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LOBLAW COMPANIES LIMITED1

Ramasastry Chandrasekhar prepared this case under the supervision of Professor Charlene Zietsma solely to provide material for class discussion. The authors do not intend to illustrate either effective or ineffective handling of a managerial situation. The authors may have disguised certain names and other identifying information to protect confidentiality. Ivey Management Services prohibits any form of reproduction, storage or transmittal without its written permission. This material is not covered under authorization from CanCopy or any reproduction rights organization. To order copies or request permission to reproduce materials, contact Ivey Publishing, Ivey Management Services, c/o Richard Ivey School of Business, The University of Western Ontario, London, Ontario, Canada, N6A 3K7; phone (519) 661-3208; fax (519) 661-3882; e-mail [email protected]. Copyright © 2004, Ivey Management Services

Version: (A) 2008-08-26

It was 8 a.m. on Wednesday October 1, 2003, when John A. Lederer, president of Loblaw Companies Limited, saw the following news item.2 Wal-Mart Canada Corp. is accelerating the pace of its expansion with plans for an undetermined number of Sam’s Club wholesale mega-outlets. Some industry insiders have speculated that the company will launch as many as 10 to 15 Sam’s Clubs next year to add to the first four it will open in Canada this fall. Many observers believe that setting up the grocery distribution network for Sam’s Club will be the first step to U.S.-based Wal-Mart Stores Inc eventually bringing its giant Supercenters, carrying a complete supermarket assortment, to Canada. Although Wal-Mart had entered Canada in 1994, it had been uncharacteristically cautious. Even a decade later, it had not expanded fully into groceries despite its own global experience that the addition of a grocery line in a store pushed the sales of the more profitable general merchandise upwards by over 30 per cent.3 Canada was Wal-Mart’s only overseas market in which it had not deployed its powerful 1

This case has been written on the basis of published sources only. Consequently, the interpretation and perspectives presented in this case are not necessarily those of Loblaw Companies Limited or any of its employees. 2 www.globeandmail.com/reportonbusiness/retail, accessed October 9, 2003. 3 Kevin Libin, “The Last Retailer in Canada,” Canadian Business, March 18, 2002, p.38.

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Supercenter concept. The launch of its wholesale brand, Sam’s Club, suggested that the arrival of Supercenters in Canada was imminent. TIME-TESTED STRATEGY

It was time for Loblaw to take a fresh look at its own strategy. The strategy had worked so far: Loblaw was the market leader in Canadian grocery, with a market share in excess of the combined market shares of its four nearest competitors, and it was the 24th largest grocery retailer in the world (see Exhibits 1 and 2). The Loblaw strategy was both consistent and transparent, listing the following elements in the company’s annual reports:4 x x x x x x x

Use the cash flow generated in the business to invest in the future. Own real estate to maximize flexibility for future business opportunities. Use a multi-format approach to maximize market share over the longer term. Focus on food but serve the customer’s everyday needs. Create customer loyalty and enhance price competitiveness through a superior control label program. Implement and execute plans and programs flawlessly. Constantly strive to improve the value proposition.

The strategy was driven by

INDUSTRY OVERVIEW

Growing at an average rate of four per cent, food retailing was a $66.8 billion business in 2002 (see Exhibit 3). The rate of growth was impressive in light of two factors: Canadians paid the lowest prices for food in the world, and food inflation was less than two per cent per annum.5 Grocery retailers also occupied four of the top 10 retailer rankings in Canada in 2002. A broad spectrum of competitors prevailed in the Canadian grocery sector — from stand-alones with limited market presence to integrated firms involved in manufacturing, importing, wholesaling and retailing. They also operated at various levels: local, regional and national. The presence of high levels of discount stores

4

Loblaw Companies Limited, 2002 Annual Report, p.3. Ibid, p.7.

