Tesco Demise and Fairway Market IPO – The Downs and Ups of US Food Retailing

Tesco Demise and Fairway Market IPO – The Downs and Ups of US Food Retailing
Written by:
Invezz Newsdesk
22nd April 2013
Updated: 1st December 2019

As British Giant Exits US Market, Homespun Manhattan Grocer Looks To Head West

A Tale of Two Grocers

As Tesco (LON:TSCO) on 17 April formally lowered the boom on its seven-year-old US adventure, booking a £1.2 billion write-down in the process, over on the other side of the continent another grocer was taking a giant leap of confidence in the American retail food sector. Fairway Market of New York City launched its IPO on the NASDAQ Global market (with the symbol ‘FWM’), with plans to expand from the existing 12 stores ultimately to 300. And that confidence appears to be well-placed. The offer price of $13 per ordinary share quickly found favour with Fairway’s share price bid up to $17.35 on its opening day. Yesterday, on its first full day of trading, Fairway’s share price climbed at a measured pace throughout the day, touching $19 late on but easing back to $18.90 at the close. That was an 8.53 percent gain on debut, the more creditable in light of NASDAQ’s fall for the day of 1.2 percent.

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That price puts a market capitalisation of $447.84 million on a business which had similar origins to – but which is utterly dwarfed by – Tesco, the world’s fourth largest food and retail group and which – following the hit to its share price on announcing the US retreat and a first-time ever underlying loss – was valued yesterday at $45.14 billion.As is famously known, Tesco started life in 1919 when demobbed soldier Jack Cohen – the son of a Polish emigrant to the UK and born Jacob Kohen – started a market stall in the East End of London. The first Tesco-branded store opened, in north London, in 1929. Rather less well-known outside the borough of Manhattan is the founding of Fairway Market by Nathan Glicksberg – grandson of a Russian émigré – as a fruit and produce stall in NYC’s Upper West Side at the outbreak of World War 2. But whereas Tesco went public early in its life – in 1947, to fund a round of the aggressive grocery chain acquisition programme which had by then become the company’s modus operandi – Fairway till this past week had remained in private ownership for over 60 years, with three generations of the founding family successively at the helm.

Private Equity Buy-In – The Classic Model

The IPO has its genesis in the January 2007 buy-in by private equity firm Sterling Investment Partners, operating out of Westport, Connecticut, reportedly for $150 million and an 80 percent stake. At the time, according to the Sterling press release, Fairway ‘[did] the highest volume sales per square foot of any grocery in the country’. Fairway then had just four stores, including its foundation site at Broadway and 74th Street, whose confined space guaranteed a shopping experience which had become legendary amongst Upper West Side residents. In its 16 April report on the IPO, the New York Times wrote that ‘navigating a shopping cart through its narrow aisles is a full-on contact sport, like driving a bumper car through a Middle Eastern souk’.

In copybook style, with Sterling’s money and nous and the playing through management, Fairway has expanded to 12 stores in the Greater New York metro area – so including New Jersey and Connecticut – and they’re more generously proportioned than the flagship. But it seems the cachet remains, with customers and media fulsome in their praise for the product mix – from staple to gourmet to downright exotic – and a second-to-none customer service, both in-store and at check-out.

And now the plan is to take the grocery store that’s ‘Like No Other Market’ – Fairway’s slogan – nationwide. Upwards of 300 Fairway Markets are being envisaged in an expansion programme that will see the group leaving its roots far behind and taking on the major players in US food retailing. The big question for investors who bought in at the IPO or who’re otherwise following the stock is surely whether Fairway can make that transition from beloved neighbourhood store to nationally-recognised retailer without losing in the process the essence of what has defined the brand to this point. And in one of the most cut-throat business sectors in the United States.

How Not To Do It – The Folly of Fresh & Easy

You’d have thought that if anyone could make it in the American retail grocery market, it’d be Tesco. Having conquered home turf, with no High Street left unshopped, and having established a dominant position in a raft of countries in Europe and Asia, Tesco had the experience, the financial muscle and the management expertise to get it right in America. Yet from the start in 2007 there seems to have been a lack of confidence, with the major case in point surely being the decision to eschew its own identity and run with the concocted ‘Fresh & Easy’ for the US market. But is it ‘Fresh & Easy’, or ‘fresh & easy’, or indeed ‘fresh&easy’? Because each variant is used at different locations on the chain’s own website – still up and running, though the death knell’s been sounded – as if management haven’t themselves ever been sure of the brand’s identity.From very early days, Fresh & Easy (we’ll run with that) started getting bad press. In a press release of 24 February 2008, just 15 weeks after the inaugural six-store launch in southern California, the Tesco subsidiary breathlessly reported the opening of its 50th outlet. ‘It’s been an exhilarating first 100 days’ the PR gushed, albeit – and with hindsight portentously – ‘with its fair share of ups and downs.’ But external media weren’t being so kind. Just four days later, for example, the Orange County Register – in whose patch most of the original stores were opened – was reporting under the headline ‘Tesco’s Fresh & Easy off to rocky start, industry watchers say’ that sales were coming in at $30,000 less a week than budgeted and that some of those 50 stores were ‘ghost towns with eager to please clerks often outnumbering shoppers’.

