Where to next for the UK supermarket industry?
The UK grocery market is undergoing change and the Big 4 supermarkets – Tesco, Sainsbury’s, Asda and Morrisons – are all racing to stay ahead. We have a look at how the industry is changing and how this could impact the market.
Supermarkets vs discounters
Up until around 2014, the UK grocery market operated under a simple three-tier system. You had the likes of Waitrose and Marks & Spencer catering to the affluent, Morrisons and Walmart-owned Asda serving the more cost-conscious consumer, and Tesco and Sainsbury's swallowing up everyone in-between.
But the arrival of German chains Aldi and Lidl disrupted that structure. Although both companies entered the UK market during the 1990s, they didn’t begin to encroach on the Big 4’s territory until much later. Their entry introduced a fourth discount tier. By sticking to the basics and stocking significantly fewer product lines, the pair quickly started to steal custom from those supermarkets stuck in the middle: Asda and Morrisons were no longer cheap while Tesco and Sainsbury’s suddenly went from being reasonably-priced to expensive. The fact the two discounters began rapidly expanding whilst consumers and the economy were still recovering from the financial crash was no coincidence, and years of stagnate wage growth that had struggled to keep up with inflation meant more and more people became enticed by the German’s cut-price model.
This has had a profound effect on the market. The Big 4 have been forced into a corner and had to compete on price. They have been unsuccessful: Aldi and Lidl’s combined market share has more than doubled from under 6% in 2012 to over 13% today while the Big 4 supermarkets, although still firmly in charge, have loosened their grip with their combined market share falling from over 76% to under 69%.
It is not just the discount chains that have managed to grow their market share over recent years, although no other company has come close to replicating the success of Aldi (which has grown at a much faster pace than Lidl). Iceland, having revived demand for long-lasting frozen produce, has a larger slice of the market than it did a few years ago and Waitrose has also shown there is growth at the higher-end of the market. Ocado Group, the UK’s only and the world’s largest online-only grocery chain, is still tiny in the grand scheme of things with just over 1% of the market but has seen growth accelerate, and Amazon is thought to be gaining significant ground following its acquisition of Whole Foods (which has a handful of UK stores to bolster its existing online grocery businesses such as Amazon Pantry).
UK grocery market share: Big 4 slip as smaller rivals rise
(2012-2018 market share based over 12-week periods ending in August of each year)
The disruption caused by the German discounters is starting to reach breaking point for some. Tesco has launched an entirely new store format named ‘Jack’s’ (after its founder) to directly compete with Aldi and Lidl. The new chain will stock just 1800 product lines – a tiny amount considering Tesco has over 10,000 own-label goods alone. Sainsbury’s has openly said the rise of discount chains is a key reason why it wants to merge with Asda, stating it wants to scale-up in order to compete effectively and arguing any competition that would be lost through the merger would be replicated by the two fast-growing rivals. Meanwhile, Aldi and Lidl’s respective plans to replicate their success through aggressive US expansion has prompted fears over the pond.
Supermarkets restructure and repurpose store formats
Aldi and Lidl are both using the current momentum to their advantage. Aldi and Lidl each have over 700 UK stores and are opening around 50-70 new branches each year. Aldi has openly stated it wats to have around 1200 stores open by 2025.
While the pair can grow from a low-cost base and open new stores fit for the modern era, the Big 4 have been left with bloated and unbalanced property portfolios. Over the ten years to 2012, before the threat of the discounters started to become a reality, the Big 4 had grown their share of the market from around two-thirds to over three-quarters and, justified by their success, they continued to invest in larger stores (many of which were out of town) and expanding product ranges.
Over the last five years, however, huge out of town locations have given way to smaller, more convenient outlets as people shift to smaller but more frequent shopping trips during the week. Although hypermarkets and supermarkets are forecast to grow over the coming years, they will both significantly lag that anticipated from convenience stores, discount chains and online, according to grocery research and training charity IGD. Plus, the anticipated growth comes after a long period of restructuring of larger store formats that has seen the Big 4 close several hyper/supermarkets to ensure they only keep ones in prime locations.
