Retailer Tesco Dives into British Banking

London - It's already the world's third-largest retailer, selling everything from groceries to gasoline at more than 4,300 stores worldwide. Now Britain's Tesco figures it can persuade the 20 million customers who visit its U.K. stores each week to add banking to their shopping lists. "We plan to bring Tesco's reputation for value for money to financial services," says Andrew Higginson, the Tesco executive overseeing the effort.

Since last spring, Tesco has opened pilot branches at six stores in England and Scotland that offer insurance, credit cards, and simple savings accounts. This year, Tesco aims to roll out more branches—Higginson won't say how many—and in 2011 expects to introduce mortgages and checking accounts. "Tesco has brand credibility and a strong focus on the consumer, which should bring some innovation to the British market," says Liz Hartley of research firm Datamonitor. She predicts Tesco will be one of Britain's top 10 banks within 5 years, with 1.5% of the market.

British banks have been battered by the financial crisis and the loss of consumer confidence it caused. Now, Chancellor of the Exchequer Alistair Darling wants new rivals to shake up the U.K.'s four giants—Barclays (BCS), HSBC (HBC), Lloyds, and Royal Bank of Scotland (RBS). After bailouts of Lloyds, RBS, and others, regulators ordered them to sell nearly 1,000 branches, creating opportunities for upstart competitors.

Tesco isn't the only one trying to seize the day. Others include Richard Branson's Virgin Money; Metro Bank (COBH), led by Vernon Hill, an American who built Commerce Bancorp into New Jersey's largest lender (before resigning when regulators said he awarded contracts to companies controlled by his relatives); and Home & Savings Bank, backed by U.S. private equity firm Blackstone (BX). But only Tesco and Virgin have banking licenses, and only Tesco has 600-plus supermarkets that might serve as ready-made branches.

Tesco got its license in 2008 when it paid $1.5 billion to buy RBS out of Tesco Personal Finance. That joint venture, launched in 1997, provided 5.5 million customers with insurance, credit cards, and loans, and 500,000 with savings accounts. But most of its activity was online, and it had no physical presence in stores. Furthermore, it couldn't offer profitable products such as mortgages and checking accounts.

A big challenge for Tesco is that consumers rarely change banks. And not all the incumbents are on their knees: On Feb. 16, Barclays said net income for the second half of 2009 more than doubled, to $11.8 billion. Another worry is that like Wal-Mart Stores (WMT), which has tried and failed to break into banking in the U.S., Tesco could face greater oversight if it gets too big. It sells nearly one-third of Britain's groceries and processes 1 in every 10 credit-card transactions, but in banking, "Tesco is the underdog," Higginson says. "We are up against well-established competitors."

Higginson believes Tesco has the right mix of service and convenience to keep customers happy. He plans extended hours on evenings and weekends, and the 15 million people who hold Tesco loyalty cards give the company an extra edge. Tesco has vast amounts of data about these customers, who get points for spending at Tesco's stores. So if a customer uses her loyalty card at the gas pump, Tesco might offer her car insurance. "We have a head start," Higginson says. "It's much better to focus our marketing on people who already know and love Tesco."

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