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Not Everyone Buys Tesco's Strategy

By Beth Carney British grocery and retailing giant Tesco hasn't had trouble pleasing investors lately. Shares of the country's largest supermarket chain rose to an all-time high of $5.93 on Nov. 25, after its third-quarter trading report showed better-than-expected results. Among the impressive figures: In a competitive home market, sales rose 12.3% over last year.

All signs suggest that Tesco's strategy of aggressive cost-cutting and expansion into products ranging from digital cameras to mortgages continues to work. In September's interim results, the company -- which operates some 1,900 stores in Britain and 440 more in Ireland, Eastern Europe, and Asia -- announced half-year pretax underlying profit growth of 24.4%, outpacing last year's 21.9% pace.

GROWING SLICE. Moreover, the top British retailer is staying ahead of its rivals. According to researcher TNS Superpanel, which gathers spending data electronically from 15,000 British households, Tesco now accounts for 28.3% of the country's supermarket business, up from 26.5% a year ago.

Its closest competitor, Wal-Mart-owned (WMT) Asda, holds a 16.7% market share, up from 16.5% last year. Verdict Research, a London-based retail consulting firm, estimates that Tesco takes in $1 out of every $11 spent on retail in Britain.

"These are pretty stunning figures," says Iain McDonald, a retail analyst at Numis Securities in London, who applauds the way Tesco translates its buying power into lower prices. Says McDonald: "They're in a virtuous circle."

SIGNS OF CONCERN. However, try telling that to the handful of protestors who were passing out leaflets and holding signs outside one of Tesco's new, small, inner-London convenience stores last week. While office workers and holiday shoppers dipped into the store for lunch fixings and other essentials, the activists handed out postcards addressed to Tesco Chairman Sir Terry Leahy, imploring him to increase what the company pays dairy farmers for milk.

In another sign of concern over the retailer's dominance, on the day Tesco released its strong third-quarter results, a coalition of advocacy groups representing convenience stores, dairy suppliers, a women's group, and environmentalists made a formal application to the Office of Fair Trading asking for an investigation into consolidation in the supermarket industry. One of the group's claims is that the big chains are unfairly squeezing out smaller stores with predatory pricing.

Other supermarket chains have also felt some heat. A different group of dairy farmers has blocked depots owned by Asda with their vehicles to protest milk prices. And the petition to the Office of Fair Trading affects the entire supermarket industry, where Tesco and Asda are followed in market share by J. Sainsbury's and the William Morrison supermarket groups. Still, Tesco's market-leading position makes it the biggest target for complaints.

VILLAGE PRESERVATION.One reason for the recent increase in concern over the chain is its highly visible move into the convenience-store market. In 2002, Tesco purchased a chain of 1,202 T&S convenience stores, and this year it bought another 45-store London-based chain. Thanks mainly to conversions from these chains, in the first six months of this year, Tesco opened 200 small stores in Britain.

Analysts have praised Tesco's push into smaller stores as a move that sets it apart from Asda, which has focused on superstores. But the strategy has also exposed Tesco to additional criticism. In the North London village of Highgate, for example, where Tesco recently replaced a small grocery store, not all residents are pleased.

Brendan Nolan, a member of the local preservation group, is concerned that the new Tesco will threaten not just the local independent grocer but also the newsstand, two wine shops, and a butcher. He is printing leaflets urging his neighbors to patronize the village grocery shop, which he says has lost 40% of its business since Tesco moved in. "If the village store is forced out of business, it will have a deleterious effect on the whole street," Nolan said. "We'll be down to one grocery store, and it will just be Tesco."

SLIPPING REPUTATION. Tesco officials say the company is fair to suppliers and doesn't engage in predatory pricing. They also contend that far from hurting local communities, Tesco stores have revitalized some Main Streets by drawing foot traffic. As for complaints about competition, Jonathan Church, Tesco communication manager, says, "We make no apology for bringing value to customers."

To what extent such protests will tarnish Tesco's generally good corporate reputation is unclear. A survey conducted by Nottingham Business School and published in Management Today magazine shows that Tesco slipped from first place to fourth in an annual list of Britain's most-admired companies. Tesco lost the top spot, which it won handily last year, because of its community and environmental record, says Matthew Gwyther, the magazine's editor.

However, analysts say Tesco is unlikely to be hurt in the near future by any backlash, as long as it continues to offer low prices and desirable products. "Part of getting a better deal for customers is inevitably putting more pressure on your suppliers," says Gavin Rothwell, senior analyst at Verdict Research.

COMPROMISE HOPE. Indeed, even some of Tesco's opponents acknowledge the benefits the store has brought to their neighborhood, in the form of affordable groceries. Tony Hillier, president of the Heath & Hampstead Society conservation group, has been lobbying Tesco to change the look of its new store in his Hampstead neighborhood, saying it's out of place on the historic street.

But even Hillier agrees that in a commercial district dominated by high-priced clothing stores, Tesco's low-cost groceries are welcome. Moreover, he was encouraged by a meeting angry residents had with a Tesco official. "We hope very much we will not have to escalate the campaign," says Hillier. Certainly Tesco -- and its shareholders -- would hope the same. Carney is a reporter for BusinessWeek Online in London

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