Convenience stores and online growth outpaces larger store formats
|2018 value (£ billion)||2023 value (£ billion)||% change in value|
Most of the Big 4 spotted convenience stores offered a faster-growing opportunity than their traditional store formats early on: Tesco had more convenience stores than supermarkets as early as 2013 and Sainsbury’s followed a year later. Tesco has since become the undisputed market leader in convenience following its merger with Booker Group, with over 8100 convenience stores under various brands. That is more than double its closest competitor, Nisa-Coop, which has over 3500 stores after the pair merged together, in turn leapfrogging both Costcutter and Spar. Meanwhile, Sainsbury’s has fewer than 1000 convenience stores under its Sainsbury’s Local fascia. Morrisons, which no longer runs convenience stores but instead supplies them at a wholesale level, has said 'our focus on the core supermarkets is a key priority in our turnaround', pointing to the fact supermarkets take 50p in every £1 spent on groceries in the UK. Both Tesco and Sainsbury’s have continued to open a handful of new supermarkets each year but have predominantly focused on expanding convenience store networks, while both M&S and Waitrose are also prioritising smaller-store formats.
Although the Big 4 continue to open new stores, the rate of expansion is miniscule compared to the German discounters. This is partly because the Big 4 have been trying to fix their existing ones by closing the worst-performing stores, relocating others, refreshing branding and repurposing space. They have all let out excess space in their stores to partners that can help attract footfall. Morrisons has added Amazon lockers, Timpsons, car washes and, on one site, a McDonald's drive-thru. Tesco has opened concessions with the likes of the Arcadia Group (Topshop etc…), Holland & Barrett, Dixons Carphone and Next. Sainsbury’s has taken it one step further by purchasing Argos and rolling out the brand across its stores.
When retail tycoon Mike Ashley began taking advantage of the retail sector’s weakness by purchasing failing businesses like House of Fraser (and attempts to buy firms like Debenhams), it became clear that he was planning on pulling the trigger on a long-held ambition to create a one-stop shop for retail. Although his strategy of bringing numerous brands under one roof has drawn the usual criticism, it is not that different to what the Big 4 are trying to do, the main difference being Ashley wants to own it all. But Sainsbury’s purchase of Argos is a tentative step down a similar path. Although the Big 4 are unlikely to undertake such aggressive M&A, any company capable of complimenting store networks will be on their radars, particularly if valuations continue to take a battering from the tough retail conditions. However, as the Big move into new areas, including home, leisure, garden and general merchandise they will be reminded of past failings and divestments, such as Sainsbury’s abandonment of Homebase.
Supermarkets urgent need for an omnichannel approach
Amazon’s high-profile takeover of Whole Foods demonstrated the urgent need for an omnichannel sales approach to compete in the grocery market or, known by its catchier name, ‘bricks and clicks’. Unlike many retail sectors, online is not a one-channel solution for groceries as it is for the likes of clothing or travel, both of which comfortably generate over half of all sales through the internet. Players like Ocado have tried to make groceries an online-only business but, in truth, the company makes more money licensing out technology than it does selling groceries (even if it is M&S groceries).
It is clear supermarkets need a blend of everything: the weekly shop may be falling out of favour but people still want big stores for big shops, as well as convenience stores for when they need to pop-out for essentials like milk and bread. Attitudes are changing but people still prefer to pick-up fresh produce in-store and mostly buy non-perishable goods, such as laundry detergent, online.
Catering to all these preferences is not easy nor cheap but the sector has done well to bring it all together. Take Click & Collect as an example: a customer buys goods online (from a third party or, in Sainsbury’s case through Argos) and then comes in-store to pick their parcel up, where they can be enticed to buy more. If Amazon had the same scale in bricks that it does in clicks, it would undoubtedly be making an effort to ensure you had to go to a Whole Foods to pick up any parcel it you bought through its platform.
Technology continues to open new sales channels that the industry will have to adapt to. For example, more people are expected to conduct internet searches using their voice than a keyboard within the next decade, mostly through devices such as smart speakers.
Supermarkets: can they keep a grip as consumers shop online?
