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Supermarkets continue to load their shopping trolleys with deals as Tesco announces a strategic alliance with European giant Carrefour. The sector is awash with mergers and partnerships, but what does it mean for supermarkets and what’s in store for the wider industry?
Supermarkets and the wider retail industry have had everything thrown at them over the last couple of years. Brexit still poses a huge threat and the industry is no closer to understanding what they will be dealing with once the UK leaves the EU, and in the meantime they have had to deal with the knock to sterling that has raised the costs of imports. Consumer spending has been tight and facilitated the rapid rise of discount chains. Online competition continues to grow with Amazon posing a bigger threat than ever, and supermarkets now find themselves racing to catch up with the digital era.
But, as more retailers fall victim amid the demise of the high street, the supermarkets are proving to be much more innovative as well as daring when it comes to addressing the industry’s woes and reshaping themselves for the modern age.
Much of the drastic change in the supermarket industry has been driven by high levels of mergers and acquisitions (M&As), as well as partnerships as companies team up to better defend themselves against tougher conditions. But what does this drastic change mean for supermarkets, and what’s next on their shopping lists?
‘I’m delighted to be entering into a strategic alliance with Carrefour. By working together and making the most of our collective product expertise and sourcing capability, we will be able to serve our customers even better, further improving choice, quality and value,’ – Tesco chief executive, Dave Lewis.
The UK’s leading supermarket and Europe’s biggest retailer have announced they will form a strategic partnership that will see Tesco and Carrefour jointly purchase own-brand products and certain other goods. The pair will combine their buying power for an initial three-year period.
Exact details of the deal have not been provided as of yet, with a formal operational framework to be signed ‘within the next two months’.
Although the pair’s ultimate goal is to work together so they can offer ‘even lower prices’ to their customers, they will both continue to work with their suppliers at both a local and national level, suggesting that the partnership may not cover all products, such as fresh produce.
|£57.5 billion||€81 billion|
|£1.8 billion||€700 million|
|£1.3 billion||€255 million|
(Source: company reports. Tesco data for the financial year to 24 February 2018. Carrefour data for the financial year to 31 December 2017)
Although both companies have vast international operations, the pair have managed to largely avoid overlapping with one another, but the deal is not expected to include the areas that they do compete, in Poland and China.
There are a few reasons why Tesco and Carrefour have decided to combine their buying power.
Firstly, while some analysts have suggested the partnership is a possible precursor to a mega-merger between the two giants, Tesco knows it would have a tough time pushing through any type of deal so soon after its £3.7 billion acquisition of the UK’s largest food wholesaler, Booker Group.
Secondly, both Tesco and Carrefour have struggled to compete with discount chains like Aldi and Lidl, particularly on own-brand products that have been key to the German pair’s success over the last five years. In the UK, for example, Aldi and Lidl currently hold a combined share of the grocery market of around 12.7% compared to just 4.8% back in 2011.
Aldi and Lidl have heavily geared their promotions and offers to their own-brand products and this has been supported by consumer’s improved perception of cheaper, own-branded supermarket goods. Their business models are based around small stores that offer a no-thrills experience, selling large volumes of a more limited variety of products at a lower price. Aldi and Lidl stores tend to stock around 2000 products – while UK supermarkets like Tesco and Sainsbury’s are thought to offer around 20,000 products. This has allowed Aldi and Lidl to build buying power over suppliers and lower the cost of the likes of logistics, giving them an edge of their larger rivals.
Since leaving consumer goods giant Unilever to take over at the helm of Tesco in 2014, chief executive Dave Lewis has been focused on turning Tesco around following heightened competition and an accounting scandal that knocked both its finances and reputation. In terms of product, Lewis has been steering Tesco’s focus to lower cost, own-brand products as well as fresh produce.
Operationally, the firm has sold off several overseas ventures to streamline the business and to cut costs, as well as abandoned its long-struggling Tesco Direct arm that sold non-food products while launching the likes of its Farm Brand that sells fresh produce and meat that can compete on price with the German discounters. Although, Charles Wilson, the former Booker Group chief executive that is now leading Tesco’s UK and Ireland operations, has said Tesco ‘remains committed to bringing a compelling range of general merchandise to its customers, both in-store and online at Tesco.com’, adding closing Tesco Direct is an ‘essential steps towards establishing a more sustainable non-food offer’.
Meanwhile, it is a similar story at Carrefour. Chief executive Alexandre Bompard took over in the middle of 2017 and launched a transformation plan at the start of 2018 aimed at stripping out €2 billion of costs from the business by 2020, while significantly upping investment in e-commerce to €2.8 billion by 2022. Carrefour’s former CEO, Georges Plassat, had been criticised for failing to bring the French giant into the modern world, falling behind growing online rivals and sticking to the hypermarket model that the business was built on back in the 1960s.