5

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and private labels and the high degree of market concentration had made Canadian grocery rank among “the most advanced grocery markets in the world.”6 Canadian grocery stores often co-operated on the supply side even as they competed on the demand side. Smaller stores pooled up with large buying groups to negotiate volume discounts from suppliers. Integrated firms sold to independents. Retailers owned wholesalers and vice versa.7 Such interactions made Canadian grocery a fertile area for mergers and acquisitions. By contrast, Loblaw’s approach was characterized by an equal focus on organic growth. CONSUMERS

Grocery shoppers were creatures of habit. They went to the same store to buy the same goods and services at almost the same time and day of a shopping period, making the business amenable to relationship building. The advent of supermarkets in the 1930s and the focus on self-service that gathered momentum in later decades had made shopping impersonal. Re-establishing that link with the customers, through the use of technology, was now being seen by mega-grocers as a means of gaining leverage over competitors. Most grocers offered a frequentshopper loyalty card. The data gathered through it was also used to secure better terms with manufacturers and distributors. There were (increasing the number of households shopping in their stores), (increasing the number of shopping trips the shoppers made) and (getting shoppers to spend more on each shopping trip). Low price, quality service, quality products and breadth of product assortment were important. The increasing incidence of double income families fuelled the demand for readyto-heat and ready-to-eat convenience foods. Fast-food chains, take-outs and restaurants were growing in response. This, in turn, reduced the share of unprocessed cooking ingredients in the overall food bill of a household, estimated at $6,438 per annum in 2002, or 11.12 per cent of annual household expenditure. However, 70 per cent of Canadian meals were consumed at home, even though most were not cooked from scratch.8 Grocers developed new categories like home meals replacement (HMR) and offered on-site cooking demonstrations. Some had franchised restaurants in their premises both to lure traffic into the stores and to provide a value-added facility.

6 Perry Caicco, “Loblaw Companies Ltd: A Company in Transition,” CIBC World Markets Equity Research Report, February 18, 2004. 7 “The Abuse of Dominance Provisions as Applied to Canadian Grocery Sector,” Competition Bureau November 2002 Bulletin, www.cb-bc.gc.ca, accessed October 5, 2003. 8 “Canadian Grocer,” 2001-2002 Executive Report, p.15.

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SUPPLIERS

Retailer-supplier relationships were characterized by power plays. The scale would tilt in favor of the one wielding the most clout at a point in time. A supermarket was like a landlord letting out shelf space for rent. The rent was a combination of different allowances that a manufacturer paid to the retailer to get secure shelf and warehouse position of its products, to encourage advertising, and to reward high volume purchases.9 They included, for example, listing fees, slotting fees, over and above allowances, vendor allowances for merchandise returns, quantity discounts and merchandising allowances. There was no standard basis on which the amount of each allowance was determined. The category manager10 usually had the last word in deciding how the shelves were stocked. Smaller suppliers often were at the mercy of their grocery customers since a large percentage of their business was in the hands of just a few buyers. Producers of category-leading products were in a better position: grocers had to carry their products (often as loss leaders) to attract and retain their customers. The higher a supplier’s market share relative to a grocer’s, the more power it commanded and vice versa. Consolidation among either suppliers or grocers would shift the balance of power temporarily, and consolidation was increasing on both sides. Mega-grocers took a long-term view of the relationships with suppliers as part of ensuring cost-efficiencies and seamlessness in operations. They involved suppliers in merchandizing, category management and supply chain management, using enterprise resource planning (ERP) technologies. Suppliers used their industry associations to push for standardization in the ERP programs of the mega-grocers to avoid having overlapping systems, one for each customer. COMPETITORS

According to the National Market Survey 2002 conducted by Canadian Grocer, there were 1,791 supermarkets, 8,342 convenience stores, 3,906 affiliated independents and 10,109 unaffiliated independents in the Canadian grocery business (see Exhibit 4). The independent sector accounted for 39.3 per cent of the grocery market sales in 2002.11 The unaffiliated independents (usually smaller stores) were facing tough times: 418 of them went out of business during 2002.

