Wednesday, December 12, 2007

Mid-Week Marketing Memo: Tesco's Fresh & Easy

Analysis: Three reasons why Tesco's Fresh & Easy Neighborhood Markets venture could be a huge success--and three reasons it could be a historic food retailing failure

Unless one lives in a media-deprived cave these days, they likely know all about the launch last month in the Western USA of Fresh & Easy Neighborhood Markets, the convenience-oriented, hybrid basic grocery market, fresh foods format retail food store from British grocer Tesco. (If you do live in that media-deprived cave, just type Fresh and Easy, or Fresh and Easy Neighborhood Markets into the search box at the top of this blog.)

To date, Tesco has opened 24 Fresh & Easy grocery markets in Southern California, Arizona and Las Vegas, Nevada. The majority of the stores thus far are located in Southern California. As we've reported, Tesco also will begin opening Fresh & Easy stores in Northern California early next year. The grocer also is looking to expand--perhaps as early as mid 2008--to Chicago, New York and Florida.

We call the 10,000 to 13,000 square foot, convenience-oriented Fresh & Easy Neighborhood Markets format, a cross between a limited assortment, neighborhood independent grocery store and Trader Joe's. Like the limited assortment neighborhood independent, or limited assortment, small format price-impact chain (think Aldi or Supervalu's Save-A-Lot for example), Fresh & Easy stores offer a selection of national brand and private label groceries.

And, similar to a Trader Joe's, the grocery markets' offer a selection of fresh produce (mostly pre-packaged), meats (all pre-packaged) and other perishables. Fresh & Easy stores also feature (more so than Trader Joe's) a strong selection of prepared foods, ranging from basics like meat loaf and mac n' cheese, to more upscale offerings. All of the prepared food items are made at the grocer's kitchen facility in Southern California and delivered to its stores daily.

On the basic grocery side of the strategy, Tesco is positioning the stores as a price-impact/low-price leader grocery store. Early November price comparisons in Southern California done by us and others like the Los Angeles Times, showed Fresh & Easy to have lower overall prices on a market basket of basic grocery items than all the region's major supermarket chains: Ralph's, Von's, Stater Bros and a couple others. In fact, Fresh & Easy store retail prices on the items in the basic grocery market basket were about the same as those at the region's leading price-impact warehouse store.

At the other end, strategically speaking, Tesco has positioned the grocery markets as the "premium" retail destination for fresh, prepared foods--ready-to-eat, ready-to-heat, and grab-and-go selections. The stores' also have a slight hint of upscale in their wine, beer and spirits selections; a nod to Trader Joe's merchandising philosophy. There's even a version of TJ's famous "Two-Buck-Chuck" $1.99 per- bottle wine. Fresh & Easy's version is a Shiraz variety from Australia, branded as "Big Kahuna." It sells for $1.99 bottle as well.

The Fresh & Easy format

The Fresh & Easy format qualifies as "new" in U.S. food retailing in our analysis. That's not to say it isn't more like existing formats than it is different, as we described above--but rather that the grocer's positioning and merchandising strategy in the small format box qualifies it as "new" to the U.S. food retailing scene in the main. (Note: we use quotes around "new" to denote a nuanced definition of the word.)

What makes the Fresh & Easy format qualify as "new" in our analysis is the combination of price-leading, basic grocery product retailing, combined with fairly upscale prepared foods retailing at the same time in the same small box. The only similar food retailer doing this type of "high-end/lower-end" merchandising and positioning in a large way is Costco. It's extremely successful warehouse stores combine low prices on basic groceries and other consumer goods with specialty, gourmet, natural and organic grocery offerings.
Costco's prepared foods program also ranges from the very basic, to much higher-end offerings. It's the preferred place to shop for everything from inexpensive car batteries, to expensive champagne and organic cereal, which you see co-mingled together in the shopping carts at the stores' regularly.

However, it's one thing to be able to do such low-price/high-end merchandising successfully in a big box like Costco does, and quite another thing to be able to do it successfully in a 10,000 square foot store.

Three reasons why Fresh & Easy could be a big success

Here are the three reasons Tesco's Fresh & Easy stores could be successful. First, is what we call the "big box blues." Shoppers (especially middle-aged and older ones) are getting tired of navigating huge Supercenters and superstores. Everything from the amount of time it takes to find a parking spot in the stores' huge parking lots, to traveling miles inside the store while shopping, to waiting in long checkout lines, is making many shoppers in the U.S. seek out smaller format alternatives. There are numerous studies backing up this fact. Walgreens, which is about the size size as Fresh & Easy, is one of the hottest drug retailers in the nation, for example.

