Nick Morgan

The traditional “Big Four” supermarkets, Tesco, Sainsbury’s, Morrisons and Asda might become the “Big Three” following Sainsbury’s announcement on Monday to merge with Walmart subsidiary Asda in a £10bn mega-merger. The combination of Sainsbury’s and Asda would create Britain’s biggest grocer by market share, meaning the duo would control just shy of one third of the market, toppling Tesco off top spot. The big might is that the merger will almost certainly trigger a UK Competition and Markets Authority (CMA) investigation (more on this later).

Walmart, Asda’s parent company, is set to receive almost £3bn in cash and 42% of the newly combined business in return for selling Asda. Together, the deal will create a network of 2,800 stores, 330,000 staff and 31.4 per cent UK market share. The plan is to keep both Sainsbury’s and Asda brands alive and, rather amazingly, not close any stores. However, some of the mechanics of the merger may be out of the duo’s hands as some analysts believe up to 15 per cent of the combined store estate may need to be sold to rivals in order to secure regulatory approval from the CMA.

Under pressure

The two supermarkets are facing pressures from within the traditional “Big Four” market, with the current market leader, Tesco, completing a £4bn purchase of wholesaler Booker in March 2018.

At the other end of the spectrum, the phenomenal growth of German discounters Aldi and Lidl has also squeezed the “Big Four”. If one factors in the online retail giant Amazon’s move into grocery retail and other online grocers like Ocado, it is easy to see the pressures on the traditional supermarket model of a big out-of-town store.

The “discounters” and “online” players have transformed the sector over the past decade making it more competitive than ever. They have been in prime position to benefit from a change in consumer behaviour.  The large out-of-town superstore has become less popular as consumers move towards local discounters and the ease of online shopping.

The proposed merger marks an ambitious attempt by Sainsbury’s to re-position itself in the market and create a new force in UK retail. For Mike Coupe, CEO of Sainsbury’s, bigger seems to be better as Sainsbury’s still ride the wave of acquiring Argos in 2016. This latest merger plan goes to show Sainsbury’s are prepared to be aggressive in finding new ways to disrupt the retail market.

The trends

Consumer markets like the traditional “Big Four” UK grocer market, the UK mobile network market and high street betting shops are often referred to by economists and analysts as an oligopoly. The market is deemed ‘imperfect’ because there are many buyers, but a few concentrated suppliers dominate the market.

Mergers are commonplace in the world of oligopolistic competition. The cosy relationship in the UK mobile network market between the likes of Vodafone, EE, 02 and Three was once also home to Orange and T-Mobile. The oligopolistic nature of the mobile network market meant that only the huge could survive so out went Orange and T-Mobile and in came EE. A similar deal is emerging across the Atlantic between US T-Mobile and rival Sprint. This tie-up would leave the US with only three major players in mobile.

The arguments in both mobile and groceries are the same; by taking a competitor out of the market, the market will become more competitive. The paradox holds that, for example, if Sainsbury’s does not buy Asda, the likes of Tesco and Morrisons (and now perhaps Amazon), will eliminate them both. In essence, the “Big Four” needs to become the “Big Three”, or it will become the “Big Two”.  However, the proposed new “Big Three” will be under scrutiny from the CMA before any deal is finalised, which could take up to a year.

The future

The sheer size of the potential merger, carving out over 30% of the market for the duo, will hinge on regulatory approval by the CMA. A CMA investigation will be carried out in two phases; with phase two kicking off if the potential for a substantial lessening of competition is identified. That is a given, so the CEO of Sainsbury’s is asking for the CMA to fast-track straight to a phase two investigation.

The duo is likely to point out that despite the market appearing to move to a “Big Three”, the market is in the midst of a tidal shift and the pressures from online retail and the German discounters Aldi and Lidl mean that the market is far more dynamic than simply three or four big players.

For us, the consumer, the duo will argue that the economies of scale gained will result in operational efficiencies and greater bargaining power helping lower prices and create more choice. It has also been suggested that Asda will become home to Argos stores, which adds another dimension to the merger as a retailer rather than just a grocer.

However, this is not such great news for the suppliers, who are likely to bear the brunt of price drops if the duo really do stick to their guns and avoid store closures. Although this decision is somewhat out of the duo’s hands since the CMA may suggest store divestments are essential for the merger to gain approval and therefore job losses may be inevitable.

The competition in the retail sector is as fierce as ever. This latest merger may be an indication that other deals are on the horizon as retailers innovate and react to changes in consumer behaviour and seek to keep up with the market. This move between Sainsbury’s and Asda goes to show that Aldi, Lidl and Amazon are not the only retailers capable of surprising the market.

The merger might prove to be a very cunning move by Sainsbury’s in tackling Tescos off its top spot; however, it would leave 60 per cent of the market in control of just two companies. Such a stranglehold will cause a headache for the regulators and is probably bad news for small suppliers who are likely to see their margins squeezed further. Nevertheless, if the deal goes ahead, for better or worse, the UK grocer’s market will have changed dramatically.

Nick Morgan is a trainee at Stephenson Harwood