Reading Philip Clarke's Tea Leaves: Might A Mixed Corporate/Franchise Model Be in Fresh & Easy Neighborhood Market's Future?

Incoming (March 2011) Tesco CEO Philip Clarke, currently director of international operations, Europe and Asia, and director of corporate information technology, just might have a grocery store he wants to sell you - or at least offer a franchise agreement on.

The Insider - Heard on the Street

At the start of a 19-day trip to review Tesco's operations and stores in Asia, incoming CEO (March 2011) and current head of the global retailers European and Asia retail operations, Philip Clarke, gave interviews to a number of United Kingdom publications, which published the stories today.

The content of the interview pieces are all pretty much identical - Tesco's PR team did a good job prepping Clarke and he did an excellent job staying on message with the various reporters. Here are the three most comprehensive interview pieces: The Telegraph and Bloomberg (each of the stories are at those linked publication names.)

Most all of the information Phillip Clarke offered in the interviews is already known to Tesco-watchers like Fresh & Easy Buzz and others.

The interview information is certainly worth reading though. For example, Clarke talks a bit about the $3.1 billion Tesco is investing to build 80 five-story Lifespace malls, which are in the 400,000 square-foot range and include a Tesco hypermarket, in China. He also offers some comments about the retailer's Asian operations and plans, as well as offering some interesting notes on his travel schedule and how he plans to operate when he becomes CEO in March of next year.

What interested 'The Insider' the most however - and what also happens to be the most new-news worthy aspect of the interviews - is Philip Clarke's comments that Tesco has franchised 18 of its 226 Homeplus Express convenience store format stores in Korea.

Korea is Tesco's second-largest market outside of the UK, where it generates about 70% of its total revenues. The retailer has operated in Asia for 13-years. Clarke has been in-charge of Asia and Europe for six years. He's also the head of Tesco's corporate IT function.

And even more interesting, incoming Tesco CEO Clarke says in the interviews that the retailer plans to start franchising its stores in other part of the globe, having judged the 18-store test in Korea a success.

The UK Telegraph did the best job of all the interviews on the franchise aspect, breaking it out in a separate piece, 'Tesco takes franchise route in overseas push,' which you can read here.

Below (in italics) is the key part of the Telegraph interview piece regarding Tesco's Korea test with franchising and its plans to expand the model elsewhere:

"We are [still] experimenting with it. But we will be doing it in other places I'm sure," he (Clarke) said.

'However, Mr. Clarke refused to be drawn on which markets Tesco was considering or whether they included the UK. But he added: "I'm struggling to think of places where it wouldn't work, rather than places where it would. There are always people with the entrepreneurial spirit who want to work hard and make money for themselves."'

'Mr. Clarke described how impressed he had been after meeting one of the first franchises in Korea. "It works for them, as I have seen. They get a nice business with a good system behind them. As a consumer you wouldn't be able to tell the difference. It is a bit like a franchised McDonald's."'

'In South Korea franchisees have put up 20pc of the capital required to build the new convenience stores, with Tesco supplying the remainder. The retailer has not revealed details of how it splits the profits with its franchisees, although it is understood Tesco has guaranteed franchisees a minimum income.'

You could easily ad the following to Philip Clarke's comment about struggling to think of places where a franchise model wouldn't work: There's no place in the world where the franchise model works better, or is more popular, than the United States, 'The Insider' says.

A little background

We've mentioned numerous times in various stories since we started Fresh & Easy Buzz nearly three years ago that a mixed corporate ownership/franchise model could serve Tesco's Fresh & Easy Neighborhood, which currently operates 163 stores in California, southern Nevada and Metro Phoenix, Arizona, very well - and perhaps even be a part of Tesco's U.S. salvation if Fresh & Easy doesn't at least break-even by the end of 2012.

And - it just so happens Tesco's Fresh & Easy Neighborhood Market is already set up rather well - from its corporate structure, centralized distribution system and the easy-to-stock, shelf-ready cases it uses for its private brand products, to the store layout and fairly simple operations system in place to run them - for a combination corporate store ownership/independent owner-operator franchise type arrangement, like those used by Supervalu's Save-A-Lot chain, convenience store giant 7-Eleven and numerous grocery wholesalers in the United States, with their voluntary banners which are franchised by many independent grocer customers.

