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Jens Kristian Balle

When Sobeys headed to Western Canada to snap up Safeway for $5.8 billion, it was on top of the world. Since then, it has booked billions in write downs and dumped its CEO. Why did everything go so terribly wrong?

Carole Taylor is checking a nifty shopping-list app on her smartphone in the produce department at the Safeway not far from her southwest Calgary home. It is here that she first noticed changes at her favourite store a couple of years ago—and they weren't pleasant ones.

Taylor is the kind of customer Safeway, acquired by the parent of Sobeys Inc. in a blockbuster, $5.8-billion deal in 2013, wants to keep coming back. A growing number haven't been. Taylor, a university administrator, prefers a full-service grocery store to a big, noisy, price-slashing warehouse. But Safeway, despite a convenient location and similar prices, is her second choice behind Calgary Co-op, also a full-service grocer.

In the months following the takeover, some of the fruit and vegetables she bought at Safeway, like nectarines and red peppers, lacked their usual quality and spoiled quickly. That hadn't happened before. Items elsewhere in the store, including rubber gloves, seemed always out of stock.

"Finally, I asked them, and they told me it was because of the sale of the company. They were changing their product lines, so they were waiting for the in-store brand to come in. That took months," Taylor, 58, says while pushing her cart down aisles plastered with green and yellow signs blaring that thousands of prices have been slashed. On a Sunday afternoon in September, it's not crowded; if one's fear is his car-door getting dinged by another shopper parked too close, there are ample free spots in the lot to assuage it.

Recently, the produce has improved, Taylor says. But the variety is still inferior to Co-op, so the change is not enough to make Safeway her go-to store again.

Carole Taylor's red-pepper complaint may not sound like a big deal. But multiply it by thousands of customers, and you've got the biggest retailing fiasco in Canada since Target Corp.'s northern foray self-destructed.

For Stellarton, N.S.-based Empire Cos. Inc., the parent of Sobeys, a dream acquisition has turned into an existential struggle. After a string of costly missteps and some bad timing that culminated in the company's CEO stepping down, Sobeys finds itself having to reinvent itself to woo customers back to Safeway.

It won't be easy. In the past two quarters, same-store sales in its West business unit, which includes Safeway and Sobeys stores, skidded 3.6% and 3.9% respectively. That's raised questions about how long the bloodletting can continue. The company's counterpunch is a major price-cut initiative, as advertised on those in-store signs. For a full-service grocer like Safeway, with its higher costs per square foot of store space, it's a big gamble.

It was hailed as a masterstroke when Empire acquired Canada Safeway in 2013 following exclusive talks with its American owner initiated by CEO-to-be Marc Poulin and then-CEO Paul Sobey under the code name "London." The purchase instantly gave Sobeys girth in Western Canada and made it Alberta's No. 1 supermarket chain operator. Rivals, including Ontario- and Quebec-focused Metro Inc., had also coveted Safeway, with its 213 full-service stores from Vancouver to Thunder Bay, four major distribution centres, 12 manufacturing plants and $1.8-billion worth of prime real estate.

In fact, Poulin's first call after finalizing the deal was to Metro CEO Eric La Flèche, an old high-school chum. It was a courtesy, not an opportunity to gloat, he said. "I wanted him to be aware of it just to be fair and polite," he told The Globe and Mail in 2014. "I called him and said, 'Eric, we're making this announcement, you may want to huddle with your PR team and prepare yourself because you're going to get lots of questions.'"

At the time, Western Canada was the Promised Land for the grocery business. The economy was on a tear and the world's major retailers had taken notice. Target was at the start of its Canadian invasion (which would end unceremoniously in creditor protection), and its food offerings were front and centre in the big, shiny red-and-white stores. Wal-Mart, the behemoth of Bentonville, was vastly expanding its own grocery shelves in the West. A few weeks after the Safeway deal was announced, Loblaw, already the nation's top grocer, agreed to buy Shoppers Drug Mart in a $12.4-billion deal, and Shoppers' food aisles were soon stocked with its buyer's President's Choice brands. The industry was red hot.

The Safeway debacle cost Sobeys CEO Marc Poulin his job.

The Safeway debacle cost Sobeys CEO Marc Poulin his job.

