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A Sobeys store in Calgary.

TODD KOROL/The Globe and Mail

Sobeys Inc. is turning up the pressure on its suppliers, demanding price cuts in the wake of its $5.8-billion purchase of Safeway Inc.'s Canadian stores.

The country's second-largest supermarket chain, which added 213 stores in Western Canada when the deal closed, in early November, has told suppliers of food and other merchandise they will have to shave their prices by 1 per cent, retroactive to Nov. 3 – a move that observers say could prompt rival grocers to follow suit.

In a letter dated Dec. 24 and obtained by The Globe and Mail, Sobeys also says it will not accept price rises from suppliers through 2014, with some exceptions such as pharmaceutical items.

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The demand reflects the tightening grip of big retailers in the grocery sector and the severe competitive tension in the food business. U.S. discount giant Wal-Mart Stores Inc. is increasing its presence in food, and Target Corp. opened a chain of Canadian stores last year. Supermarket leader Loblaw Cos. Ltd. is preparing to close its deal for Shoppers Drug Mart Corp., which will add to its purchasing heft.

The result has been virtually no food cost inflation in Canada. Prices rose just 1.1 per cent in November from a year earlier. In some categories, such as dairy and cereal products, prices are falling.

"To support growing sales and to improve our internal productivity, we expect to fully leverage our new consolidated scale," says the letter to suppliers from Dale MacDonald, senior vice-president of category management and national procurement at Sobeys. Copies of the missive were sent to Marc Poulin, the chain's chief executive officer, and 13 of its executives.

"It's a very aggressive move in a very, very, very competitive marketplace," said Bruce Winder of retail specialist Bruce Edward Winder Consulting. "Other retailers will see it and hear about it and say, 'Where's my 1 per cent?' "

Since grocery sales volumes tend to be relatively stable, retailers rely on having some price inflation to increase profits. When inflation is minimal and their pricing power with consumers is weak, they lean more on their suppliers to help make gains.

"The manufacturers who are behind these products are really going to hurt," said Marion Chan, principal at TrendSpotter Consulting, which advises food and beverage suppliers. "It's going to be very difficult."

Suppliers reached would not comment, nor would industry groups including Food & Consumer Products of Canada, which represents major grocery manufacturers.

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Sobeys spokesman Andrew Walker would not elaborate on the letter or potential savings. "This letter was part of our ongoing vendor management, which we do not discuss publicly," he said in an e-mail.

In an interview last month, Mr. Poulin said the supermarket chain is testing lowering prices on some products. In some cases, Sobeys research found that the gap between regular and sale prices was too large.

Ms. Chan said Sobeys' demands from suppliers may benefit consumers and some smaller suppliers, which could generate bigger volumes of business from the newly-merged retailer even though they will have to drop prices.

Still, the timing is rough on the manufacturers because they have generally set their 2014 budgets, Mr. Winder said. The reductions will mean they will have to find savings in other areas, such as marketing, to make up for squeezed profit margins. Or suppliers may price upcoming new products higher than they planned, he said.

"The manufacturers will obviously not be very happy about it," Mr. Winder said. The 1-per-cent cut can be material in a sector where profit margins are already slim, he said.

In quarter ended Nov. 2, Sobeys reported that its gross margins slipped to 22.5 per cent from 23 per cent a year earlier because of heavy discounting. Other segments, such as apparel, enjoy margins that are more than twice as large, Mr. Winder said.

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In its letter, Sobeys says its acquisition of Safeway Canada will provide it with a new growth platform in Western Canada, the country's fastest-growing region, while also significantly increasing the retailer's economies of scale. To help it gain scale, Sobeys will require the retroactive 1-per-cent "synergy savings rate" from suppliers, it says.

"This 1 per cent synergy savings rate will be deducted from payments starting the end of January 2014," the letter says. "Retroactive savings will also be deducted. The rate applies to all branded and private label grocery products.

"In addition, and as you are aware, current market retail pricing conditions leave no room for absorption of cost of good increases. As such, Sobeys Inc. will not accept any cost of goods increases through 2014."

It will make some exceptions in cases of pharmaceutical supplies and "single commodity items," which are currently priced daily or weekly, such as sugar, or possibly "where extraordinary unforeseen circumstances apply," the letter says.

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