The Reason Behind a Big Retail Combination

Canadian retail is working against form and is actually exciting. The venerable Bay department store is battling for the upscale market. The Bay’s recent US$2.9-billion purchase of Saks is a direct challenge to competitors Nordstrom and Holt Renfrew. Then we have another transaction. The Loblaw acquisition of Shoppers Drug Mart is significant on any scale. A CDN$12.4 billion cash and stock purchase combines Canada’s largest grocery and pharmacy chains. The plan is for Shoppers to retain its brand name and operate as a separate division of Loblaw. That is all well and good but over time the businesses and brands will truly merge if this combination is to succeed.

The reasons this combination took place are clear. It gives the combined company a competitive edge in their home market. It helps battle increasing and innovative competition from the United States. In the nearest term both businesses will benefit from an impressive supply chain and transportation network. Soon combined purchasing will provide handsome savings in the categories they share like food and personal care products. Shoppers will lend their management expertise in pharmacy and beauty with Loblaw’s and the reverse will take place in food.

All of this is expected to produce $300 million in cost savings after three years, without closing any stores. The owners have further ensured Canadians that the two loyalty programs will be unaffected and will evolve into an improved joint card. There is also a promise to roll out a fresh, new combined house brand. In the meantime, Shopper’s Life brand will begin appearing in Loblaw’s and the grocery chain’s PC Blue Menu will be made available in Shoppers.

But anyone who thinks the two stores will stay the same is pushing a wobbly shopping cart. There are two overriding strategic imperatives that will bring about significant changes.

Brand & Merchandise

Loblaw has been looking south of the border with some concern. While the company has an enviable position of selling high-margin, high-quality house brand merchandise it is threatened by Whole Foods and others. Galen Weston has stated that the vision for this combined entity is to deliver on a merchandising strategy of “Health, Wellness and Nutrition”. This is a strategic stake in the ground and is admirable on many levels not least of which is promoting better lifestyles for Canadians.

This focus demands changes to buying, the supply chain, and branding. It also suggests they know something the average shopper may not. I am concerned that they are surrendering a large part of the market that enjoys deep-fried carbs. If you have ever shopped for healthy, natural products they come at a significant premium. The same fare at a Whole Foods will set you back much more than a trip to Canadian grocery stores IGA or Sobey’s. This could mean loss of market share as they rollout the strategy or having to offer something to everyone and that is never a wise course.

Loblaw has been attempting to communicate a down-home, food-sourced-locally image but a more purposeful migration to “healthy” will come at a cost. Bill Bernbach of advertising fame once said, “A principle is not a principle until it costs you money.” I appreciate Mr. Weston’s stated focus both from a principled and a business perspective but it will cost the combined companies in the short-term. Health, Wellness and Nutrition is a long-term bet predicated on a belief that people will change both their eating and shopping behavior. Loblaw will need to spend and do more over the next five years communicating healthy living than the Canadian federal government.

Experience & Location

Retail is meant to be an experience. The earliest department stores set out to provide entertainment and selection while the first grocery stores provided convenience, quality and cleanliness. These were innovations over the previous ways goods were bought and sold. Now this modern acquisition demands a fresh look at retailing. Together Loblaw and Shoppers will operate 2,348 locations including the control of one-in-five Canadian pharmacies. The bean counters will soon be looking at the costs of carrying properties where target markets overlap. Real estate is a huge expense and managing operating costs in retail is an imperative.

So yes, I am saying that eventually there will be a rationalization in the store portfolio. This will come with a silver lining because both Loblaw and Shoppers are innovators. Shoppers is always experimenting with formats and floor space. Last year they opened the BeautyBoutique concept store. It encompasses more than 4,000 square feet that would fit nicely in a Loblaws (the median grocery store size is 46,000 square feet).

Loblaw is also an innovator. The grocer launched a test pilot of a new concept called Nutshell Live Life Well. It is a stand-alone franchise catering to the health-conscious crowd. The first location is set to open in Toronto this fall but may be preempted by this deal. The concept could find new life in an entirely new format. They have notably tested Live Life Well as part of the Loblaws at Maple Leaf Gardens.

I contend that the first move will involve converting Shoppers’ locations into Loblaw express stores comparable to Walmart Markets. These smaller stores are meant to “woo shoppers with easier parking, less crowded aisles and quicker checkout.” That sounds like a Shoppers Drug Mart. At the same time they will look to shut down or revamp Loblaw locations while very few current Shoppers’ locations will be divested.

Most radically I believe the combined company is quietly sketching plans for a brand new store design. At first glance it would resemble a hybrid of a Loblaws and Shoppers. Slightly larger in size it would house a virtually complete Shoppers. There would be one pharmacy sharing space with the health and beauty merchandise. It would remain open 24 hours in certain locations as Shoppers does but at night would be cleverly partitioned so the grocery aspect could be cleaned and restocked. An innovative food aisle could actually act as the physical break between the two “stores” ensuring food sales on the pharmacy and health side when the grocery side is closed.

I expect further innovations in this format for convenience, variety and quality. It is not hard to picture more emphasis on wine selection in the form of specialty boutiques, a Starbucks or the current Loblaws’ Tea Emporium, expanding into fine prepared meals (under a new in-house brand) to directly combat Whole Foods, and perhaps a true farmer’s market and artisan area. The Loblaws in the former Maple Leaf Gardens currently features an omelet station, sushi bar, and an eighteen-foot wall of cheese so the company is willing to stretch the grocery store concept and offer up some theatre.

It would come as no surprise if these new store designs incorporate a drive thru so one could pick up their prescription, dry cleaning, milk, bread, wine and a cappuccino with ease. Any of these predictions are viable because they deliver on entertainment and convenience. Shopping has become more interesting because companies want us to come more often. The average number of trips per week to a grocery story is two point two times with the average transaction totaling approximately $27. More visits means more money but the ultimate goal of this acquisition is to drive larger transactions per visit.

Success will rely on changing Canadian consumer behavior. Loblaw intends to make consumers more aware and healthier. It will offer more in more locations. It will dazzle by what it offers under one roof. It means to innovate how and what we buy. While Mr. Weston espouses a healthy principle it is clearly premised on the wealthy goal of more Canadians spending more, more often.

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