• by Sarah Mahoney  @mahoney_sarah, July 6, 2010

It wasn't all that long ago that just the mention of Fresh & Easy Neighborhood Market, Tesco's small-format grocery store invented just for U.S. consumers, made U.S. food retailers weak-kneed and nervous. But the tepid performance of the West Coast chain since its 2007 launch has been a continual disappointment, which last week erupted in very public rebuke to Tesco management: Shareholder activists challenged the company's executive compensation plan, precisely because of the fat salary it will pay Tim Mason, CEO of Fresh & Easy.

While the board's recommendations did ultimately pass with 53% of the vote, 38% of the votes were against the proposal, leading the Financial Times to call it one of the five biggest shareholder rebellions in more than a decade.

"The extraordinary opposition vote reflects investor outrage over the excessive pay awarded to Tim Mason, Tesco's second-highest paid executive, despite the dismal performance of the U.S. Fresh and Easy business he oversees," Michael Garland, director of value strategies for the CtW Investment Group, a U.S. group representing union-sponsored pension funds, says in a statement.

"Normally, a board's recommendations would pass with something like 90% of the vote," Jim Prevor, a supermarket analyst who writes the Perishable Pundit blog, tells Marketing Daily. "So this is an enormous vote of 'no confidence.'"

In addition to chiding Tesco for not linking Mason's pay to Fresh & Easy's performance, CtW also called the company out on murky reporting tactics, claiming that the stores make only about $9 in sales per square foot per week, not the $11 Tesco has claimed. And CtW also faulted Tesco's decision to buy out the U.S. interest in two companies -- 2 Sisters and Wild Rocket Foods, both major Tesco suppliers elsewhere -- that came to the U.S. just to act as Fresh & Easy suppliers.

While some analysts are calling for Tesco to cut its losses now and exit the U.S., Prevor says there continues to be plenty of speculation that the retail giant will find a bigger way to both cloak the extent of its missteps with Fresh & Easy and still expand in the U.S. -- either through acquisition, joint ventures, or even franchising.

"There have been plenty of rumors about executives flying back and forth to Minneapolis, home to Supervalu, which is struggling, and it also owns Save-a-lot, another small-format store," he says. (Save-a-lot, a limited assortment chain that competes with Aldi, he says, is heavily owned by franchisees.)

And it is also possible Tesco has its eye on a deal with Target, he says. "In order to compete with Walmart in the U.S., it needs supercenters, and while there are plenty of regional competitors, Target is the only national one. But certainly, it is just not viable to keep losing a quarter of a billion dollars a year."

Part of the problem is that Fresh & Easy's focus was more British marketing science than American pantry. "One of the big problems Fresh & Easy has had from Day One is that the stores have very uniform assortments, so a store in an upscale area like Scottsdale, Ariz. will have the same product mix as a store in a depressed area, like Compton, Calif."

What is really a shame, he adds, is that if the format had been a winner, the recession might have been "a great blessing to Tesco," allowing it to exploit real-estate opportunities. "If this format was viable, Tesco, which is so well financed and capital rich, could have really done well."

A Fresh & Easy spokesperson did not respond to an email seeking more information by the end of business day on Tuesday.