Continental shift

While noisy recriminations have followed the collapse of merger talks between Asda and Safeway, the ultimate target of their merger ambitions, Tesco, has been quietly pursuing its own mould-breaking plans.

Although it’s the UK market leader, Tesco recognises that there is not a lot more market to be wrung out of the UK, and is accelerating its European expansion. As a result, the two Tesco marketers, preparing to leave for Central Europe, have a lot on their minds.

John Burry and Reg Curtis, two of the chain’s trading directors, are taking charge of commercial operations in Central Europe. Burry becomes commercial director in the Czech Republic and Slovakia, where Tesco has 13 stores. Curtis becomes commercial director in Hungary, where it has 43.

The newly-created positions – described by Tesco as “all-encompassing roles” have been created as the chain announces a 100m investment in its European operation this year, and prepares for major expansion in Central and Eastern Europe.

The two executives will be responsible for merchandising, buying and marketing the Tesco stores springing up across Central and Eastern Europe. The chain has also created the position of European trading supply director and handed the post to trading director for non-food Paul Mancey.

Asda and Safeway may ponder the possibility of knocking Tesco from the number-one spot by uniting or buying a smaller competitor, such as William Morrison (MW October 2). But Tesco believes it has established supremacy in the UK, and is now pouring resources into a second front of overseas expansion.

Since its first investment in Hungary three years ago, when it took a 20m stake in the Global chain, much has changed in the UK, with Tesco coming to dominate the market. The next three years may see the chain lose its dominance in its home market to a revitalised Sainsbury’s or amalgamated Asda and Safeway, but more importantly for Tesco, time will also reveal the wisdom of its international strategy.

Tesco owns about 100 stores in the Czech Republic, Hungary and Poland, where last year it invested 76m. Whether the stores can justify this investment will be down to how Curtis and Burry read these new markets, and how kind the markets are to them.

Despite enthusiastic predictions about economic growth in these markets, the two newly-appointed marketers will be wondering whether Tesco’s interests in Central Europe will go the same way as its investments in France.

Little-noticed press reports, which came out at the same time the Asda/Safeway story broke, claimed that Tesco has put its French chain Catteau up for sale. Despite the chain’s denial, it does still raise questions about its ability to judge international markets. Tesco says it is developing new plans for Catteau, which it bought in June 1993 for 150m.

Under recently-appointed chief executive Andre Mercier, who joined from rival chain Docks de France, Tesco says it is “developing a strong business plan for the operation, which will make it a much stronger business”. Catteau definitely needs some new plans.

Tesco’s half-year results, published last month, showed that sales only rose by one per cent last year. “This performance, together with a lower gross margin, the closure of much of Catteau’s wholesale operation and an adverse impact due to the strong pound, has resulted in an operating profit of 1m in the first half of this year,” said Tesco chief executive Terry Leahy at the results announcement. This compares with 5m profits in 1996.

Tesco has ruled itself out of involvement in the protracted bidding war for French supermarket group Casino, which is the subject of a hostile FF31bn (3.3bn) takeover bid from rival Promodès. The addition of Casino would have given Catteau the size it needs to compete effectively. Without it Catteau’s future is less certain.

After the half-year results, Leahy told analysts that the company had wanted to become involved in the consolidation of the French retail industry, but failed. The prices being asked are just too high. Catteau, too small to reap economies of scale, offers Tesco two options. It can either expand the chain through acquisition – opening more stores is difficult because of French planning restrictions – or sell to a rival chain.

Having already invested 300m in its French operation since 1993, Tesco is seeing precious little return. Some speculate that if Promodès bought Casino, Tesco might sell its Catteau chain to the newly-enlarged group and keep a small stake in the group. But a third retail chain Rallye, which already owns 33 per cent of Casino, is emerging as a favoured white knight bidder.

Tesco has confirmed that it has hired investment bank Goldman Sachs, but says this is not to engineer a sale of Catteau, rather the bank will be “looking at European business initiatives and strategies that cover the whole of Europe”.

Evidently Tesco misjudged the difficulties of expansion in France, but it should have been aware of the potential pitfalls. There are strict planning restrictions on out-of-town development, limiting its room for expansion, but that was the case before Tesco entered the market. The French economy has been sluggish for some years now, but that’s no surprise either.

