Sainsbury’s-Asda merger

Almost a year ago the merger between Sainsbury’s and Walmart’s Asda, the second and third
biggest supermarkets in the UK was presented as one in which everyone would emerge
advantageous: shoppers, staff, shareholders, and suppliers.

Though the UK’s Competition and Markets Authority (CMA) has come to an opposite conclusion
after a year-long investigation, establishing that the Sainsbury’s £7.3 billion acquisition of
Walmart-owned Asda would in effect result in higher prices, less choice, poorer service for the
customers. Which effectively should not be allowed (Hills, itv news, n.d.) to proceed under any
circumstances.

The merger could have created a firm with monopoly power (UK legal definition: a firm with
more than 25pc market share) (Pettinger, n.d.). The CMA identified 629 areas where there
could be a substantial lessening of competition in supermarkets – and a further 290 areas
where online competition could be reduced – while cited 132 locations where competition in
petrol and diesel retailing could be reduced (Jonathan Eley, n.d.).

The promise (Hills, n.d.) by Sainsbury’s to cut prices by £1 billion in the coming 3 years was
deemed “vague” and “not credible”. While the Sainsbury’s and its chief executive Mike Coupe
accused the CMA of ignoring the evidence and maintains that blocking the merger is effectively
“taking £1 billion out of customers’ pockets”.

Patrick O’Brien, retail research director at GlobalData argues “The heat is on Mike Coupe”, the
architect of the supposed deal. Patrick added, “He appears to have wasted a year chasing the
impossible dream while his competitors took advantage of its distraction”.

The CMA stated UK shoppers and motorists would be worse off, lessening the competition at
both a national and local level, with prices rising in stores, online, and at petrol stations. While
Coupe stuck to his guns and blamed (James Davey, n.d.) it to be an issue with CMA’s analysis,
“The specific reason for wanting to merge was to lower prices for the customer,” he said in a
statement.

The Sainsbury’s and Asda conglomerate would (Sikka, n.d.) have turn the ‘big four’ into the
‘giant three’ – the combined market shares of Asda at 15.4 percent and Sainsbury’s at 15.3
percent, would have overthrown the Tesco at 27.4 percent from its top seat. The merged
business would have around 28,00 supermarkets, convenience stores and petrol stations,
330,000 employees and around 31 percent of the market with annual sales of £51 billion.

Stuart McIntosh, the chair of the CMA inquiry group, said: (Wood, n.d.) “It’s our responsibility
to protect the millions of people who shop at Sainsbury’s and Asda every week. We found this
deal would lead to increased prices, reduced quality, and choice of products and poorer
shopping experience for UK shoppers”.
The Shore Capital analyst Clive Black said the Sainsbury’s board looked guilty of “arrogance and
naivety”, with Coupe sounding “juvenile and impetuous” when things did not go his way. Black
rubbished the idea that Sainsbury’s and Asda were “social justice charities” on a crusade to cut
prices for shoppers. “This was about Sainsbury’s growing earnings and Walmart wanting to get
out of the UK.”

Earlier in the year some of the experts commented on customers, employees and suppliers
fears and stakes in the intended deal. With John Colley, a professor at Warwick Business School,
saying: (Butler, n.d.) “Ultimately there have to be job losses and the suppliers will have to pay
through lower prices … customers will see a reduced choice.”

Tim Roache, general secretary of the GMB said: (staff, n.d.) “Hundreds of thousands of workers
stand to be affected and all know such announcements tend to be followed by management
speak like ‘rationalization’ in the name of ‘efficiency’. What that usually means is job losses or
cuts to pay, terms and conditions.” While David Madden of CMC Markets said: “Increased
competition from Aldi and Lidl is the main motivation behind the proposed deal. The deep-
discounters have disrupted the UK supermarket sector severely.”

One would say why this much hassle by the companies. For that to make sense we’ll have to
look into the UK’s grocery market, which is extremely competitive. Sainsbury’s and Asda are
looking to respond to pressure from discounters such as Aldi and Lidl, to be more competitive
against Tesco, and be able to counter online threats such as the rise of food delivery apps and
Amazon.

Richard Lim, chief executive of research consultancy Retail Economics, says (Espiner, n.d.) the
“biggest driver here is about scale”, pushing lowest prices from suppliers. Through “price
harmonization” Sainsbury’s expect to make cost savings of £350 million. Employing this way can
potentially squeeze small suppliers – warned MPs.

However, critics have argued that Sainsbury’s has not laid out the plans about which products
will see price drops, over what period – “by around 10pc on many of the products customers
buy regularly” – stated Sainsbury’s. Mr. Lim though said, assuming Brexit goes smoothly,
Sainsbury’s and Asda would be able to pass cost savings on to consumers.

