Sainsbury's and Asda proposed merger

1 May 2018

Sainsbury's and Asda proposed merger

A defensive move with no guarantees of success

Legacy retailers and supermarkets operate in a hostile environment. So far this year 14 large retailers have failed, resulting in the closure of 1,236 stores and loss of 13,176 jobs. The traditional supermarkets’ grocery business is under attack from discounters and their non-food business from the internet retailers. And Amazon is toying with the idea of entering the grocery market, dwarfing the pain inflicted by discounters.

The proposed merger between Sainsbury’s and Asda creates scale enabling them to better withstand the current strong headwinds. Together they will have close to a third of the market, replacing Tesco (with 27.6% market share) as the market leader. The combined group will have a turnover of £51bn, a network of 2,800 stores and 360,000 employees. They will account for £1 in every £3 spent on groceries, giving them strong purchasing power.

Combining the second and the third largest supermarket groups makes sense because their capabilities and competencies are complementary. Asda is big in non-food and pricing but weak in e-commerce and private label. On the other hand, Sainsbury’s’ acquisition of Argos has bolstered its e-commerce capability and private label is one of its core strengths. Their customer base is different, reducing dangers of cannibalisation. Geographically they complement each other as Sainsbury’s is strong in the South and Asda in the North. The combined group will have greater muscle to negotiate favourable deals with suppliers. Finally, the deal paves the way for Sainsbury’s to open Argos branches in Asda stores, bolstering non-food sales of the combined group.

The deal promises £500million of cost savings and lowering of prices by around 10 per cent on products customers buy regularly. Mike Coupe, CEO of Sainsbury’s, has been at pains to point out that there will be no store closures or job losses as the result of this deal. Yet unions are concerned about jobs and small suppliers worried about the market power of the new organisation.

The proposed deal will create a duopoly – Sainsbury’s/Asda and Tesco combined will have a market share close to 60 per cent. The merger could also create concentrated local monopolies. To protect public interest the proposed deal will be forensically examined by the Competition and Market Authority (CMA). This may take up to a year and there is no guarantee of approval or the possibility of imposition of onerous conditions rendering the deal unfeasible. For example, requiring disposal of significant number of stores may scupper the deal because disposal in the current condition is difficult and costly negating any possible savings. Sainsbury’s/Asda no doubt will point to the Tesco and Booker deal which was nodded through. They will also argue that the market is competitive, pointing to 1,000 combined stores of Aldi and Lidl as well as the growth of online retailers offering additional choice to many consumers. Politicians and unions are already calling for close scrutiny of the deal and its potential effect on competition, consumer, suppliers and employees.

The deal promises to enhance Sainsbury’s/Asda’s ability to more effectively compete with discounters and on-line retailers. It also has the backing of Qatar Investment Authority, the largest Sainsbury’s share holder. Yet leaving aside CMA’s inquiry, the proposed deal runs a number of risks. Sainsbury’s’ management needs to divide its attention between successfully integrating Argos and back office of the tie up with Asda. But a merger of this magnitude and complexity requires the undivided attention of the management. Can Sainsbury’s manage both deals effectively given its lack of M&A experience? The intention is to retain the two brands and maintain operational independence. This adds to the complexity, and mergers at the best of the times are complex. 

Combining effectively two large organisations with two different management teams, operation and culture, is challenging, requiring considerable management skills and goodwill. Despite the familiarity of the two CEOs with each other’s businesses, implementation carries significant risks. The omens for such deals working well is not good. Both the Morrison and Safeway and Carrefour and Promodes deals proved problematic. Sainsbury’s and Asda’s deal potentially gives the combined group scale to more effectively navigate the market both in relation to discounters and disrupters such as Amazon. But it carries considerable execution risks. Its success or failure ultimately depends on skills of its managers.