Build or Buy?

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Build or Buy?

By Pan Demetrakakes - 04/01/2014

CPG retailers who want to expand the number of their stores face the same choice that many supermarkets present to shoppers every day:

Build it from scratch or buy it ready-made?

When it comes to establishing new outlets, the two basic options for most CPG retailers are: organic growth, where new stores are built from the ground up or converted from dormant structures; or acquisition, where dozens (or more) of new outlets can be acquired all at once.

CPG retailing, especially in the grocery industry, has seen plenty of both strategies. Major acquisitions in 2013 included the purchase of Safeway by Cerberus Capital Management; Kroger's purchase of Harris Teeter, an upscale grocery chain based in North Carolina; and in Canada, the acquisition by Sobeys of Safeway's Canadian operations.

On the other hand, organic growth has been the norm for many of the industry's ongoing success stories.

"Accomplished grocers like Wegmans, Woodman's, H-E-B, WinCo, HyVee, have been successful building stores one at a time," says retail consultant David Livingston. "The road to bankruptcy in the grocery biz is paved with companies that borrowed money to buy mediocre supermarkets. All those names we've seen for 100 years have pretty much been regional grocers, debt-free, that build stores one at a time, and stayed privately held."

One of the biggest advantages of organic growth is that it confers "complete control of development and assets, from site selection/location to store design to staffing and management," says Sandra Skovan, US research director for consultancy Planet Retail. "Through organic growth, you're not buying someone else's headache."

"Through organic growth, you're not buying someone else's headache."


Planet Retail


The most obvious control is over the precise locations of the new stores. Gary Weber, partner in Right Site Systems and owner of Weber Realty Research in Dallas, says that organic growth gives retailers the "ability to use a clean-slate approach to identify optimum site search areas, which may include shadow retail locations, i.e. sites adjacent to exiting substantial retail projects."

Organic growth gives more control over the inside of the store as well as the outside. When stores are "built organically, you can control the outcome from the onset," says Chris Studach, creative director of King Retail Services. "The level of brand adherence is normally much higher than retrofitting another store unless big changes are made. The cost of making those changes is often felt twice–you may pay for what you don't want, and pay to replace it."

Companies that want to grow organically don't necessarily have to build every one of their own stores. Buying or leasing an empty building is often the better, or only, option.

The right shell building "could substantially reduce time-to market if appropriate existing buildings are available (previous tenant has vacated), as long as the building footprint meets a CPG [retailer]'s footprint and prototype requirements–primarily, size, sight-lines, access and parking," Weber says.

Choosing between building new stores yourself or buying up buildings is often a matter of what's available in a given market. Aldi, the discount chain based in Germany, is in an aggressive expansion mode, planning an average of 130 store openings per year over the next five years, which would bring its U.S. total to nearly 2,000 by 2018.

All of Aldi's growth in America has been organic, says Joan Kavanaugh, vice president of corporate buying. Decisions on whether to build new buildings or buy old ones are made on an ad-hoc basis.

"We prefer to build and own our stores, but in places such as the Northeast and Southern California, the ability to purchase and build is more limited, so we will often lease in those instances," Kavanaugh says.


The question of organic growth versus acquisition becomes especially acute when a company is seeking to expand into an entirely new geographic territory. This reduces or eliminates one of the inherent advantages of organic growth: building out from a center base, which allows customer bases to overlap and word-of-mouth to take hold.

Meijer Inc., a grocery chain based in Michigan, is moving into the Wisconsin market in a big way, planning to open eight stores there by 2016. Kroger CEO J. Michael Schlotman told an investor conference in March that his company would be moving into a new, unspecified market in the near future. Both companies have traditionally pursued an organic growth strategy–Kroger's purchase of Harris Teeter being a notable exception–and presumably will do so for the new markets. (Neither company responded to a request for comment.)

Weber says companies moving into a territory need to study the market carefully for such factors as how many local consumers fit their customer profile, how many stores will be required initially and in subsequent years, and how the new stores will be supported in terms of supply chain, IT and other enterprise-wide operations.

In some areas, organic growth is not a good option simply because there isn't enough land available at a reasonable price, like in densely populated urban cores or "first-ring" suburbs.