'The Insider' doesn't know if incoming Tesco CEO Philip Clarke has Fresh & Easy Neighborhood Market USA in mind as he ponders where the global retailer might extend the Korean mixed- corporate ownership/franchise model test he's describing and has deemed a success. What I can tell you though is that a person in a position to know such things told me not that long ago that in meetings Tesco executives have discussed the longer-range potential of such a mixed system for Fresh & Easy Neighborhood Market on more than one occasion, although it hasn't been something at or near the top of the Fresh & Easy strategic plan playbook.

But come March 2011, the Tesco, and Fresh & Easy USA, strategic playbook will get a new set of eyes and thinking - those of new CEO Philip Clarke.

Tesco corporate director and Fresh & Easy Neighborhood Market CEO Tim Mason also gets a promotion, and new title, come March of next year, that of Co-CEO. However, Mason won't be the Co-CEO in the literal interpretation of the term, sharing half the Tesco CEO duties with Clarke. Instead he will remain CEO of Fresh & Easy, along with taking on the overall leadership and responsibility for Tesco's corporate marketing, branding and sustainability. Clarke will be the CEO, as Sir Terry Leahy currently is, with those exceptions. And he will still also have veto power and final decision-making regarding Tesco policy and operations.

A mixed corporate-ownership/franchise model for Fresh & Easy

I'm, as has Fresh & Easy Buzz been in its past mentions of the topic and issue, generally favorable about the scheme (its mine not Tesco's, as far as I know) of a mixed corporate store ownership/independent-operator-owned franchise system for Tesco's Fresh & Easy Neighborhood Market for a number of reasons. In fact, were I running the Fresh & Easy show, I would have already put such a model in place in the form of a strategic plan blueprint for sometime in the future. As far as I know, Tesco, or the senior executives at its Fresh & Easy Neighborhood Market, has not done this thus far.

I'm going to offer five reasons in this column - I have more but those will have to wait for a future column - why 'The Insider' is favorable on a mixed corporate ownership/franchise model for Fresh & Easy. That model would have Tesco owning Fresh & Easy Neighborhood Market just like it does now. But doing as Supervalu does with Save-A-Lot and convenience store company 7-Eleven does, splitting the (new and some existing) store ownership between corporate-owned and operated and independent (by groups and individuals) owned and operated stores.

It's interesting to note both 7-Eleven and Supervalu, with Save-A-Lot, decided about two years ago to increase the percentage of their respective stores that are owned by franchisees. Supervalu wants to have 80% of its Save-A-Lot units independent operator-owned in the not to distant future, as well as having most of its new stores being owned by independent groups or individual franchise holders.

The just-announced plans in which drug chain Rite Aid is converting 10 of its stores in South Carolina to combination Save-A-Lot Foods/Rite Aid Pharmacy stores is a perfect example of that strategy. Rite Aid is essentially licensing Save-A-Lot from Supervalu as a franchise holder. Supervalu will be involved in the stores like it is with other franchise holders. It supplies the stores with product, including its store brands, and provides merchandising and marketing services, along with a few other things.

Rite Aid has over 4,000 stores in the U.S. Imagine if beyond the 10 -store test, the drug chain converts just 500 of those stores to the combination Save-A-Lot/Rite Aid format over a 12- month period. That's essentially 500 "new" stores in a year for Save-A-Lot. And since Supervalu it plans to double its Save-A-Lot store count, from the current 1,200 or so to about 2,400 over the next five years, that would go a long way in achieving the objective.

7-Eleven USA's goal is to eventually have as close as it can get to 100% of its thousands of U.S. convenience stores owned by independent operators. It started working on that plan about two years ago. The chain is aggressively searching for new franchisees and selling as many corporate stores as it can to qualified independent operators. As part of the strategy, 7-Eleven's preference regarding new store openings is to have as many as it can franchisee-owned. And those it's opening as corporate stores will, according to the plan, eventually have independent owner-operators.

In other words, Tesco would be far from alone if it were to institute a mixed corporate-owned/independent operator-owned model somewhere down the road.

The mixed corporate/franchise store and even franchise-only store model has a long history of practice and success in U.S. food and grocery retailing, if done well. For example, most of the Food 4 Less (not those owned by Kroger in Southern California though) banner discount grocery stores in the U.S. are franchisee-owned and operated stores. The franchisees are grocery wholesalers. The stores are owned by both ownership groups, such as the multi-store Food 4 Less chain in California's Central Valley and Central Coast regions, and individual owner-operators.

