The grocery market's M&A and partnership activity of the last 18 months has been justified by several purported reasons and benefits. We set out to identify whether the partnership announcements were driven by desperation or opportunity.
2017 saw unprecedented consolidation and acquisition within the food and grocery industry, arguably as a response to the Tesco-Booker merger. The creation of such a large player in an already consolidated space was a good reason for competitors to reassess business strategy and resilience in a highly competitive market; but some responses were more panicked than others.
The grocery market’s M&A and partnership activity of the last 18 months has been justified by several purported reasons and benefits. We’ve set out to identify whether the recent partnerships in the grocery space were driven by desperation or opportunity.
Partnerships for scale
Scale in retail nearly always improves buying power. This has become even more pertinent with the ongoing input cost increases that retailers continue to experience with higher levels of CPI, PPI and RPI; the devaluation of sterling; increased raw material costs driven by bad harvests; a loss of hedging protection on contracts; the effect of implementing living wage; rental price increases; and fixed costs such as fuel and maintenance continuing to increase. Retailers have absorbed the majority of the margin erosion associated with this spiralling cost base, and very little has been passed onto suppliers despite the fact that supplier margins are often double digit versus the very low margins of a supermarket.
Historically, large suppliers have had power over the supermarkets (small suppliers certainly don’t have power over the grocers), forcing them to absorb cost increases or pass them onto the consumer; such as with Marmitegate or the shrinkflation of Cadbury’s chocolate bars. Retailers have tried clever tactics such as removing one famous branded product and seeing whether consumers go elsewhere or switch to a competitor, then use this information as a bargaining tactic against the supplier. For (a hypothetical) example – the supermarket removes Galaxy 100g bars, sees that consumers just pick up the 100g Dairy Milk or the 150g Galaxy, then the supermarket goes back to Mars and shows them that consumers are happy to see less of a range of Galaxy without it impacting sales, thus Mars should offer a better deal otherwise they will stop buying 100g Galaxy.
However, deals to create enough scale that suppliers will have to be more accommodating to the retailer have occurred during 2017 and 2018. Tesco-Booker was the first, creating scale buying opportunities across the grocery retail, convenience retail, and wholesale markets. Although the two businesses seem relatively separate from each other, it allowed Tesco to find growth in the less mature wholesale market as well as leverage its buying power across multiple shared suppliers, and use Booker as a supplier in itself. Although operational overlap is limited, the addition of convenience space through Budgens/Londis/Premier to Tesco’s convenience operation, and the pure scale in the UK grocery market means that Tesco-Booker = opportunity.
Now, Tesco is generating international scale by partnering with Carrefour. These two retailers are among the largest physical retailers in the world, and for many overlapping suppliers, maintaining supply contracts with them is essential. This deal is purely for strategic buying power and does not interfere with the operation of each business. Thus, Tesco-Carrefour = opportunity
However, not all scale deals offer as many instant synergies. The recent announcement of a Sainsbury’s-ASDA merger took the market by surprise, given their lack of overlapping customers, distinctly different propositions, ASDA’s challenge to survive against the discounters, and very different operating models. SBRY-ASDA will command over 30% of the UK grocery market, larger than Tesco’s share, but size isn’t everything. Although there are some quick wins with ASDA, as it is an improving business recently moving back into positive LFL territory, the combination of the two businesses is not immediately compelling. Sainsbury’s has been struggling to maintain share against Tesco, a recently improved Morrisons, and the rapidly growing discounters. The deal was likely driven by Sainsbury’s panic of having immaterial market share over time. For this reason, Sainsbury’s-ASDA = driven by desperation, but equally if they can focus on the right areas then it could produce a business which is more robust.
Expanding with something new
Innovation in the food and grocery market has been limited compared to the rest of the retail market. Online grocery growth has been slower than anticipated due to the habitual nature of food shopping, and convenience store small shops driving the majority of growth. However, Ocado has been the pioneer of the technology-driven online grocery proposition, with robotic dark stores, centralised stock, and a highly developed user interface on their website.
Ocado has recently secured partnerships with Casino, Sobey’s and Kroger. These partnerships are driven by selling a service, with Ocado providing their online grocery solutions. Thus, it’s a different kind of partnership, and it’s opportunity driven for both businesses.
Similarly, Amazon’s acquisition of Whole Foods was to gain a physical foothold in the US grocery market. The US online grocery market takes up a very small proportion of the US grocery market (c2%) and thus physical grocery shopping still rules. In order to grow household presence, it made strategic sense for Amazon to try to expand online grocery penetration with a physical presence. Amazon-Whole Foods therefore is opportunity driven too.
The domination of the convenience market by Tesco-Booker’s Premier/Londis/Budgens/Tesco Express/Tesco Metro offering led to a number of retailers with convenience space partnering up to defend themselves. Nisa-Co-op was one of these defensive deals, which otherwise wouldn’t have occurred without the TSCO-BOK merger. Although they have a similar business ethic emphasising power to the business owner, there are few other similarities and the deal hasn’t generated change within the businesses themselves. Thus Nisa-Co-op = desperation.
Morrisons-McColl’s had more strategic opportunity. Morrisons has excess capacity in its vertically integrated supply chain, and a lack of convenience space. Therefore, by partnering with McColl’s, more manufacturing requirements are generated and a way into the high-growth convenience market is produced. Any volume into Morrisons’ vertically integrated supply chain is incremental profit, so the deal makes strategic sense. The revival of the Safeway brand also means that any brand dilution effect is mitigated. Morrisons-McColl’s = opportunity.
Sainsbury’s acquisition of Argos married a business with too much space but high footfall with another business which had low footfall and no reason to occupy any space at all. By ending the leases on the majority of Argos stores and integrating Argos’ digital proposition into hubs in Sainsbury’s stores, immediate cost cutting and incremental profit was generated. Crossover between the two businesses is low, and apart from the 1-2% sales halo effect and cost synergies from store closure and improved efficiency, the two businesses won’t affect each other. Sainsbury’s-Argos = opportunity, but it did come from Sainsbury’s LFL growth slowing and needing to find bottom line growth somewhere.
Space consolidation and footfall drivers
Timpsons, Snappy Snaps, Patisserie Valerie, Yo Sushi, Wasabi, Doddle… Just about every small retailer has been invited into a supermarket to rent floor space. Although there should, in theory, be a symbiotic relationship between the businesses as footfall is driven, many of the businesses taking floor space are struggling too. As a result, the brands carry the risk of diluting the supermarket’s brand and taking away from the customer shopping experience. Supermarkets grew too quickly in the period where their 4% margins were unchallenged, and now that costs are increasing and consumers move towards convenience stores, the retailers are left with too much unprofitable space, and they’re desperate to offload it somewhere. The barrage of small retail units in supermarkets = desperation.
Overall, the majority of partnerships in the grocery market have had some strategic sense; but the fear of Tesco-Booker industry domination, the pressure of input costs increases on margins, and the excess of space in the market, has led a number of businesses to seek quick fixes. The retail market is fundamentally shifting as consumer spend continues to move online and into convenience stores, and consumers become increasingly discerning about shopping experience and range offering. Sharing cost increases with another retailer, or renting space out to another retailer struggling to maintain footfall levels isn’t going to solve any problem in the long term, it’ll just slow the margin erosion.
To survive the retail shift businesses need to evolve with the consumer. Acquiring, merging, or partnering with cutting edge businesses, retailers offering something new, or where there are clear quick wins all make strategic sense in this highly competitive and dynamic environment. Merging because losses will be smaller, or because the resulting company will be “too big to fail” are just short term solutions.
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