The question is whether Tesco’s French misjudgment will be repeated in Central Europe. Clearly, if things don’t work out there, it will have been a much cheaper experiment than in France. But Central Europe is still largely unknown territory for Tesco, and the chain has some crucial issues that it must tackle before its operation can be judged a success.

Tesco’s half-year results show a much better performance for Central Europe than they do for France. In Central Europe sales rose by 114 per cent from 67m to 135m compared with the same period last year, while in France sales plummeted from 329m to 274m, a fall of 16.7 per cent. The figures show a sales increase of 3.3 per cent for the two regions combined. In Central Europe start-up costs of 8m led to losses of 3m, though the chain claims this means “underlying profits” are up 25 per cent at 5m.

In the Czech Republic – the Central European country closest to the economies of the West – multiple retailers are estimated to take little more than a quarter of the retail market. This suggests that they have plenty of room for growth. But whether the Czechs will take to Tesco’s format is another question. The same can be said of Hungary and Poland, which are culturally more distant from the West.

Much will depend on how successful Tesco is at getting its product ranges right. The company has so far stocked many local goods, but it is planning to increase the percentage of Tesco own-label products that it carries.

Which explains the appointment of the two new marketers with their trade buying experience. It will be up to them to merchandise the products in a way that makes the stores attractive to local markets.

Significantly, Burry has been working as trading director for convenience foods, such as ready-made meals, which may suggest the direction Tesco will push its stores. Curtis was trading director for “morning goods” and the in-store bakery.

The expansion is being planned through the opening of more hypermarkets. One has already opened in Hungary, and a second is planned for November. It is understood a further six will open next year, and that Tesco is building up a “bank” of sites across the Czech Republic, Hungary and Poland for other similar openings.

There are limited options for buying up existing chains, so greenfield developments will be essential. It has also been reported that the next country on Tesco’s expansion shopping list is Latvia, and that a hypermarket will open there within the next six months.

The Poles, Czechs, Slovaks, Hungarians and Latvians have never seen anything like it. The 70,000 sq ft hypermarkets that will spring up all over their countries will offer food and a range of other products. Tesco will be able to use some of the experience it has gained opening its first Tesco Extra hypermarket in the UK, as part of a chain which may number 50 outlets one day, to plan its Central European strategy.

Essential to the success of the operation from Tesco’s point of view will be a strong own-label presence. One observer says Tesco has called on some of its own-label suppliers to set up offices in Central and Eastern Europe to supply the new hypermarkets.

If Tesco has to source its goods from the UK, this will add costs to the operation, so a local network of suppliers will be essential to its success. One of the major UK own-label suppliers, HL Foods, already has an office in Poland, and it is understood that other suppliers are looking at setting up in Central and Eastern Europe.

Tesco’s strategy in Central Europe has been to get in early, so if the economies live up to the promise that has been predicted for them, the chain will be well positioned to take advantage. This equally applies to its thinking on China.

Early this summer Michael Fleming, Tesco’s business development director and former marketing director of Asda, went to Hong Kong to look at opportunities. China is, after all, a land of 1.4 billion people, with some 500 million living in coastal areas.

The Chinese government welcomes western investment, but opportunities are being snapped up. In Shanghai, for example, it is believed that all licences for foreign retail businesses have already been taken. If anything, Tesco may be arriving late in the Chinese market. Marks & Spencer established Chinese links at the beginning of the Nineties.

The rationale behind Tesco’s moves in Central Europe is that these countries have emerging middle classes who will, the theory goes, jump at the opportunity of shopping at a Tesco hypermarket. But there are many pitfalls. Macro-economic forces, such as currency crises, can wipe out international profits in a day. For instance, retailers such as Boots and the Body Shop, with operations in South-east Asia, will bear the brunt of the recent collapse in local currencies.

Curtis and Burry carry with them the hopes of Tesco, and its shareholders, for the next ten years. Only if they read the needs of Hungarians, Czechs and Poles correctly, and if the economies of these countries develop at the anticipated speed, will Tesco be able to avoid a repetition of its experience in France.