Acquisition is a quick way to enter a densely packed market. "Usually when you look at the inorganic side, it's buying a set of stores that will get you density in a market in a short period of time," says John Bayliss, a partner with the Boston Consulting Group who specializes in grocery and big-box retail.

The most obvious acquisition strategy is to acquire a company with similar products and clientele.

"The acquisition of a 'like retailer,' such as [Whole Foods'] takeover of Wild Oats Market in 2007, speeds up time to market, puts new geography in play and eliminates existing competition," Weber says.

"The acquisition of a 'like retailer'…speeds up time to market, puts new geography in play and eliminates existing competition."


Right Site Systems

But it can also make sense to buy a retailer whose locations or products complement but do not compete with those of the existing company.

"For inorganic [growth], strategies you look for are a chain or a target that allows you to grow in either a new geography or a different market segment," Bayliss says. He looks north of the border for examples. When Sobeys bought the Canadian operations of Safeway for US$5.7 billion last year, it constituted a sudden move into western Canada, where the company had been largely absent. Such a move would not have made sense for Loblaw, Canada's No. 1 grocer, Bayliss says: "If Loblaw had bought Safeway, they'd have been doubling down in a market they already have a strong presence in."

Loblaw, on the other hand, is in the process of buying Shoppers Drug Mart, Canada's largest pharmacy chain. That's a deal where the complementarity is in the product offerings and store formats, instead of the respective geographies.


The major advantage for growth by acquisition is speed. Organic growth is necessarily slow, since it essentially means growing one store at a time. "A retailer can gain an immediate presence and go-to-market much quicker than through organic growth," Skovan says. That kind of speed can be appealing, especially when a company is under pressure to show results quickly.

Once an acquisition has been made, there remains the problem of incorporating the new company. That involves factors that include eliminating redundancies to altering store layout and merchandising to merging the corporate cultures.

The last can be quite daunting, Livingston says. "Normally when a chain acquires another chain, the sales at the acquired chain drop 15 percent because of employee morale/turnover issues and the learning curve of running a new company," he says. "It's like getting a new stepfather–the kids are all on the defensive, and it takes a while to find out if he's a good guy or not."

The pending acquisition of Safeway by Cerberus Capital Management, which already owns Albertsons and associated banners, is a recent example of a major acquisition that will likely require some adjustment.

"The Cerberus acquisition of Safeway…is, of course, the purest example of growth through acquisition, but introduces redundancy, operational, cultural, systems integration, as well as financial issues, especially potential overleverage via new debt, to name a few," Weber says.

Livingston is more blunt. Cerberus "did not buy Safeway because they think Safeway is a great retailer that will grow sales," he says. "No, they bought Safeway to consolidate redundant stores [and] use the economies of scale to reduce expenses. Really, do you think the employees of Safeway are thrilled to be owned by a private equity group known for cutting expenses to the bone?"


There is what might be called a third way in the organic versus acquisition growth debate: Snapping up properties from a chain that recently went, or will soon go, out of business.

The most recent outstanding example resulted from the decision last October by Safeway, about four months before the Cerberus deal, to shutter Dominick's, an 88-year-old chain of 72 stores in the Chicago area. As the stores closed, other grocers swooped in. Eleven were snapped up by Mariano's, the Milwaukee grocery chain headed by Bob Mariano, CEO of the Roundy's chain (and a former Dominick's CEO). Whole Foods bought seven, Jewel-Osco (a Cerberus banner) three, and others were taken by various independents or small chains.

These opportunities are tempting but they can pose a dilemma for a retailer, Livingston says: "If they don't do it, they miss out on good locations. If they do it, they must borrow money at 10 percent along with using up available cash. It's always a gamble."

The choice of a growth strategy depends on many factors, but it ultimately comes down to a classic choice in business: Quick but risky versus steady but slow.

"Organic growth allows for smart, deliberate development suited to a specific location."


King Retail Services

"Organic growth allows for smart, deliberate development suited to a specific location," Studach says. "It is easier to create a store that is more deeply in tune with the locale. This allows for pinpoint testing and evolution, and can create a marketing buzz when done well. The downside is slower market penetration and brand presence."