Nathan Denette/CP

Poulin, then CEO of Sobeys and soon to be promoted to head of Empire, trumpeted the Safeway deal as a big victory for the two companies' employees as well as for customers (neither Poulin nor any Sobeys executive would be interviewed for this story). Economies of scale were a major draw. He promised $200 million in annual savings within three years of inking the deal. This ambitious target would be realized by switching Safeway over to Sobeys' IT systems and "rationalizing" operations. That meant closing stores where Safeway and Sobeys were in close proximity, reducing staff, and unloading some manufacturing operations and distribution centres.

Though it had always been owned by its stateside parent, Safeway Inc., Canada Safeway's red-and-white S logo had become so familiar to shoppers in the West that many assumed that "Safeways" was homegrown. The retailer opened its first stores in Winnipeg in 1929, and expanded, acquiring the northern operations of the famed Piggly Wiggly banner the following decade.

In the 1960s, Safeway locations with now-familiar architectural details like a swooping storefront roof-line were fixtures in cities such as Vancouver, Calgary, Edmonton and Winnipeg. As Safeway moved to larger locations in the suburbs, smaller retailers took over the inner-city buildings. Shoppers liked the Safeway Select and Lucerne in-store brands, which at times could be picked up at a discount with Safeway Club Cards. The company's annual "Touchdown To Win" TV promotion each summer and fall enmeshed it with the western mania for Canadian Football League games.

"Almost everyone who lived here grew up with Canada Safeway," says Lynne Ricker, chair of marketing and entrepreneurship at the University of Calgary's Haskayne School of Business. "Back in the day, it was Safeway and Co-op and some local players. That was pretty well it."

In the East, the Sobeys banner is as much an institution as Safeway is in the West. J.W. Sobey founded the company as a meat delivery business in Stellarton, northeast of Halifax, in 1907. His son, Frank Sobey, pushed for expansion of the business and, in 1924, it began selling other products. Fifteen years later, it had expanded to six stores. From the 1940s through the 1960s, the company opened locations throughout Atlantic Canada. With Frank's sons, Bill, David and Donald, at the helm, it began pushing into Ontario in 1987, before finally going nationwide in 1998. Today, five Sobeys sit on Empire's board, including Paul, the fourth-generation member of the controlling family who was CEO for 15 years until handing the reins to Poulin just after the Safeway takeover.

At the time of the deal, Sobeys was no neophyte to the western market. It established a beachhead in 1998, when Empire purchased the Oshawa Group, wholesaler to the IGA chain. In 2007, it expanded through the purchase of Thrifty Foods in British Columbia.

The family knows better than most that the grocery business is one of countless details, from maintaining relationships with suppliers, deciding on optimum prices for products, keeping track of deliveries to stores, making sure shelves are stocked with the right inventory, employing the proper complement of well-trained people and, most importantly, offering an experience that keeps shoppers coming back.

Somewhere along the road out west, these lessons were forgotten.

Two-thirds of retail success is driven by intangibles that play into the shopping experience, like the service and accessibility of shoppers' favourite products. Or so says Edgar Baum, CEO and chief brand economist at strategic advisers Strata Insights. "The market wasn't crying out and saying, 'We're dissatisfied with Safeway, somebody come and give us a different grocery shopping experience.' I think that was overlooked at the time of the acquisition. It was overlooked during the integration and now they're paying for it," he says.

The many faces of Canada's Big 3 Grocers

(Tap or click arrow for Metro)

GroceryApart from the Loblaws flagship, banners include Fortinos, Zehrs, Your Independent Grocer, City Market, SuperValu, Shop Easy, Freshmart, Valu-mart (Ont., Que.), Provigo (Que.), L'intermarché (Que.), Axep (Que.), Atlantic Superstore (Atlantic), Dominion (Nfld.)Apart from Sobeys itself, the company sells under regional banners: Thrifty Foods (B.C.), Safeway (West, NW Ont.), Foodland (Ont., Atlantic), IGA (West, Que.), Co-op (Atlantic)As well as Metro (Que., Ont.), the roster includes Quebec chains Marché Richelieu and the small-format Marché AMI and Marché Extra; high-end Les 5 Saisons (two Montreal locations)
DiscountNo Frills, Box, Cash & Carry, Real Canadian Superstore (West), Extra Foods (West, NW Ont.), Maxi (Que.), Atlantic Save Easy (Atlantic)FreshCo, PriceChopper (both Ontario)Food Basics, Super C (Quebec)
SpecialtyAsian chain T&T Supermarket (Toronto), Mediterranean specialist Arz Fine Foods (Toronto) Chalo! FreshCo (one Ontario location)Adonis (Mediterranean; nine Montreal-area and two Toronto-area stores, as well as wholesaling); bakery Première Moisson, 24 mostly Montreal locations
Drugstore1,131 Shoppers Drug Mart and other 78 Lawtons Drugs (Atlantic)180+ Brunet stores (Quebec)
And then there's…PC Financial, Joe Fresh, Photo Lab, food-service wholesaling, gas bars, liquor stores, Choice Properties REIT350 gas bars, retail landlord Crombie REIT420 Quebec convenience stores (Service, Servi Express, Gem), drug wholesaling