All mergers result in job losses, and this one wouldn’t have had an exception: the ultimate
driving force behind mergers and acquisition is private profit. Mr. Lim said: “In the end, it’s
inevitable to have fewer people working in the combined unit, the motivation for the merger is
driving down costs.” After the CMA’s decision, (Walmart, n.d.) Asda, its parent Walmart and
Sainsbury’s have mutually agreed to terminate the transaction.

John Moore, senior investment manager at Brewin Dolphin, said: "This returns the focus to the
UK grocery market, which is highly competitive, and now both businesses will need to
concentrate their energies on reinvigorating and perhaps re-imagining their offerings to
shoppers."
Though some people criticized the CMA for its lag of proper understanding of the grocery
market and broader retail landscape in the U.K. By blocking the merger, they have done a
massive disservice to the British consumer. Ian Giles, a competition partner at law firm Norton
Rose Fulbright, called (Staff, n.d.) the CMA's ruling "controversial in competition law circles".

"It suggests a higher bar than had been the case in previous retail mergers. The parties perhaps
underestimated how the scale of this deal, and the CMA's focus on consumer markets, meant
they would face such serious obstacles in securing approval." In December 2017, the CMA
approved (Sikka, n.d.) Tesco’s £3.7bn takeover of Booker, the largest food wholesale supplier.
In 2015, the CMA cleared the merger of Poundland and 99p Stores. While Stuart McIntosh said,
(Jonathan Eley, Financial Times, n.d.) “Tesco/Booker was a merger between retailer and
wholesaler. I’m not sure we would see Tesco/Booker as a precedent”.

George MacDonald, Executive Editor of Retail Week had this to say: (Busby, n.d.) "Their
proposed merger was not an appeal for a helping hand but could have kept up the pace of
competition to the benefit of shoppers through, for instance, efficiencies and lower prices. The
CMA was surely wrong to kibosh the deal.” He further added: “The fact that Asda and
Sainsbury’s were willing to consider linking up, resulting in a big three, is stark evidence that the
market is not monolithic. They aimed not to leg over the consumer, but to compete better on
the shopper’s behalf.” Another analyst, Nick Coulter at Citi said (Jonathan Eley, Financial Times,
n.d.) the metrics used to justify the challenges were “unprecedented”.

Now we will look into some market realities about the proposed merger and its implications for
the customers, suppliers, and overall the UK’s economy. We’ll use the Structure Conduct
Performance (SCP) paradigm to evaluate things on the ground as they would have folded if the
merger would have gone through (in an assumptive way). The SCP is used as an analytical
framework, to make relations amongst market structure, market conduct, and market
performance.

According to Smit and Trigeorgis, “The structure-conduct-performance (SCP) paradigm asserts

that conditions of supply and demand in an industry determine its structure. The competitive
conditions of supply and demand in an industry determine its structure. The competitive
conditions that result from this industry structure influence the behavior of companies and in
turn dictate the performance of the industry.”

SCP is the study (Rekhi, n.d.) of the theory and practice of commodity pricing and output
determination under different market conditions – according to the degree of competition
between the firms in the industry – perfect competition, monopolist competition, oligopoly,
and pure monopoly.

To distinguish them by structure there are three indicators:

1. Number of firms
2. Freedom of entry
3. The nature of the product

The combination of these three factors gives rise to varying degrees of ‘market power’. Which
essentially means the degree of control over price. Is the firm a price taker or able to choose its
price, in our case the ‘giant three’ firms or to be exact the two conglomerates can have a
monopoly over price with customers and with the suppliers as well and potentially squeeze
both as they want. A firm with high market power also has very high price inelastic demand
curb with virtually no substitutes.

But does the number of firms truly define the competition in a specific industry, because there
can be many smaller firms and one or two big firms holding all the market shares! So, we’ll look
at “3 firm concentration ratio” strategy (Kenton, n.d.) to get a better picture. In our case Tesco
with 27.4 pc, Asda at 15.4 pc and Sainsbury’s at 15.3 pc.

Market Share

28% Tesco
41% Asda
Sainsbury's
16% Others
15%
Hence, the total of “3 firm concentration ratio” is equal to almost 60 pc, which forces them to
dominate the grocery market and is pretty oligopolistic (price searchers) if not monopolistic
(price makers).

Now we move on to the conduct, which refers (Tu Thuy Anh, n.d.) to a firm’s behavior. The
variables used to capture firm behavior include pricing strategies, collusion, advertising,
research and development, and capacity investment. Some have interpreted conduct as to
whether firms collude or compete. Substantial market power – means the firm has power over
the pricing which in our case is significant leverage to the top three competitors. The
concentration certainly facilitates collusion, whether tacit or explicit.