To address this, Carrefour has already formed several significant partnerships prior to teaming up with Tesco. The French retailer has partnered with Tencent in China to fend off Alibaba Group’s attempts to shake up grocery and retail markets in the country using technology, Systeme U to bolster its buying power in France, and Alphabet's Google to lead its digital transformation that should start to materialise early next year.
Thirdly, the partnership of Tesco and Carrefour, in addition to their individual deals of late, are also responding to a wave of other deals and partnerships that have been signed in the sector.
Carrefour’s smaller rivals in Europe have recently revealed they have teamed up to better compete. Casino, Auchan, Schiever and German distributor Metro AG have formed a buying alliance called ‘Horizon’ that will see the four firms start ‘moving out of a purely transactional mode of negotiation to develop collaborative, balanced and innovative negotiations’ in France and internationally.
Meanwhile, the grocery market in the UK is undergoing significant change. Following Sainsbury's acquisition of Argos to bolster its non-food offering under a deal struck in early 2016, it has more recently announced plans for a £7.3 billion cash and shares merger with Walmart's Asda to fuse the country’s second and third largest supermarket chains.
Read more about the Sainsbury’s and Asda market-shaking merger
If the deal goes ahead it is likely to have serious ramifications for Tesco. Combined, Sainsbury’s and Asda would have generated £51 billion in revenue last year, short of Tesco’s £57 billion – but the pair’s market share would have been 31.4% and overtaken Tesco’s 27.6% share of the market.
Additionally, Amazon’s entry into the grocery market continues to pose a serious threat to both UK and European grocery markets. Amazon already offers its Pantry service in the South East and London, supported by a deal with the UK’s fourth largest supermarket chain, Morrisons, which sells a variety of products through the service. Amazon’s purchase of Whole Foods predominantly unlocks a network of hundreds of US stores, but also includes a group of UK stores centred in London. Meanwhile, a small distribution deal between Amazon and Casino in France started earlier this year.
The most recent report from the UK’s Grocery Code Adjudicator showed supermarkets were treating their suppliers better after years of being criticised for making late payments and pressuring suppliers on price. However, suppliers are still extremely concerned that supermarkets, which they view as already having way too much buying power, will overwhelm the supply chain and force a race to the bottom as supermarkets aggressively compete on price.
The Competition and Markets Authority (CMA) has already revealed a ‘key theme’ of submissions regarding the proposed merger of Sainsbury’s and Asda centred around the two holding too much power over suppliers, warning it could lead to disproportionate costs and lower levels of quality and innovation. Sainsbury’s and Asda have said they aim to reduce prices of ‘many products that customers buy regularly’ by 10%.
The UK’s Grocery Code Adjudicator’s latest annual survey revealed Sainsbury’s rank in terms of how it treats suppliers dropped to fourth from second, while Asda was close to the bottom. Meanwhile, Tesco was rated as the most improved and took second place, behind discounter Aldi in first.
Sainsbury’s chief executive, Mike Coupe, has said the merger will see the pair ‘equalise’ their treatment of suppliers ‘if possible’ in order to ‘bring standards of both businesses up to the best’. While there has been opposition to the Sainsbury’s-Asda deal, including from politicians, it is important to remember that the CMA works in the interests of consumers – not suppliers – and that it gave the green light to Tesco’s purchase of Booker, which is undoubtedly bad news for suppliers.
With the likes of Lidl and Aldi putting much of their success down to selling their own products, the larger supermarkets are increasingly moving toward selling more of their own goods rather than the branded products that have traditionally filled their shelves.
Tighter purse strings have helped push consumers toward cheaper, own-branded goods and, as supermarkets continue to aggressively compete on pricing, it has been a natural move for the likes of Tesco and Sainsbury’s as own-branded goods offer better margins than selling branded products sourced from companies like Kraft Heinz, Unilever or Nestlé because they have greater vertical control.
Reports suggest around half of Tesco’s total sales come from own-branded products compared to just 25% of sales at Carrefour, and the focus on own-branded products is expected to be more beneficial to Carrefour than it is Tesco because the French firm’s margins are behind that of its UK counterpart. Tesco exited its last financial year with an operating margin of about 3% with the aim of raising that to 3.5% to 4% by 2020, while Carrefour currently boasts a margin of about 2.5%.
Watch more about Next and Tesco soaring despite death of the high street
While the brunt of any pressure on suppliers will fall at the feet of smaller companies feeding the supermarket’s product, there will ultimately be less space on supermarket shelves for branded products over the coming years, meaning larger consumer goods giants will have to invest in their strongest brands and show consumers why their products are superior to the supermarket’s.
