Meaningful Move or Too Little Too Late? Fresh & Easy Neighborhood Market Planning Early 2012 Metro Sacramento Market Launch

News/Analysis/Commentary

Tesco's El Segundo, California-based Fresh & Easy Neighborhood Market is planning to open its first stores in the Sacramento metropolitan region in Northern California early next year, according to our sources, and has recently posted advertisements for store managers on the Internet in advance of its entering what will be a new market region for the 177-store small-format fresh food and grocery chain in 2012.

On Wednesday (August 31) Fresh & Easy Neighborhood Market will hold a ground breaking at the site of what will be one of its first Sacramento-area stores to open next year, at 34th and Broadway in Sacramento's Oak Park Neighborhood. Joining Tesco group deputy CEO Tim Mason, who's also the CEO of Fresh & Easy, and other senior executives at Wednesday's ground breaking will be Ex-NBA basketball star and Mayor of Sacramento Kevin Johnson, who once owned the site of the future Fresh & Easy store in the Oak Park neighborhood where he was raised, along with members of the City Council.

Mayor Johnson's neighborhood

It should come as no surprise to regular readers of Fresh & Easy Buzz that Tesco's Fresh & Easy will kick off it plans to enter the metro Sacramento market with a ground breaking at the Oak Park-Sacramento location Wednesday - or that Mayor Johnson will be attending the event. It's Mayor Johnson's neighborhood after all.

In 2008 Johnson's then Kynship Development Company sold the Oak Park parcel to Fresh & Easy Neighborhood Market for $1.12 million. In December 2008 that deal held up the incoming mayor's swearing-in ceremony for a couple hours, as we reported here - December 3, 2008: Swearing-In of New Sacramento, CA Mayor Kevin Johnson Delayed A Few Hours Over A $2.2 Million Tesco Fresh & Easy Agenda Item.

Johnson was sworn-in though that same day and has gone on to become a very popular mayor in Sacramento, along with drawing national attention. He's also one-half of what is a major political power couple in the making: He will soon get married to Michelle Rhee, the former chancellor of the Washington D.C. Public school system, who is considered a leader, if not the leader, in public school educational reform in America. Rhee's Student's First organization has as its ambitious mission nothing less than the transform of public education in the U.S.

The mayor also has a background in public school education reform. After retiring from the NBA he returned to his hometown of Sacramento and went into business as a developer. He also set up the non-profit St. Hope organization. Among the numerous programs the foundation started a few years ago was a charter school that replaced the then-failing Sacramento High School into what has become a much more successful school than it previously was.

Johnson has focused much of his work with the non-profit St. Hope organization on the low-income Oak Park neighborhood where he was raised. After taking office as mayor in 2008 he severed his day-to-day ties with St. Hope.

He also focused much of his for-profit real estate acquisition and development efforts in the neighborhood prior to becoming Mayor of Sacramento. For example, in March 2008 when the then 42-year old Sacramento native announced he was running for mayor, Johnson owned about 37 properties in Oak Park, as we noted in this piece on March 7, 2008: Former NBA All-Star and Sacramento Native Kevin Johnson is the Driving Force Behind a Fresh & Easy Market in Sacramento's Oak Park Neighborhood. Notice what we said in the very last sentence in the story linked above.

It was in February 2008 that United Kingdom-based Tesco announced its plans to enter the metro Sacramento market region, saying it would open 19 Fresh & Easy stores, including seven units in the city of Sacramento.

The grocer's initial plans were to open the first stores in the Sacramento area in late 2008-to-early 2009. But Tesco's financial struggles with Fresh & Easy Neighborhood Market have resulted in what will end up being an about four year delay of those original plans when the first stores open in the Sacramento market next year if all goes according to current plans.

In early March 2008 Fresh & Easy Neighborhood Market CEO Tim Mason and Sacramento's then-Mayor Heather Fargo, who Johnson defeated in the local election, held a press conference in front the the very same future Fresh & Easy store in the city's Oak Park neighborhood to announce the Tesco-owned grocer's plans to open stores in the city and region.

Tesco's Fresh & Easy finally opened its first Fresh & Easy stores in Northern California in March of this year. It has opened 13 units in the region to date.

Sacramento bound, locations waiting in the wings

The retailer has opened one of those 19 stores, the unit at Elmira & Nut Tree in Vacaville. Vacaville isn't in the Sacramento metropolitan region however. The city is located about midway between Sacramento and the San Francisco Bay Area. It's about a 45 minute drive from Sacramento on Interstate 80.

