Sobeys, Safeway and a $1.7-billion blunder: How not to handle M&A

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They will teach this one in business schools. A dominant East Coast grocer coughs up major dough to acquire a western rival. Hundreds of millions of dollars in synergies are promised. Bay Street falls in love with the potential.

And then, two years into the integration, the buyer unveils a stunning stumble.

It isn't solely that Sobeys Inc. wrote off $1.7-billion last week. Amping the shock value, the impairment charge stemmed from the grocer's once-hyped Canada Safeway Ltd. acquisition. Nearly one-third of the $5.8-billion purchase price was swiftly wiped out.

Three crucial lessons lie in the dust: No matter how much strategic sense a deal makes, execution is, and always will be, everything; buyers should never underestimate the power and importance of brand value; and getting retail right is rather tricky.

Before throwing too many stones at Empire Co. Ltd. chief executive officer Marc Poulin – Empire owns Sobeys, among other assets – remember what the world looked like when he first started negotiating the Safeway deal in 2012. Target Corp. had Canadian retailers spooked by its northern expansion. Wal-Mart Canada Corp. was broadening its food offerings.

And behind the scenes, Loblaw Cos. Ltd. was plotting its acquisition of Shoppers Drug Mart. Sobeys, it seemed, had to do something.

When the Safeway deal was announced in June, 2013, the only big question appeared to be the price. Although the strategy made so much sense – especially considering rival eastern grocer Metro Inc. wanted to do the same deal – $5.8-billion wasn't chump change, which is something Metro alluded to in an e-mail to The Globe and Mail in 2013.

"Safeway knew our interest. We were not invited to negotiate. We doubt that we would have been ready to pay that amount for these assets," a spokeswoman wrote. (Let it be known that the chief executives of Metro and Sobeys are old high-school friends.)

But investors digested the price tag and by mid-2014, Empire's stock was on a tear – thanks, in part, to sudden demand for anything-but-commodity stocks. What happened from there largely falls on management's shoulders.

The supply-chain issues that have plagued so many retailers – Loblaw, Target – also stung Sobeys. When Safeway was a separate company, its U.S. parent handled its produce delivery. That changed when Sobeys took over, and it didn't go well.

New SAP software and point-of-sale technology also troubled Safeway staff; some even tried to go back to the old way of doing things. To appreciate how troublesome this can be, just ask Target, which bungled its SAP rollout in Canada and ultimately retreated as if it were a turtle going back to its shell – incurring a $5.4-billion (U.S.) writedown in the process.

And on the staffing front, Sobeys installed a new way of doing business, relocating all head-office functions to a Safeway centre in Calgary – just a few years after setting up regional hubs in cities such as Edmonton and Winnipeg. Some staff were reluctant to move. All of this sapped morale.

Sobeys, it seems, also underestimated how attached Canadians were to Safeway in the West. The grocer, which declined to comment, put its own private label, Compliments, in Safeway stores and the backlash came quickly. One sample comment posted to a Globe story announcing the writedown: "Compliments brand products are poor quality. I thought it was just me, until it became a water-cooler topic at the office and I discovered my colleagues all think the same thing. We've all started shopping at either Calgary Co-Op or Superstore instead of Safeway."

Now, Sobeys has to win these customers back and that's incredibly hard to do. "A negative experience takes about three times as long to dissipate in our minds and our recollections as an equivalent positive experience does," explained Edgar Baum, a brand-value specialist at Strata Insights Inc. who has experience both as a consultant and at Procter & Gamble Inc.

Mr. Baum also stressed that the retail world is much different today, much of it because of the Internet. "Because we have so much choice now, people get attached to the choices they make," he said – which would apply to Safeway's old offerings. "House brands have become brands; there's a whole cult following."

On the bright side, if you can call it that, the Safeway writedown is a non-cash charge and eats solely into the goodwill Sobeys assumed through the acquisition. In theory, the money could be made back. The trouble is that the Alberta market is now incredibly tough, and has turned incredibly promotional to lure shoppers. Margins will suffer.

"Progress is being made to improve the offering to Safeway shoppers," CIBC World Markets Inc. analyst Mark Petrie wrote in a note to a client, "but it will be challenging (and expensive) to gain traction.

"The questions, of course, are how long will it take for this to happen, and at what cost?" he added. "At this point, these are unanswerable, and our current estimates are 'a long time' and 'a big one.'"