Incoming Tesco chief faces problems in the US

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Asia has led the way in rapid global growth for Tesco, but an incoming chief executive faces problems in the US, writes Erikka Askeland

IT COULD be anywhere, this shiny, new and somewhat anonymous office park on the outskirts of the city. But for Philip Clarke, the chief executive designate of Tesco, this day it was Newcastle.

For the last six years Clarke has been spearheading Tesco's international business; he could just as easily have been in Tokyo, Shanghai, Krakow or Bratislava. All are places where Clarke has been overseeing Tesco's fast growth to become the world's third largest retailer behind France's Carrefour and the US giant, Wal Mart.

But last week, Clarke was playing closer to home. This new office was not about the firm's international retail empire, rather it was the insurance call centre for its increasingly important banking arm.

It was one of the first events he has attended as the new top man of Tesco following his anointment as the successor to Sir Terry Leahy, who will retire next year. The choice of Clarke was unsurprising although he has a lot yet to prove.

"Terry Leahy is a hard act to follow - Phil Clarke has his work cut out, although as a deputy of Leahy and with extensive experience at Tesco, investors are currently holding their faith," says Keith Bowman, an analyst with Hargreaves Landsdown.

The two men, Leahy and Clarke, have some striking similarities. Both began their Tesco careers as schoolboy shelf-stackers. And both grew up in Liverpool - Leahy the bright son of Irish Catholic immigrants and Clarke the son of a Tesco store manager on the Wirral. Perhaps the biggest thing to divide the two is football - Leahy is for Everton while Clarke is a Liverpool fan through and through.

But his selection also reflects the importance of international growth to Tesco. His elevation was accompanied by a boardroom reshuffle that promoted several senior executives who hold overseas roles, including Tim Mason, the head of the US-based Fresh & Easy business, who became Clarke's deputy. Another, Richard Brasher, became chief executive of the retailer's UK business.

From the outset, Clarke insisted his focus would be global. "As a chief executive I need to be sure we're meeting the needs of customers and looking after staff. I won't be running it from Cheshunt (Tesco's headquarters]," he said.

Nor will he be "crowding all over" Brasher, who according to Clarke "doesn't want me clod-hopping around".

Until now, Clarke's main area of focus has been Asia and Europe. According to the firm's half-year results revealed last week, these brought some of the firm's largest growth. In Asia, profits were up 12.6 per cent (excluding currency gains). Overall, international like-for-like sales rose 2 per cent, compared to an "anaemic" 0.3 per cent in the UK.

But the US business is the firm's problem child. Analysts estimate Tesco has pumped a staggering $1.5 billion of investment - and losses - into Fresh & Easy since it launched in 2007.

Some have called Tesco's timing to push into the US as "unfortunate". Back in the heady days of 2007, the retailer had firm ambitions to open 300 stores on the West coast of the US by now. The areas it chose to land in were booming on the back of what turned out to be a completely unsustainable housing bubble. After closing 13 stores it has been left with 168. The closures are mainly in communities hit hard by the real estate downturn that has left new-built properties empty.

Leahy, who last week presided over his last set of results for the firm, insists the US business will be profitable by 2013. But some are not convinced Clarke shares the same ambition. Mike Dennis, an analyst with MF Global, thinks the new chief executive may abandon the chain at his first opportunity.

"We expect Philip Clarke to review the figures and exit the US in June 2011 post his first full board meeting," he said, suggesting Tesco could also consider a "merger of equals" with US retailer Target as an alternative solution.

Arguably, the US is on his deputy Mason's patch and not the highest concern for Clarke. But it is the challenges he faces in the East that may be even more daunting.

Another less than stellar part of the Tesco overseas business is Japan. The firm has been there since 2003 when it acquired the Tsurukame-branded chain of 78 discount supermarkets for 139m. Then the retailer was already playing catch-up with its fierce international rivals, Wal-Mart and Carrefour. But where these focused on buying big hypermarkets, Tesco has settled on smaller city centre convenience formats, acquiring another chain in 2004 and then launching its own branded Tesco Express stores in 2007. Like-for-like sales were down 8 per cent in the first half of this year.

But Tesco's entry into the Japanese market preceded Clarke's move to take over the international business. Like the US, some figure he might let this one go too.

"It wouldn't be a game-changer... but I wouldn't be surprised if they looked to get out of Japan," says Bernstein analyst Chris Hogbin.

Instead, important areas for Tesco are now China, South Korea and Thailand where its ambitions are big.

Each market represents different strategies. In China, the aim is to build about 80 vast 400,000 sq ft-plus "lifestyle malls" that include restaurants, cinemas and small retail outlets, alongside, of course, a Tesco hypermarket.

The high streets of Beijing and Shanghai look unnervingly like those of Western cities, adorned with the likes of Marks & Spencer, Zara, H&M, Uniqlo, Mango, Adidas and Nike. Unlike the rest of the world's retailers, which focus on China's major cities, Tesco is looking into further provinces. Tesco's first "lifestyle mall" is in Qinhuangdao, China's largest coal port which is a four-and-a-half-hour drive from Beijing.

But Tesco's plans to dominate China look both expensive - some estimate Chinese expansion could soak up a quarter of the firm's capital investment in future - and they also look a very long slog. Already Clarke has admitted the opportunity is "more than a lifetime's work" - one the 50-year-old might not see to completion.

Some critics argue that Tesco should start seeing a little more of the colossal 17.5bn it has spent in capital investment over the last five years for which the retailer could have seen a bigger return. This may be one of the reasons why Tesco share price has lagged the Stoxx 600 European retail index by 7 per cent this year.

But analysts are welcoming hints from Clarke that he may adopt less expensive modes of expansion.

Earlier this month, he said he was looking at franchising in South Korea, Tesco's biggest market outside Britain, and that this model could be applied elsewhere.

But Clarke's presence in Newcastle last week also marks his interest in the potential for growing beyond food retail, particularly Tesco Bank. Benny Higgins, the bank's chief executive, told an audience of Scottish business people at an Edinburgh Chamber of Commerce dinner last week that Clarke saw international markets as a key to the bank's growth.

Already, Tesco Bank has "embryonic" financial services offerings in its overseas markets. The firm has credit cards in Thailand and South Korea, under third party agreements with local providers. Such deals with third parties mean Tesco Bank can expand easily - with infrastructure and regulatory barriers outsourced until the bank has sufficient density in the markets in which it operates.

This model replicates the very birth of the bank, which started as a joint venture with Royal Bank of Scotland in 1997. In 2008, Tesco bought out its share of the business from RBS for 1bn. Since then the group has been developing its own network in place of legacy systems inherited from RBS.

And partnership continues to be important. The bank will launch new insurance products in the coming months, following its tie-up with Belgo-Dutch insurance group Fortis - which is also a partner in the new operation in Newcastle.

Clive Black, head of research for Shore Capital said: "Tesco Bank has spent two years trying to disentangle itself from RBS, which has been an enormous project and will soon start trading off its own platform - soon in insurance and in banking over the next 18 months. That is the immediate priority, to get the UK business going.

"But that said, the Tesco model is to extend its brand out of core grocery into new geographies and new services. There's no reason why Tesco cannot take banking away from their stores in Europe and Asia and to customers in those markets. In five to 10 years Tesco Bank will be an international operation."