Another example of a retailer using a mixed corporate/independent t owner-operator model is the fast-growing salvage and discount grocery chain Grocery Outlet, which is headquartered in Berkeley in Northern California. All, with maybe a few exceptions, of Grocery Outlet's about 150 stores, located mostly in California but also in other Western U.S. states, are franchised to independents. Like Save-A-Lot, Grocery outlet supplies the stores and provides marketing and merchandising for a fee as part of the franchise agreement. Revenue comes from supplying the stores and serving as the "corporate" office. The system has been working well for Grocery Outlet. It plans on doubling its store-count, all franchisees, over the next few years.

Five reasons why 'The Insider' is favorable to a mixed model for Fresh & Easy

1. Retail merchandising

One of the key weaknesses of the Fresh & Easy stores and the chain's merchandising is its cookie-cutter product selection. For example, a Fresh & Easy store located in a neighborhood where 70% of the residents are Hispanic has generally the same amount and selection of Hispanic food and grocery SKUs as a Fresh & Easy store does in a neighborhood where the Hispanic or Latino population percentage is a mere 20%.

By the same token, a Fresh & Easy store in a neighborhood that indexes super-high for gourmet food products has roughly the same amount of gourmet SKUs as a store in a neighborhood that has a near-zero gourmet products index.

It's a failure to neighborhood market and merchandise when it comes to product assortment.

Trader Joe's can do it - basically offer the same item assortment across all stores. But Fresh & Easy isn't Trader Joe's. But even Whole Foods Market doesn't do it. Instead, Whole Foods gives its regions and stores huge latitude, beyond a mandatory core mix of course, on item selection. It does so for two reasons: Whole Foods is very decentralized, it's in its genes and corporate culture, and the chain believes strongly in neighborhood merchandising and localization. A significant portion of Whole Foods' success can be attributed to these two factors.

2. Retail Operations

A second significant weakness of Tesco's Fresh & Easy Neighborhood Market - a weakness imposed on the stores by senior management - is its rigid retail operations policy, which includes customer-limiting and thus sales-limiting practices like: self-service checkout and bagging only; offering only free plastic grocery bags and not a choice of paper bags; not accepting paper personal checks or cashing payroll and government checks; no acceptance of WIC Vouchers, accept in one store - South Los Angeles. Fresh & Easy does plan to rollout WIC acceptance to other stores however, as Fresh & Easy Buzz has reported on and written about extensively.

One of the first things a good and experienced independent grocer would tell Fresh & Easy CEO Tim Mason and his team, when considering becoming a franchisee, is that these policies are customer-limiting and therefore business and sales-limiting.

For example, there are Fresh & Easy store locations where self-service checkout-only will never work. It's a foolish idea to not offer at least one full-service checkout lane, and two would be better, at all 163 Fresh & Easy stores, however. It's business and sales-limiting to Tesco right now, and has been since November 2007, when the first Fresh & Easy stores opened.

There are Fresh & Easy (and those of any other chain or independent for that matter) locations, such as in those high-percentage Hispanic consumer neighborhoods I mentioned earlier, where cashing payroll checks is a key to a store's success because many of those residents don't use banks and instead use the neighborhood supermarket or Walmart as their bank. Don't take my word for it. Ask the CEO's of Walmart and Safeway Stores, Inc., two chains that make bank on cashing customer payroll and government checks.

These customers, regardless of ethnicity, shop at the stores willing to cash their checks. Latino consumers in particular spend on average a far-higher amount of money on food and groceries than any other ethnic group in the U.S., according to numerous studies, such as those contained in the multi-decade research on Latino's and Hispanic consumers done by UCLA professor Dr. David Hayes-Boutista. But you can also just simply ask the manager at any grocery store in a neighborhood with a high Latino population and he or she will tell you all you need to know about the value of cashing payroll and government checks in-store.

There are neighborhoods, like those containing a high-percentage of America's fastest-growing age group, men and women over 60-year of age, where not accepting paper, personal checks is just plain stupid. Check with the AARP about the high percentage of people over 60 who still prefer to use paper chacks, for example.

Last but far from least, even though it's so basic, not offering free paper bags but instead just free single-use plastic bags is just plain...well, ask any good, experienced grocer - particularly in Santa Monica, Santa Cruz, Berkeley, San Francisco (where plastic bags are prohibited from use in supermarkets) and numerous other California (and many other states) cities - how good of an idea it is. Their answer won't be 'It's a good one,' I promise you.