Besides the original 19 stores publicly announced by the retailer, we've identified five additional future Fresh & Easy store locations the grocer has acquired in the Sacramento metro region since 2008. Those sites are in the following cities: Carmichael (5025 Marconi Avenue); North Highlands (3525 Elkhorn Boulevard); Gold River (2210 Sunrise Boulevard); Granite Bay (8701-8705 Auburn Folsom Road); and Placerville (Missouri Flat Road & Forni Road).

We've also identified three additional future Fresh & Easy store locations in the greater Sacramento region. Those future stores are: Oroville (Butte County), at Goldtown Plaza Center; Sutter Creek (Amador County), Sutter Creek Crossroads at Hwy 104 and Hwy 49 (see here); and Clearlake (Lake County), Hwy 53 and Dam Road. (see here); along with a location in Suisun City (Sunset Center at Sunset and State Highway 12), which is in the Sacramento/Vacaville region.

Tesco's Fresh & Easy Neighborhood Market hasn't publicly announced or confirmed any of these additional locations. However, we've identified them using multiple sources, including filings by Fresh & Easy with the state of California for alcoholic beverage permits and licenses for future stores at each of the locations.

According to our sources, the Oak Park location will be one of the first two or three Fresh & Easy stores to open early next year in the Sacramento region. The Oak Park neighborhood, like San Francisco's Bayview-Hunter's Point where Fresh & Easy opened its newest store in the 5800 Third Street development last week, is underserved by grocery stores offering fresh food and groceries at affordable prices. Such areas have become commonly referred to as "food deserts."

Oak Park is also home to an extremely strong neighborhood organization. In 2008 Dustin Littrell of the Oak Park Neighborhood Association filed an appeal with the City of Sacramento against Fresh & Easy Neighborhood Market's design plan for the store in the neighborhood. Littrell, who's a designer by profession, included in the appeal a number of detailed proposed design changes for the future store at the location, including site changes he says would have improved traffic flow at and around the store.

The grocer fought the appeal for a time. But after the City of Sacramento Design Review Board agreed with most of the neighborhood group's proposed design changes for the store, Tesco's Fresh & Easy made a deal with Littrell and other neighborhood association leaders, agreeing to incorporate the majority of their proposed design changes in its plan; changes that were mandated by the city anyway. Fresh & Easy then closed escrow on the parcel, which it bought from Kevin Johnson's development company. [See - November 17, 2008: Sacramento City Design Board Agrees With Oak Park Group on Design Changes For Proposed Fresh & Easy Store; Escrow Closed on $1.1 Million Parcel.]

We covered and wrote about the Oak Park Neighborhood Association vs. Fresh & Easy Neighborhood Market store design issue extensively. You can read our stories at the following links: Oak Park Sacramento, Fresh and Easy Sacramento, Fresh and Easy Sacramento Metropolitan Region, Oak Park Fresh and Easy store design appeal.

Why Sacramento now?

Tesco plans to enter the Sacramento metro region with its Fresh & Easy chain early next year comes in a year in which the retailer has been focusing all of its new store growth in California.

Thus far this year it has opened 23 new Fresh & Easy stores, all in California. Of those stores 13 units are in Northern California - 11 of which are in in the San Francisco Bay Area. The other two stores are the unit in Vacaville and a store in Modesto, which is in the Northern San Joaquin Valley. Modesto is about 70 miles from Sacramento. Vacaville is about a 30 minute drive from the capital city.

Fresh & Easy Neighborhood Market also plans to continue to focus its new store growth in the Golden State for the remainder of the year. According to our sources, all the currently planned new store openings for the remainder of this year are in California.

Its been over a year since Tesco has opened any new Fresh & Easy stores in metropolitan Las Vegas, Nevada, where is has 21 units, and metro Phoenix, Arizona, where there are 28 Fresh & Easy markets. In fact, the retailer closed six stores each in the two market regions in November 2010, along with one store in Southern California, for a total of 13 units. (See here for details.)

Our sources also tell us that Tesco's focus in 2012 in terms of new store growth will be almost exclusively in California, where it has numerous future locations in both Northern California (over 50 sites in the area alone), Southern California and the Central Coast, along with a few in the Central Valley.

Entering the Sacramento market though will cost Tesco some money in terms of ongoing marketing and promotional costs, in addition to the nornal operational expenses involved in starting up. The region, where the dominant grocery chains currently are locally-based Raley's (133 stores and about $3.3 billion in annual sales), Modesto-based Save Mart (249 stores and about $5 billion in annual sales) with its Lucky banner supermarkets and Food Maxx discount warehouse stores, and Safeway Stores, Inc. (the fourth-largest food retailer in the U.S. and the overall market share leader in Northern California where it's headquartered in Pleasanton), is becoming increasingly competitive.

