Dr Jo Bentham considers what can be learnt from manoeuvring in the food retail sector

Just before the Easter holidays earlier this year, I was working through some practice microeconomics data response questions with the Upper Sixth. Having worked through the questions, used the awarding body marking scheme, we then found ourselves speculating on the future of the UK food retail sector. It was felt that something would have to shift sooner rather than later. The German discounters had made their presence known and their growing market share had made a significant impact on the market. Tesco, the market leader, had merged with Booker, the UK’s largest food wholesaler, and the students were able to recognise the synergies that would result. Amazon had just made a foray into the US grocery market and we discussed how Sainsbury’s takeover of Argos in 2016 might enable them to compete on an online basis with a potential move into the UK by Amazon. The students were emphatic that internal growth on its own would not be sufficient to satisfy the big 4 supermarkets’ need for profit margins. So, the news breaking towards the end of April that Sainsbury, the UK’s second biggest food retailer, were planning to enter into a merger with Asda, the third biggest food retailer and owned by the American conglomerate Walmart, was a timely justification of their predictive skills through analysis and evaluation.

Since this April announcement, the Competition and Markets Authority (CMA) has launched their investigation into the planned merger, which could see the biggest competition inquiry in many years. The competition authorities will be concerned with the proposed merger not only creating an operator with a bigger market share than Tesco, but also a duopoly market structure, as a Sainsbury’s – Asda merger plus Tesco would control almost 59% of the market. In 1997, a proposed smaller scale merger between Asda and the former Safeway supermarket chain was prevented on the grounds that it reduced competition. In 2003 Safeway was bought by Morrisons (the fifth smallest of the national chains) after having to comply with the selling off of 53 stores. This suggests that the CMA may want to see a minimum of four big operators within this market to ensure that there is competition and lower prices for consumers.

So, business and economics gold for A Level teaching – Market structures, Business objectives, Competition policy, Mergers, Economies of Scale, PESTLE, Porter’s Five Forces, Monopsony amongst others, and already written into my scheme of work for teaching Market Structures and Competition Policy to the A Level Economists in the summer term, and ready to create resources for the department delivery of Business Strategy and Competitiveness for the A Level Business students.

The key issues for my lesson planning and resources will focus on:

The business objectives underpinning this announcement.
Fairly static profit margins of 2-3% will have encouraged Sainsburys to find ways to lift their profitability quickly. The need to source their supplies at a reduced cost is paramount, and added to this, the impact of leaving the European Union means that they will need to be operating on a much larger scale to achieve purchasing economies of scale. The company will also want to reduce any surplus underused High Street space, whilst maintaining market share. The threat of Amazon turning up in the UK food sector has just been realised as they scout out possible sites, and Sainsbury’s wants to be ready for this. Whilst Sainsbury’s motives are quite obvious, Asda’s are less clear. Owned by Walmart, the world’s largest company by revenue, why would they want to hand over the day to day management of running this merger to Sainsbury’s? Clearly, this would free up Walmart to focus elsewhere, and reports that they are wanting to invest heavily in and develop the Walmart brand in Africa would support this decision. With a proposed option to divest their investment after four years, would suggest that this merger will provide them with the cash required to implement market development business growth strategies.

The impact on stakeholders
There is much that can be discussed here, including the probability of possible store closures and other rationalisation activities and the impact this will have on employees. Sainsbury shareholders saw their investment increase in value following the announcement, and suggests that shareholders see this as a good move. Customers may find this a more disconcerting strategy wondering whether the existing brand identities will remain and if there will be a change in pricing strategies. Will the new merged business remain focused on their existing target markets? However, from a competitiveness perspective, the spotlight will be on the suppliers. An enlarged supermarket chain creates the possibility of an increase in monopsony and buying power, with suppliers already concerned about the further squeeze on already slim margins.

The direction of the CMA inquiry
The CMA will be concerned about the possibility that the merger will reduce consumer choice, possibly see a deterioration in the quality of services, and will lead to higher prices. Retail analysts are predicting that the two companies will have to sell a number of stores in order to convince the CMA that the proposal will not inhibit competition. Interestingly, in 2003,when Morrisons acquired Safeway, their sale of stores allowed Waitrose to become a more significant player in the UK food retail market. This could be seen as an opportunity for the smaller chains.

As we await the recommendations of the competition authorities, this could be the case study that keeps on giving. Please let me know how you decide to use this material, and if you would like to write an article on any other items of Business and Economics in the News, please contact me on jobentham@gmail.com or on Twitter at @Benthambiz .

https://www.bbc.co.uk/news/business-43945254 – Sainsbury’s vow Asda deal will cut prices.
https://www.bbc.co.uk/news/business-43947212 – Sainsbury’s – Asda deal in nine charts.