Fresh & Easy offers inexpensive, clear reusable bags called 'bags for life' for just 20 cents each, which is a good idea. But when a grocer chooses to offer free single-use plastic bags but not the free paper option, it offends many shoppers. It's not smart to offend shoppers, even one, in the highly competitive food retailing business. Fresh & Easy would be far better off to dump the free plastic bags and just offer the 20 cent 'bags for life,' and its other reusable options, if it doesn't plan on adding a free paper option. And since it hasn't added paper bags as a free option in the nearly three years its been in business, it probably won't.

3. Geographic expansion

While Fresh & Easy's centralized distribution system is a plus for a mixed corporate owned-operated/independent owner-operator franchise model like I've been describing, its a negative for the grocery chain's current corporate model. Why? The start up costs of growing Fresh & Easy beyond its current California/Nevada/Arizona region, with a couple nearby exceptions, isn't cost-effective under the current performance-level of the chain., losing $200 million-plus a year for the last two years with about the same loss projected by Tesco for its fiscal year 2010/11, which ends in early 2011.

For example, for the last two years Tesco has been attributing its heavy losses with Fresh & Easy to the economic recession, and the fact the three states where it has its 163 stores are among the hardest hit by the recession. Thye have been. No question.

The logical response to this defense by Tesco, and we've heard it from dozens of Fresh & Easy Buzz readers not familiar with the centralized system Fresh & Easy operates, is: 'Why not open stores in states doing much better in the recession, such as Texas, Utah and a number of others, then rather than opening more stores in California, Nevada and Arizona. (Fresh & Easy hasn't opened a new store in Nevada for over a year, by the way. And its opened just a handful so far this year in Arizona. Nearly all the chain's new store focus has been in Southern California and the Bakersfield and Fresno regions in California's Central Valley, to a lessor extent.)

This response makes perfect sense. The problem is that in order to do so, Tesco has to build a distribution center, along with other infrustructure, in those regions to serve the stores. Doing so at this point in time would mean taking losses far beyond the already steep $200-plus million a year Tesco is losing on Fresh & Easy. Hence, the over-centralization trap.

It's not cost-effective to expand geographically, even though it's what makes the best sense for Fresh & Easy. After all, if bad economies are the key problem, spreading the business to regions where the economy is doing well makes good sense, right? But only if the cost of doing so can be justified. It can't right now for Tesco's fresh & Easy, due primarily to the high expenses of the centralized system.

With a mixed store ownership system, in which the independent owner-operators pay a certain amount of money up-front and an annual franchise fee, Tesco would be able to eventually free up cash to use for such geographical expansion, making moving into other regions of the U.S. far less expensive than it will be under 100% corporate ownership of the stores. Of course all this is predicated on the stores - and Fresh & Easy chain - eventually making a profit. The jury remains out on that one.

4. Overall cost-savings

Tesco's Fresh & Easy has more high-paid senior executives than most U.S. chains many times its size in terms of both store-count and sales volume. In addition to CEO Tim Mason, who made over $5 million last year, there are Fresh & Easy Neighborhood Market senior executives for buying/merchandising, marketing, finance, real estate, legal and more, all making six-figure salaries with bonuses, at the chain, which has annual sales of about $500 million.

I know of many chains with multiple times Fresh & Easy's annual sales - Stater Bros ($3.5 billion), Save Mart Supermarkets (over $5 billion), Raley's ($3.2 billion) - and those are jus for examples, all in California - with nowhere near the number of senior executives as Tesco has at Fresh & Easy. Even Trader Joes and Whole Foods Market, both of which have sales of about $8 million annually and stores located throughout the U.S., have flatter senior executive structures, and thus less costly, than Tesco's Fresh & Easy does.

Fresh & Easy's senior executive-heavy structure is due in-part to the fact Tesco set up Fresh & Easy Neighborhood Market as a stand-alone Delaware-based corporation. Therefore it has corporate officer/executives, which divisions of Safeway Stores, Inc. and Kroger Co., like Ralphs and Vons in Southern California, both of which have far more stores and do much more in annual sales than does Fresh & Easy, don't have (Fresh & Easy has less than 100 stores in Southern California. Ralphs and Safeway have about three times that many. They also do more than three times Fresh & Easy's annual sales volume) But the exec-heavy structure it's also due to reasons any experienced food and grocery retailer should have a hard time understanding. And despite the corporate structure explained above, it's far from neccessary to have.

