Target Practice: Canadian food retailers brace for invasion of Target, Wal-Mart supercenters

Maybe there’s never a good time to face a massive influx of new supercenters, but it won’t stop retailers in Canada from asking, Did it have to be now?

The high-profile arrival of U.S. mass merchant Target Corp. to Canada next spring — along with an ongoing expansion effort from Wal-Mart that’s rapidly turning its store base into grocery-led supercenters — has coincided with a consumer mindset that could prove to be all too welcoming for the newcomers, sources said. This reflects a Canadian economy that after a quick recovery from the 2008 recession, has once again stagnated and resulted in a consumer that is especially focused on price and value. For supermarkets, sales have largely been flat, store traffic is down and baskets slightly up as shoppers remain cautious.

“Just about all Canadians today are concerned about the economy, so price is on every grocer’s mind,” George Condon, a former editor at Canadian Grocer magazine and an industry consultant, told SN. “It’s one of the overriding issues in the industry — keep your prices as low as you can.”

To this, Minneapolis-based Target will add at least 125 new stores, beginning next spring as it converts the Zellers stores it purchased, and Wal-Mart said it would double its supercenter rollout by way of store expansions and conversions of former Zellers passed along by Target. The Canadian version of the Bentonville, Ark.-based retailer plans 73 projects in 2012 alone — its busiest year since arriving in Canada by way of the Woolco purchase in 1994.

“Because Wal-Mart is expanding in the marketplace, and margins have been tight, a lot of operators have been doing projects with supply chain management and other things to be more efficient,” Ed Strapagiel, a retail consultant based in Toronto, told SN. “And because things are tight, almost any significant new entrant into the market, like Target, is simply going to ratchet things up a little higher. Everyone’s concerned about it.”

Read more: Target Begins Hiring for Canada Stores

It’s not all doom and gloom up North, however. Despite some local flare-ups, sources say competition has been rational — so far — and supermarkets are making progress improving efficiency and investing in their internal capabilities to be more competitive.

“If the consumer was in a better place, this wouldn’t matter too much. The size and pace of [the supercenter expansion] would be digestible,” one industry observer, who asked not to be identified, told SN. “But the problem is the Canadian consumer went into hunker-down mode when employment growth slowed, and unless we get the consumer going the economy is going to be a drag and Wal-Mart and Target’s growth is going to be more punitive than it would be normally.”

Assessing Target’s potential impact on the Canadian market has become something of a cottage industry for retail watchers in Canada. While no two studies are alike — Target’s most vulnerable new counterparts are either Costco, Sears Canada, Wal-Mart or Loblaw, depending on the particulars of the report — observers are united in the notion that Canadians are very much looking forward to the superstore.

'More Enthusiasm for Target Than Wal-Mart'

“Surveys that I have done indicate there is more enthusiasm for Target coming into Canada than there was about Wal-Mart coming in 1994,” said Strapagiel, whose own report suggests Sears and Wal-Mart are the most vulnerable competitors. “There are a lot of Canadians who like to shop Target when they are in the States.”

Specifically, Strapagiel’s surveys indicate that 61% of Canadian shoppers are  “very” or “somewhat” interested in shopping at Target when its stores arrive in March — and that interest is greater than those who have actually shopped there before. “It appears Target’s reputation precedes it, even among those who have never set foot in one,” he said, but noted those who have shopped Target in the U.S. are especially enthusiastic over its arrival.

Another survey by Kantar Retail also predicts a warm welcome for Target that can increase particularly if execution is good as the rollout begins. “Target Canada’s continued resonance will depend on two factors: its ability to deliver the experience that shoppers expect, and its competitors’ responses,” Kantar said. Of particular interest, Kantar said, “is price position and assortment, as lack of leadership or in-stock availability may leave an eager shopper base disaffected.”

Part of the difficulty in pinpointing Target’s competitive impact has to do with the fact that few understand at this point how extensive the food offering at Target Canada will be. While its footprint among the acquired Zellers stores is considerably smaller than that of Target’s U.S. stores, sources acknowledge that Target stores in Canada will all offer at least some food. Many of the Zellers stores it is replacing had fresh and frozen and dry groceries as well.

But at an average size of around 83,000 square feet, there would be less room for the full grocery component Target has become accustomed to operating in its 120,000-square-foot-plus stores in the U.S. Also, sources said, they expect Target will put its best foot forward and showcase the categories for which it’s known best — home goods and apparel — for the Canadian shopper.

