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the loblaw-shoppers deal

Loblaws and Shoppers Drug Mart each control nearly one third of the grocery and pharmacy markets, respectively.Gloria Nieto/The Globe and Mail

In an industry where margins from generic drug sales are under pressure and competition has intensified, Shoppers Drug Mart Corp. has reinvented itself as a modern-day general store, a sector trend begun among U.S. competitors that will now put pressure on Rexall, London Drugs, and Jean Coutu Group (PJC) Inc.

Loblaw Cos. Ltd.'s announcement Monday that it will acquire Shoppers for $12.4-billion is a move that buys into that small-format model. If approved, the deal will also provide Shoppers with newly strengthened buying power with its product suppliers, and that could mean more competitive pressure for other small-format retailers attempting to provide a variety of services under one roof.

"What they're going to do right away is to go to companies like Procter & Gamble and Unilever, and say, 'Bad news, guys, two of the biggest players buying your products are now one,'" said Mark Satov, a retail specialist at Satov Consultants.

According to industry research firm IBISworld Inc., Loblaw controls nearly one-third of the grocery market in Canada, according to 2012 estimates, and Shoppers has roughly the same share of the pharmacy industry based on 2013 estimates. Combined, that creates new negotiating heft; and better supply chain management for Shoppers in the food and grocery segment where Loblaw's core expertise lies, and for Loblaw in the health and beauty segment where Shoppers has far more operating experience.

"Right now, Shoppers is figuring food out, and has built a billion-dollar business. But it's not the most efficient part of Shoppers' business," said Raymond James analyst Kenric Tyghe. "Loblaw – some challenges aside – at the end of the day, they know grocery very well."

The Loblaw-Shoppers tie-up also introduces new competitive pressure on other players in the market. Shoppers is not alone in pursuing a small-format, general store-like model.

Wal-Mart Stores Inc., which has long marketed its stores as offering everything under one roof at a discount, has been experimenting with smaller formats (less than 60,000 square feet) already in the United States. Its Neighborhood Market and Walmart Express stores are proving competitive against grocery stores, drugstores, and even dollar stores. While its big-box outlets still account for the vast majority of its locations, the company has said the small stores are helping to drive growth, and that 40 per cent of new store openings in fiscal 2014 will be the smaller versions.

The push into the small-format direction is driven by changing consumer habits, as demands on time force consumers to look for more one-stop shopping solutions in their neighbourhoods, without having to drive to bigger retailers. The convenience store industry has already responded by attempting to alter its down-market image and offering more fresh foods. Loblaw has integrated pharmacies, as well as health and beauty products, into its locations. And along with Shoppers, drugstores have increasingly been selling everything from digital cameras and iPods to milk and dry goods, household items, and expanded beauty products.

This not only helps those retailers to market themselves to busy, younger urban shoppers, but it also addresses Canada's aging population. Seniors are the fastest-growing demographic group in the country, and prefer to stick closer to home when running errands, Mr. Tyghe observed. "It's very much about proximity and convenience."

While the new general store model has worked for Shoppers – the price per share of Loblaw's offer represents a 27-per-cent premium to Shoppers' closing price a day before the announcement – there is room for Shoppers to improve in its food offerings, said Doug Stephens, author of The Retail Revival. The challenge, he said, will be to augment that section with some of Loblaw's products without disrupting the overall shopping experience.

"They have to be very careful with the Shoppers Drug Mart model – a lot of allegiance there," Mr. Stephens said.

Ultimately, the advantages for Shoppers stem from the buying power the chain inherits, which will allow it to provide whatever product mix works for changing consumer habits at a lower cost.

The "buying clout and synergies" Shoppers would gain post-acquisition will prompt competitors to find ways to match these benefits, said Kevin Grier, a senior market analyst at the George Morris Centre.

"What happens to everybody out there who is not in a combination like that?" consultant Mark Satov said. "If Shoppers felt they can't deliver the next wave of growth on their own, and they are dominant, what does that say for the others?"