Can Tesco Freshen Up Its U.S. Chain?

U.K.-based Tesco Plc, the world's third-largest grocer after Walmart and France's Carrefour, landed in the United States with a bang in late 2007, launching its much-anticipated Fresh & Easy Neighborhood Market stores in California, Arizona and Nevada.

Tesco, which had been a dominant player in Central Europe and Asia, hyped big plans for the chain. Sir Terry Leahy, Tesco's then chief executive officer, said in 2006, "We intend that we'll grow as rapidly as we can in the U.S., and, if we're right and the thing is as successful as we expect it to be, then we have the potential to develop, in Tesco terms, a very substantial business in the United States."

After dispatching an advance team of 50 managers to scope out the U.S. market by observing California consumers' eating and shopping habits, including how they cooked and what they threw away, Tesco had a vision: It would develop as many as 500 neighborhood markets with fresh produce and meats and good-quality, value-priced prepared meals.

"We knew to be successful we couldn't be just another grocery store. So we really needed to design and bring something that was more tailored to the modern American consumer, a store that's equally relevant for somebody who's looking to grab an affordable meal at a quick-service restaurant or a fast-food restaurant as [opposed] to someone who's looking to do their entire week's shopping at a traditional grocery store," says Fresh & Easy spokesman Brendan Wonnacott.

But among other challenges, the economy didn't cooperate. El Segundo, Calif.-based Fresh & Easy was trying to break in to a competitive marketplace during a tough time. What's more, industry experts say the stores didn't meet the needs of American consumers.

"Tesco really went to America on a wave of over-optimism and, to our mind, flawed analysis," says Clive Black, an analyst with ShoreCap in England.

While Tesco executives initially had clear a timeline for hitting profitability this year, they haven't achieved their milestone markers. Instead, five years after Fresh & Easy's launch and with $1.1 billon (700 million British pounds) lost, Tesco executives aren't offering a new break-even target date. The unit, which has 186 stores, reported a loss of 153 million British pounds (about $249 million) in 2011, an 18 percent improvement from the prior year but a disappointment from the company's projections. "At some point in 2013 we will be breaking even in some months," Laurie McIlwee, Tesco's chief financial officer, told The Wall Street Journal in April, declining to be more specific.

Pressure Mounting

Yet with its stock price sagging, Tesco, which also is struggling in its U.K. market, faces pressure to improve its performance. Shareholder Richard Black at Legal & General Investment Management in London, which holds a 4 percent stake in the company, made news in April when he called for Tesco to exit the United States entirely to focus on its core units. "Strategically, the business needs to think about its capital allocation and return on capital," Black told The Sunday Times of London. "It needs to think long and hard about what it wants to be. Can it be everything to everyone, or should it focus on its gem, the British grocery business? Of course, this is likely to raise questions about other areas of the business, such as America."

Fresh & Easy's difficulty gaining traction doesn't surprise industry observers, such as Harvey Hartman, founder of the Hartman Group in Bellevue, Wash., who conducted his own "retail ethnography" in 2008 on Fresh & Easy stores in San Diego and Phoenix. "Fresh & Easy felt like a stranger in a strange land; as if it were dropped down from the heavens above as a prefab solution to a hypothesized set of consumer 'needs.' Far from the category killer many had suggested, Fresh & Easy seemed flat. Or, as one particularly insightful consumer summed it up, 'I just don't get this place,'" Hartman says.

While Hartman found Fresh & Easy staff to be "obsessively friendly" as they tried to make the shopping experience easy, consumers were primarily interested in the fresh part of the value proposition. But the chain pre-wrapped every fruit and vegetable sold, which impacted its image, Hartman says.

Retail consultant Bob Reynolds, a former executive with Safeway based in the Bay Area, who went on an expedition to Fresh & Easy stores in Los Angeles in 2008 was put off by limited assortments and gaps in the shelves. Six and eight months after the stores opened, "The out-of-stocks that they had in their stores just left gaping holes" on store shelves, Reynolds says.

While U.K. consumers will return to a store the next day for items otherwise unattainable, Reynolds says, unforgiving U.S. consumers would go to the competition, such as Trader Joe's, and not look back if a Fresh & Easy store did not have what they wanted after a couple visits.

Tesco may have had preconceptions about the U.S. market because the countries share a language, says Bill Bishop, chairman of Willard Bishop, a retail consultancy based in Barrington, Ill. "As a consequence, they were more prone to making mistakes."

Making Adjustments

But Bishop credits Tesco with dusting off itself and fixing the problems."I was frankly quite impressed with what I have seen [recently] compared with what I saw a few years before. They could be a very important force in the areas in which they operate," he says.

The stores have been refitted to emphasize house brands and "warmed up" with pastel colors, wood trim and product photos, Tesco's Wonnacott says. Signage has improved as the stores "evolved," and the assortment of SKUs has expanded. Reynolds says the inventory gap problem has been fixed. While consumers still face automated checkouts, they can get help from employees anchored to the registers. Plastic was taken off the produce so consumers could decide for themselves about freshness.

"You walk into the store [and] we're leading with a very large floral display, that fresh side of things," Wonnacott says. "We added microwaves, for example, as customers are looking for a grab-and-go lunch. They're able to heat it up right in the store, which is extremely convenient and highlights the 'easy' in Fresh & Easy."

Prepared holiday meal packages with rib roast, sides and dessert to feed a family of eight for $45 to $65 were hits at Christmas. Similar boxes were offered at Easter.

The company scaled back on expansion into Northern California until a year ago and recently opened its first stores in Sacramento. Earlier this year, Fresh & Easy closed some underperforming locations, though in November 2011 it added an Express line of streamlined, 3,000-square-foot stores that carry about 2,700 grocery items and feature espresso bars. It planned to have 200 locations open by the end of 2012. "It really was just about being prudent and, particularly as the economy improves, we continue to refine what we do as a grocer. There's still an incredible amount of opportunity for us," Wonnacott says.

Tesco chief executive Phil Clarke hasn't given up on Fresh & Easy. He told the Financial Times in March, "What I am yearning for is a day I can say not just, 'Hey do you know what, it's got to break even.' but 'Look here at the prospect of strong returns.'"

Some analysts wonder if Fresh & Easy will reach that point. While analyst Black questions whether Fresh & Easy will ever succeed in the United States, he acknowledges improvement: "I don't think Fresh & Easy [is] necessarily proven and out of the woods yet, but it's certainly got a much better basis today to look [ahead] more optimistically than it has at any stage in the last five years," he says.

One fact everyone can agree on: It hasn't been easy.

Howard Wolinsky is a Chicago-based business and technology writer whose work has appeared in BusinessWeek, Chicago Tribune, Crain's Chicago Business and Chicago Sun-Times.