“The biggest bang for the buck Target will get vs. their previous life as Zellers is in apparel, home goods and housewares. And it would be wrong for them to cheat those high-margin categories to make room for food when the biggest problem those stores will have at first is struggling with too much traffic,” one observer said. 

“What [Canadians] shop for when they visit Target in the States isn’t Kellogg’s Corn Flakes or Nescafé coffee — they can get that here — it’s apparel and home goods,” added Strapagiel. “Target is very well recognized for that in Canada, and I think they will do very well with that to start.”

Read more: Canadian Retailers Tout Innovations

An approach that begins with general merchandise follows the pattern of Wal-Mart, which arrived in Canada in 1994 with the purchase of 120 Woolco stores. Today, the retailer, based in Mississaugua, Ontario, operates around 335 stores nationwide — the majority of which are supercenters thanks to an aggressive effort to expand or relocate existing stores and build new ones where possible. The company said 2012 would see record expansion totaling 73 new projects and 4.6 million square feet of new store space. Included in this total are 39 former Zellers stores. It expects to operate 375 stores by January.

Although Wal-Mart Stores does not disclose its sales in Canada individually, Condon estimates the company is generating around $7 billion in annual food sales. “That’s up from nowhere eight years ago,” he noted.

“The fact that Wal-Mart has added so much square footage of new grocery space has created a ripple effect across the grocery industry,” he added. “And that’s the thing the grocers are worried about with the arrival of Target. Every new square foot affects somebody in some way because some sales will spill over.”

'Big 3' Can Compete on Price

While the new entrants represent a threat to supermarkets’ market share, they may not be the same kind of price enemy they are in the United States. That’s because despite the ambitious growth, Wal-Mart remains a distant fourth in nationwide share and Target isn’t yet in the picture. That gives Canada’s “Big 3” traditional supermarket operators more clout with suppliers. Further, each operator has a low-cost discount division with which it can battle Wal-Mart’s EDLP offering, sources said.

“Something like 35% or 37% of all groceries in Canada are bought at discount supermarkets,” Condon noted. “That meant that when Wal-Mart came in, it couldn’t come in lower. That’s different than in the States.”

According to estimates from one analyst, Loblaw commands the largest portion of the food retail market in Canada with 30% share, followed by Sobeys (17%), Metro (11%) and Wal-Mart (7%). If Wal-Mart completes its conversion to supercenters, it will control around 10% to 11% of the market.

Wal-Mart’s rapid growth likely earns it some pull with suppliers, but its share simply does not give it the leverage of a $3 billion company like Loblaw, the analyst added. “I’ve had CPG companies tell me, ‘If Wal-Mart is selling my product for lower than Loblaw’s selling it for, then it’s because Wal-Mart is taking a lower gross margin.’”

According to Condon, the rising demand for value from Canadian consumers has prompted retailers to exercise their leverage with suppliers. “The manufacturers haven’t been happy about this, but what can you do? If one of the big companies in Canada says they want another 1% or you’ll get de-listed, you pay,” he said. “That’s one way the grocers are staying profitable, by getting stuff from the manufacturers.”

Canada’s largest grocer has seen slow growth in sales and its profitability has slipped in recent years as it works toward greater efficiency in the head office and more distinction in its stores. Vicente Trius, Loblaw’s president who arrived in 2011 from the French retailer Carrefour, has emphasized a deliberate approach, saying Loblaw would fix stores “category by category” while slowly migrating the Brampton, Ontario-based company to a common IT platform. In July he said Loblaw’s first stores would migrate to the SAP system by year-end, representing the first fruits of a five-year, $2.3 billion technology investment that is expected to be complete
in 2014.

Read more: Loblaw Plans 700 Corporate Layoffs

The Kantar Retail study identifies Loblaw’s Real Canadian Superstore division, along with Costco, as the most vulnerable to lose grocery and health and beauty sales to Target, and
Loblaw’s clothing label, Joe Fresh, featured at Superstores, most exposed to Target’s fashion offering. Kantar said around 70% of Superstore shoppers in a survey expressed interest in shopping at Target for those items.

Moves to improve efficiency at Loblaw were illustrated by 700 job cuts last month — a 10% reduction in its corporate workforce. “We’re managing costs where it makes sense by reducing administrative expense. We will continue to invest in driving the business forward by devoting more resources to enhance the customer proposition,” Trius said.