America Not Comfortable With British Revolutions

Fresh & Easy early on became a particular target of retail grocery guru Jim Prevor, himself hitherto a chain-store owner over on the East Coast, whose widely-read perishablepundit.com regularly carried news and commentary on the start-up. Prevor saw in Tesco’s history and the Fresh & Easy model a range of threats to the way that the grocery business – from retail back along the supply chain to wholesalers and producers – operated in America. Writing in May of 2008, Prevor justified his preoccupation with Fresh & Easy in these words –

There are, of course, many interesting things being done by retailers all over the country. Yet few are rolling out by the hundreds of units; few represent completely new concepts and few are demanding as much change by the supply chain.

Not least, Prevor estimated that if Fresh & Easy’s 10,000 square feet store model succeeded, and were to be mimicked nation-wide, around 6,800 supermarkets, 34,000 small-format stores and 15,000 convenience stores would close. In Prevor’s words, ‘a revolution in real estate and the food business’. And the ‘revolution’ would spread – into the primacy of house brands over proprietary labels, and in retailer domination of the supply chain, both very much a la Tesco’s way of doing things in the United Kingdom.

Or With Self-Service Checkout

It wasn’t to be and by April of 2009, theweek.co.uk was running the headline ‘Fresh & Easy: Tesco’s great American disaster’. US shoppers, it had by then become apparent, either didn’t like or didn’t understand either the freshness or the easiness of the concept and were avoiding the store in droves. For sure, Americans didn’t like the self-serve checkout idea, foisted some years earlier on Tesco’s UK customers. Theweek.co.uk quoted one representative sentiment: ‘I’m sorry,’ huffed an unnamed American, ‘but only offering self-serve checkout is a complete non-starter. I’m paying for the groceries – they need to provide a full service checkout.’ To which many long-suffering Tesco shoppers would probably have appended an ‘Amen’.

Sir Terry’s Sullied Swansong

Fresh & Easy’s conquest of American food retailing was supposed to be long-serving CEO Sir Terry Leahy’s finest hour. There was never any question of a toe in the water. A year or so into the campaign, when Leahy still had three years to serve, he assured US media that Fresh & Easy was ‘a rollout and not a test’. Given his standing as one of the finest business managers Britain had ever produced, and Tesco’s offshore successes elsewhere under his watch, the bullish stance helped for a period to assuage some of the doubts increasingly being aired in the media about the great American adventure. But in that year, 2010, while Tesco globally booked a £3.8 billion bottom line profit, up 12 percent on the prior year, Fresh & Easy weighed in with a loss of £186 million, making the business nearly half a billion sterling down since its launch.

It couldn’t continue of course. Cost-cutting measures – including the ‘temporary’ closure of some stores and a moratorium on others ready to open, cash registers in place – failed to stem the haemorrhage of cash and finally it fell to Leahy’s successor Philip Clarke, like his father before him a career Tesconian, to bite the bullet. A going-concern sale of the 200-plus stores in California, Nevada and Arizona – quite apart from the huge distribution centres in LA – seems highly unlikely and Tesco also stands to take a huge hit on selling the plots it had stockpiled in anticipation of its march eastwards across the continent.

Tesco Just Didn’t ‘Get It’

In all the commentaries generated on this unprecedented flop by the flagship of British retailing, the constant theme has been of a failure to understand the American consumer. In a country where the inevitable entreaty to have a nice day – done to death in the view of foreigners – epitomises the cult of customer service, perhaps more than any other aspect of Fresh & Easy it was that obligatory self-service checkout – the machine utterly indifferent to what kind of a day you had – which showed just how much Tesco, despite its years of preparation, had misread the US grocery market. Americans just don’t do self-service.

But Fairway Surely Does

That, it can be said with some confidence, is not a mistake likely to be made by Fairway Market as it embarks on its own campaign westwards across the nation. At least in its heartland – New York City’s Upper West Side and Harlem – Fairway has made its name synonymous with customer service, from the aisles staff ever ready to proffer advice and assistance to the generously-populated checkouts to the bag-carriers. But of course that service comes at a significant cost to the bottom line, in a sector that operates on razor-thin margins at the best of times, and it remains to be seen whether it can be replicated as the planned expansion gets underway.

