Tuesday, April 15, 2008

Fresh & Easy Buzz Analysis: Tesco PLC on Fresh & Easy Neigborhood Market USA's Sales and Operations to Date


Fresh & Easy Buzz Editor's Note: Below is the text portion (in italics) about Fresh & Easy Neighborhood Market USA from Tesco PLC's press release issued today on its annual corporate sales and profits.

In its full press release, which you can view here, Tesco breaks out sales and profit performance for its international operations in the UK, Asia and elsewhere. However, the retailer doesn't break out the sales and profit figures for Fresh & Easy USA.

However, Tesco PLC CEO Sir Terry Leah said today the U.S. operations will lose about $200 million in its first full-year of operation. Additionally, as you can see in the very last paragraph below, Tesco says beginning in September, 2008 it will start breaking out Fresh & Easy USA sales like it does with its retail operations throughout the globe.

From today's Tesco PLC press release on Fresh & Easy USA:

United States. We are very encouraged by the start Fresh & Easy has made. The first stores opened only in November and we now have over 60 trading. Whilst it is still early days, the response of customers to our offer has surpassed our expectations – with our research regularly confirming that they like the quality and freshness of our ranges, as well as the prices and the convenient locations of the stores.

Sales are ahead of budget and sales densities are already higher than the U.S. supermarket industry average, with our best stores exceeding $20 per square foot per week. We are seeing strong growth in the early stores as we step up, as planned, our marketing programmes and as we build awareness of the brand. This is also reflected in the strong sales performance of recent openings in all of our markets in Southern California, Nevada and Arizona. Fresh foods and own brand products have sold particularly well, confirming that the core of our offer has already gained acceptance with customers.

Progress with real estate has been good and we have secured enough sites for our immediate needs – although the deteriorating property market, particularly in Arizona and Nevada, will mean that some of the third-party developments in which we had planned to open prototype stores later this year, will now be deferred. Nevertheless, we still expect to open around 150 new stores this year.

Our Riverside distribution centre (DC) and kitchen operation is gearing up well as volumes rise. As we announced last November, we have taken the necessary steps to secure the site and begin the process of obtaining the necessary permits to launch operations of our second DC in Northern California in due course. We expect a proportion of these costs will be incurred in the current year.

Last April, with our Preliminary Results, we said that costs of recruitment and training of staff for the stores, combined with the other pre-launch costs and initial trading losses, would involve estimated US start-up costs of around £65m in the financial year. We have delivered on this guidance – trading losses were £62m. We expect losses to rise this year to around £100m and then reduce thereafter as early stores begin to mature and we see increased overhead recovery from higher volumes.

US segmental reporting of sales and trading results within International will begin with our Interim Results in September.

Fresh & Easy Buzz Analysis

First, we want to repeat two things we regularly discuss here in Fresh & Easy Buzz.

Number one, is that Tesco has launched one of the most ambitious new store opening blitzes in U.S. grocery retailing history with its Fresh & Easy grocery store venture in the Western USA. The retailer has opened 61 of its small-format, basic grocery and fresh foods convenience-oriented grocery markets in the U.S. states of California (Southern California only to date), Arizona and Nevada in about 170 days.

Second, like we often say here, those who rule out Tesco in general and its Fresh & Easy grocery store venture in the USA specifically, do so at their own peril. Tesco, the third largest retailer in the world after Wal-Mart and France's Carrefour, is an innovative, determined and nimble retailer. Further, as we write frequently--and as Tesco CEO Sir Terry Leahy stated today--Fresh & Easy isn't just a test for the retailer in the USA--it's a full-fledged venture.

We now offer some brief analysis on the key points in Tesco's text from its press release regarding the retailer's Fresh & Easy Neighborhood Market operations in the USA thus far:

Fresh & Easy customer response

Tesco says in its pres release: "The response of customers to our offer has surpassed our expectations--with our research regularly confirming that they like the quality and freshness of our ranges, as well as the prices and the convenient locations of the stores."

