How One Smart Company Got It All Wrong

Suppose you’re the CEO of a successful, multinational food retailer. You’ve had good luck opening stores in numerous countries, many with cultures much different from that of your home country.

You’ve decided the time is right to roll out a fleet of stores in yet another country, this time one that has a culture quite similar to your own.
You’re confronted with many questions to be answered and decisions you need to make, such as:

Should you conduct consumer research, or just send a team of executives to the target country to examine the situation on the ground?

Will you develop a store format similar to the type of shopping experience in the target country, or a brand new format?

Will you source product for the new stores from a third-party distributor while the format is being fine-tuned, or will you spend vast sums developing your own distribution and production prior to opening a single store?

If you chose the first, more cautious approach in each of these questions, then clearly you’re not the chief executive of Tesco, nor would you have been the architect of its adventure in America.

Tesco is a huge multinational food retailer with impeccable credentials when it comes to operating stores in a variety of locations. Based in the UK, it is the world’s fourth largest retailer that sells substantial amounts of food. With worldwide annual sales of more than $92 billion and about 5,400 stores, it trails only Wal-Mart Stores, Carrefour and Metro Group.

Tesco operates with success not only in its home country, but at least 15 others — countries as diverse from one another and from the U.K. as China, Hungary and Turkey.

So when the idea of opening stores in the United States arose, it probably seemed like a fairly simple piece of work to then-CEO Terry Leahy, given the cultural similarities between the nations.

To set the table for what Tesco wanted to do — develop a new-style store format that could quickly roll out across the entire nation — Tesco formed “Project Aquarius,” a team of 50 or so executives, which in 2006 was dispatched to the region selected for the first stores, southern California. There they were to get to know some families and to discover what they would like to see in a different sort of food store.

They did that, and then recommended their envisioned format — destined to be known as Fresh & Easy — a convenience-store-like format of modest size, 10,000 square feet to 30,000 square feet.

In those spaces, they felt, should be a range of high-quality fresh-prepared meals, pre-packaged produce, a small grocery line, wine, and beer. All stores were to have customer-operated checkout kiosks only.

The new store, although different from anything in the market, would lift a page or two from the Trader Joe’s and Whole Foods play books.
Fresh & Easy was positioned as the answer for consumers who might like to quickly grab a few items for a meal or two at home, but who also wanted restaurant quality.

During the development stages of Fresh & Easy, Tesco made considerable efforts to keep its plans secret, even going so far as to construct a prototype store in Santa Monica, CA that was enclosed in a larger building to protect it from prying eyes. It also quietly bought up scores of store locations and started work on an 800,000 square foot distribution and pre-pack center. The idea was to be able to quickly roll out stores, all of which would be supplied by the distribution center.

Eventually, though, plans started to leak out by way of securities analysts and trade publication interviews. It became known that Tesco intended to open stores in the desert southwest at first, then quickly move to open many stores in population centers around the nation, hoping to reach sales of more than $1.6 billion with 10,000 stores in five years or so. Conventional supermarkets were to be overwhelmed by this juggernaut.

All those activities were to be fueled by an initial investment of more than $430 million, and an ongoing significant-investment commitment each year thereafter.
Thus armored, the first Fresh & Easy stores opened late in 2007 in southern California.

Today — more than four years in — Tesco has lost hundreds of millions of dollars in the U.S. The most recent fiscal year produced losses of about $250 million on sales of $545 million. Far from opening thousands of stores, its 180 units are all in California, Arizona and Nevada. Some stores have been shuttered and “mothballed” awaiting an upturn in business.

Many Tesco shareholders are loudly calling for Tesco to abandon the U.S.. Investor Warren Buffett, who owns 3% of the company, has called Tesco’s decision to come to the U.S. “foolhardy.”

How did a smart company such as Tesco get it so wrong?

Most likely, the seeds of failure were sown when the executives were sent to the U.S. to plumb the cultural depths. It’s a vain pursuit to ask consumers to declare what they want in the absence of being able to show them some alternatives. Consumers didn’t tell Apple they wanted an iPad, but when shown one they were all over it.

Moreover, the stores were different enough from those consumers knew to seem odd. Early versions of Fresh & Easy stores were seen as “cold,” lacking decor. They were small. Product lines were seen as too limited. American shoppers tend to distrust pre-packed produce. Unfamiliar brands were offered. Many customers were reluctant to operate the self-serve checkouts, yet no alternative was offered.

In all fairness, Tesco’s timing for the new stores – just as the U.S. economy collapsed — was horrendously unfortunate. Conversely, it could be argued that the Fresh & Easy format, premised on the offer of giving consumers high-quality fresh-prepared meals at home, might prosper by catering to the new frugality the recession ushered in.

Perhaps the overriding downside of the format is that it’s an urban store planted in a car culture. The format forced a second shopping trip on consumers to pick up the balance of what they wanted for their pantries. The format might have done better if located in a dense urban area where shoppers on foot might welcome the chance to get high-quality meal solutions.

Finally, the cost of failure was greatly multiplied for Tesco because of the expense of building a distribution center in southern California, and of planning more for northern California and Phoenix. Instead, Tesco could have used third-party distribution to avoid being placed in a “do or die” situation.

What can be done to salvage Fresh & Easy? Tesco has made a number of moves intended to fix the most glaring deficiencies of the stores. Newer stores tend to be larger, trending toward the top end of what was planned, decor has improved and bulk produce was brought in. The self-serve-only checkout scheme may change because it’s under siege in California, which has a new union-backed state law prohibiting self checkout in stores selling alcohol.

So far, the tweaking hasn’t been sufficient to stem the tide of losses, although Tesco recently issued a third-quarter report stating that total sales grew by 26% and comps rose by 11.9% in the period. Neither dollar amounts nor profitability was given, however.

A number of management changes have been made. Tesco has a new CEO, Philip Clarke, who has frankly acknowledged that he needs to take a look at Fresh & Easy to assess its future. The executive who led the California consumer-research team has left the company.

For the near term, it looks like Tesco is digging in. It still has plans to open about 50 new U.S. stores per year with the hope the economy recovers sufficiently to permit success to finally overtakes the venture. Tesco doggedly predicts break-even could be achieved in two or three years.

Nonetheless, it might be foolish to wager that Tesco is in it for the long term. The lights may yet go out in America.

David Merrefield About David Merrefield

David Merrefield is principal of DRM Initiatives, Inc., a retailer consulting group. He is the former Vice President and Editor of trade publication Supermarket News. He is based in New York City.