Sainsbury’s/Asda vs M&S/Ocado – a tail of two tie-ups

Written By:

Stephen Springham, Knight Frank

01 Mar 2019

7 minutes to read

Categories: Retail UK

• Scant media coverage of the official retail sales figures for January from the ONS, largely because they were positive. Year-on-year retail sales values were up 4.3%. The figures were noteworthy because the increase was driven almost entirely by volume growth (+4.2%), with minimal inflation. Brexit-induced inflation has now largely annualised and washed through the system and earnings growth is now substantially higher than RPI. What reasons will the media now find to explain retail malaise, other than the overly-simplistic rise of online?
• Contrasting messages from the fashion sector. Primark expects first half sales to be 4% ahead of the same period last year, although group like-for-likes are likely be down by 2%, on account of a -3% l-f-l fall in the Eurozone. The business also stated that pre-tax profit will come in well ahead of last year due to improvements in margin mix. Sales in the UK have been 2% ahead of last year, with cumulative like-for-like sales improving since the last trading update in January. But more upmarket counterpart Ted Baker has warned that full year profit will be lower than expected due to foreign exchange movements and costs associated with system upgrades and inventory write-downs. In a statement, the company said profit before tax is now expected to be in the region of £63m.
• Ongoing strong performance from Hotel Chocolat. For the 26 weeks to 30 Dec, profit before tax was up 7% to £13.8m, while sales increased 13% to £80.7m. A total of 14 new stores opened in the UK and Ireland in the period, which also saw the business launch its first stores in New York and Tokyo. More seasoned international operator The Body Shop reported a 1.7% increase in sales to £797.5m in its 2018 financial year, driven by a 1.8% increase in like-for-likes across non-franchise stores. UK sales increased 2.3% during the period on a like-for-like basis, and were up 2..5% in the fourth quarter of the year. The retailer closed a net 62 stores globally in the year and ended the period with 2,935 stores (including franchise outlets).

Stephen Springham, Head of Retail Research:

“The CMA are going to have a field day” was the exact text I sent to a very good friend who works in senior management at Sainsbury’s the day news broke of their proposed merger with Asda. In the wake of last week’s announcement from the CMA, this now seems eerily prophetic. But not for one minute did I think said field day would involve the CMA blocking the deal outright and I am as surprised as anyone with its provisional findings.

It was as much the aggressive tone of the CMA that was surprising, over and above the findings themselves. It doesn’t just have concerns, “it is likely to be difficult …to address these concerns”. Reading between the lines, it doesn’t matter what concessions Sainsbury’s and Asda are prepared to make, the deal is not going through, in the eyes of the CMA.

The concerns themselves? The merger would “reduce competition” (ten key players becoming nine, I think we can all do the maths on that one?), lead to a “poorer shopper experience” (because a merged Sainsbury’s/Asda are going to go out of their way to make their stores horrible and get staff to be nasty to customers?) and “lead to higher prices” (the first thing a merged business with heightened buying power is going to do is hike prices in such a cut-throat, price-sensitive market?). The last objection in particular seems to owe more to an economic textbook from the 1920s that it does to modern day retail market dynamics.

Is the deal dead in the water? It would seem hard for it to come back from this, although I have no doubt that Sainsbury’s will come out all guns blazing in challenging it – possibly even mounting a legal challenge? As I’ve written on many occasions, my support of the proposed merger in terms of strategic direction for either party was never 100%. My personal concerns were less about differences in market positionings, much more about executional risk (possible indigestion, distraction and taking up a disproportionate amount of management time). But I would stop short of calling the deal collapsing a blessing for both parties.

The CMA has certainly lived up to its billing as an erratic, inconsistent force that is impossible to second-guess. After all, this was a body that saw fit to investigate Poundland’s acquisition of 99p Stores, yet perversely waved through the much larger and hugely significant Tesco / Booker merger with next to no concessions. I can almost hear Tesco’s board laughing from here.

Just as one major supermarket tie-up seemingly comes to nought, another one comes out from left field. Ocado has announced the creation of a new 50-50 joint venture (JV) with Marks & Spencer. M&S has agreed to pay Ocado £750m for a 50% share of the new JV with Ocado retaining 50% ownership. The JV will combine M&S’s branded food and beverage range with Ocado’s existing range of Ocado own label and third party branded products, to offer over 50,000 SKUs to consumers. M&S product will be available on the platform by September 2020.

For some, Ocado is synonymous with Waitrose and the two have been in partnership since 2002. Although this long partnership will come to an end, this really shouldn’t be a surprise. Waitrose/John Lewis could easily have bought out Ocado on many occasions in the past, yet opted not to. Instead, they launched Waitrose.com and maintained a supply agreement with Ocado, which lapses in 2020. With Waitrose.com coming of age and continuing to grow strongly, it was pretty obvious that they would not extend the partnership beyond this time. Ocado shoppers that used the service purely on the basis of its association with Waitrose can simply swap allegiance to Waitrose.com.

In terms of M&S and Ocado, this is not a simple swap deal for a new supplier – this essentially splits the Ocado business into two, with M&S and Ocado joint partners on the grocery side and Ocado Solutions being retained by Ocado and free to continue to drive partnerships elsewhere in the world.

The deal is effectively another masterstroke for Ocado. As a standalone retail operation, it was always going to struggle to be a viable, profit-generating business. But by positioning itself more as a Business Solutions Provider and effectively leasing out its technology, best-in-class supply chain capability and intellectual capital, the whole business model changes, as do its potential financial returns. The substantial cash that Ocado will be receiving from M&S will neither jeopardise nor compromise its lucrative partnerships with other international grocery retailers – Kroger in the US, Sobeys in Canada, Casino in France and ICA in Sweden.

Whether this is a masterstroke for M&S is an entirely different question. M&S’ lack of an online food operation was cited by many as a competitive weakness and although it had launched tentative tests in certain areas of London and the South East, it was patently clear it wasn’t going to succeed if it continued to go it alone.

Other analysts, particularly those of an “online cheerleader” persuasion, have heralded the tie up as a very wise strategic move for M&S. The issue is that said analysts tend to have a very loose handle on the hard financials of retailing. Yes, online continues to be a fast-growing channel within the grocery market, but its profitability is anything but proven. Volume / big basket size is central to success and M&S is less aligned to this model than the ‘Big Four’. All the more reason it should supply through Ocado than try and do it themselves.

An overdue investment in a high growth channel with a great partner, plugging a strategic gap and competitive weakness. Or over-paying to keep up the Joneses in a venture that won’t be profitable and won’t address the core failings of the existing business? Maybe the CMA has the answer?