[See the numerous stories and analysis at this link - Northern California Special Report - for a good primer on just how competitive Sacramento and all of Northern California is fast-becoming.

For example, Sprouts Farmers Market and Sunflower Farmers Market are both focusing on opening numerous stores in the Sacramento region next year. Sprouts currently has two stores in the region, one unit in Roseville and another in nearby El Grove. Sunflower Farmers Market opened its first store in Northern California earlier this year. That store is also in Roseville.

Additionally, discount chain Target has added its "P-Fresh" fresh food and grocery sections to a number of its discount format stores in the Sacramento region and has plans to add more next year.

And Walmart Stores, Inc., the world's largest retailer and leading seller of food and groceries in the U.S., is putting a major focus on the Sacramento metro region with its smaller-format (30,000-60,000 square-foot) Walmart Market stores, having thus far acquired a number of sites for the stores in the region, with plans for more. Walmart also has plans for more supercenters in the Sacramento area.

We expect Walmart to open its first Walmart Market unit in the Sacramento region in early 2012. That first store - or at least one of the first units - will likely be the location at Highway 65 and Second Street  in Lincoln, which is near Sacramento, where Tesco has had a future Fresh & Easy store site (at Lincoln and Sterling) since early 2008. [For more details see - January 10, 2011: Walmart 'Gets Real' With Smaller-Format Grocery Store Initiative in California; First Stores On Tap; and July 6, 2010 story - Walmart Looking for Store Sites in Northern California For 20,000 Sq-Ft Neighborhood Market by Walmart Prototype Store.

A Fresh & Easy Buzz correspondent recently saw workers inside the vacant former Rainbow Market store in Lincoln tearing out interior materials and loading them into a Walmart Stores truck trailor parked in the parking lot, signaling work has began on turning the building into a Walmart Market grocery store.

A number of other Walmart Market grocery stores - which at their smallest (about 30,000 square-feet as is the case with the Lincoln unit) have three times the selling space as Tesco's 10,000 square-foot Fresh & Easy stores, carry four-to-five times the number of SKUs as Fresh & Easy (which offers about 5,000 SKUS), and offer a full selection of produce, meats and fresh-prepared foods plus in most cases an in-store pharmacy - will be located near the current planned Fresh & Easy Neighborhood Market locations in the Sacramento region.

Sacramento: Continue to pay or start to play

Last year as part of a nearly year-long special report on food and grocery retailing in Northern California we wrote a series of stories about whether or not Tesco would launch Fresh & Easy into Northern California in 2011 (which it ultimately did, opening the first stores in March of this year), starting with this report - April 19, 2010: Tesco Debating Whether to Launch Fresh & Easy Into Northern California This Fiscal Year... or Wait.

We followed the April 2010 report up with this story - June 26, 2010: Tesco Planning to Announce in July When First Northern California Fresh & Easy Neighborhood Market Stores to Open . Three weeks later on July 18 our 'The Inside' columnist wrote this: 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.

On July 29, 2010 we reported in this story - July 29, 2010: Tesco's Fresh & Easy Neighborhood Market Putting Together List of Managers Interested in Transferring to Northern California - that the wheels were in motion at Fresh & Easy regarding a Northern California launch.

On August 19, 2010, less than three months after we started reporting and writing about the retailer and Northern California, Tesco's Fresh & Easy announced in a press release it planned to open its first eight stores in the region in March 2011, as we wrote about here: Tesco Will Open its First Eight Fresh & Easy Neighborhood Market Stores in Northern California in 'Early 2011.'

Our analysis throughout 2010 (and long before that) was that Tesco should focus first in Northern California on opening the numerous locations it has in the San Francisco Bay Area. It's done just that - as noted earlier 11 of the 13 stores opened in the region so far are in the Bay Area.

We also said (best described in the July 18 column by 'The Insider') that by waiting to launch into Northern California in 2011 rather than doing so earlier, like in mid-to-late 2009 or even 2010, Tesco was late to the party for a number of reasons, including timing its entry two years late when the region's competitive profile had increased considerably compared to 2009.

But our analysis remains that from a strategic perspective, despite being extremely late to the party it was the right move for Tesco to launch in Northern California, with a focus on the Bay Area, rather than continuing to postpone, which among other things would have meant continuing to pay monthly rents on even more vacant building, plus its mothballed distribution center in Stockton, that it currently is. At least 13 of the more than 50 locations the grocer has in Northern California are open and operating.