Tesco shares plunged in 2014 as a consequence of a poor set of full-year results, followed by the accounting scandal. Shares now trade only 9% lower than they did before releasing its 2014 annual report.
Read more on whether there is a renaissance for Tesco and its share price
Tesco shares have gained 29% since acquiring Booker, helping them reach their highest level in June since mid-2014. Since announcing the partnership with Carrefour, Tesco shares are up 4.5%.
Is the potential power of Sainsbury’s, Asda and Argos being underestimated?
‘If the deal goes through, the prospect of Sainsbury, Asda, and Argos working together, with Walmart chipping in too, is a pretty powerful combination,’ – Laith Khalaf, senior analyst at Hargreaves Lansdown.
It is early days for the Sainsbury’s-Asda merger and the former’s share price has jumped following the announcement, but investors have reason to feel confident about not only the deal being pushed through but the prospects the combination, twinned with Argos, could deliver. Sainsbury’s has announced it has secured a £3.5 billion financing package to fund the Asda deal, claiming it had way more offers from the banks than it needed.
Firstly, Sainsbury’s has already demonstrated its ability to integrate at speed. At least 200 Sainsbury supermarkets have had an Argos branch added in the 18 months since it purchased the retailer, and after rolling out its Click & Collect service to over 1100 Sainsbury and Argos stores the supermarket has now rolled out its Tu clothing range onto the Argos platform, with the hope Asda’s George range of clothing and homeware can be added if the merger gets clearance.
Argos has also been beneficial to results. Sainsbury’s said general merchandise sales grew at double the rate of its overall retail sales and outperformed the wider market, while its online service and convenience stores continue to support its core business.
Argos brings a lot to the table. Its website is the third most visited retail website in the country. Shifting Argos branches into its own stores is logical as more Argos sales are originating online (currently about 60%). But with about 80% of Argos orders being picked up in store, Sainsbury’s can attract large volumes of footfall into its supermarkets where, with the help of Walmart, it can entice consumers to pick up the essentials or even grab a trolley for a weekly shop. If Asda is added to the network then Argos will be rolled out to these stores too, which are thought to have a better demographical fit to offer even more potential for Argos.
However, Argos’s digital capabilities are nothing without its delivery service that allows same-day and next-day delivery, utilising smaller stores compared to rivals like Amazon that operate out of huge, centralised warehouses.
There is also a link between Sainsbury’s decision to buy Argos and its more recent move to take the Nectar Points loyalty scheme back in-house. Nectar had originally been a loyalty point scheme shared between a group of major retailers including Sainsbury’s, Homebase (which the supermarket bought and sold-off as part of the Argos deal), and Centrica's British Gas, but the supermarket chain has slowly become the last major player standing.
While the collapse of the Nectar coalition damaged the appeal of Sainsbury’s loyalty programme, the supermarket has since turned itself into a multi-service provider spanning groceries, general merchandise, telecoms and even financial services, giving it a stronger and more varied portfolio to take on Nectar alone. Sainsbury’s has done well to take the opportunity as Nectar will provide invaluable data on its customers that will be key to managing product choice, marketing, supply chain management and logistics.
For Walmart, one of the reasons for its decision to try to merge Asda with Sainsbury’s was in order to shift its focus to new areas of high growth, specifically in India where it agreed to buy FlipKart for a staggering $16 billion at around the same time the Sainsbury’s-Asda deal was announced. FlipKart will be Walmart’s foundation to capture the Indian market, where again it is preparing for stiff competition from Amazon.
Although Walmart is preparing to battle for longer-term growth, its immediate concern is in its home market in the US, where again the likes of Amazon are constantly treading on its toes. But the merger could provide Walmart with a new weapon against Amazon in the US, where it might choose to look at importing Argos’s logistical capabilities to help compete on delivery with the online giants. Walmart already has strong digital capabilities with a smartphone shopping app and automated parcel pickup machines – which, in turn, all fit in to the digital models of Sainsbury’s and Argos.
There may be reason for investors to feel good about their chances of the merger going through but there potential barriers to the deal are plentiful. Sainsbury’s and Asda have tried to alleviate concerns about job losses with its promise to keep both brands and its intention not to close any stores. Although they won’t have much say over store closures if regulators think otherwise, and there is no guarantee the Competition and Markets Authority (CMA) will agree combining two of the UK’s largest supermarkets is good for competition.
If given the green light then a bigger and better Sainsbury’s will be borne: one with the market share and buying power needed to rival long-standing leader Tesco, and one with the world’s biggest retailer standing behind it. The supermarket should also be applauded for its focus on the customer. While Tesco has decided to bolster its retail strength with Booker’s wholesale and logistical capabilities, all of the decisions made by Sainsbury’s have centred on the customer – lowering prices, widening product ranges, improving delivery – while also being more digitally-steered.