9

Anne Kingston, “The Edible Man,” Macfarlane Walter and Ross, 1994, Chapter 2. A category was a group of products that were inter-related. A manager with profit center responsibility headed each category. Examples of categories were produce, meat, housewares, dairy and grocery. 11 Jerry Tutunjian, “What’s Up and What’s Down,” Canadian Grocer, February 2003, p.26. 10

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Grocery Chains

In 2003, there were 44 grocery chains in Canada (see Exhibit 5). Loblaw faced competition from four leading chains: Sobeys, Metro, A&P and Canada Safeway. Each had a distinctive profile.

Sobeys Inc. In 1907, Sobeys Inc. set up in Nova Scotia, had over 1,500 stores in 10 provinces. It was the second largest national distributor with an estimated 15 per cent share of the Canadian food market. Employing 33,000 people, Sobeys had sales of $10.41 billion in 2002. Its retail banners included IGA and PriceChopper. Metro Inc. Metro Inc., another home-grown enterprise of over 50 years standing, was the leading supermarket chain in Quebec. It had sales of $5.15 billion in 2002, and employed 10,733 people in its 833 stores. Metro had several banners, including the discounter Super C, and three private labels: The Irresistible, Econochoix and Super C. Atlantic and Pacific (A&P) Established in 1927, A&P had 240 stores in prime locations in Ontario generating sales of $3.99 billion in 2002 under three banners: discount grocer Food Basics; Dominion, mainly in Toronto; and A&P in the rest of Ontario. A&P Canada was the best performing division of the U.S.-based The Great Atlantic and Pacific Tea Co. Inc., which was in serious financial trouble. Having recently gone through major capital rejuvenation and a change in marketing strategy emphasizing freshness, A&P Canada was in a growth mode. Canada Safeway Canada Safeway was started in 1929 as a subsidiary of Safeway Inc., the thirdlargest supermarket operator in the United States. Canada Safeway had 214 stores located primarily in Western Canada, capturing a 28 per cent share there. Employing 28,000 people, it had sales of $3.48 billion in 2002. Canada Safeway served its own stores and independents through its three distribution centers.

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Wholesale Clubs

Wholesale clubs charged an annual fee (ranging between $30 and $50), and offered a broad range of products and services at low prices for bulk purchases. They lured away high volume “stock-up shoppers” from the grocery chains. Stores were functional, sans frills. The wholesale club was a profitable format in Canada. Costco Wholesale Canada was the leading wholesale club in Canada. It had 61 outlets and about four million members, which included small businesses and many individual consumers. The launch of Sam’s Clubs in Canada by Wal-Mart posed a direct threat to Costco, which had enjoyed a first mover advantage in Canada since 1985. In the United States, Costco had dealt with competition from Wal-Mart through differentiation. Unlike Sam’s Club, which went after bargainhunting Wal-Mart customers, Costco U.S. had positioned itself towards smallbusiness owners. The focus on a slightly higher-end customer had not only led to a significantly higher average sale per customer but also limited its competition with Sam’s Clubs in the United States, which was generally perceived as downscale. Specialty Chains

Specialty chains operated smaller stores in niche segments, such as ethnic groceries and organic foods. The ethnic foods market, estimated to be of the order of $6 billion,12 was likely to grow due to immigration patterns. Its customers comprised the five major ethnic communities in Canada — Chinese, South Asian, Middle Eastern, Central and South American and Caribbean. The $1.8 billion organic foods market was growing at 20 per cent per annum.13 The world’s largest natural and organic foods chain, based in the United States, had opened its first overseas store in Toronto in May 2002. Whole Foods Inc. products competed directly with Loblaw’s PC Organics natural food products. Convenience Stores

Convenience stores complemented supermarkets by allowing consumers to fill up between shopping trips. The convenience store segment had grown faster than grocery supermarkets, increasing in number from 6,629 in 1997 to 8,342 in 2002.

12

John Schofield, “The Ethnic Market in Canada,” Food in Canada Magazine, November/December 2002, p.28. 13 Lisa Rostoks, “Romancing the Organic Crowd,” Canadian Grocer, August 2002.