Though the Sainsbury’s CEO Mike Coupe said (Pettinger, n.d.) that “The new firm would enable
greater in investment in technology to offer better service and deliver for customer”, we can’t
be sure the research and development capacity increase will be based on real customer
betterment or just to support the firms standing in the market. We have the example where
Tesco the market’s biggest share-holder deliberately (Butler, theguardian, n.d.)delayed
payments for more than two years, to boost its profits as well as colluding (Peacock, n.d.) with
other retailers and suppliers to fix cheese prices.

Conduct, in turn, determines the performance or outcome measured in terms of allocative

efficiency or the degree to which certain macroeconomic goals are attained. The most
important goal appears to be consumer protection. The variables mostly used to measure
performance are profitability and price-cost margin. This stresses the elimination of restrictive
and unfair trade practices. The effectiveness (WEISS, n.d.) of collusion and therefore the level of
price-cost margins will rise with concentration.

A key issue (Tu Thuy Anh, n.d.) in the empirical literature in SCP is the measurement of
performance. Theory suggests that the Lerner Index is a good measure of the extent of a firm's
market power:
Lerner Index = (Price –Marginal Cost) / Price
When the Lerner index > 0, firms are said to have market power. However, it is not always
possible to derive the Lerner index empirically. It may be difficult to obtain marginal cost data.
Also, firms may have numerous products, each priced differently.

One major facet (Rekhi, n.d.) of the paradigm that bears real significance is the relationship, if
any, between concentration and profits. Industries in which a few dominant firms account for a
major portion of total output are often said to be concentrated. Aggregate concentration refers
“to the degree of control over economic activity exercised by the largest firms in the economy”.
The definition suggests two things: increased control of the economy by large firms and
decreased the role of an individual entrepreneur.

The aggregate concentration certainly affects pricing decisions:

  Apparently, to the extent that as long as there is a harmony of interests among a few
large firms, none of them will seek any price change that is indeed going to be injurious
to others.
 Any changes in aggregate concentration may lead to changes in market concentration
that affect the firm’s pricing decision.
However, the relationship between size and pricing behavior is tenuous at best.

In effect, the SCP is based on a model of Cause and Effect. Industry financial performance is
caused by the competitive conduct of players in the industry; this conduct is in turn caused by
the industry structure. So, meaning if you change the industry structure by reducing the
competition the performance is going to get affected.

Market concentration refers to the degree of concentration within an industry rather than in
the aggregate economic system. It provides a summary measure of the degree of monopoly
power in an industry and, in this sense, enables us to measure the degree of imperfection in a
market. It is well known that in most markets we have situations which lie between the two
extremes of perfect competition and monopoly.

The other type of measure of market concentration is known as a summary measure. The two
most commonly used summary measures of concentration are the Gini Coefficient and the
Herfindahl-Hirschman Index – concentration index.

We will employ the Herfindahl-Hirschman Index (HHI) to find the market concentration before
the merger and after the (supposedly if the merger had gone through) union of Sainsbury’s and
Asda.

The HHI in economics and finance, a measure (Bondarenko, n.d.) of the competitiveness of an
industry in terms of the market concentration of its participants, often pre- and post-M&A
(mergers and acquisitions). The U.S. Department of Justice has been using HHI since 1982 to
measure market concentration for antitrust enforcement purposes. Is based on the formula:

HHI = S1^2+S2^2+ ……. Sn^2

Here S1, S2, etc. refer to the percentage market share companies hold in the given industry.

As per the U.S. Department of Justice, the Federal Trade Commission 2010 Horizontal Merger
Guidelines (DOJ-FTC, n.d.), the agencies will a market in which the post-merger HHI is below
1500 as “unconcentrated,” between 1500 and 2500 as “moderately concentrated,” and above
2500 as “highly concentrated.” A merger (Chin, n.d.) potentially raises “significant competitive
concerns” if it produces an increase in the HHI of more than 100 points in a moderately
concentrated market or between 100 and 200 points in a highly concentrated market. A merger
is presumed “likely to enhance market power” if it produces an increase in the HHI of more
than 200 points in a highly concentrated market.
Now, if we apply the HHI in our scenario with only taking the “big four” as our data to analyze
i.e. Tesco-27.4, Asda-15.4, Sainsbury’s-15.3, Morrisons-10.3.

Before the merger:

HHI = 27.4^2+15.4^2+15.3^2+10.3^2 = 1328

After the merger (if had allowed by CMA):

HHI = 31^2+27.4^2+10.3^2 = 1817

As according to the DOJ-FTC guidelines, post-merger the market falls under the “moderately
concentrated” and with an increase of 489 points in the HHI figure. This potentially raises
“significant competitive concerns” and though the market is not highly concentrated the stark
increase in the HHI points is presumed “likely to enhance market power” concerns.

So, it would be safe to say the CMA did the right job by torpedoing the merger, as it would have
(at least according to the HHI) resulted in disrupting the economic fabric and as per the CMA
“poorer service for customers.”

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