For two years the industry has been abuzz in anticipation of Tesco's landing in the Southwest United States. Some pundits ballyhooed the arrival of the world's third largest grocer — which has held its own against Wal-Mart in its home market of Britain — as something that would revolutionize the U.S. supermarket industry.

In November, the hype ended as the very first of Tesco's 200 U.S. locations, dubbed Fresh & Easy Neighborhood Markets, opened in Los Angeles and Las Vegas. It plans to open stores throughout Southern California, Arizona and Nevada.

The reception? Color some experts unimpressed.

Bear Stearns grocery analyst Robert Summers visited three new Southern California Fresh & Easy stores in Arcadia, Upland and West Covina during their first week of operation and says the stores just didn't live up to the lofty expectations.

“Our general impression was that the stores were decent, but not engaging and lacked the hook to attract most U.S. consumers,” he says.

That could present some real challenges for the company, which is projecting sales of $1,000 per square foot — on par with Whole Foods. Summers says Tesco's objectives may be unreachable and may show a naive view of the U.S. grocery market. Whole Foods's sales productivity stems from its unique product offerings, customer service and “exacting real estate selection.”

“The Fresh & Easy sites that we visited expressed few of those characteristics that would suggest achieving a Whole Foods-like productivity level is a realistic target,” Summers says.

The stores are more likely to sell to consumers who are looking for a quick meal since there are fewer options on the shelves. The stores also feature self check-out registers, which are meant to help shoppers get in and out of the store more quickly.

But Herb Sorensen, founder and CEO of retail research firm Sorensen Associates, based in Oregon, sees the chain's focus on quick shopping trips as a positive, since most grocery store trips involve picking up just a few items. “Half of all shopping trips in the supermarket [result in shoppers buying] five or fewer items,” Sorensen says. That means quick trips represent the lion's share of all shopping trips.

Sorensen also visited a few of the new Fresh & Easy stores in the week they opened. He says he was most impressed with the feel of the stores. The smaller footprint had him expecting a convenience store vibe but instead, he found a true supermarket feel that's low on frills. “The renovation is clean and not offensive at all but it is really Spartan,” he says. “The floors, for example, are old concrete with a coating on them. This is part of selling Trader Joe's quality at Wal-Mart prices.”

The stores were also built inside older stores that have been leased to Tesco. Summers calls the sites B locations. “Two had constrained parking options shared with multiple retail concepts while a third had signage that was not visible from the road,” he says. “The speed at which Tesco is seeking to ramp up its unit openings in order to leverage the massive distribution center it has built has forced the company to compromise on its site selection process, in our opinion.”

Summers isn't the only one concerned about the company's development strategy. Tesco has taken some heat for the locations of its first 13 stores. Although the company promised to locate stores in “food deserts” or areas that have a higher poverty rate than the country at large and no full-service supermarket within a half-mile. Only one so far fits the description, according to a report by the California-based Urban and Environmental Policy Institute at Occidental College. The rest of the stores are primarily in middle-class, suburban areas.

Greg Good is a senior communications specialist for the Los Angeles Alliance for a New Economy and a member of the Alliance for Healthy and Responsible Grocery Stores, a group that has been pushing Tesco to put its commitment to open stores in food deserts in writing. The group is asking Tesco to sign a Community Benefits Agreement, a legally binding agreement hashed out after negotiations between community and corporate executives, laying development, workforce and environmental impact plans. To date, no such agreement has been used in the development of a grocery store chain before, Good says, although the Los Angeles International Airport's $500 million modernization plan in 2004 did include one.

The group sent Tesco a letter in September asking to discuss the possibility of an agreement. But so far, the Alliance hasn't heard back from the company. “We haven't heard from them. They've said just trust us,” Good says. “It's actually insulting.”

Tesco has also drawn some heat from the United Food and Commercial Workers International Union (UFCW), which has criticized Tesco's salaries and expressed concern about its choice of locations. UFCW members protested at ICSC's Western Division show in San Diego in September dressed as Revolutionary War-era-British redcoats.

