalogue as well as online.
 
Tesco has also found new ways for its grocery products to reach consumers. Tesco.com online food store saw H1 sales rise by 28.7% with profits, excluding the start-up costs associated with Tesco Direct, increasing by 43.1%. Revenues from the online sale of groceries and alcohol totalled GBP554m, with profits reaching GBP33.8m. Tesco.com has around 750,000 regular users and is receiving almost 220,000 orders each week.

"We are the number one online retailer in the UK, and although it's still early days for Tesco.com we believe that it will become an increasingly important retail format," a Tesco spokesperson told just-food.

However, the real growth opportunities for Tesco lie in foreign expansion. "In coming years, international growth will become increasingly important," Black said. "In overseas markets, Tesco started with a food-based hypermarket model. As its international capabilities strengthened we have seen new formats and services coming through. Going forward, the biggest opportunities for growth are in international markets so we expect to see Tesco formulate a strategy based on this in future years."

Currently, Tesco operates in ten European and Asian markets where sales in the six months to 27 August increased by 15% to around GBP10bn, accounting for about a quarter of group sales. With the exception of Hungary and Japan, underlying sales grew in all of its overseas markets during the half.

And growth looks set to continue. Tesco recently said it was would deliver its largest programme of international store openings this year, with the planned addition of some 6m square feet of new store space added in overseas markets, added to a further 1m square feet obtained through the acquisition of 11 former Carrefour stores in the Czech Republic. By the end of the year, 60% of Tesco's floor space will be outside the UK.

Tesco's international operations are not as mature as its UK business and we are beginning to see aspects of the UK model coming through internationally as the retailer expands its product offering and adopts a multi-format strategy.

Tesco's current international operations therefore still present opportunities for growth as they reach maturity. Leahy predicts that China could be the next country to see retail consolidation as some international chains exit the market and those left seek to grow through acquisition. "Consolidation is picking up and Tesco will play its part at the right price," he said.

Tesco is also moving into new markets. The retailer is preparing to launch a chain of convenience-style stores based on its Fresh and Easy concept in the west coast of the US, some time next year.

The US has traditionally been a graveyard for British retailers, with the likes of Sainsbury's and Marks and Spencer being forced to retreat from the market. However, through the development of a closely guarded and unique model designed to appeal to US consumer preferences, Tesco is optimistic of its chances of success.

International expansion is not without its pitfalls. The group's H1 sales in Hungary, where Tesco is the market leader, were held back by political instability. Likewise, expansion in Thailand is currently facing challenges following the military coup there this month.

Tesco remains undeterred. "We are confident of our ability to adjust to international markets," the spokesperson said. "While occasionally problems beyond our control may arise, as in Thailand, we remain confident that they can be overcome."

Meanwhile, Leahy is bullish about the company's international aspirations. "Our international business is our biggest opportunity, both for growth and delivering returns."

With all this talk of international expansion, some fear that Tesco runs the risk of losing focus in its core UK market, as it will constitute a declining part of group profits in the coming years. However, Tesco seems to have learnt the lessons of other international retailers, notably Carrefour and Wal-Mart, who have been forced to beat a retreat from unprofitable overseas markets in recent months. The UK is also likely to remain the company's single most profitable market, a fact that is sure to sharpen its focus and ensure that it continues to deliver retail innovation both at home and overseas.