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The Big Four UK supermarkets are set to become the ‘big three’ after the shock announcement of the proposed merger between Sainsbury’s and ASDA this week. The deal, so-called ‘project solar’ to ensure secrecy, caught the retail industry off guard as the second and third largest grocery retailers decided to join forces.

According to Euromonitor International, the merger would give the companies a combined 24% value share of the grocery offline market dwarfing that of Tesco which currently leads with 22% and far ahead of other rivals – Morrison’s (8%), Aldi (6%) and Lidl (4%). In terms of stores the deal would make strategic sense with ASDA traditionally having a strong presence in the North of England with Sainsbury’s dominating the South-East. It is likely that the Competitions Market Authority would force the combined company to sell off some stores with 70 of ASDA’s 630 outlets within a mile of a Sainsbury’s to avoid a duopoly in certain UK towns/cities.

Source: Euromonitor International

‘Asdbury’s’ or ‘Sasda’ would have a particular stranglehold of the hypermarket channel with almost 50% value share between them – any hypermarkets or large supermarkets in close proximity to each other would likely need to be sold to ensure fair competition. However, ASDA has no convenience stores so Sainsbury’s will continue to have a strong presence in ‘top-up’ shopping and ‘food-to-go’ with room to grow as it is currently ranked fifth with a 9% value share.

Food price deflation threat to growth in the UK grocery sector

What is clear from the proposed deal is that Sainsbury’s and Walmart are very aware of a potential Amazon acquisition in the UK supermarket industry which is why they are looking for scale in order to safeguard their future. They are also concerned at being able to maintain price competitiveness with discounters Aldi and Lidl also continuing to eat at their market share.

Walmart recognises how tough the UK grocery market is to crack and has seen first-hand the threat Amazon faces to its domestic business since Amazon’s acquisition of Wholefoods so is right to be wary of the same happening in the UK. With food price deflation a threat to the growth of grocery retailers, Walmart is following Tesco’s lead by putting more emphasis on its home market at such a challenging time. If ASDA and Sainsbury’s are able to drop their prices by 10%, as suggested by Sainsbury’s CEO Mike Coupe, then the group would be in a much better position to compete on price against the current competition of Aldi and Lidl and future threat of Amazon.

Source: Euromonitor International

Non-Grocery provides opportunity for higher margin gains

In 2016, Sainsbury’s acquired the mixed goods retailer Argos. Like with the current ASDA acquisition the deal was unexpected, in part because Argos has a more downmarket image relative to Sainsbury’s. Argos established itself as a catalogue shop selling a comprehensive range of non-grocery products. Although the brand had begun to be seen as dated, Argos had successfully re-invented itself as an online retailer, with currently just over 50% of its revenues generated online. By acquiring Argos, Sainsbury’s was hoping to expand both its non-grocery offering and its online presence.

So far integration of Argos into Sainsbury’s, including rolling out Argos concessions in its stores, has been slow. However with the proposed merger with ASDA, Sainsbury’s is in a position to fully realise its GBP1.4 billion acquisition of Argos. On a number of levels Argos is a much better match for ASDA than Sainsbury’s. By their nature ASDA stores are established as hypermarkets making them more of a destination for non-grocery purchases. The larger selling space of ASDA stores allows room to allocate space for Argos stores with a wider range of goods within the existing ASDA estate. Meanwhile Argos’s relatively more downmarket customer perception is more in line with that of ASDA.

By bringing together Sainsbury’s, ASDA and Argos, the combined group will exponentially have strengthened its position in non-grocery sales. This is significant as non-grocery offers higher margins than grocery due to the relentless rise in competition from discounters Lidl and Aldi and potentially Amazon in the future. In the longer term Sainsbury’s may rely on non-grocery, including Argos, for most of its profits, with grocery to drive footfall in its stores.

What implications does the merger have on the wider UK grocery sector?

The proposed merger of Sainsbury’s and ASDA will undoubtedly force the remaining players in UK grocery to respond. The current fourth largest player, Morrison’s, will feel even more exposed, with its 8% market value share potentially falling 14 percentage points behind Tesco, the new number two. Morrison’s has been subject to rumours of a take-over by Amazon, which now increasingly seem plausible. Tesco is in the middle of its own integration after the acquisition of wholesaler Booker and will likely lobby the Competitions Market Authority to ensure it is not unfairly disadvantaged by the merger.

German discounters Aldi and Lidl have been the success story in UK grocery retail, both having more than doubled their value sales over the past five years, whilst their rivals’ growth has remained largely flat. Looking beyond the integration of ASDA will be whether Sainsbury’s revisits the discount channel after its failure to make a success of Danish discount brand Netto. Despite critics worried about an impending duopoly, consumers are likely to benefit from increasingly lower prices as the UK supermarket price war has no end in sight.

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