We won't argue that point with Tesco, as its their view and opinion. However, we will offer five very key aspects about the Fresh & Easy format, operations and merchandising practices consumers in high numbers have told us they dislike. These aspects of Fresh & Easy are preventing it from gaining repeat and primary customers, based on our research and analsysis:

>The self-service checkout process in which rather than having a store clerk check a customers grocery orders they have to do it themselves, along with bagging their own groceries.

>The lack of selection of a number of key national grocery product brands popular in the Western USA in the stores. What we call a better tailored Western USA product mix.

>The overall lack of a sense of place the stores have. This is a key reason why most Fresh & Easy customers are secondary and tertiary shoppers to date rather than primary shoppers, which the grocery chain needs in order to meet its sales objectives.

>The offering of strictly pre-packaged produce. Fresh & Easy shoppers tell us they would shop the stores much more often and buy much more produce if the majority of the offering was in bulk like 99.5% of American grocery stores offer, rather than pre-packaged like Fresh & Easy merchandises it.

Pre-packaged produce is fine for a specialty grocery chain like Trader Joe's because its not looking the be the primary "neighborhood grocer" like Fresh & Easy is. Western USA consumers love a wide variety of fresh, bulk produce even more so than U.S. consumers in general, and aren't likely to ever make a grocery store which doesn't offer it their primary shopping venue.

>Not enough localization of the stores to the neighborhoods they are located in. For example, the Fresh & Easy market in low-income, primarily African American Compton, California looks identical to the store not far from the Las Vegas, Nevada gambling strip and the store in majority white, suburban, middle class Chandler, Arizona.

We aren't suggesting Tesco should have a different style and design of store for each different neighborhood. Far from it. There is a certain egalitarianism in the stores which is a good thing. What we are suggesting though is the the stores need to better reflect the history, culture, characteristics and demographics of the neighborhoods they're located in. This can easily be accomplished by merely taking the basic Fresh & Easy format and store design, and adding local touches on top of that. That's the definition of localization in retailing.

For example, adding minor elements (on top of the basic format and design) that reflect the Compton community and the neighborhood the store is in, for example. Adding some simple, Southwestern elements which reflect the Phoenix, Arizona/East Valley region where the majority of the Arizona Fresh & Easy stores are located, would be a good idea. The same for the Nevada stores, which are all located in the Las Vegas, Nevada Metropolitan region. Give them some localization--let local consumers know the stores are part of the community rather than a cookie-cutter chain.

The lack of enough local (and local to the region) food, grocery and beverage products in the stores also is a problem. Were Fresh & Easy to increase the amounts of local food and grocery items in each of the three regions in which its 61 stores are located, not only would the grocer garner tons of positive publicity, but even more importantly it would find it's stores gaining more primary shoppers, more new customers, and happier existing ones. Like Tesco knows better than nearly any retailer in the UK, local is hot. It's also hot in the USA--especially in California, where its a red hot concept.

Store sales

In its report and press release today, Tesco says: "Sales are ahead of budget and sales densities are already higher than the U.S. supermarket industry average, with our best stores exceeding $20 per square foot per week."

Lets analyze that sentence. "Sales are ahead of budget." That's meaningless to us since as any business person knows sales budget's are dynamic. For example, let just suppose Tesco's Fresh & Easy had an original sales budget of overall sales for this point in the chain's time of $200,000 per store, per week. However, like all start ups do, it frequently revises that sales budget, some times up, but mostly down with a start up.

Therefore, lets just say that instead of today's sales budget being $200,000 per store, per week, which it might have been for a long time; it gets revised downward to say $120,000 per store, per week. Hypothetically of course. As a result, if the stores are performing slightly above that amount, they are therefore "exceeding" the sales budget. We aren't making an claims in our analysis--rather just making the point that from a sales performance analysis that statement in meaningless.

Further, do you know of a retailer that, if it had 61 stores open for less than five months, and those stores were exceeding the retailer's sales targets already, they wouldn't want to hang a bright lantern on that fact and release the numbers. We don't.

We should note, we don't expect Fresh & Easy's overall sales to exceed targets at this point. If they are, it's a major achievement which should be announced in bold, banner headlines in a press release, along with the numbers, by Tesco.

Best stores exceeding $20 per square foot per week. Tesco's Fresh & Easy grocery stores average 10,000 -to- 13,000 square feet in size. That means these "best stores" are doing at least $200,000 per week in gross sales.

