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PRICE OF SUCCESS

Tesco’s scale is generating low prices — and heat from regulators and rivals

By Curt Hazlett

To at least one of its big competitors, Tesco is a fast-growing giant trying to corner the grocery business in Britain’s most promising locations. To its many smaller competitors, Tesco is a ruthless price-cutter that threatens to crush local retailers.

To all of them, big and small, Tesco CEO Sir Terry Leahy has this reply: Get over it. Competition is good, he says, and the British retail environment is only going to get rougher.

This bare-knuckle approach to business has set Tesco in the spotlight in Britain, where the Competition Commission is in the early stages of investigating whether it and other large chains have engaged in practices that hurt suppliers and consumers.

As Britain’s largest retailer by far, Tesco is getting most of the headlines, and its winner-take-all style has even earned a nickname from

British pundits: Tescopoly. The commission’s findings are not expected until the end of the year, but its early work has already prompted bickering among the supermarket chains themselves.

Like U.S. retail giant Wal-Mart, Tesco has been criticized for squeezing local retailers with its low prices and fast expansion. Since it overtook rival J Sainsbury in the 1990s as Britain’s largest retailer, Tesco’s U.K. presence has grown to nearly 1,800 stores and its share of the national market to 31 percent — nearly twice that of its nearest competitor, Asda, which is owned by Wal-Mart.

Tesco’s emergence is part of a wave of change that has remade Britain’s once-sleepy grocery business. “The market here has been highly competitive since the 1970s,” said Bryan Roberts, a retail analyst at Planet Retail, a London market research firm. “You have Tesco, Asda, Sainsbury and Morrisons, and when you factor in all the smaller competitors, it adds up to a fiercely competitive sector.”

Between 2000 and 2005 the number of supermarkets, convenience stores and specialized groceries fell by 2 percent, 8 percent and 7 percent, respectively, according to the Competition Commission, and yet the number of stores operated by the four largest chains more than doubled.

As the chains took hold, smaller retailers began calling for a government inquiry into what they saw as unfair practices. The Office of Fair Trading began one in 2004 and concluded in May 2006 that there was enough evidence to refer the matter upward to the Competition Commission. (Actually, this was a flip-flop for the Office of Fair Trading, which had drawn the opposite conclusion in 2005 but was forced to reconsider because of the ensuing criticism.)

The industry as a whole may be under the microscope, but it is Tesco that has gotten most of the attention, much of it focused on the retailer’s real estate strategy. Like all the chains, Tesco has acquired properties for its development pipeline. Tesco’s portfolio, however, is far larger than the others: 185 prime development sites across Britain, or 55 percent of the total sites owned by supermarket chains.

In documents filed with the commission, Sainsbury contends that the size of Tesco’s “land bank” gives it the potential to effectively corner the British supermarket business. If all of the land were developed, Sainsbury charges, Tesco would control 43 percent of the market by 2010.

But the commission disagreed in a preliminary finding in January, saying that its own calculations did not support Sainsbury’s conclusion and that Tesco’s potential market share was in fact “considerably lower.” Sainsbury publicly and strongly held to its own view. For Tesco this was an encouraging, if early, victory, because some had speculated before the commission issued its report that the government might call for divestiture of at least some of the land if it found that Tesco did possess an unfair advantage.

The finding also was an occasion for Tesco to fire back at Sainsbury. Tesco’s finance director, Andrew Higginson, told the media that his company’s large portfolio reflected only that competitors were “not doing a very good job” of property acquisition. CEO Leahy rubbed salt into the wound by telling the press, “That projected share is nonsense, so what does that say about the credibility of the evidence provided by that party?”

The bickering is a natural outgrowth of the industry’s competitive nature, says Planet Retail’s Roberts. “To be honest, they are all as bad as each other in the way they try to buy land,” Roberts said. “If they can’t successfully develop it, they’ll impose covenants on it so no competitor can open there. They are all very cutthroat, but Tesco has been a lot more intelligent in terms of the land it buys, and it has forged some very good relationships with property developers.”

As is the case with Wal-Mart, the controversy over Tesco’s market dominance illustrates the fundamental conflict between modern economics and traditional shopping patterns. “There’s a real difference between what the public say and what the public do,” said Roberts. “Everyone is willing to stick the boot into Tesco and bemoan their dominance, yet they are obviously the most popular destination for everyone’s shopping requirements.”

And despite the drop in overall stores in Britain, it is clear that the industry’s consolidation has benefited consumers by lowering prices. Grocery sales have risen 17 percent since 2000, while food prices have fallen 7 percent, according to Competition Commission data.

Competition for prime land is growing across Britain. “I believe this points to further intense competition in the future,” Leahy said. “Competition is good for consumers and will remain so in the future.”

But will regulators agree?