With it's small footprint size and combination low-price focus and fresh, prepared foods positioning, Fresh & Easy stores might be able to capitalize on this growing consumer trend. If shoppers feel they can get their Bounty paper towels, Tide detergent, and Best Foods Mayonnaise, along with prepared foods and fresh produce and meat, at a convenient store that offers good prices, they just might make the switch to Fresh & Easy from their current supermarket. It's these primary shoppers Tesco hopes to lure to its stores in addition to secondary ones. In fact, it needs to lure a mix of primary as well as secondary shoppers to succeed.

The second reason Fresh & Easy stores could succeed is what we term "the ubiquity factor." Tesco's strategy is one that plans on emulating that of powerhouse coffee retailer Starbucks. Put a Fresh & Easy grocery market in every neighborhood in its trading area, Tesco's philosophy goes, and shoppers will beat a path to your door--just like they do at Starbucks.

Ubiquity is a good strategy, but not by itself. Like Starbucks, the Fresh & Easy retail offering must be appealing to consumers first. If so, then having stores in "every" neighborhood will not only reinforce that positive offering with shoppers, it also will add a uniformity and convenience factor. Like Starbucks or McDonalds, consumers know that regardless if they visit a store in California, New Jersey or South Dakota, there will be a uniformity in the experience.

Third and last, Tesco's Fresh & Easy format could succeed do to the most basic of all retail variables--price. If Tesco can maintain it's current retail prices on basic groceries--which we have doubts about--it will essentially be the low-price leader in it's markets. In the Southern California market basket price surveys we mentioned earlier, Fresh & Easy stores were 8-10% cheaper than nearby Ralph's (number one market share) and Von's (number two) supermarkets. (The market basket contained basic items like milk (gallon), eggs (dozen), laundry detergent, toilet paper, mustard, ketchup, and other everyday grocery items. Only everyday retails were compared. Items on special were excluded.)

These percentage differences are huge. However, we have doubts Tesco can maintain these retail price differences over time. It's one thing to price that low early in the game, but maintaining such prices over the long-term is another story. At some point a retailer has to make money. At the current retail prices, Fresh & Easy stores' will have to sell lots of higher margin prepared foods to even come close to hitting standard U.S. gross margin levels for food retailers.

However, if the British grocer can somehow maintain these low retails, it could make them a formidable competitor in the basic grocery sector. There is one problem though. The store's selections are just too limited in assortment. To grab primary, basic grocery shoppers, Tesco will have to expand the grocery selection (especially national brand) in the Fresh & Easy stores, in our analysis.

Three reasons why Fresh & Easy could be a big failure

The often repeated phrase, "I have good news and bad news, which do you want to hear first?" seems a good opening sentence at this point. We gave the good news regarding Fresh & Easy's potential fate first. So here's the bad news--three reasons why the British grocer's U.S. venture could go the way of Webvan (1990's online delivery service flop touted by many as a venture that would revolutionize food retailing) and Krispy Creme Donuts (one of the most promoted concepts and hottest stocks in the 1990's. Today, it's nearly bankrupt.)

First, Fresh & Easy could fail do to "operational and retail ethnocentrism." What, you ask? We'll explain. Tesco has imported from the UK nearly it's entire supply chain for it's Fresh & Easy Neighborhood Markets venture. It's fresh produce and meat procurement is being done by a British firm, which has set up shop in Southern California. Ditto with it's wine and spirits importation and supply chain. It's private label program also is imported from the UK.

The grocer's prepared foods operation also is British. Rather than preparing the foods in-store, as is the proven method with U.S. supermarket chains and independents that are successful in prepared foods merchandising, Tesco's operation is a centralized kitchen operation. The prepared foods items are then delivered to the stores. While we understand why the grocer is doing this (store size is a key factor), it's risky to do in the U.S. based on a number of similar attempts--and failures--by other food retailers to so so. (We aren't suggesting it's wrong to try it though.)

The stores also offer too few nationally branded grocery items, and too many private label we believe. Clearly, Tesco likely believes that if Trader Joe's can do so well with mostly private label, so can Fresh & Easy. However, part of TJ's charm is it's quirky store brand items, mostly specialty, natural and organic packaged goods. Additionally, it's taken TJ's many years to establish it's private label program. When it comes to more basic grocery items, rather than specialty and natural groceries, U.S. consumers generally look to national brands, although that is changing with the advent of quality store brand lines.

In order to succeed, we believe Tesco will need to localize it's operations and product mix more--not only to the U.S. as a whole but to the communities and even neighborhoods where its stores are located. Buying local is one of the top trends in the U.S. It's also a wise move from a marketing perspective for a foreign retailer (ask Wal-Mart, especially in Canada and in the UK with ASDA) to localize it's operations and merchandising mix as much as possible in the countries where it does business. In fact, Tesco has a major local initiative in the UK. Why not in the U.S. with Fresh & Easy? Maybe it's coming?