We have estimated here based on our sources that overall, all of the Fresh & Easy stores open to date (sales combined together) are doing about 60,000 -to- $100,000 in per-store, per-week gross sales.

We've also said in conjunction with publishing our estimates that we know some stores are doing above the $100,000 number. For example, when we first published our sales estimate a couple months ago, we mentioned based on our source information that the store in Los Angeles' Glassell Park neighborhood was doing well above $100,000 per week in gross sales.

Therefore we have no dispute with Tesco's claim that some of its best stores are doing $20 per square foot per week in gross sales. However, some could mean two, four, ten or more stores. It's just meaningless data for an analyst.

Based on our sources however, we don't believe there are many of the stores doing $200,000 or more per week in sales. It's a strong sign for Fresh & Easy though if just two or three are doing those numbers.

Additionally, we are open to the suggestion that since we first published our $60,000 -to- $100,000 overall sales estimate, that number range may has gone up a bit. Although to date our sources tell us if it hasn't overall. And if so, not by too much. But we are open.

Remember, the key is overall sales of the 61 stores. All it takes is 15 or so to bring that number down in major way. And, we know there are some Fresh & Easy stores in locations that are underperforming seriously. In those cases mere location may be the key reason. In at least three cases of such stores we are aware of, those stores are located in former supermarket or drug store buildings which the previous retailers closed.

Store brand products

Unlike some analysts, we believe Tesco's Fresh & Easy store brand offering is good in the main. We think some of the packaging needs adjusting--bolder graphics here, better lettering there--but overall the line is pretty strong.

We do agree the store brand needs marketing and promotion behind it. And it appears to us Fresh & Easy has plans to do that. The brand name, Fresh & Easy, lends itself to lots of creative brand marketing schemes. We can think of many but will leave that to Tesco to create.

We do believe however that the current store brand/national grocery brand mix in the stores is skewed too high in the Fresh & Easy brand direction. We estimate it's about a 65% -35% or 60%-40% store brand/national brand mix ratio (Fresh & Easy brand being the highest of the two). We think an at least 50%-50% store-to-national brand ratio as we've written about in the past, is needed. Remember, Fresh & Easy isn't Trader Joe's, which is a specialty grocer. Rather, Fresh & Easy's positioning is to be a grocery store "for everybody," a neighborhood market which requires lots of primary shoppers to achieve its mission and sales goals.

The $200 million loss

Lastly, a number of analysts will probably make a big deal out of Tesco taking a $200 million loss in its first year of operations of Fresh & Easy USA.

First, we are surprised at the low number, if the true loss really ends up being only $200 million.

After all, in our experience, for a grocery retailing start up, especially one headquartered in California which is America's most expensive state to do business in, losing $200 million in the first year of operations is chicken feed. Additionally, even the concept of a grocery retailing start up is rare in the U.S. Part of the reason that's the case is because the start up costs are so high.

We think this lower than anticipated (at least by us) loss (if it stays at $200 million) is in part the result of the excellent retail commercial real estate deals Tesco has cut in Southern California, Arizona and Nevada. Most of the stores built to date have gone into empty retail buildings, many of which used to house supermarkets like Albertsons and Ralphs or drug stores like Rite-Aid.

Tesco has in many cases obtained these buildings relatively cheaply and with excellent leases do to the economic downturn in the commercial real estate market in the U.S. Further, the cost of gutting the interior of these buildings and turning them into a Fresh & Easy grocery store is significantly cheaper than building a new store from the ground up. The basic building's shell, electrical, piping and other infrastructure is already there. The savings is huge.

Of course, despite the cost savings of this building reuse strategy, the jury is still out on many of these locations because in part one of the reasons the previous retail tenants closed their grocery and drug stores at the locations was store underperformance in that particular spot.

Conclusion

Tesco offered a few good specifics on its Fresh & Easy Neighborhood Market USA grocery store retailing venture today in its report on annual corporate sales and profits.

For example, we think it was smart of the retailer to announce the $200 million annual loss estimate for Fresh & Easy's first year of operations.

