Pardon the Disruption is a column that looks at the forces shaping food retail.
The pandemic has lifted the fortunes of grocers across the nation as U.S. shoppers trained a large portion of their food spending on their local supermarkets.
That chaotic but profitable period has given way to a quagmire of challenges involving inflation, supply chain disruptions and difficulties keeping stores and warehouses properly staffed. Consumers, frustrated by the high prices and shortages they’re seeing, are spending less and starting to trade down to cheaper stores. Retailers may be starting to feel like that glow of shopper goodwill they’ve enjoyed, particularly early in the pandemic, has dimmed.
But the greatest challenges still lie ahead. While the pandemic has given grocers renewed relevance and energized their sales, it has also helped prop up weak competitors that previously struggled to compete on price, service and innovation. As consumers shift more of their food dollars back to restaurants and seek out lower prices, these companies are going to once again be fighting for their lives.
In addition, the sudden increase in digital adoption fueled by the pandemic is pressuring grocers to invest in new technologies and services. Many grocers are building out their own e-commerce platforms and fulfillment networks rather than relying solely on third-party providers. This has ramped up the race for digital advertising dollars as grocers establish retail media shops. Meanwhile, state-of-the-art systems that can manage shelves, forecast shopping behaviors and speed up the checkout process promise long-term savings — but often require a hefty investment and a pipeline for testing, scaling and refining.
Expansion is also becoming painful as the cost of building and opening stores is rising. And the needs to innovate, rapidly test and explore new horizons like alternative store formats are becoming critical for companies in an increasingly complex industry.
Who holds the upper hand amid all these rising pressures? Retailers with the scale and resources to operate efficiently and keep pace with technological and consumer changes. This is why I expect the gap between large and small retailers to widen in the coming years when it comes to consumer experience and services. And it’s why I expect we’ll see merger and acquisition activity among regional grocers accelerate over the next few years.
Margin pressures add up as regionals get ‘squeezed’
The term “regional grocer” is a wide-ranging one that encompasses retailers operating anywhere from 50 stores to upwards of several hundred generally spread across two or more states in a particular geography. In its recent report on regional grocers, Coresight Research maps out a range of companies, including Publix, which operates more than 1,000 stores, and Coborns, which runs around 70 stores in the Upper Midwest.
But regional grocers, generally speaking, share a common challenge of needing to stay competitive with national competitors and also grow their sales and store footprint. This challenge was growing increasingly difficult before the pandemic hit. Some companies, like Central Grocers, went bankrupt, while others turned to M&A in order to expand and boost their economies of scale.
During the pandemic, regional grocers were the ones doing almost all of the deals. Raley's acquired Bashas', Tops and Price Chopper merged, Brookshire Grocery Company bought Reasor's in Oklahoma and C&S Wholesale Grocers snapped up Piggly Wiggly Midwest.
In announcing these deals, executives noted the improved scale and negotiating power they’ll have with suppliers. That was an important step as grocers have struggled to keep their shelves stocked, said David Ritter, managing director with Alvarez & Marsal, who frequently consults with regional grocery executives. And it will become increasingly important as retailers look to keep their prices sharp and wholesale costs down.
“With [cost of goods sold] being your biggest bucket of spend below the top line, the more leverage you have and the more stores you have with your national CPG vendors, the better you can negotiate with them,” Ritter said. “And in a world where they're raising your prices 9, 10, 11%, having that scale to become more important in their eyes actually really matters.”
Ritter also told me the cost of expansion has gone up considerably as everything from real estate to raw materials has become more expensive. This has delayed construction projects and in some cases made building new stores prohibitively expensive. Acquiring competitors is increasingly looking like the more cost-effective way to expand, he said.
"It's an interesting situation where they're too expensive to build, but you still have aspirations for growth. So that leads you more clearly to an M&A path," Ritter said.
Another key pressure driving M&A in the years ahead is the need for regional grocers to keep up with digital innovations from the likes of Kroger, Walmart and Amazon — a pressure that the pandemic has accelerated. Coresight Research noted in its recent report that while M&A activity was dominated by national players in the five years leading up to the pandemic, it expects regional grocers to combine over the next few years as they try to match their larger competitors.
“Without sufficient scale and financial capacity to invest in their e-commerce infrastructure, many small and mid-sized grocers will find it increasingly difficult to match the standards set by larger companies,” the report noted.
Ken Fenyo, president of research and advisory with Coresight, told me e-commerce investments have become a significant capital expenditure in the past two years as grocers build out branded e-commerce platforms for pickup and delivery. This has meant building out IT departments, hiring dedicated staff to pick and stage orders, and launching new apps, sites and services.