The fastest-growing channel by far is online, with IGD forecasts suggesting the value of online grocery sales in 2023 will be over 50% higher than that seen in 2018. Still, online penetration of the UK grocery market is significantly lower than other industries. According to Nielsen, just 6% to 7% of sales in the global Fast-Moving Consumer Goods (FMCG) industry in 2018 were made online, compared to over half of all books and music sales and over 60% of fashion purchases:
Online penetration of global grocery market remains low
|Books & Music||49%|
|IT & Mobile||47%|
(Source: Nielsen. % of total global sales completed online in 2018)
Online penetration of the UK grocery market is in line with the global average and ahead of the rest of Europe. Adoption of online shopping is growing faster in developing countries than developed ones as they are building companies and infrastructure from the bottom-up rather than top-down. This is demonstrated by the large amount of groceries bought online in China and South Korea:
Early days for online grocery market but UK leads Europe
|Online FMCG Sales as % of total|
(Source: Nielsen. Data taken in September 2018)
The biggest barrier to adoption is fresh produce. Although the amount of fresh produce being bought online by UK shoppers is rising the clear majority still prefer to buy goods like fruit, veg and meat in-store. Supermarkets have also had the task of building the fulfilment centres needed to gather orders, although more are being fulfilled directly by stores themselves. For example, Morrisons recently added a new Ocado-run site in Erith to bolster its delivery service but has also introduced a ‘Store-Pick’ service that sees stock taken directly from stores.
Adoption of online has presented a short-term stick and a long-term carrot. The supermarkets must invest now to avoid being left behind, even if online sales still represent a minority of sales (although Sainsbury’s claims over 20% of its food sales are made online now, and 60% of all Argos orders originate online). However, all the signs suggest online is the future of groceries and, considering the lower-level of labour needed (twinned with developments in areas like automation), a viable way of returning the industry to higher margins after being squeezed by the discounters.
For now, providing a quality online service with good coverage, and at a profit, has been a struggle. The highest cost has been the last-mile delivery that has restricted the Big 4’s ability to roll-out a good service nationwide. Amazon, despite all of its logistical and delivery capabilities, only offers its online grocery services in select urban areas with dense populations. Morrisons took nearly a year to expand its online service from covering 60% of the nation to 75%. The scale of the Big 4 will help alleviate the cost-burden of implementing these services – both Tesco and Sainsbury’s insist their online businesses are already profitable – but the lack of logistical capabilities has already started to drive consolidation: The M&S-Ocado deal being a prime example.
Going forward, supermarkets will need to deliver smaller baskets more frequently in less built-up areas, pushing costs higher. These challenges have given birth to new models in other parts of the world. In China, for example, a new service is being trialled that sees customers pick from thousands of independent drivers able to deliver their shopping, complete with reviews and other features that draws mental images of existing services offered by companies like Uber and Deliveroo.
The online challenge is also one of the reasons that both Morrisons and Tesco have moved into the wholesale market as this also helps compliment their ability to deliver.
Supermarkets react to changing consumer trends and habits
Environmental concerns, changing dietary habits and higher consumer awareness has forced the industry to respond. Cutting down on plastic, putting an emphasis on organic, local produce and sourcing ethical ingredients are just some causes that have drawn media attention. Iceland found success with its decision to cut palm oil from all its own-branded products and customers of Morrisons have embraced the move to introduce ‘Wonky Veg’, which beforehand would have been deemed low-quality and unfit for sale, and therefore often wasted.
Supermarkets are also attempting to reclaim lunch and dinner. Having once been the destination to pick up a sandwich for lunch as well as the ingredients for your dinner that evening, supermarkets have lost ground in both areas. Companies such as Greggs (which has had huge success with its vegan sausage roll, even though only 3% of Brits identify as vegan) and coffee chains like Costa Coffee and Starbucks have all championed the ‘food-to-go’ market (also known as grab-and-go) and stolen lunch custom. Meanwhile, the number of people cooking their own meals has been in decline, meaning companies like Uber, Deliveroo and Just Eat have all benefited at the supermarket’s expense.