5. Knowledge and learning

Lastly, one of Tesco's biggest missteps with Fresh & Easy has been it's failure to understand, or desire not to understand, many key elements of food and grocery retailing in the regions where it has its 163 stores, particularly the importance of regional, sub-regional and neighborhood marketing and marketing.

The chain has improved in these regards somewhat over the last nine -to- 10 months, but it has a long way to go.

Much of this self-inflicted misfortune is due to the fact Fresh & Easy executives didn't listen very often or very much to their headquarters category managers, retail district managers and store managers, who had solid experience in food and grocery retailing experience in places like Southern California and Arizona, on a host of matters in which the experienced employees offered suggestions and advice.

That practice has changed somewhat in recent times, compared say to the first two years of operations, as the pressure on CEO Mason and his team to perform has increased, while losses at Fresh & Easy remain unchanged despite the opening of many new stores, which Tesco has said is key to breaking even adn eventually making a profit - the building of critical mass, if you will.

A mixed corporate/franchise model would bring not only local expertise - the independent grocer/franchisees - into Fresh & Easy, it would also bring an abundance of ideas, based on experience, to the grocery chain and its operations. This is, frankly, experience missing from Tesco's Fresh & Easy, since neither CEO Tim Mason or any of his senior executives had any experience in U.S. food retailing, let alone in California, Nevada and Arizona, until they came to the U.S. to start up Fresh & Easy. The first stores opened in November 2007. So that's going on three years experience. 2007.

American born retail operations senior vice president Jeff Adams, who joined Fresh & Easy in early 2008 from Tesco's Tesco-Lotus division in Thailand, where he was CEO, has some previous experience in the U.S., having worked for Walmart a number of years ago. However, all of his recent experience until joing Fresh & Easy was in Europe and Asia.

I'm not suggesting Tesco need staff all of its senior executive positions with veterans of U.S. and Western USA food retailing. But having all those key positions staffed by former Tesco UK men, and all but one are men, is a mistake. Walmart, for example, does the opposite, staffing the key positions at most of its non-U.S. divisions with executives experienced in country.

There are other reasons why a mixed corporate/franchise system could work well down the road for Tesco's Fresh & Easy. I will go into those reasons in a future column.

It's to early to implement a mixed system at Fresh &Easy yet, however, in my analysis, although America is filled with so many entreprenuers and great independent grocers that even with its current losses I bet if Tesco started signing up potential, qualified franchisees next year it would get some takers.

Although I love the ancient Asian practice of reading tea leaves, best demonstrated to me by an elderly and wise Chinese man many years ago, I can't say for sure if incoming Tesco CEO Philip Clarke has Fresh & Easy Neighborhood Market in his mind as one of those regions beyond Korea where the global retailer is considering adding the franchise element.

But, if you look at this map, Tesco isn't in all that many regions of the world - seven countries in Europe, six in Asia - and Fresh & Easy in the U.S. And I think I can rule out at least five of the European and Asian nations in terms of franchise potential based on culture, economic systems, politics and the status of Tesco's operations in the nations (I doubt it would franchise in the UK, for example). That leaves nine potential countries, with the U.S. - and Fresh & Easy Neighborhood Market - being one of the nine in the running.

['The Insider' column is a regular - generally fortnightly - feature in Fresh & Easy Buzz. As a columnist, he offers news, insight and anlaysis, along with opinion and commentary in his columns. Below are past, recent columns by 'The Insider.']

~June 12, 2010: Will Phil Clarke Shake Things up at Fresh & Easy Neighborhood Market USA When He Becomes Tesco CEO in 2011?

~September 3, 2010: How the California Grocers Association and its Members Can Snatch Victory From the Jaws of the Defeat of California's Plastic Bag Ban

~August 22, 2010: Challenges & Opportunities: Tesco's Fresh & Easy Neighborhood Market Will Supply its Northern CA Stores From its Riverside County DC in Southern CA

~July 18, 2010: When it Comes to Northern California - its Competitors are Rome Burning and Tesco's Fresh & Easy Neighborhood Market is Nero Playing the Fiddle

~July 13, 2010: A Few Words on The Life and Death of Veteran Southern California Grocer Roger K. Hughes

~June 27, 2010: The Insider: Will Tesco Acquire Supervalu, Inc. and Change its 'Fresh & Easy' Game in America?

~May 20, 2010: Welcome to Discountopia USA

~April 29, 2010: Heard on the Street: There's Something About Albertsons ... In Southern California