The Meaning of M&A
Mergers and acquisitions have been heating up in CPG retailing, especially in the grocery sector. There were 37 supermarket mergers/acquisitions in 2014, up from 28 in 2013 and the most since 2013, according to The Food Institute.
Our panel of experts includes:
Bruce Cohen, senior partner, Kurt Salmon
Michael Dart, partner, private equity, A.T. Kearney
Alida Destrempe, senior analyst, Kantar Retail
Jim Hertel, managing partner, Willard Bishop
Mike Paglia, director, retail insights, Kantar Retail
Steven Platt, director, Platt Retail Institute
Karen Short, analyst, Deutsche Bank
Neil Stern, senior partner, McMillan Doolittle
Q. Why are we seeing so many mergers/acquisitions?
Dart: This is the inevitable part of a long-term expansion in both retail space and product brands. We have a marketplace that is becoming oversaturated with choice–for example, retail square footage per person is at an all-time high–specifically for products. With the growth of online retailing, the increase in competitive capacity and choice has even further accelerated. This is the era of consumer power and choice on steroids. When markets have excess supply over demand, the natural impact is an industry consolidation or shakeout.
Short: Online retailing is going to happen whether food retailers like it or not, and what that is going to do is accelerate the consolidation in the industry. The basic math is that, when you have such a high fixed-cost business, if you lose 1 percent of your volume, that's 10 percent of your profit. The increasingly prevalent online options are definitely going to cause straight exits from markets and closures, and also consolidation.
Hertel: Mergers can create efficiencies by cost-cutting redundant internal functions. They also create scale that can be leveraged with trading partners to extract better costs (as a retailer) or terms (if a manufacturer).
What's not clear to me is how much profit improvement either party can make due to scale alone. What's more clear to me is that if you don't merge, you are likely to feel that you're at a competitive disadvantage unless you have unique products or a niche market you serve extraordinarily well.
Stern: Consolidation is a two-edged sword. It does put more concentration in the hands of fewer players, which means more leverage and tougher negotiations. It also means fewer jobs as companies look for cost saving synergies. But, there is still plenty of competition, which will continue the need for innovation.
Platt: One of my hypotheses is that coming out of a recession, people are going to be spending a little less money, one, in saving more money, and two, in just being a little more cautious.
Also, there's just too much capacity. Look at the number of stores out there. As more and more of it shifts to internet-based, store formats in the future are going to start to shift too. You're just not going to need as much real estate to service your customers, because they might want it delivered to their house. So you've got a shrinking customer base, way too much brick and mortar, consumers coming out of the recession, a structural shift in spending–that's going to be driving consolidation in any industry.
Q. What will be the effect on small- to mid-sized retailers? Does this open, or close, doors for them?
Dart: The opportunity for smaller, mid-sized retailers to offer a better value proposition–more unique products, focusing on the emerging trends around organic, natural etc., and provide a highly differentiated experience will be even greater. In periods of change like this there is typically a lot more customer fluidity in both shopping and buying habits, so the opportunity to acquire new customers exists.
Stern: Grocery retail is still under significant changes in the U.S. Even though we have seen some consolidation, there are still a number of large and growing regional chains that are thriving (Publix, H-E-B, Wegmans, etc.). [Consolidation] actually provides opportunity for mid-level retailers. Haggen is taking advantage of divestiture to grow, and one can argue that national chains are not nearly as flexible.
Hertel: Big mergers often create opportunities for smaller players who can be focused on who counts: the consumer. If you're a "modestly sized" player, take a deep breath and keep your eyes on the consumer.
Q. What will be the impact on the industry as a whole?
Dart: Obviously time will tell, and it will depend from whose perspective you look at. I think we will see overall industry profitability improve with these mergers, as costs are cut by the consolidation and overall competition is reduced. Eventually consumers will likely see fewer price promotions with reduced competition, but this may be a few years away. Weaker retailer locations, brands and products will be eliminated, as will jobs in many of the companies–both at HQ and in the field.
Q. What do you think of the Albertsons/Safeway merger?
Cohen: The Albertson's and Safeway merger takes advantage of their combined scale in the west. Both companies were challenged with improving their performance. The consolidated operations should generate increased cost saving and improve the performance of the combined entity.
Paglia: The significance of Albertsons' acquisition of Safeway is hard to tease out, as it's still very early on in the integration of the two companies. That said, the combined entity ought to have much greater buying power to leverage with suppliers. At the same time, though, it's appearing that the new organization will be much more decentralized than Safeway was in the past, which will most likely create more complexity for suppliers in terms of call points and ensuring execution.
Q. What motivated Heinz's acquisition of Kraft?
Cohen: For Heinz, faced with modest top line growth but ample cash flow, a combination made a lot of sense to look for further combinations. They could leverage cost management and increased operating effectiveness as one (not the only) of their strategic weapons in the industry. For Kraft, who itself was struggling with growth and also had its own plan of cost reduction, the combination accelerated and surpass the performance improvements as a standalone entity. The combined entity could take advantage of the aggressive 3G cost management approach, leverage scale benefits and drive more substantial cash flow generation. The larger cash flow could then be redeployed toward growth initiatives such as enhanced marketing and promotion, new product development, international growth and lastly but importantly, strong returns for shareholders.
Q. What about Kroger acquiring Harris Teeter?
Destrempe: When Kroger acquires a banner, it evolves and learns from that acquisition. Harris Teeter has everything from an online, click-and-collect offering to an urban format (roughly 15,000-20,000 square feet). Online and small formats are not Kroger's strong suit, but Harris Teeter enables learning opportunities around those operations. What also makes this merger so successful is that there is alignment between Kroger and Harris Teeter's strategy and brand. Both have strong management structures with similar corporate beliefs. For instance, both retailers are known for their service levels, and it's been an easy transition for Kroger to apply its Customer First ideas into Harris Teeter's stores and corporate thinking.
Cohen: Kroger's acquisition of Harris Teeter, on the other hand, was driven by regional growth opportunity. Kroger is a fantastic operator. Harris Teeter was a quality regional operator and provided a good platform for regional expansion. For Harris Teeter, they faced increasing competition by stronger competitors including Kroger and Publix. They could continue battle against the giants or seek to partner with a larger organization that could solidify and expand its position. Likely, Kroger will continue to sustain the key elements that attracted consumers to Harris Teeter and try to leverage its significant infrastructure to improve costs.
Q. What is the significance of Haggen picking up divested Safeways?
Cohen: Albertson's selling stores to Haggen was a different situation as well. It was really necessitated by the government. Albertson's needed to find a partner to sell stores to, or they couldn't combine with Safeway. This rapid expansion for a regional operator will be intriguing to watch. Expanding into new geographies and competing against different operators will be a new challenge.
Short: [Haggen's pickup] was basically it [for divested Albertsons stores]. A lot of people seemed to think there would be all these assets that people could pick up, but I was pretty consistently saying, "There won't be any, because there's no overlap." If you don't have to sell it, you are not going to sell it to a competitive food retailer. Why would you bring more competition onto yourself?
Some of the largest corporate organizations in the food industry have been formed by way of mergers and acquisitions for reasons of cost-cutting opportunities, revenue growth or to adjust to the shopper's ever-changing path to purchase. As we turn our eyes to the next big merger, and rumors say it's likely Delhaize/Ahold, keep in mind lessons learned from the past.