Asda/Sainsbury’s – The next chapter of grocery disruption

After considerable speculation over the weekend we now know the details of the proposed merger between Sainsbury’s and Asda. Here’s Savvy’s initial view.

While this partnership may have seemed unlikely a few years ago, the changing dynamics of the grocery market over recent years have made consolidation increasingly inevitable. Limited growth in the grocery market, allied with the rapid rise of discounters has put the Big Four under substantial pressure. At the same time, the rise of online and the roll out of convenience stores means there is too much capacity in the market. Something had to give.

Asda in particular has found trading challenging over the past few years. Once known almost universally as the cheapest grocer among shoppers, Asda has seen its competitiveness eroded as Aldi and Lidl have scaled up. Its EDLP business model has been fundamentally disrupted by the discounters’ lower cost models of operation. Strategically it has looked lost.

Sainsbury’s too has found trading more difficult over recent times, especially at its core grocery business. And it will be painfully aware that the likes of Aldi and Lidl are targeting its southern England heartland for much of their expansion over the next few years.

A further consideration here is Amazon. While it has only made limited share gains to date, the online retailer has set out big ambitions to win in the UK grocery market. It remains possible that Amazon could make an acquisition, such as Morrisons which already supplies Amazon’s fresh foods. Amongst the big four, it is more a matter of when, rather than if, Amazon launches a full assault on the food market.

That’s the background, but what do we know so far?

While the deal is being presented as a merger, the detail reads more like a takeover, with Sainsbury’s leading the new larger business, headed by Sainsbury’s CEO Mike Coupe. Asda’s CEO will sit on Sainsbury’s board. Wal-Mart is taking a step back, but will own 42% of the combined business and will have two seats on the PLC board. Crucially this final point means Wal-Mart will maintain access to know-how and innovation in one of the world’s most competitive grocery markets. Wal-Mart will also give the merged business access to its global sourcing and technology.

It has been confirmed that both fascias will continue to trade independently. This makes good sense. First geographically, Sainsbury’s is more dominant in the south and Northern Ireland, while the bulk of Asda’s stores are focused in northern England and Scotland. Second, and perhaps more importantly, these two businesses have different propositions and core target audiences. While Asda’s focus has always been on low prices, Sainsbury’s offer emphasises superior quality. Finally, Sainsbury’s also has a large convenience business, while Asda does not.

It was also confirmed today that stores would not close. Of course the CMA may very well force divestment of some stores in local areas where the combined group is too dominant. We would also anticipate closure of Argos stores as leases expire, as there is a considerable and immediate opportunity to open Argos concessions in Asda stores. This final point is key as the combined business would be a leader in non-food as well as food. In the medium-to-long term we expect there will be some store closures as it remains our view that there is simply too much space in the UK grocery market.

While the Asda and Sainsbury’s stores estates will be maintained, we expect there will be change behind the scenes as the new group seeks to create efficiencies and ultimately improve competitiveness. Head office functions are likely to be consolidated, especially around central functions and systems. We would also expect a consolidation of the two supply chains.

One of the most significant implications of the merger will be the enlarged group’s buying scale. Sainsbury’s and Asda are the second and third largest players respectively, and together they would have share similar to Tesco’s. The combined business would benefit immediately from better buying conditions, as it has already stated that it would apply the best buying terms of either company for each supplier. In addition it would have considerable scope to negotiate lower prices as a result of its enlarged scale. This, combined with the ongoing sourcing support from Wal-Mart may be enough to allow Asda to realign its prices to regain share from discounters. Already the management have pledged to reduce prices by 10% across every day products – this alone will help close the current price gap.

A final point worth noting at this time is customer insight. Asda has traditionally struggled to really understand its shoppers due to its lack of a loyalty card. The merger will mean the Sainsbury’s Nectar scheme can be used across the whole business. This will deepen insight and will also open new opportunities to personalise the shopper experience across the two businesses.

It’s still early days and there is a lot to consider. We also wait with interest to see how the CMA intervenes. However, this is an exciting development that will reshape the market at a structural level, potentially shifting some of the momentum away from discounters. It may also be a catalyst for further change, with Amazon no doubt re-evaluating its UK plans. Tesco too will be considering how it is affected – it’s been a long time since it’s had a competitor that rivals its scale.