Bear in a China shop

Triple challenge forces Tesco's Chinese retreat

Tesco appears to have chosen an odd moment to sound the retreat in China. As the country's consumers become increasingly prosperous, the UK group is in talks to fold its stores into a joint venture with a larger local rival. But Western supermarkets in China are grappling with multiple challenges. Tesco's response is disappointing but realistic.

The mooted joint venture would combine Tesco's 131 stores in China with the Vanguard chain operated by China Resources Enterprise, which has close to 3,000 outlets. The UK retailer will receive a 20 percent stake in the venture despite contributing just 14 percent of its combined revenue.

Compared with Tesco's costly and humiliating withdrawal from the United States, the outcome looks respectable. However, a minority stake in a subsidiary controlled by a large Chinese corporation is unlikely to be a long-term investment. Tesco's brand is also likely to be phased out over time.

The UK retailer's hand has been forced by three challenges. First, returns have been disappointing. Chinese consumers tend to make more frequent visits to supermarkets but spend less when they do so. As a result, sales per square metre in China tend to be much lower than in the United States or Europe. Meanwhile, rising wages are pushing up costs and squeezing margins even further.

Local competition is another factor. When Western grocers first arrived in China, domestic supermarket chains were sub-standard or non-existent. But as the country develops, the appeal of foreign chains has waned. The promise of future demand has also encouraged retailers to open more stores more rapidly, pushing down returns.

Then there's the web. Though e-commerce volumes are still  small - just 1 percent of all food shopping in China in 2011 was done online, according to McKinsey - they are growing fast. Online retailers are now able to deliver fresh produce in big cities like Shanghai, according to Planet Retail analyst Yujun Qiu. That will further undermine the profitability of large hypermarkets.

Tesco is not alone. French rival Carrefour has also grappled with falling or stagnant sales, and is reported to be considering an initial public offering or merger of its operations in China or Taiwan. For Western groups, it's another costly reminder that the benefits of China's growth are spread unevenly.