*Store counts are for food stores only. Revenue and profit for Loblaw are fiscal 2015 (year-end Jan. 2, 2016); for Sobeys, fiscal 2016; for Metro, fiscal 2015 (year-end Sept. 26, 2015) / Source: Company filings

In modern grocery merchandising, house brands are often the only thing that distinguishes one chain from another. Yet intense customer loyalty to Safeway's brands took Sobeys by surprise. In many cases, Select and Lucerne products were identical to the goods from Sobeys' Compliments line that replaced them, Poulin said in June as he explained to analysts Empire's hefty $2.1-billion net loss for the year. In a few cases where formulations hadn't been the same, shoppers still weren't happy after they were made identical. "Customer reaction was not what we anticipated," he conceded.

"You hear it on the street in Calgary, literally," Ricker says. "You have to push store loyalty, and you do that with things like corporate brands. I go to Safeway to get Lucerne black cherry yogurt or Safeway Select products. I can buy bananas anywhere."

It wasn't immediately evident for months after the takeover, but Sobeys had problems at each step of the chain from warehouse to cash register—and some of these hitches existed before the deal. Safeway, which struggled in its own home U.S. market and would soon be taken over itself, had treated the Canadian business as a cash cow while investing as little as possible in modernizing the operations, says Kenric Tyghe, retail analyst at Raymond James. "What Sobeys thought they were buying, and what Sobeys ended up getting, turned out, I think, to be two different assets," Tyghe says.

Supply-chain problems were a particular drain on efficiency after the deal. Sobeys made a transitional arrangement with Safeway to maintain U.S.-based produce sourcing and buying. As the arrangement expired, Sobeys took over purchasing and immediately suffered glitches as new buyers became responsible for keeping fruit and vegetables on the shelves. The result is what Taylor, the Calgary shopper, experienced with her peppers. "We basically had, for a number of months, difficult replenishment of our stores in produce," Poulin explained in late June. "The quality of what we were putting out for the customers was impacted as a result of that."

Such issues, and empty shelves as a result of supply-chain snafus, are business killers because customers have a low tolerance for being inconvenienced, Ricker says. "I go to your store needing bananas, and you don't have any? Are you kidding? Now I'm going to have to go somewhere else," she says.

That the IT side of the supply chain would be a hitch should not have been a surprise. Following acquisitions of new businesses at large retailers, massive IT systems must mesh thousands of SKU, or stock keeping unit, codes, and that can lead to myriad glitches. Enterprise software snafus have upended the supply chains and internal systems of other Canadian retailers, including Loblaw and Target Canada. In fact, Sobeys itself abandoned a SAP system in 2000 following a system crash, resulting in a $50-million writedown. It returned to the German software provider—whose systems are used by many of the world's largest corporations—a few years later.

At Safeway, Sobeys installed new SAP software and point-of-sale technology that frustrated staff, some to the extent that they tried to go back to the old systems. Sobeys also relocated all western headquarters functions to a centre in Calgary—just a few years after setting up regional hubs in cities such as Edmonton and Winnipeg. These changes, too, took a toll on employee morale.

The confusion in the ranks didn't help supplier relationships, either. A marketing representative at one Canadian-based manufacturer said that, even up until this year, it took as long as six months for some distributors to get a meeting with key buyers who could agree on and finalize store-level promotions, such as a sale or special displays. That hurt his brand's sales. "A lot of the budget I had to invest at Safeway was basically left because nobody could make a decision on promotional activities," says the rep, who spoke on condition of anonymity, fearing loss of future sales.

What's so surprising is how long the woes stayed under wraps. At the end of the 2014 fiscal year, Poulin said Safeway was being successfully integrated into the Sobeys fold. It was becoming more efficient and costs were coming down throughout the organization. In fact, by the end of the first year, Safeway and Sobeys in Western Canada were already well down the road to delivering half of the promised synergies. Sobeys said it would close 50 underperforming stores in the company's network, 60% of them in the West. Overall sales jumped 20.6% accounting for the Safeway takeover, and 2.2% excluding it.

