Industry consolidation has been the topic at Canada's grocery trade industry gabfests this year. Key players began have begun sounding like teenagers chattering about which cheerleader is going to date which football player.

"Not a day goes by that we don't hear rumors about mergers and acquisitions," said Grant Hansen, President and CEO of Canada Safeway to a recent meeting of the Canadian Council of Grocery Distributors. "It's clearly the topic of the day."

Co'op Atlantic CEO Eric Claus who addressed the same conference, agrees. "This year has been marked by a continuation of the whole consolidation process," said Claus, citing the grouping of 28 Coops to form the Atlantic Regional Cooperative, -- Canada's second largest. "It's a phenomenon that is bound to continue."

Much of the consolidation talk pervading players in the Canadian grocery retail market has been sparked by news from both the U.S. and Europe where domestic players -- plagued by stagnant or slow-growing markets, -- are turning abroad for expansion.

"Worldwide, the industry continues to consolidate at a very rapid rate," says Eric Bass, an analyst with Netherlands-based Rabobank. "Within the last four years, annual sales of the world's 20 largest food retailers have increased from US $600 billion to more than US $850 billion."

Canadian food retailers are behind their European cousins when it comes to consolidation, with the three largest accounting for about half of domestic food sales. About a dozen European countries have higher levels of concentration, with Sweden topping the list at 95%. U.S. consumers tend to spread it around a bit more, with only 30% of the market controlled by the three largest players.

Beyond slow domestic growth, there are other factors pushing grocery retailers to get bigger. Getting better returns to scale through increased buying power with suppliers is one. Having the ability to spread out the cost of implementing of increasingly expensive EDP systems is also a consideration.

But probably the biggest factor pushing international industry consolidation is the enormous pressure on grocery retail CEOs to boost earnings growth and to maintain their high stock valuations, both of which are at unsustainable levels for a mature industry.

Neatherland's based Ahold is a good example of how European players are taking the lead in the consolidation process. Ahold lets the companies it acquires keep their identities and retain much of the acquired managerial talent. The idea is that local employees can best exploit local markets. Thus Ahold has sparked the imagination of a wide variety of retailers since pretty much anyone is a potential merger or acquisition target.
Through a variety of moves particularly Latin America and East Asia Ahold has transformed itself from a minor local player into the fourth largest grocery retailer in the world, and is now present in 25 countries and generates more than 80% of its revenues on the international scene.

With Canada's grocery retail business dominated by locally-controlled players who know their markets well, such as Loblaws, Sobeys and Metro, domestic retailers present an attractive target for international firms such as Ahold, who are looking to expand. That leaves experts trying to figure out how our country fits into the plans of multinational players. Is Canada ripe for the pickings?

According to Claus, the answer is yes. "Canadian retailers are very attractive targets, especially in the mid- to large- sized category," says the Co'op Atlantic President and CEO. "(Despite our sparse population), Canada has very strong retailers."

Others are not so sure. "Whose going to buy who?" asks John Scott, president of the Canadian Federation of Independent Grocers skeptically. "The Canadian grocery industry is already highly concentrated. A lot of the people talking about mergers are just trying to build up the value of their own companies."

Independent retailers are worried that continued consolidation is going to weaken both their competitive position in future price wars, and their negotiating power with suppliers.

Ironically, loss of bargaining power in dealing with increasingly powerful suppliers affects the majors as well. Suppliers have long complained about large retailer's stringent price demands and their additional "volume discount" requests, and have responded with a round of consolidations of their own. But now it seems that the shoe is on the other foot.

"What are the implications of having just one or two suppliers in many categories?" asks Nick Jennery, president of the Canadian Council of Grocery Distributors citing the fact that many retailers have access to only one supplier of baby products as an example. "It gives the supplier considerable power."

According to Jennery consolidation talk should focus on the people who buy groceries. "The key (with consolidation), is to look at its effect on consumer," says Jennery. "And preliminary results from our organization's current price trend survey, show that they are getting a great deal."

So with tough pricing competition in the Canadian market, international players would be crazy to and jump in. Right?

Maybe not. On its face, the Canadian grocery market looks like a pretty tough nut to crack. A wide range of retailers from niche based independents to cross country chains, provide Canadians with an unparalleled variety of high-quality products at attractive prices. Any substantial move into the Canadian market by an international player would have to come either through an acquisition or a building program, and both present considerable problems. Worse, market size is limited to population growth, and foodservice companies continue to cut into potential expansion opportunities.

With several Canadian retailers substantially upgrading their networks, and many under-performing locations being closed, a new player building from scratch would face considerable obstacles in trying to achieve a foothold.

So if a new player building up a new network from scratch is out, that leaves acquisitions. But buyouts present problems of their own. Canada's two largest players, Loblaws and Sobeys, are invulnerable to hostile bids, and any takeover move would require management consent.

The two major American players, operating in Canada - A&P and Canada Safeway are also tough nuts to crack. Safeway Canada looks like a prime candidate to expand its market share, and its assets would make a great fit with A&P.

But A&P is a loose cannon. It holds a strong position in several markets, notably a 34% piece of the Greater Toronto Area pie. However A&P's American parent seems to be treating the Canadian operation as a cash cow, by not releasing adequate funds to maintain and upgrade its infrastructure.

Since it is one of the crown jewels in the A&P empire, the highly-successful Canadian unit is unlikely to be sold off separately. Over the long-term A&P's current policy can only result in a gradual loss of market share to the competition.

According to Domenik Dlouhy, of Dlouhy Investments Inc. the most likely takeover candidate remains Quebec-based Metro Inc. "The company is gaining market share, has super management, has raised dividends and is trading at eight times forward earnings," says Dloughy. "That makes it a highly attractive proposition."

But the biggest threat to Canadian grocery retailers is that of two U.S. players, Wal-Mart and Costco. According to projections made by National Bank Financial analyst Perry Caicco, the two (who Ciacco calls the "Evil Empires") have quietly grabbed a 7% share of the Canadian market. This total could jump to 10% by 2005, which would leave them combining for third place behind Loblaw and Sobeys.

What makes the Wal-Mart and Costco threat so serious is that both have grabbed a big chunk of the market, and nobody seems to know where the business came from.

"The Evil Empires are subversive," says Ciacco in a recent research report. "We have yet to find a single food store manager who has ever admitted that Wal-Mart of Costco has taken sales from them."

Although Costco still has room for expansion in some markets such as the GTA, growth seems to be leveling off recently. But Wal-Mart seems ready for a big to move. According to Caicco, the company is unlikely to roll out its successful U.S. Supercenter operation in the Canadian market for the time being, and possibly not ever. Wal-Mart has stated its intention to roll out its highly successful pantry line-up to 90% of its Canadian discount stores, which could make a considerable dent in sales projections for a lot of Canadian retailers. And Wal-Mart has plans for another 60 to 70 of these stores over the next five years.

It's hard to see how things will play out in the short term, but a few things seem clear says Rabobank's Baas. "You will probably end up with a few international retailers, plus strong regional players, says Bass. "The wave of globalization is not yet over yet, and European grocers will likely continue to lead the way. But retailers must choose, when stuck in the middle, you are out."

Charts and visuals

***Show chart of the world's ten largest food retailers, as well as the top Canadian players

Diekmeyer can be reached at peter@peterdiekmeyer.com

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