UK retailers seek defensive alliances

The expected wave of mergers among retailers, sparked by the proposed link between Asda and Kingfisher, could pit UK store groups against their larger rivals around the world.

According to consultancy Gemini, not one UK retailer ranks in the world’s top ten store groups, and some observers say that the British baulk at the thought of taking on the foreign chains with their wafer-thin margins and massive buying power.

The Competition Commission inquiry into UK supermarkets reinforces the widely held belief that the food retailers are using their market power to keep prices artificially high. But although they may be portrayed as the bullies in the UK high street, the prospect of competing on a level playing field with overseas companies has got UK retailers running scared.

The proposed merger of Kingfisher and Asda is a defensive move against the arrival of US hypermarket chain Wal-Mart. It echoes the situation in 1994 when Kingfisher boss Sir Geoff Mulcahy feared the arrival of US DIY giant Home Depot, which would have competed with Kingfisher’s B&Q chain. Mulcahy helped see off this threat by imitating the 100,000 sq ft Home Depot format with B&Q Warehouses. Once again, Mulcahy may have put off the day when UK retailers have to face the full force of overseas competition.

At the announcement of the Asda deal, Mulcahy said: “It is the nature of the game that is changing. If you do not build scale then you will not be able to offer value to customers.”

Yet, despite the existence of these pressures stretching over a decade, and the shadow of Wal-Mart for at least the past two years, Kingfisher is one of the few UK retailers which has made any headway in achieving significant foreign expansion – a development seen as essential by City analysts as growth opportunities fade at home.

Nearly 400 of its 2,600 stores are in France, it owns 55 per cent of Europe’s number one DIY retailer, Castorama, as well as electrical retailer Darty.

Other UK retailers, including the UK market leaders, are far behind Kingfisher and, more importantly, their counterparts on the continent.

Even Tesco, which has ventured into the Far East and Central Europe, lags behind – due in part to the intense battle UK supermarkets have to wage in their domestic market to maintain share.

John Bateson, senior vice-president at Gemini Consulting, says: “Tesco is our biggest player but it is only the 13th largest in Europe – UK companies are sub-scale. The supermarkets need to stop worrying about each other and start competing in Europe.”

One problem for UK companies, however, is a lack of available partners with which to enter European markets. And once there, they may face even stiffer competition than in the UK. Tesco pulled out of France last year, unable to take the heat of European retail competition.

Bateson says: “One reason British retailers haven’t targeted Western Europe is because they would have to compete with the large international groups which are there already. They have to get an international presence but there is little scope for doing so.”

Sainsbury’s, for example, has been linked to Netherlands food retailer Royal Ahold and the two share some similarities, yet the 110-year-old Dutch company earns 68 per cent of its sales outside its home market. By contrast, Sainsbury’s earns three-quarters of its revenue through its UK supermarkets business.

Foreign retailers have forged ahead of the UK through the acquisition of smaller companies in mainland Europe.

The large retail groups such as Switzerland’s Metro Group, France’s Intermarché/Spar, and Germany’s Rewe Zetrale, which rank third, fourth and fifth in the world retail sales league (behind Americans

Wal-Mart and Sears), have developed businesses in most European countries.

Yet, even they are restricted largely to southern Europe, South America, and the Far East for further expansion – owing to the strength of Northern European players.

Retail Intelligence analyst Clive Vaughan says: “If there’s one thing that stands out, it is that there has been so little merger activity in Northern Europe. Even Wal-Mart has yet to succeed in Western Europe. It has two companies in Germany, one successful, one not. The opportunities of moving elsewhere are far greater.”

Henley Centre chairman Paul Edwards says: “To compete long term, European retailers have to consolidate into a smaller number of much bigger players.”

Yet, on the evidence, the big names may do better to consider cross-sector deals similar to that of Kingfisher and Asda both in the UK and Europe.

However, most names which have been speculatively lined up for mergers – Marks & Spencer and Tesco being the most recent – have been dismissed as too mismatched to be taken seriously.

Edwards says: “The next one to consider is Dixons. Dixons and Boots? Dixons and Sainsbury’s? M&S and Sainsbury’s would be a better fit than with Tesco because of culture. It is a lottery, pulling names out of a hat, but some of the partnerships would be logical.”

He believes mergers with businesses in related industries such as distribution companies are just as likely as with retail rivals but adds that there is potential for deals everywhere.

“Tesco could tie with the market leader in any country and the same with Sainsbury’s. It is simply a question of will,” he says.

So far, neither Tesco nor Sainsbury’s has clearly pursued strategies to merge their food businesses with companies in other sectors. Both have preferred to develop non-food lines through their own hypermarket formats, Extra and Savacentre respectively.

However, Tesco chief executive Terry Leahy’s recent comment that “everyone is talking to everyone” suggests there may be more surprises to come.

One retail analyst says: “Now Asda has been taken out, who knows if Wal-Mart will come? But it could take over someone like Morrisons, trade at ridiculously low prices and destroy share prices in the sector. Or it could buy Tesco – it is big enough.”

Such acquisitive power is a fearful thought for Britain’s top companies, particularly given the downward trend in share prices in the sector.

British retailers – especially the supermarkets – are fond of saying they are the best in the world. But they have not faced the full heat of competition with the world’s leading store groups.

It would be an unfair fight the British could lose hands down – UK supermarkets’ margins of up to seven per cent meeting foreign chains’ margins of two per cent. But in the rapidly consolidating global retail market, it is likely they will be forced to face up to, or be taken over by, more powerful European and US rivals.