This brings us to the metro Sacramento market and 2012.

Basically Tesco is left with two choices: Either start opening its numerous locations in the market region next year or continue to keep them vacant and pay for the privilege. It's chosen to do the former rather than the latter, despite the fact the Sacramento and San Francisco Bay Area regions are very different and distinct markets, although they are geographically close and have some similarities.

More expenses, continued price and margin pressures

Tesco CEO Philip Clarke has said the world's third-largest retailer will break even with Fresh & Easy by the end of its 2012/13 fiscal year, which is just 18 months away. The 2012/13 fiscal year ends in February 2013.

But in our analysis it isn't going to happen for a variety of reasons. First off, on the expense side of the ledger Tesco is spending a considerable amount of money on a variety of changes it's making to its existing Fresh & Easy stores, all of which we were the first publication to report on beginning early this year. Tesco and Fresh & Easy have since publicly confirmed all of the changes we reported on.

The major changes Tesco is in the process of making to its Fresh & Easy stores include: remodeling the store bakery sections and adding small in-store bakeries with ovens; moving the floral departments to the front of the stores; and replacing the reach-in style frozen food cases with more modern and energy-efficient upright frozen food display cases with glass door fronts. (You can see photos of the in-store bakery and upright frozen food cases here.)

Other changes include: resetting the health and personal care sections in the stores; removing the fixed location Kitchen Table in-store food sampling stations and replacing them with mobile units; and adding high-quality faux wood floors to some of the units, such as the store in Manhattan Beach, California, which is the first store to get the floors. According to a source in a position to know, the wood floors cost $75,000-$100,000 per-store.

The source says Fresh & Easy plans to install the floors over the existing cement floors in up to one third of its 177 stores, which if it does will cost a few million dollars. That's a wasteful and non-sales generating expense (even if the floors are only added to 10 stores) for a chain losing so much money - $300 million in Tesco's most recent fiscal year ended in February 2011 - not only our analysis but in our experience in the industry as well.

The wood floor, which we've seen at the Manhattan Beach store and is without a doubt of a high quality, actually looks out of place with the rest of the Fresh & Easy interior package, which is spartan and includes warehouse-style shelving and other more minimal design features. When it comes to grocery store interior design, the whole is always greater than the the sum of its parts, even if those parts are high quality and expensive like the wood floors are.

The numerous changes to the existing stores will cost Tesco many millions of dollars at a time when it needs to control rather than increase its expenses on Fresh & Easy Neighborhood Market.

On top of these fresh expenses Tesco continues to pay monthly rent on at least a score of future store locations in California, Nevada and Arizona which it has yet to open, along with its mothballed Northern California distribution center, which sits empty in Stockton except for the security guard out front who keeps watch on the vacant building every day.

In terms of sales and operations, the markets Tesco has its 177 Fresh & Easy stores in are among the most competitive in the United States - and they're getting even more competitive as new grocers enter them - Winco Foods is coming to metro Phoenix, Arizona in 2012, for example - and existing players open new stores - Walmart's major focus in California with its supercenters and Walmart Market, for example - along with the continued growth of Target, Costco, Safeway Stores, Trader Joe's, Whole Foods Market, Sprouts, Sunflower Farmers Market and a couple other grocers in California - for example.

Add in the continuing poor economy - California, where 128 of the 177 Fresh & Easy stores are located has the second-highest unemployment rate (a bit over 12%) in the U.S. after Nevada, for example, and Arizona isn't much better - along with a state government that's broke.

Analysts don't see the state's economy improving much in 2012, although some areas like the San Francisco Bay Area and coastal portions of Southern California are doing better than the state as a whole is.

As a result, the continuing poor economy - particularly in California where all but 49 of the 177 Fresh & Easy stores are but also in Nevada where the grocer has 21 units and Arizona (28 stores) - combined with the heavy competition in those markets means continued pricing pressure, which in turn means Tesco isn't going to be able to raise retail prices on the products it sells in its Fresh & Easy stores significantly enough to add the much needed margin growth required to break-even with Fresh & Easy by the end of the 2012/13 fiscal year end.

Tesco reported a negative 38% margin for Fresh & Easy for its most recent fiscal year ended February 2011. In contrast, to serve as a comparitive illustration Whole Foods Market recently reported a plus-36% margin for its most recently-ended fiscal year. Whole Foods' has about the highest margin of any grocer. But few if any grocery chains can make a profit with a margin under 20%.