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Online Shopping

Online grocery shopping accounted for only $100 million in sales in Canada. Grocery Gateway, a Toronto-based e-grocer, dominated the market, growing its customer base from 7,000 in 1999 to 14,200 by mid-2002.14 AC Nielsen studies indicated that 57 per cent of Canadians were Internet users in 2000, up from 31 per cent in 1997. A survey in 2000 showed that grocery orders through the Internet numbered between 800 to 1,000 per day, and the average size of an order was $120. New families and young singles were driving contemporary online grocery sales in Canada, but electronic security was a major barrier to shopping online for some consumers.15 Competitive Outlook

Small entrants in the independent category entered the market frequently. Two of the most recent large entrants to the Canadian grocery were Whole Foods, which had entered a niche market of organics, and Wal-Mart, which had entered Canadian retail by acquiring 122 Woolco stores. Grocers in the mid-sized category were potential acquisitions for global firms pursuing expansion. European grocers were known to be on the prowl for acquisitions since their home markets had reached saturation levels and the rate of growth was slowing down.16 However, the limited market size in Canada and lower margins were major disincentives. Each of the four leading grocers in Canada — including Loblaw — had been the subject of regular media speculation as a take-over target of various global firms. GROCERY OPERATIONS Supply Chain and Logistics

An average Canadian grocery store carried 25,000 to 40,000 stock keeping units (SKUs). Strong supply chain and logistics functions were thus crucial. Demand forecasts were, in large part, judgment-driven, despite the use of computers. Poor forecasting or logistics led to expired or obsolete products, which drained profitability, or conversely, to out-of-stocks, which reduced sales and customer satisfaction.

14

Lynne Davidson, “The Milkman Returneth,” pwcglobal.com/RealEstateTrendsSummer 2002, accessed October 7, 2003. 15 “Canadian Grocer,” 2001-2002 Executive Report, p.30. 16 Peter Diekmeyer, “Are Canada’s Retailers Ripe for the Picking?” www.cdngrocer.com, accessed October 7, 2003.

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Technology

Canadian retail was leading the revolution in technology, ahead of U.S. retail, with its ECCnet. Put into place in mid-2003, ECCnet was a national, online, standardized product registry for synchronized data exchange. It provided the foundation on which subsequent technology platforms, like Radio Frequency Identification, could be deployed without delay. Potential savings for grocers were estimated at one per cent of sales.17 Scale

The average size of a Canadian supermarket was 28,000 square feet, generating average weekly sales of about $300,000. Goliath stores averaging 110,000 square feet could generate a million dollars in sales a week.18 Scale advantages included lower costs of handling incoming materials and lower procurement costs, but backroom support was crucial, and the store had to run at full capacity. Profitability

The margins of a supermarket chain were among the lowest of all industries. Posttax profits averaged between 0.5 per cent and two per cent. Independents had higher margins of up to five per cent but on lower sales (see Exhibit 6). Since store profitability was linked to space, costs were calculated per square foot (see Exhibit 7). The data on product profitability or even on category profitability was not always reliable due to the number of variables in cost allocation and cost apportionment. 19 LOBLAW Company Background

Loblaw Companies Limited was a part of George Weston Limited, a broadly based Canadian company operating in two distinct business segments: food processing and food distribution. Founded in 1919 by Theodore Pringle Loblaw and J. Milton Crok, Loblaw Grocetarias, as it was then known, was a prosperous chain of 113 stores spread in Ontario with sales of $50 million in 1947, when Garfield Weston, a young baker in Toronto, acquired a small stake in the company.20 Now controlled by a third generation member of the Weston family and spearheaded by a professional team led by John Lederer, Loblaw was Canada’s largest food 17

“Canadian Grocer,” 2001-2002 Executive Report, August 2003, p.32. George H. Condon, “Taming a Goliath,” Canadian Grocer, March 2002. www.georgemorris.org/HMR update, accessed October 12, 2003. 20 Charles Davies, “Bread Men,” Key Porter Books, 1987, p.92. 18

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