By Lisa Baertlein
LOS ANGELES (Reuters) - British grocer Tesco <TSCO.L> is making major changes in its Fresh & Easy stores as analysts worry that the 1 1/2-year-old U.S. chain is still searching for a successful niche.
In what it calls an "evolution," Tesco is putting more focus on value and adding about 1,000 items to its small-format Fresh & Easy stores' current 3,500-product assortment, which represents about 10 percent of what a typical U.S. supermarket carries.
"This isn't about changing the concept of Fresh & Easy," Tesco spokesman Jonathan Church said. "What we've got to do is fine-tune the model for the customer we have before us today."
When Britain's biggest retailer crossed the ocean, it promised to fill a hole in the U.S. market, and its small Fresh & Easy stores have become known for selling prepared foods in areas often underserved by big supermarkets.
But finding a sweet spot in the competitive U.S. grocery market has proven difficult, particularly as the country grapples with its worst recession in decades.
Church said the stores' new products would include Fresh & Easy quiche, pita chips and gourmet hamburger buns; low-priced store brands like the upcoming Mother's Joy breakfast cereals; and nationally available items like Guerrero tortillas.
The move comes just weeks after Tesco said Fresh & Easy had a bigger-than-expected loss of 142 million pounds in the fiscal year ended in February. But it affirmed its commitment to the chain, which has 120 stores in Southern California, Las Vegas and Phoenix.
As shoppers spend less, Fresh & Easy has slowed its initially aggressive expansion. It put plans to enter Northern California on hold, and multiple stores around the U.S. Southwest -- some fully equipped with shelves and checkout lanes -- sit unopened.
Some analysts say Tesco moved too fast and made too many wrong assumptions about the U.S. market.
If the concept was working, an established and well-financed retailer like Tesco would be using the economic downturn to drive out weaker U.S. players, said Jim Prevor, editor of Perishablepundit.com.
"The fact that they haven't chosen to take that path is really evidence that the concept is the problem," he said. "You may find a hole in the market, but there may not be a market in the hole."
Tesco spokesman Church disagreed, reiterating the view of the company -- and some analysts -- that the economy is to blame.
Traffic at Fresh & Easy has increased, he said, and sales at stores open at least a year are up 30 percent. He declined to give a dollar figure for sales.
Gene Jones, who was shopping at a store near downtown Phoenix, counts himself among Fresh & Easy's fans.
"I like the product, I like the prices, the food is usually good," said Jones. "Right now, it has everything I need."
Analysts said Tesco has the skill and resources to succeed in the United States, but some worry that the problems might set a precedent for its plans to expand around the globe, including in China, India and Japan.
"There is absolutely no guarantee that Tesco will be able to 'crack' any of these markets," Morgan Stanley analysts said in a recent note, "and the (admittedly limited) evidence to date suggests to us that there is a very real risk that Tesco could destroy a great deal of shareholder value in trying."
RUNNING INTO RECESSION
Tesco opened its first Fresh & Easy in late 2007, when the U.S. economy was hitting the skids.
It built a Disneyland-sized distribution centre about an hour east of Los Angeles and began opening "one-size-fits-all" stores for the 850,000-square-foot facility to serve.
By contrast, Wal-Mart Stores Inc <WMT.N>, the world's biggest retailer, has moved much more slowly as it tests four competing Marketside stores in the Phoenix area.
Fresh & Easy's early plans called for 200 stores in the United States by February 2009. The chain now expects to open its 200th location by November 2010.
The company snapped up leases in new suburbs in Arizona, California and Nevada, where foreclosures are now among the highest in the country. It also opened urban stores, some where other supermarkets had failed.
Retail consultant Bill Bishop said space is scarcer in Britain, so when a store opens, it's often a hit. "There is no guarantee that a store is going to be well-received in the United States," he said.
Likewise, Perishablepundit.com's Prevor said the United States has more low-priced restaurants than Britain does, so Fresh & Easy erred by focussing on heat-and-serve meals.
While the chain has stepped up advertising to promote "EXTRA-LOW prices," it isn't the only food seller catering to customers who have made the shift to thrift. Wal-Mart and supermarket operators ranging from Kroger Co <KR.N> to Whole Foods Market <WFMI.O> have also increased their value offerings.
Unlike those competitors, Fresh & Easy does not accept manufacturers' coupons.
Analysts say Fresh & Easy's smaller stores have the best chance in urban areas where shoppers are looking to get in and out quickly. That view appears to be holding up, but they said the chain must drive more business if it is to thrive.
Tia Johnson, who was also shopping at the Fresh & Easy near downtown Phoenix, said she liked the store's low-key environment, but added that she does most of her "major" grocery buying at the chain's larger rivals.
"I think it would make it too big if they had more product," Johnson said. "There's not a lot of lines; you're not bustling through that madness of carts and lines and craziness."
(Reporting by Lisa Baertlein in Los Angeles, Tim Gaynor in Phoenix and Mark Potter in London; Editing by Lisa Von Ahn)