Supermarket Consolidation

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Sean Hinton

Supermarket consolidation has changed the grocery retail landscape in the U.S. and beyond. Originally, supermarkets rose to prominence by selling numerous types of goods under one roof, largely replacing small grocery stores and other retailers that only sold one particular type of product. Smaller supermarkets have since been increasingly supplanted by even larger supermarkets, the cavernous stores that now dot the retail landscape. In order to increase efficiency and maintain competitiveness, supermarket chains began consolidating, a trend that has led to the dominance of the grocery retail industry by a shrinking number of giant companies.

The effects of this trend have been widespread. Not surprisingly, smaller chains have suffered as supermarkets' low prices and large variety have attracted an increasing number of customers. As the largest supermarkets grow, they're accounting for a larger and larger percentage of their suppliers' sales. Manufacturers are becoming increasingly dependent on a small number of retailers for sales volume, which gives these retailers significant leverage to bargain for lower prices. This can negatively impact any firm whose goods are sold in supermarkets.

Effects of Supermarket Consolidation

U.S. grocery market in 2001, by % volume

U.S. grocery market in 2006, by % volume

As with any industry trend, supermarket consolidation can only happen with customers' permission. If customers were opposed to consolidation, they could voice their discontent by not shopping at the large supermarket chains. As we've seen, however, they do patronize these "hypermarkets". The reason for this is that larger, consolidated supermarkets can offer customers several benefits that smaller grocery stores generally cannot.

• Affordability and Convenience

Large, consolidated retailers are able to use their size and purchasing power to lower their customers' prices, often by a significant amount. As the grocery retail landscape becomes dominated by a few massive players, these companies are accounting for larger and larger percentages of food and beverage manufacturers' total sales. Manufacturers are growing increasingly dependent on huge supermarkets for business, giving these retailers considerable leverage over their suppliers' prices. Though this trend can harm any firm whose goods are sold in supermarkets, the resulting prices are typically lower than those of smaller retailers. These lower prices, combined with the sheer variety of goods sold in today's supermarkets, have been primary drivers of the shift from small, local grocery stores to cavernous "hypermarkets".

• Standardization

Though stores in different locations don't have identical inventories, large retailers do generally offer some degree of standardization in terms of the types of goods sold. Smaller retailers, whose inventories often vary widely, cannot offer the same degree of predictability and standardization as large retail chains, which can be an argument both for and against supermarket consolidation; while some consumers appreciate the familiarity that large supermarkets provide, others enjoy the variety and specialization of inventory that smaller supermarkets can offer. This leaves small retailers with the option to specialize in a certain niche that is neglected by larger chains, which can help insulate a retailer against the effects of supermarket consolidation.

• Private Labels

Supermarket consolidation has also spurred the increased penetration of private label goods. Private label goods, often called "store brands", are products sold at just one retailer. They are often designed to compete against branded products, offering customers a cheaper alternative to national brands. Though the public generally used to see them as low-cost imitations of branded products, private labels have overcome this reputation and achieved significant growth in recent years. Large retailers like Wal-Mart and Target are particularly fond of private labels and have greatly expanded their offerings in the segment. In addition to appealing to customers' frugality, private labels provide higher margins than national brands and can increase a retailer's customer loyalty to the store as a whole. While this trend has led to lower prices and increased variety for customers, it can substantially harm the manufacturers of branded goods.

Who benefits from more consolidation?

• Whole Foods's (NASDAQ:WFMI) position at the high end of the food retail market could benefit the companies if consolidation among supermarkets continues. The larger retailers often emphasize cost savings in their marketing campaigns, whereas Whole Foods and Wild Oats focus on high-quality organic and gourmet products. As such, people who might have previously gone to smaller grocery stores for high-end foods are likely to turn to these specialty grocers for their upscale culinary needs. This niche is consolidating itself, with Whole Foods planning to buy out fellow natural retailer Wild Oats (NASDAQ:OATS).
• The Cott Corporation (NYSE:COT) and other manufacturers of private label goods could benefit from the increased popularity of private labels, which supermarket consolidation has encouraged.

Who benefits from less consolidation?

• SuperValu (NYSE:SVU) and Koninklijke Ahold, N.V. (AHO) are two of the top six grocery retailers in the U.S. Though they are still significant players in the grocery retail market, they've seen declining market share in recent years. Continued consolidation among supermarkets could make it more difficult for these companies to maintain their market share.
• Del Monte Foods (NYSE:DLM), the Clorox Company (NYSE:CLX), and Revlon (NYSE:REV) are all major suppliers to Wal-Mart (NYSE:WMT), who accounts for 24%, 23%, and 23% of their revenues, respectively. Wal-Mart also accounts for over 20% of sales for Procter and Gamble (NYSE:PG) and Newell Rubbermaid (NYSE:NWL). Manufacturers such as these, whose sales have become increasingly dominated by a smaller number of retailers, have become less free to set their own prices, which can lead to lower profit margins. These companies would likely benefit from decreased consolidation.