This intense competitive environment also makes it difficult for Tesco to reduce or eliminate the regular use of its deep-discount store coupons which offer shoppers up to 20%-25% off their total grocery purchases. Fresh & Easy has most recently tried to reduce the heavy frequency in which it issues the coupons both online and via direct mail pieces to shoppers homes. However when the grocer does so, the stores see a reduction in sales, which is why, based on our monitoring of the coupon distribution, we've recently seen an increase in the frequency in which the grocer is once again issuing the coupons.

Launching in the Sacramento region in early 2012 - a new market with all the expected an unexpected costs such a launch can bring, particularly to a chain like Fresh & Easy which needs numerous stores in a region to open based on its strategic plan - is only going to add to the cost side for Tesco in terms of its attempt to break even in the next 18 months. Therefore, the launch, coupled with the other factors we've noted above, will in our analysis prevent Tesco from breaking even with its U.S. venture by fiscal 2012/13-end.

No break-even in 18 months

In fact, we will offer a prediction. The prediction is between now and the end of fiscal 2012/13, Tesco CEO Philip Clarke will say publicly that the retailer will not meet its goal of breaking-even with Fresh & Easy by fiscal 2012/13-end, perhaps offering as the "primary reasons" Tesco's decision to make the major changes noted in this piece, along with the continuing poor economic conditions in California, Nevada and Arizona.

Such an announcement, if we are correct, could come as early as October of this year, when Tesco announces its first-half fiscal year financial results. The first half of Tesco's 2011/12 fiscal year end this month. Much more likely though - October 2011 is too early in our assessment - if such an announcement comes, it will come in mid-2012 when Tesco announces the results of the current fiscal year which ends in February of next year.

Of course we could be wrong in our analysis. Tesco could break-even with Fresh & Easy as Clarke says it will 18 months from now. If so we will be the first publication to offer our congratulations and say our prediction is wrong.

Can Tesco make a viable business out of Fresh & Easy?

Meanwhile Tesco will launch into the metro Sacramento region at about the same time next year as when Walmart Stores begins opening the first of what it plans to be numerous Walmart Market smaller-format grocery stores.

At the groundbreaking ceremony on Wednesday at the site of the future Fresh & Easy store in Sacramento's Oak Park neighborhood, Tim Mason, Tesco group deputy CEO and CEO of Fresh & Easy Neighborhood Market, will perhaps announce the locations of one or more additional of Fresh & Easy stores it plans to open first in the Sacramento area, along with the Oak Park unit. (We are working on finding out ourselves.)

Mayor Johnson will be there - the popular former NBA all star who sold that very same parcel of land that will house the Oak park Fresh & Easy store to Tesco - and he and the members of the Sacramento City Council will welcome Tesco to their city with open arms.

Members of the Oak Park Neighborhood Association will also be at the ceremony on August 31. They will celebrate the coming of a store they thought would open at least two years ago, along with celebrating the fact they first began trying to lure a grocer to the neighborhood a number of years before Tesco agreed to come with Fresh & Easy in late 2007-early 2008.

Like was the case in San Francisco's Bayview Hunters-Point, where all the local chains like Safeway Stores and others said no, so to did Raley's, Safeway, Save Mart and others say no thanks to putting a store in Oak Park. Tesco said yes. And in our analysis the location is going to be a good one for Fresh & Easy Neighborhood Market, just as we've said Bayview-Hunters Point will be an excellent location for the grocery chain.

But hanging over Wednesday's ceremony and formal announcement by Tesco's Fresh & Easy that's it's headed to California's capital city of Sacramento will be that most important question, which is can Tesco break-even with Fresh & Easy Neighborhood Market by early 2013, and even if it does can the United Kingdom-based retailer go beyond that most basic metric and eventually turn Fresh & Easy into a viable and profitable food and grocery retailing enterprise for the company in America, having invested about $1.5 billion in it so far and sustaining an operating loss since the first stores were opened in November 2007 that's approaching $1 billion?

We've offered our analysis on the first part of the question, predicting Tesco will not break-even with Fresh & Easy by the end of its 2012/13 fiscal year. The jury remains out for Tesco as to the second part of the question, whether or not it can ever make something viable and profitable out of Fresh & Easy.

But if our prediction about Tesco failing to reach break-even by the end of its 2012/13 fiscal year with Fresh & Easy is correct, Clarke will have to address the second part of the question before then. His decision and that of Tesco's board will be: If Fresh & Easy Neighborhood Market isn't at or very close to break-even by then, does it make financial sense to keep on going or will it be time to pull the plug on Fresh & Easy and stop the losses, instead investing the money back home in the UK, in Central Europe (another growth region) or in Asia, which is where Tesco is putting its most major growth focus on over the next few years?