The threat to supermarket sourcing: Brexit and borders
The UK grocery market is heavily dependent on importing goods from abroad. According to Parliament figures, 62% of all fresh food is imported into the UK and, while many items like bananas come from non-EU countries, the majority comes from our European neighbours. 46% of the UK’s fresh food comes from Spain and 22% comes from the Netherlands. As the government has conceded: '50% of all food consumed in Britain is imported, with 32% arriving from the EU'.
It is unsurprising then that Brexit poses a real threat to the industry and the country’s food supply. Research conducted by Kantar Worldpanel shows 80% of British consumers are worried about the price of groceries in the event of a no-deal Brexit, while 63% are concerned about the price of clothing (another big area for the supermarkets with brands like TU at Sainsbury’s, George at Asda, F&F at Tesco or Nutmeg at Morrisons). It claims 'more than one in three shoppers have started, or are considering, stockpiling with a focus on food cupboard essentials'.
Supermarkets are also taking 'extraordinary measures' to prepare for a no-deal by stockpiling goods, testing longer-lasting varieties of vegetables and lowering quality standards (through Wonky Veg, for example). Some are 'quietly delisting and simplifying imported ranges and products' and even 'hiring their own border inspectors to fast-track their imports' while investing in new shipping capacity and alternative routes. Fears go beyond availability, according to Kantar, which said it had even heard of supermarkets 'developing new security measures to protect… against potential looting and rioting'.
Morrison’s USP over its three rivals is its manufacturing arm. The company has been gradually taking control of the production of its own goods and reducing its reliance on third-party suppliers. The firm has said this, twinned with the fact it is British farming’s largest supermarket customer, makes it 'well-placed' to mitigate some of the economic pressures facing the industry at present. It has also been sourcing more locally, with over 30% of all fresh produce in its stores coming from the local area, and only stocking milk, eggs and meat made in Britain.
Although supermarkets can strive to source produce domestically and locally, there is no escaping the fact that the UK must import food. The question, therefore, is where does this food come from? Geography argues the UK will still source fruits from Spain and vegetables from the Dutch post-Brexit, but the changing landscape for international trade could throw that logic out of the window. For example, US President Donald Trump has been pushing for agricultural concessions in return for wider trade deals with the UK, the EU and others. This has sparked headlines fearing ‘chlorinated chicken’ and ‘steroid-injected beef’ will hit UK shores. Put bluntly, Brexit not only threatens supply chains but the quality and cost of the produce that goes through it.
Supermarkets: new markets, new competition
Groceries remain the bread and butter of the Big 4 but, amid the challenges, all of them have diversified in search of new growth. Sainsbury’s has made a big push into general merchandise through Argos, which also stocks home, leisure and garden ranges. Morrisons has opened home and leisure sections as well as temporary garden centres in excess car park space in the summer.
More notably, both Tesco and Morrisons have established wholesale businesses. For Morrisons, this allows it to benefit from the growth being delivered by convenience stores without having to operate them. After striking its biggest deal yet with McColl’s, the supermarket now supplies around 1700 convenience stores, petrol forecourts and other outlets. It has even signed a deal to start exporting a large range of its own-label goods to Thailand, demonstrating further advantages to Morrison’s approach to manufacturing. For Tesco, the acquisition of Booker meant the largest supermarket had teamed-up with the largest wholesaler that, together, is also the largest convenience store operator in the country. That allows Tesco to benefit twofold from the growth being delivered by convenience stores by both supplying and operating them. However, it is important to note that a key reason the deal was awarded competition approval is because a large proportion of Booker’s convenience stores are under no obligation to buy supplies from Booker, allowing them to purchase from elsewhere – maybe even Morrisons.
The Big 4 may be moving into new markets to escape the pressure being applied by the discount chains but this only encounters new rivals. Sainsbury’s addition of Argos will intensify the battle with Amazon. Home and leisure formats will put them toe-to-toe with companies like Dunelm and turn-up rivalry with non-food discounters like B&M's, which has been stealing customers looking for homeware or dry goods. Expanded clothing ranges will have to compete with the wider market, particularly as more brands start to be offered under one roof. And trying to reclaim lunch and dinner will put it up against formidable players in the takeaway and food-to-go industry such as Greggs, Uber, Deliveroo and Just Eat. While the Big 4 can compete in these new markets they do not necessarily have the upper hand.