Freshco 'Freaked the Market Out'

Stellarton, Nova Scotia-based Sobeys is lauded for stores that appeal to food lovers but the jury is still out on a newly crafted discount division, sources said.

Freshco, which Sobeys introduced in 2010 as a replacement for its lagging Price Chopper discount banner, has created a stir behind aggressive pricing on perishables. “That freaked the market out a bit because perishables are where the money is,” one observer told SN. “But when you’re cornered like Price Chopper was, you might do things that aren’t so rational.”

Although Sobeys has not reported results of Freshco separately, officials recently said its top and bottom line results were improving. “The assumption is they are not as profitable as they need to be and ultimately, that is not sustainable,” the observer added. “They’re still investment spending.”

Read more: Acquisition Boosts Sobeys' Q1 Results

Elsewhere, Sobeys is making progress on the cost front behind robotic warehouses in Ontario and Quebec, providing dramatic labor savings. Some believe the company will eventually open a third unit to serve its stores in Western Canada. Sobeys earlier this year transitioned to a new chief executive officer, Marc Poulin, lauded for building Sobeys’ strong IGA division in Quebec.

By one estimate, the grocer least vulnerable to the Canadian supercenter rollout is Metro, as the Montreal-based retailer operates the fewest stores in areas where supercenters have targeted the most future growth. Analysts laud Metro for consistent execution and for growing sales modestly even as consumer sentiment soured. “They wake up every morning and run their business well,” one observer said. “Nothing sexy.”

Read more: Metro to Sell Gas Foodservice Division

While Target’s impending arrival remains the big issue facing Canadian grocers, those looking for the next big thing may turn their attention from Minneapolis to California and Safeway’s home offices in Pleasanton. With concern over Safeway’s lagging performance in the U.S., and the need for supermarket operators in Canada to respond to the growing supercenter threat, many believe the time is right for Safeway to sell its Canadian division.

Safeway Canada operates 225 stores in Western Canada with a leading market position in Vancouver and Winnipeg. Its strength in Canada has provided Safeway recent financial help — namely a $1.1 billion dividend from Canada to the U.S. last year, which the company used to pay off debt.

“Canada Safeway is seen as the next prize, the next logical takeover candidate,” Strapagiel said. “However, my understanding is that they are doing quite well, in part because the economy in Alberta is doing better than the Eastern part of Canada due to oil and gas development. So unless the U.S. company really needs the money, I don’t know why they would sell.”

U.S. analysts believe Safeway is not getting credit for its operations in Canada. One observer said the unit could generate up to $5.5 billion in a sale — more than its parent company’s total market capitalization today. Spinning the unit off in an initial public offering in Canada is also a possibility, although that would require more enthusiasm from Canadian investors around the grocery space than they have shown recently. 

Sidebar: Questions Surround Sobeys-Target Alliance

While industry watchers are generally in agreement that Target stores are destined to be a hit when they open in Canada next year, Target’s impact on the food business is considerably murkier.

The uncertainty even extends to Target’s food supplier. Sobeys, the Stellarton, Nova Scotia-based retailer, was selected as Target’s provider of frozen, dairy and dry groceries, including its private brands. But estimates of the size of the business and its impact on Sobeys have been hard to come by. Sobeys said the agreement would boost distribution efficiencies and help to lower costs but has not quantified those savings yet.

Asked about its expectations with Target during a conference call in September, Marc Poulin, Sobeys’ chief executive officer, indicated that much still depended on Target.

“We haven’t sold a single case to Target yet. And as far as how it’s going to ramp up … it’s depending on Target’s plan,” Poulin said. “Therefore it’s almost [as though] I have to refer your question to Target. It’s not for me to tell you what their opening schedule is.”

An analyst who asked not to be identified said he expected Sobeys’ grocery sales to Target could offset a portion of the sales hit its conventional stores might absorb as a result of Target’s rollout. But he suspects the trade won’t be a profitable one.

Read more: Sobeys, Target Partner on GM

“It’s wholesale margin and not retail margin,” the analyst said, “and I would assume Sobeys bid pretty aggressively for the Target business. Nobody knows how profitable it will be.”

Sobeys on the other hand could see some benefit in the other direction, as an expansion of the agreement with Target announced earlier this year could bring additional general merchandise and convenience selections to Sobeys’ stores. But like the food agreement, officials of both retailers have so far been reluctant to provide additional detail.