Global Scale – Is it Important?
by Dave McCarthy

Below is a summary of a speech given to the IGD conference Global Retailing in January.

Introduction

With more companies diversifying overseas and strong national players like Wal-Mart, Tesco and Carrefour now competing on neutral grounds, we need to ask “Is global scale important?” and is it more important than  national (i.e. local) scale? We ascertain that global scale is emerging as a powerful competitive weapon and that successful retailers will work with successful manufacturers to grow profitable market share. However, the industry restructuring necessary to achieve these benefits will result in casualties.

Scale and Food Retailing 

Food retailing is characterised by strong economies of scale in areas such as procurement, distribution, advertising, etc. However, scale itself is not a guarantee of success – if it was Sainsbury would still be market leader. Neither is lack of scale a guarantee of failure (e.g. Morrison). However, the efficient use of scale is the long term winning format (e.g. Wal-Mart and Tesco). As companies have reached dominance in their home markets, they have turned to overseas as a route to growth. Dominance in new countries has been the priority and while the transfer of skills from home markets has been widespread, the benefits of global sourcing for food have so far proved elusive.

Global Sourcing Benefits in Food Retailing

Not all products are suitable for global sourcing (e.g. short coded products) and local tastes will always vary. However, there are an increasing number of global brands and products that will transcend borders. Add to this commodity products and products with weak branding and there is a huge opportunity for international synergies in buying. However, to date this has not happened. Suppliers have been structured to service local markets and international retailers have been more of a confederation than one centralised operation. This is now changing and retailers are pushing for global benefits from suppliers, who are resisting. But global scale will become a major competitive advantage as it is in the long-term interests of retailers and suppliers to forge global relationships.

Take a hypothetical example. Say, Asda approaches a multi national supplier and asks for a discount because it is now the world’s biggest retailer. The supplier says “No”, because as a UK subsidiary of a multi national supplier it receives no benefit from giving Asda extra discount. Asda then phones Bentonville. Bentonville phones the suppliers’ corporate centre. Corporate centre phones UK subsidiary and explains “There is a bigger picture and we are working hard with Wal-Mart on a number of projects. Give Asda what they want”. UK subsidiary complies.

As stated, this is a hypothetical example and the conclusion is that the role of national/regional offices could decline. It also suggests that international retailers will try to consolidate business with international suppliers. But what is in it for suppliers?

Again, take Asda as an example. The following table is our estimate of a break down of Asda’s sales between non-food , own label, domestic brands and international brands. We estimate that at the time of acquisition, c.20% of Asda’s £8.2 billion turnover came from international suppliers.

We forecast that by 2004, Asda sales will have increased to c.£17 billion, of which 40% will come from international suppliers. In other words, the turnover attributed to international suppliers will have increased from £1.6 billion to £6.8 billion - a fourfold increase. But, Asda will want something in return for quadrupling certain suppliers’ business. A 1-2% margin benefit, say, would equate to c.£70m-£140m. However, this is not necessarily lost profit to the supply industry. For Asda to hit our sales target, it will have to win market share and such share gains must come from more inefficient retailers that are more expensive for suppliers to serve. Therefore, at least part of the £70m-£140m price reduction will come from cost savings throughout the supply chain.

So, the choice in this example is simple. Suppliers must trade off a reduction in margin with substantial gains in market share. We believe global scale benefits will develop as retailers will command lower input prices and suppliers will gain access to unprecedented volume growth. Most companies will sensibly settle for improved returns driven by increases in quantum profit, even at the expense of margin. Pile it high, sell it cheap is as true today as ever it was (note: there will be important roles for local and speciality  suppliers). 

Local / National Scale

But retailers must not neglect local scale, which still provides huge benefits. The table below compares the impact of advertising to sales for Tesco and Asda. If both companies spent £40m last year, it would have been almost 0.5% of Asda sales, yet just 0.25% of Tesco. Despite the strength of Wal-Mart, Tesco retains strong local scale benefits while it strives for its own global scale.

* Hypothetical figure

The growth of global scale must not be at the expense of local scale. It is better to be strong in one market than weak in many.

Conclusion 

The efficient use of scale is a prerequisite to strength at home, which, in turn, is a prerequisite to successful internationalisation. The globalisation of retailing will benefit successful retailers and suppliers, but there will be some casualties. Consolidation and concentration will increase for retailers and suppliers, and we anticipate the emergence of a super-league of retailers – half of which will come from Europe. The efficient use of strong local scale and strong global scale is an unbeatable combination.

David McCarthy is a Food Retail analyst in the Equity Research department at Salomon Smith Barney. The views expressed are McCarthy's own and are not necessarily shared by Salomon Smith Barney or any of its affiliates"

Date article published: 06/06/2000