Having been volatile over recent years, Sainsbury’s shares have broken out to new highs after announcing its merger plans. While the acquisition of Argos gave shares an initial boost they soon dropped off and in March 2018 shares hit a four-month low.
But the Asda deal has pushed Sainsbury’s shares to their highest level since July 2014, with potential to head higher. As the merger progresses investors will have to start revaluating the value of the new Sainsbury’s, and consider whether Argos and Asda are both being priced in.
The moves made by the larger players in the market initially paints a bleak picture for the other contenders in the industry.
For Ocado Group, the grocer-turned-technology firm, is still on a high following its landmark deal to roll-out a string of distribution centres using its automated platform in the US on behalf of Kroger, one of the world’s largest grocers. This is in order to position it to try to become the leading technology partner to the worldwide grocery and retail market.
Read more about the Ocado share price soaring after striking transformational deal with Kroger
Kroger has been the biggest deal to date so far and revived Ocado’s share price after investors spent years fearing it couldn’t deliver, but it is worth noting Ocado had signed a series of other deals beforehand with Sobeys in Canada, ICA in Sweden and Carrefour’s French competitor Casino.
Ocado shares have quadrupled since November 2017 as the firm started to strike deals in Europe, jumping over 85% since the Kroger deal was announced earlier this year, sending Ocado shares to an all-time high.
A report from broker Peel Hunt has argued Ocado, one of the newer members of the FTSE 100, should aim to become the ‘Microsoft of Retail’ by making its technology the open industry standard, pointing toward Microsoft's success by opening up its operating systems to PC manufacturers compared to firms like Apple that limit their software and systems to their own hardware.
At Morrisons, it may look like the supermarket is the only one without its own game-changing deal to boast about, but the story at Morrisons is worth watching even if it is taking a more subtle approach compared to its peers.
Morrisons has been focused on using the growth being generated from its division that supplies convenience stores such as McColl's Retail Group to help counter the tough retail conditions, while building relationships with suppliers to launch new products, such as the successful Wonky veg range, that will be welcomed by farmers. Its own-branded products have also been key to Morrisons, which sources the majority of its fresh food and produce through its own manufacturing facilities. Some of that echoes Tesco’s concentration on fresh produce and strength in wholesale after buying Booker.
Morrisons shares hit their lowest level in for 18 months in March 2018 but have since been revived after recently hitting levels not seen since the start of 2014 in mid-May.
The supermarket’s distribution network is managed by Ocado’s technology, which is gaining momentum, and its deal with Amazon that has been in place since early 2016 is an important partnership with what is the biggest threat to the grocery market over the medium and long term. Plus, its power over suppliers is boosted by its membership of the AMS Sourcing Group, a buying group comprised of European retailers including Dutch firm Ahold Delhaize, ICA and Booker.
While rumours have circulated that Amazon’s big move into the UK or European grocery markets could be facilitated through what would be a landmark merger with the likes of Sainsbury’s, Carrefour or Ahold Delhaize, Morrisons may now be top of the list following the recent market activity and the fact the pair already have a partnership. Being the last man standing may have its benefits.
The sector will remain busy over the coming years and the recent wave of deals is not necessarily over. All of the major UK supermarkets delivered growth in sales (including like-for-likes) in the initial three months of 2018, albeit at a slower rate than in previous periods, but shareholders should expect most of the supermarkets to deliver a better bottom-line this year.
Tesco will now have to draw up its deal with Carrefour and start demonstrating the benefits of the deal not only to customers, but also investors - some of which still need convincing that buying Booker was the right thing to do so soon after Tesco’s recovery from the accounting scandal.
Sainsbury’s now has the mammoth task of getting a message across to staff, customers and regulators that the deal is not detrimental to the market or to weaken competition in the market, convince suppliers they won’t be squeezed as a result, and gain the support of investors that such a drastic move is the best way to rival not just Tesco, but the longer-term threat of Amazon.
Ocado Group will continue to look for more deals after gaining endorsement from Kroger, which will be a firm verification that Ocado’s strategy works if the partnership proceeds without hitting any blips, and Ocado could play a major role in the wider industries fight against online giants like Amazon. Morrisons too looks set to play a role, and could be the next chess piece to be captured in the market’s rapidly evolving game of chess.
But the hype circulating the current M&A and partnerships in the market does not detract from what remains a tough retail grocery market that is still trying to cope with weaker sterling, a clouded view of their market post-Brexit, as well as rising costs for things like labour and business rates – all while the wider retail market continues to struggle with more high-street stores falling victim as the days go by.
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