As Does The Competition

For sure the competition will be ready to clip Fairway’s wings at the earliest opportunity. Prominent amongst the rivals likely to be confronted as Fairway breaks out of the eastern seaboard, at an envisaged rate of three to four stores a year, are Whole Foods (NASDAQ:WFM), Safeway (NYSE:SWY) and Trader Joe’s. With market caps of $15.76 billion and $6.38 billion respectively, Whole Foods and Safeway are many times Fairway’s size and doubtless back themselves to see off any challenge from this Big Apple pretender to their established turf. Which in Safeway’s case is the West Coast and mid-West primarily. And Whole Foods, though with far fewer stores than Safeway (around 300 to the latter’s over 1,600), has a firm grip on the profitable natural and organic side of retail food, a space that Fairway undoubtedly has plans to occupy.

Trader Joe’s – Fairway’s Benchmark?

As for Trader Joe’s, this aggressively expanding privately-owned chain – out of Germany, so demonstrating that foreign ownership of US food retail can be made to work – was reputedly the market participant on which Fresh & Easy most closely modelled itself and may prove to be Fairway’s toughest opponent. For although around half of its 395 stores are in southern California – where the first to carry the now emblematic name opened in Pasadena in 1967 – Trader Joe’s has succeeded in traversing the continent, albeit in reverse of the planned Fairway route. Chicago was breached in 2000 and Manhattan fell on St Patrick’s Day in 2006.

Being privately-held, Trader Joe’s financials are closely guarded, though Supermarket News estimates sales of $8.5 billion for the 2010/11 financial year, from the then 365 stores – or around $23.28 million per store for the year. By comparison, Fairway Market’s IPO prospectus reported net income in fiscal 2011/12 of $554.9 million, which translates to a very impressive $46.24 million per store.

It’s clear that Trader Joe’s earns customer loyalty in the same way – though with different techniques – as Fairway Market. Consumer Reports’ last survey – from April last year – of the country’s best and worst supermarkets, based on over 24,000 reader responses, ranked Trader Joe’s as second most-liked, behind the privately-owned Wegmans. And Supermarket News gave it 22nd place in its ranking of 75 US food retailers for 2012.

Trader Joe’s – Funk Meets Retailing Nous

Like Fairway, Trader Joe’s is well-stocked with helpful and friendly store-folk and it works hard at maintaining the funky image that founder Joe Coulombe (the ‘Joe’ in Trader Joe’s) conceived when he rebranded his original Pronto Market stores to get away from an unwanted association with 7-Eleven. So, the staff still wear those loud – but funky – Hawaiian shirts, and messages to personnel are conveyed by coded bell-rings rather than amplified disembodied voice. But perhaps much more to the point, Trader Joe’s has nailed the house-brand segment of retail food, with around 80 percent of its shelf-space ‘Trader’-branded – from proprietary suppliers bound by contract not to exploit the connection.

Paths Will Inevitably Cross

Private-label may not be exactly where Fairway sees itself going, though for supermarkets it’s where the best margin can be made, but plainly if it is to head west – which is the plan – it’s bound to meet more of Trader Joe’s coming in the opposite direction. And whereas Fairway has opted to put itself under public scrutiny – and regulation – Trader Joe’s is accountable to no-one but the US taxman and its tightly-held German ownership, which happens also to operate the vast Aldi Nord discount supermarket group, comprising 2,400 stores in Germany and another 2,000 elsewhere in Europe.

You can’t invest in Trader Joe’s but if you could, and given the choice between an established player with a proven ability to get outside its comfort zone and across the North American continent, and an enterprise just now embarking on that journey, you’d probably go with the safe money – which is a Trader Joe’s rather than a Fairway’s. But then again, if Fresh & Easy had been floated off by Tesco back in 2007, pre-launch, who wouldn’t have been tempted to buy a piece of the venture?

Fairway Markets – Made In America

At least in these very early days, the equities market has shown its approval of the Fairways Market float. And, by extension, of the enterprise’s values, its mission, stated strategies and of course its management – the UWS street-smarts now enhanced by Harvard Business School alumni. All of which have coalesced in winning and keeping enviable customer support in the highly-competitive NY groceries market. As Bloomberg’s IPO piece on 17 April put it, ‘Investors seem to think Fairway is in a strategic sweet spot.’ This notwithstanding the losses booked on account of store opening costs, and the big slug – nearly half – of the IPO funds earmarked for settlement of deferred dividend due to pre-float proprietors, meaning primarily Sterling Investment Partners.

Seemingly, the market has placed a premium on a tried and true business model, crafted slowly and surely over many years and very much in the ‘American way’. Fairway is the antithesis of Tesco’s brash ‘rollout not a test’ presumption on the American consumer and the market for now is backing it to succeed where Tesco failed.

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