SEOUL (Reuters) - Tesco Plc (TSCO.L) finally managed to open a near-3,000 sq meter super store in South Korea, its largest market outside Britain, after a seven-month delay by agreeing not to stock 15 items including radishes, mangoes and some cuts of local beef.
Big-box retailers in South Korea such as Tesco and Costco Wholesale Corp (COST.O) are reluctantly bowing to government demands aimed at protecting local merchants -- including plans to fine the super stores if they set up without the consent of nearby local merchants.
There are signs that Seoul's new restrictions could scare off investors.
"In my view, there is no longer much merit in investing in the South Korean market. Investment from (Tesco) headquarters will decrease," said Lee Seung-han, chairman of the Homeplus Group, Tesco's subsidiary in Korea.
Not long after signing free trade agreements with the European Union and the United States which reduced the shelf price of products from fruit to wine, the South Korean government last year started tightening controls on hypermarket operators.
New rules forbid big-box retailers from operating two Sundays a month, while a further measure banning them from opening an outlet near a marketplace with rows of mom-and-pop vendors will come into effect this month.
Homeplus' Lee Seung-han said Tesco was not considering leaving, but acknowledged that regulation and market saturation have dimmed the prospect of new investment after entering the South Korean market in 1999.
Tesco, the world's third-largest retailer, reports full-year results on Wednesday, and analysts expect revenues from its Korea operations will fall due to the government's restrictions.
Stiff competition in South Korea has already chased off Wal-Mart Stores Inc (WMT.N) and Carrefour SA (CARR.PA), both pulling out in 2006. And giant U.S. retailer Costco operates just nine stores in the country, six fewer than it has in Japan.
"Large discount stores are going through a very difficult period due to regulations on operating hours and business days, on top of the economic slowdown and weaker spending," Lee told a gathering of local farmers' representatives last week.
Tesco, whose South Korean operations account for roughly 10 percent of its global sales, said the long delay in opening its Homeplus super store in Seoul cost the company 70 billion won ($61.63 million) from lost sales potential.
To appease small retailers and smooth the way for the store's opening in March, Homeplus agreed to remove 15 items from its shelves effectively giving nearby mom-and-pop shops exclusive selling rights for those goods.
Amid fierce competition from strong local brands such as E-Mart Co Ltd (139480.KS) and Lotte Mart, which is owned by Lotte Shopping (023530.KS), Homeplus expanded from two stores in 1999 to 133 stores in 2012 after starting out as a joint venture with Samsung C&T Corp 000830.KS.
But Homeplus is now feeling the squeeze.
Last August, Tesco completed a property sale and leaseback deal of four Homeplus stores and mall space with total gross proceeds in excess of 300 million pounds.
"Homeplus has turned to a conservative investment strategy including asset sales as expansion becomes difficult," said Ahn Na-young, analyst at Fitch Ratings unit Korea Ratings.
Korea is the biggest foreign market for the British retailer, while Costco declined to disclose the size of its South Korean business.
The government last year responded to public criticism that its policies favored the powerful conglomerates and contributed to a widening income gap by introducing new measures to level the playing field.
One of the new restrictions which forced big-box retailers to close two days per month resulted in Homeplus sales falling 4.4 percent last year, according to a official with knowledge of sales.
A law requiring discount stores to close between midnight and 10 a.m. in addition to the two Sundays per month is expected to reduce revenues by a further 5 percent every quarter, said Hyundai Securities analyst Lee Sang-ku. The law has received parliamentary approval and is expected to be implemented during the first half of 2013.
Homeplus declined to comment on the figures. Costco also declined to comment.
The new conservative government in Seoul - which made an election promise last year to help mom-and-pop stores - looks set to impose further restrictions.
A new law that comes into effect on April 24 empowers regional governments to bar new stores within one kilometer of traditional markets, of which there are some 1,517 nationwide.
And a parliamentary bill up for review this month seeks to require large retailers to pay 10 percent of store revenue as a penalty if they set up without nearby merchants' consent - a steep fine considering discount stores' average profit margin stood at about 6 percent as of 2011, according to data from the Korea Chamber of Commerce and Industry (KCCI).
The government's new restrictions have angered foreign players such as Costco, and aroused concerns about future entries into the country.
Costco last year defied local legislation to close two days per month, prompting a crackdown by authorities on minor parking and saftey violations at three of its Seoul stores.
Costco's competitors including Homeplus, E-Mart and Lotte Mart had successfully fought the restriction with a court injunction, with stores remaining open without penalty. But Costco hadn't joined the injunction.
Addressing Seoul's legislature in November, Costco's country manager Preston Draper expressed regret over the perception that Costco had flouted the city's laws, but argued the legislation had been deemed flawed by a local court.
As of now, all nine Costco stores in Korea are closed twice a month.
Another international retailer, Swedish furniture group IKEA, is still waiting for permission to open a store on 78,198 square meters of land it bought two years ago as city officials - including the mayor - try to quell protests.
Despite wringing concessions from the likes of Tesco and support from the government, small businesses say they are still under pressure.
In an open marketplace near the newly opened Homeplus store in Seoul, store owners say sales have fallen 20 to 30 percent.
"Merchants have tried to become more competitive, but there are limitations," said Park Chur-woo, who has sold china for 26 years near where Homeplus plans to open a new store in December.
"There is already a Costco and an E-Mart within 1 kilometer of our traditional market. If the store opens, some 1,200 merchants and their family members will be turned out on the streets."
Other Koreans, however, are wary that the new rules may impinge upon their shopping habits.
Big-box stores offer a wider selection of goods in a single stop, conveniences such as easier parking, and accessible prices driven down by cut-throat competition between major retail chains.
"I understand that traditional markets are having a hard time. But we would go (to traditional markets) if they made it easier to shop there. It's not about policies ordering closures on Sundays, it's about having better products, cheaper prices and easier parking," said Kim Seung-won, a Homeplus shopper.
Additional reporting by James Davey; Editing by David Chance and Jeremy Laurence