Technology service providers are able to shoulder some of the more complex and expensive parts of running an online shop. And companies like DoorDash and Instacart are offering to handle services like dark stores, quick commerce and consumer data. But grocers will want to keep a firm grasp on the shopper experience and not outsource too many components of digital commerce, as many have done over the past few years.
Along with the growth in e-commerce has come an explosion in retail media platforms recently, including among regional grocers. These services, which earn revenue for retailers on sponsored listings, search primacy, banner ads and other digital marketing services, are helping retailers like Kroger and Hy-Vee recoup some of the money they’re shoveling into e-commerce. However, as with online shopping, expanding and attracting attention from consumers and CPGs is a scale game, said Fenyo.
“Ultimately, it's about having more eyeballs and then getting brands to invest to reach those eyeballs,” he noted. “That's why the Krogers and the Walmarts of the world really get a disproportionate share of the attention from brands today.”
Not only are regional grocers contending with large, well-established competitors — they’re also having to defend their flank from discount retailers like Aldi and Dollar General that are expanding rapidly and nabbing shoppers with low prices that most supermarkets can’t match. Fenyo said regional grocers are increasingly “getting squeezed” by these two competitive threats.
“Now you're fighting a war on two fronts,” he said.
Who might be acquiring and where?
I doubt we’ll see much M&A activity as long as inflation’s impact remains an open question for grocers. Assuming experts are correct in forecasting moderating costs by the end of this year, I think next year is a strong bet. Fenyo said he believes the M&A pipeline will remain strong this year amid “market choppiness,” and that announcements about deals will likely accelerate starting next year.
Fenyo also believes combinations will happen between companies in overlapping or adjacent geographies, similar to the Raley's and Tops deals. This will allow grocers to reach new markets while also building scale and taking advantage of brand awareness along with existing assets like distribution centers.
I believe we'll also see regional grocers snap up distressed independent grocers, similar to Brookshire Grocery's acquisition of Reasor's. These small chains and mom-and-pop shops are having an even harder time coping with price inflation and the pace of innovation, and we'll likely see more of them cash out rather than continue to fight.
So who might go shopping? I think Ahold Delhaize is definitely looking to acquire. In recent years, it has been adding stores incrementally to its existing banners as competing retailers have come under duress. That will likely continue. The Dutch conglomerate could also be looking to add a sixth banner, but it’s hard to see where that might happen. It prefers operating on the East Coast, where its grocery companies stretch from Maine down to the Carolinas.
The only other region left to fill is Florida, meaning a potential Winn-Dixie acquisition could happen, though right now that seems foolhardy given Publix’s dominance in the state. More likely, it seems, is Ahold Delhaize closely watches Kroger’s store-less expansion and, if it succeeds, brings FreshDirect to the Sunshine State.
The ultra-competitive Northeast and Southern California markets seem ripe for consolidation. Raley's, hot off its Bashas’ acquisition, could fill in the space between Northern California and Arizona by picking up a SoCal chain like Stater Bros.
I could also see Meijer nabbing a grocery chain in the near future. The superstore retailer has a homespun line of grocery stores and made a strategic investment in Fresh Thyme Farmers Market several years ago. It could buy up smaller players that come under pressure, or it could make a bigger play for a mid-sized player like Giant Eagle or Schnucks.
Ritter believes that strong regional grocers will continue to get stronger and that they will be the ones most active in M&A activity. Strong players will also be able to be first-movers on new technology in the coming years, he said, as a “wealth” of innovations in shelf scanning, cashierless checkout and other areas come to market. Although large chains like Kroger and Albertsons command more investment capital, they’re tough for tech companies to land a pilot with, Ritter said, while regional grocers can be more welcoming and move quickly.
“I do think that the market is starting to bifurcate into regional grocers with the aspiration to grow and regional grocers that have more of a just-hang-on mindset, and I expect that to continue,” he said.
Even as M&A activity sputters back to life, however, the grocery industry could see shifts in the ways companies approach expansion over the next few years. Kroger is pushing into Florida and the Northeast — two markets where it doesn’t operate any stores — with its online service powered by automated warehouses. If that program succeeds, it will likely spur other retailers, like Ahold Delhaize and Walmart, to test online-only expansion.
Indeed, digital growth is remaking stores, and it could remake how retailers test and grow. Already, we’re seeing retailers use dark stores and pickup points to reach new markets. As online demand continues to rise, retailers could push into cities, suburbs and rural markets with e-commerce deployments that are a fraction of the cost of building and running a store.
For now, though, stores remain retailers’ core assets, and for the foreseeable future, companies will focus their expansion and margin-building efforts there.