The following year, revenues climbed another 14.2%. Things were so rosy for Empire that it treated shareholders to a dividend increase. Investors bid the shares up to the point where the company opted to split the stock.

But in Sobeys' 2016 fiscal year, everything seemed to go wrong at once.

In March, Empire stunned investors by writing down $1.6 billion of the value of Safeway as customers drifted away. Just three months later, it lopped another $1.3 billion from its book value, meaning half the worth of the acquisition had evaporated within just three years. It's clear that Sobeys materially overpaid for Safeway, Tyghe says.

Sales had fallen off a cliff, and only partly because of the economic downturn in the Alberta and Saskatchewan economies, observers say. Oil prices collapsed in late 2014, and within months, energy companies put the brakes on many of their expansion plans and began rounds of layoffs in the field and at headquarters.

The problems at Safeway may have simmered in the background much longer had the slowdown not hit. "It would have given them more time to reposition the footprint and fix the problems," Tyghe says. "But it moved a lot quicker than they could fix things, because of the oil-price slide."

It took time for consumers to rethink their buying habits, creating a lag effect on the full-service grocers, Tyghe says. But then, shoppers changed in a big way, trading off some of the comfort and convenience of the likes of Safeway for prices offered by the big discounters—No Frills, Real Canadian Superstore and Wal-Mart. Sobeys' weak flank was exposed: Unlike Loblaw, it had no discount banners in the West.

In Eastern Canada, Sobeys has its own FreshCo discount banner. It has not made the offering out west, saying it first has to get its existing house in order. Whether it's possible to be a lower-price retailer with full-service costs is untested in a fiercely competitive region that already has well-established discount supermarkets.

It's notable too that the western slump hasn't defeated other retailers. "This is not a write-off because the economy tanked. This is a write-off because the economy tanking showed the deep chasm between the two brands and how they came together," says Baum. "The category brand exper-ience was not acknowledged by Sobeys, and planning for the integration of two cultures, processes and cust- omer bases was not acknowledged and accounted for."

From a high of $31.59 a share in early 2015, Empire's Class A non-voting stock had tumbled 27% by early October. The company lost 15% of its worth in one day last March, when it announced its first writedown.

When he explained the second writedown at the end of the fiscal fourth quarter, Poulin urged patience, acknowledging softening sales trends—not just in the West but across the country. He pledged to stay focused on cutting costs, "renewing" Empire's network and setting pricing policies aimed at keeping long-time customers and attracting new ones. Poulin would not get the opportunity. Within weeks, Empire announced it was cutting ties with him, effective immediately, naming two-decade veteran François Vimard, the company's chief financial and administrative officer, as interim chief while the board sought a full-time fixer to lead a recovery.

Vimard presided over the release of Sobeys' first-quarter 2017 results, announced in September. They showed a rebirth had not taken hold yet, with sales slumping again in the West—and elsewhere. Net earnings slumped 40% and sales fell again. Key to getting the operation back in shape, Vimard told analysts, will be paying attention to the myriad details in stores that had previously kept Safeway customers loyal. As far as the $200-million savings target, it's evidently been thrown out. Vimard said the quest is now to lower costs as part of everyday business.

Vimard wouldn't bite on analysts' questions as to how things will differ under his stewardship versus Poulin's, or if the board is close to naming a new full-time boss. The lower-price strategy, known as Simplified Buy and Sell, was formulated under Poulin's leadership and has recently been instituted out west. It involves Sobeys streamlining and standardizing relationships with its suppliers as a way to compete more on price against rivals. "What I'm doing is just refocusing," Vimard says. "My predecessor put a lot of good strategies in place that we're implementing. By doing that, I think we forgot some focus that has to be done at store level."

The company's workers are worried that the woes of the western business could follow closely the sad saga of Target in Canada, in which a poor understanding of the market and supply-chain problems led to squalls of customer complaints. It chewed away at the reputation of the massive retailer and its CEO, who resigned, and prompted it to flee the country.

"We've all been concerned about the financial news that we've seen," says Jeff Traeger, president of UFCW Local 832, which represents Safeway and Sobeys hourly staff in Manitoba. The local has about 2,200 people working under banners, down from about 3,200 at the time of the takeover. The bargaining unit is scheduled to go into talks with the company in late 2017 or early 2018. Its Alberta counterparts are preparing to hammer out a new contract early in 2017. The big concern, says Traeger, is "you're going to have another Target on your hands."