The recent decision by Tesco to enter into a partnership with major hypermarket operator China Resources Enterprise (CRE) represents a strategic move by the U.K. retail giant to achieve a foothold in the booming Chinese market without incurring significant cost or risk.

Tesco hypermarket in China. Photo: Planet Retail

So say U.K. retail analysts, who point out that although Tesco will withdraw its brand from China, it will gain from CRE's success, local expertise and huge presence in a complicated market that is tipped to grow by 50% over the next three years.

Similarly, CRE is set to benefit from Tesco's experience and best practice in multi-channel retailing, with analysts suggesting CRE may tap into Tesco's two major assets – convenience and e-commerce – as well as its experience with loyalty marketing.

"It's a very good deal for Tesco and a very clever move in what will be a huge market in the future,” Planet Retail analyst David Gray  tells www.freshfruitportal.com.

"CRE, meanwhile, will acquire Tesco’s store presence in Shanghai which was missing from its nationwide network that also includes Hong Kong."

Gray points out that Tesco has paid a fee of over £100 million (US$168 million) in order to clinch the deal and must hand over its 131 hypermarkets, which CRE will integrate into its 3,000-outlet strong Vanguard hypermarket network.

"For sure the Tesco brand will disappear in China but it would’ve been a huge cost and too much money for Tesco to make it work in the market by itself," Gray explains.

"Tesco would need to invest in distribution centers and open a lot more stores to make a larger and more profitable operation in China, so £100 plus million is a small amount in comparison."

With Tesco's global business facing challenges, particularly in the U.K., and lessons only recently learned from the exit of its Fresh & Easy chain in the U.S., both analysts say the retailer is placing a renewed focus on treading carefully and saving costs.

"Tesco is refocusing its capital expenditure on markets in Europe rather than Asia so it made a degree of sense to make a partial exit from China where it's understood that Tesco was making a loss," explains Bryan Roberts, director of retail insights at Kantar Retail.

Tesco will provide back-end support to CRE and will receive just 20% of the gains from the partnership, although there may be scope to increase its stake in the future.

However, now that Tesco is part of the biggest retail player in China it will gain significantly from the combined turnover of the two companies.

Indeed, according to figures from Planet Retail, Tesco's total banner sales in China totaled CNY15 billion (US$2.4 billion) in 2012, falling far short of CRE's huge sales of CNY79 billion (US$12.7 billion).

But combined, the two retailers will account for around CNY94 billion (US$15 billion) in total sales, leapfrogging the previous number one retailer Auchan, which achieved sales of CNY81 billion (US$13 billion) during 2012.

Potential outcomes

With the integration of the two businesses expected to take a year to 18 months to complete, it remains too early to know how the partnership will play out exactly.

In a statement, however, Tesco's chief executive Philip Clarke said the deal will allow the two companies to combine their strengths to "build a profitable multi-channel business" and offer China "the best of modern retail".

Analysts suggest that could mean CRE may tap into Tesco’s knowledge and excellence in the convenience and e-commerce sectors and possibly work on a loyalty scheme.

"Tesco is world class at convenience, so when Tesco entered China the local retailers mostly feared the potential for the Tesco Express format to be rolled out," Roberts explains.

In terms of China’s food market, however, Gray warns that the deal may not prove so beneficial given that another large multinational retailer is effectively pulling back from major investment.

"Usually when foreign retailers expand in a country they invest in modernising the food chain by improving food quality and hygiene etc, but in China that won't come from Tesco now," he notes.

Success was lacking in China

Other retail multinationals operating in China, including Walmart and Carrefour, have also found it difficult to succeed, according to Roberts, with Auchan the only firm that has managed to perform well thanks to its partnership with RT Mart, a Taiwanese hypermarket operator.

Overall, the analysts claim a lack of scale, local knowledge and market understanding ultimately prevented Tesco from moving up the retail ranking and turning a profit in China.

"Tesco has been operating in China since 2004 but the business is very small and way down the ranking," Gray notes.

"The local competitors are very strong and are arguably better attuned to local shopping habits, plus they have the scale, the buying power and the trading relationships with local suppliers and manufacturers," adds Roberts.

"The informal retail sector in China has also been incredibly resilient in terms of wet markets and street markets."

Gray explains that a number of few food scares and scandals in China have also led to a lack of trust in fresh food and a preference for buying at local markets.

"Chinese consumers like to see and buy food that is extremely fresh – for instance they buy a lot of live food, like live fish from tanks at markets."

In addition, Gray says a lack of knowledge meant Tesco established its stores in unsuitable, freehold locations, which led to many being closed down in favor of better, leasehold locations.

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