Still, while some may criticize Tesco's specific site selections, many agree that the choice to start in the Southwest is a smart move. “The Southwest market is not nailed down tight. It's much more accepting,” Sorensen says. Californians, he says, are particularly willing to try new things. “It's not a bad place to test anything.”

Tesco, with its reputation for selling prepared foods, is entering the grocery market at a time when specialized grocers like Trader Joe's, Wild Oats and Whole Foods are finding success supplying a smaller number of products to a niche population both in the Southwest and around the country. Privately owned Trader Joe's, for example, caters to a more upscale demographic with its private-label brands while Whole Foods markets its products to organic food shoppers.

Tesco can lay claim to being a part of the specialized grocer movement in some respects. The Fresh & Easy stores will have a footprint of only 10,000 square feet — some 30,000 square feet smaller than a typical supermarket — and will carry only 3,400 SKUs, the industry's standard for the number of products on the shelves. A traditional supermarket carries about 30,000 SKUs.

But with its mainly part-time staff, centralized supply chain and private-label offerings, the chain's prices are lower than many specialized grocers like Whole Foods or Trader Joe's. The lower prices will likely allow the chain to reach a more diverse population, says Sorensen. In fact, that's part of its plan. Tesco has said it plans to reach out to lower-income areas historically neglected by the major supermarket chains.

The grocery industry, of course, already has a good number of entrenched players in the southwest, and several major chains have a substantial presence in the region. Safeway currently operates 417 stores under the Vons and Safeway banners in the areas soon to be home to Tesco. Kroger, meanwhile, operates 565 Ralphs, Food 4 Less and Smith's names and Supervalu operates 313 Albertsons stores in the region.

Other family-owned and smaller businesses also have a footprint there, such as Henry's Farmers Market in California and Bashas' Supermarkets in Arizona. Patrick Dempsey, principal at Phoenix-based Lee & Associates, says the local grocers are used to competition from discount heavy-hitters Wal-Mart and Costco and found ways to compete.

Up until recently, Dempsey says, Phoenix's grocers were faced with a population boom and were forced to expand to keep up. But as more competition came into the marketplace, the grocers focused their energy on their existing stores.

Grocers in the region are “a lot more in tune with what their customers need,” says Patrick Donahue, president and CEO of Costa Mesa, Calif.-based shopping center developer Donahue Schriber. Donahue points to Safeway as an example, which has remodeled stores in a new lifestyle format that carry more prepared foods. “Tesco is a completely different model,” Donahue says. The stores are “shoppable” from a size standpoint, but he thinks they will appeal more to older shoppers looking for quick trips, but “I don't see them having a marked impact.”

The local companies also understand the peculiarities of the Arizona market.

Bashas', for example, has begun developing locations with parking areas topped by canvas canopies so shoppers aren't forced to come back to hot cars. The chain also offers a concept called Food City that caters to the city's Hispanic population.

Dempsey says he's not sure Tesco will be able to beat that local market know-how. He says Tesco isn't likely to steal shoppers from the major chains anyway due to its smaller and more specialized focus on prepared foods. Some grocery analysts are inclined to agree. Summers says in a November note to investors that Tesco may only capture less than 2 percent of the total share of the grocery market in the region.

LAS VEGAS DEMOGRAPHICS

Population: 591,536
Median household income: $44,069
2007 retail construction: 3.6 million sq. ft.
Vacancy rate: 4.5%

Sources: City of Las Vegas Office of Business Development, Marcus & Millichap Real Estate Investment Services

PHOENIX DEMOGRAPHICS

Population: 1.4 million
Median household income: $41,207
2007 retail construction: 7.4 million sq. ft.
Vacancy rate: 6.5%

Source: U.S. Census Bureau, Marcus & Millichap Real Estate Investment Services