Supermarket M&A: horizontal or vertical?
The changes sweeping the industry has sparked a series of M&As and alliances across the sector, either as a form of consolidation or to diversify. Tesco and Europe’s largest retailer Carrefour have struck a strategic buying alliance after Sainsbury’s attempt to buy Asda. The Nisa-Coop tie-up and the M&S-Ocado partnership is further evidence of the increasing need to merge services and scale-up to keep a competitive edge. Meanwhile, Sainsbury’s purchase of Argos, Tesco’s acquisition of Booker and Amazon’s takeover of Whole Foods shows companies are also using M&A to enter new markets. Morrisons has been focusing on taking control of manufacturing, as have companies like Greggs.
The current environment means there is a broad range of potential targets for supermarkets to expand both horizontally or vertically. The growth in convenience stores puts companies like McColl’s on the radar and, as stated earlier, any company that has the ability to compliment supermarket estates (or better, the bricks and clicks link) could be targeted at the right price.
Technology will also continue to drive M&A as this will be the biggest factor in delivering lower costs and profitable online businesses. With that in mind, there is every chance that Amazon could take the plunge and bid for a supermarket that can give it the same scale in the UK as Whole Foods provides in the US. And, considering that, Morrisons is the early favourite because of the existing partnership between the two, with the supermarket chain already supplying Amazon’s ‘Fresh’ and ‘Pantry’ ranges in the UK.
However, there are two pending items that could materially alter the course of future M&A within the UK grocery industry. The first is Brexit, which will continue to encourage firms to kick-the-can down the road until some clarity is offered. The second is the Competition & Market Authority’s (CMA) decision on the Sainsbury’s Asda merger. Doubts have been growing over whether the merger will be approved and, if it is, whether it will be worth it considering the number of divestments that would be needed. Sainsbury’s has accused the CMA of moving the goalposts after believing its sign-off on the Tesco-Booker deal was a signal that M&A activity was welcomed.
Even if the CMA approves the deal it is likely to come with the need to sell-off a large number of stores, potentially eradicating the justification behind the deal in the first place. The regulator has already sent a strong message that while vertical mergers to diversify are welcome, it is not quite ready to support large-scale consolidation.
Supermarkets: Big Data and knowing how to use it
Supermarkets are great at gathering valuable data on consumer’s buying habits, mainly through loyalty programmes like Tesco Clubcard or Sainsbury’s Nectar points. It is one of the key reasons Amazon – already flooded in data about how we purchase almost everything else – took the plunge and bought Whole Foods, and that is a major concern for other UK supermarkets.
Although the Big 4 have become great gatherers of data none of them have shown they truly know how to wield data in the same way Amazon does. Customers are starting to push for personalised ads and offers, and the need to understand what the customer wants through Big Data is only getting greater. This could be another driver for M&A if supermarkets fail to find a solution.
Data also goes beyond the customer and is being used to automate ordering to reduce waste and improve efficiency, which is why Ocado’s technology has become increasingly popular with retailers, having signed deals with larger players like Kroger, the largest supermarket chain in the US. This is another area where Amazon has shown its potential to disrupt after it introduced the Amazon Go store format that has replaced virtually all staff with technology by using sensors to monitor when products are taken off the shelves and bill people as they walk out the door. This is another example of how supermarkets need to rapidly adapt if they want to see higher margins again and return to the days when it wasn’t all about competing on price.
This information has been prepared by IG, a trading name of IG Markets Limited. In addition to the disclaimer below, the material on this page does not contain a record of our trading prices, or an offer of, or solicitation for, a transaction in any financial instrument. IG accepts no responsibility for any use that may be made of these comments and for any consequences that result. No representation or warranty is given as to the accuracy or completeness of this information. Consequently any person acting on it does so entirely at their own risk. Any research provided does not have regard to the specific investment objectives, financial situation and needs of any specific person who may receive it. It has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such is considered to be a marketing communication. Although we are not specifically constrained from dealing ahead of our recommendations we do not seek to take advantage of them before they are provided to our clients. See full non-independent research disclaimer and quarterly summary.
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