Why? For three reasons: it shows a willingness to be more open about the venture by Tesco, it gives investors and others a "real" number to work with, and it takes what would have been lots of speculation in the press about what the Fresh & Easy loss will be essentially off the table. Of course, there still will be some analysis about whether or not the loss will really be only $200 million. But with Tesco announcing its own number, such speculation will be minimal.

In terms of saying: "Some of our stores are doing over $20 per square foot per store in sales, exceeding the U.S. supermarket industry average," it's already getting Tesco some good PR in the popular UK and U.S. business press. Reporters and writers without much experience in the supermarket industry don't realize this is essentially meaningless data (no disrespect to Tesco, it's good general PR) because it could mean hypothetically out of 61 stores you have 10 doing 200,000 per week in sales, 40 doing less than $100,000 in weekly sales, and 11 that are doing $35,000 in weekly sales.

In other words, the retail grocery business is all about store location from a weekly sales standpoint, and from a sales data standpoint it's all about the aggregation of the weekly gross sales of all those 61 stores into the whole.

A little real life analogy: In the early late 1980's, Safeway Stores, Inc. had a store in San Francisco, California that was doing $850,000 per week in gross sales in only about 35,000 -to- 40,000 square feet. They had another store, a 20 minute drive away, that was doing about $200,000 per week in about 30,000 square feet. In other words, on store dramatically exceeded the U.S. supermarket industry average, the other was dramatically below the average.

The chain had about 12 supermarkets in San Francisco at the time. The city's population was about 700,000.

Safeway corporate didn't judge the San Francisco region district manager on the phenomenal performance of that standout store when it came to his job evaluation and bonus potential; they rated him on the performance of all 12 stores in the city.

In other words, a few exceptions to the norm don't matter--it's the aggregate. That's one reason analysts look at what's called same store sales when evaluating supermarket industry company performance.

We won't be able to see same store sales when Tesco breaks out its Fresh & Easy USA sales numbers in six months in September, 2008 as it says it will in the press release, since there were no stores open last year to compare with this year, or the November, 2007 start to September, 2008 period.

That's fine though. What we will be able to see and analyize will be sales numbers for stores open anywhere from 11 months, to some that will only have been open a week or so before the sales figures are released. Just like the Tesco international sales breakout for the UK, Asia and elsewhere, this will give investors and others a much clearer picture of Fresh & Easy than is currently available.

It also will be good for Fresh & Easy senior management, who after September won't have to deal with sales estimates likes ours and those from others.

That same mangement team also has six months to improve sales performance by making and implementing key format, operations and merchandising changes, like those we've been suggesting in Fresh & Easy Buzz for months and others, and launching what we've suggested is a much needed marketing campaign, which needs to include more than public relations-oriented marketing, but real advertising such a radio and perhaps some print and billboard advertising in support of the radio blitz.

[We hear from our sources that with the hiring of its new PR firm, which we reported here, the Fresh & Easy team plans to focus almost exclusively on "free media" rather than include advertising. We think that's a mistake.]

The good news for Fresh & Easy is that parent company Tesco PLC banged out some great annual sales and profit numbers today, sending its stock price north by a number of points and giving Tesco some well-earned props from stock analysts and the media (including us by the way) on its annual performace.

Every dollar that Tesco stock goes up by in the next few days means more capital available for Fresh & Easy USA to make and implement those changes we mentioned above--and to create and launch that marketing campaign. If done well, these changes and marketing activities could result in some strong numbers when Tesco does break out Fresh & Easy USA's sales and profit numbers this coming September.

By the way, that Safeway San Francisco region district manager mentioned in the analogy above was finally able to convince his bosses at corporate headquarters to close that San Francisco store. The chain also has opened a number of new supermarkets in the city since the early 1990's.

1 comment:

Philip said...

I can think of at least one retailer that wouldn't trumpet the fact that it's sales in a particular market are ahead of budget and provide the budget and actual numbers to back it up - Tesco. Tesco has never, ever published such budget to actual comparisons for any of its other businesses anywhere in the world, even though many of them must have beaten budget often in recent years. It sounds to me like you are expecting Tesco to act like an American company, but it isn't an American company. Thus your assumptions reflect a cultural misunderstanding on your part.

Oliver Chettle
Bedford
England