The second potential ingredient for failure is ironically one of Fresh & Easy's ingredients for success. It's flip side if you will. That ingredient is the stores' format and positioning itself. The combination basic grocery/low-price leader/prepared foods positioning runs the risk of confusing shoppers. For example, primary shoppers want extensive fresh produce and meat departments in the stores they shop regularly at. Fresh & Easy has neither. They also want an extensive enough selection of basic groceries, and national brands, available to them so as to not have to always shop at two different stores. Fresh & Easy fails on that count as well.

Despite the great prices, the store's currently seem in our analysis to be secondary and tertiary retail destinations rather than primary ones. Trader Joe's does very well as a secondary shopping-type retail chain. However, it's a strong secondary retailer. The question is, with TJ's playing that role well, is there room in that same space for Fresh & Easy? We think not. Rather, it needs a mix of primary as well as secondary shoppers in order to succeed, especially on the scale Tesco has in mind for the chain.

Lastly, Tesco's Fresh & Easy franchise could fail based on customer service. The chain is using a self-scanning, self-checkout scheme in its stores. Each checkout has a scanner that customers are to use on their own to compute their order. Currently, in the stores thus far opened, staff is at the checkouts to help shoppers, and to help them bag their orders if it looks like they're adverse to doing so themselves. We can tell you from observation shoppers are in the main adverse to doing so.

Most shoppers we've (and others) have observed didn't seemed all that pleased to do the self-checkout. Although tried by some food retailers in the U.S.--mostly limited assortment warehouse-type stores--it isn't as of yet a popular option with U.S. shoppers. At Fresh & Easy stores, self-checkout also lends to the format confusion mentioned above. The somewhat upscale store design, combined with the extensive prepared foods offerings, tends to negate a feature like self-checkout. There's an incongruity to it.

Most of the store staff we've observed, and heard about from other observers, are friendly and try to be helpful. They seem like a great bunch of people. However, we've also heard from many that compared to Trader Joe's, for example, Fresh & Easy staff seems far less knowledgeable about the stores' product mix and operations. We're willing to chalk that up to the newness of the venture--after all the first stores just opened a month ago, and some have only been open for weeks or days. It's something Tesco must correct however, and build better training into their culture so that new hires can hit the ground running from nearly day one. In stores that small, associates should be neighborhood friendly, and extremely knowledgeable about store product mix and operations.

Conclusion: balance, perspective and the future

In many ways, while writing this piece we thought it premature of us to even do so, considering the newness of Tesco's Fresh & Easy retail venture. However, in part we're doing so because we think some analysis and perspective needs to be offered on the operation to date.

About 70% of the U.S. business press is proclaiming Fresh & Easy as the second coming in food retailing in the U.S. writing that it will become a dominant player nationally in as little as five years, for example. Conversely, about 15% of the business press has already doomed Fresh & Easy to the dust bin of U.S. retailing history. This is especially true among the UK business press, by the way. The remaining 10% seems to be offering a balanced picture of the venture. They're offering that Fresh & Easy stores offer something new, with the potential to succeed, but with lots of improvements needed in order to get there.

Our main point in this piece is just that. It's clear Fresh & Easy is far more than an experiment for Tesco in the U.S. It's a major venture. The grocer has hit the ground running--and with a fat wallet--offering up a food retailing start-up the scale of which hasn't been seen in the U.S. for a long time, especially from a foreign retailer. Stores are opening weekly and major geographic expansion plans are being rolled out at the same time. Success and failure will come, as it does in all aspects of retailing, based on having the correct strategy, positioning and execution, along with those external variables like timing and the economic environment.

Tesco has miles to go with Fresh & Easy to get there (success) in our analysis. The strategy, positioning and execution all need evaluating and some rethinking. In particular, we suggest reviewing the extensive research the chain did on U.S. consumers. There is some disconnect between all the valuable data the grocer gathered and how that information ended-up getting translated at retail.

Additionally, localize. Tesco needs to shed its ethnocentrism a bit and bring in more U.S.-based trading partners, as well as tailor the stores more to their communities and neighborhoods. Lastly, don't make (retail pricing) promises you can't keep. Nothing will hurt Fresh & Easy more than Tesco having to raise its retail prices on basic groceries considerably down the road because the items were priced to low to begin with. Consumers are likely to take this as a bait-and-switch type scenario and might not forgive it.

Being a low-price grocery leader, along with a fresh, prepared foods leader and somewhat upscale grocer combined, isn't an easy niche to build. We give Tesco credit for attempting it. We also suggest Tesco executives study Costco in that regard. Positioning is identity. A strong identity can lead to retail success. A bad one to failure. The good news is, there's plenty of time to make that positioning and identity better for Tesco. The bad news is, it can only be done by first shedding some of that operational and retail ethnocentrism.

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