CANADIAN PRICE WARS 2004-06-07 (2)

BRIAN DUNN

TORONTO -- When it comes to pricing in Canada, Safeway and A&P have taken different paths to compete against market leader Loblaw Cos., based here.

The dynamics of the market are changing, however, as more competition enters the country and as Loblaw takes its discount superstore concept to the eastern regions of the country.

A&P and Safeway are the largest U.S.-based food retailers operating in Canada, where pricing pressures have been acute for several years despite the lack of pressure from superstores operated by Wal-Mart Stores, Bentonville, Ark. A&P, Montvale, N.J., has been aggressive in the rollout of its Food Basics price-impact format in eastern Canada, where it competes with Loblaw. Safeway, Pleasanton, Calif., meanwhile has resisted taking a low-price tack in Canada, analysts said.

"Safeway only operates in Western Canada and has been stagnant and they've lost market share," said Perry Caicco, CIBC World Markets, also based here. "Their prices are outrageously high, but they've got good store locations, which is what they rely on."

According to data from tracking firm ACNielsen, Loblaw's market share grew by 1.3% for the 12-month period ended Dec. 31, while Safeway dropped 1.5%, and A&P stayed the same. Sobeys' share also declined 1.7%, while Metro took a 5.1% dive, mostly in urban areas where Wal-Mart does not operate. Wal-Mart's share grew by 12.7%.

Safeway Canada has been more profitable than the company's U.S. operations, however, and sales and profits in Canada grew last year. Safeway reported that its Canadian division recorded $4.04 billion in sales and $229.8 million in operating profits in fiscal 2003, representing 11.4% and 39.9% of Safeway's companywide totals, respectively.

A&P, meanwhile, has for several years been buoyed by the performance of its Canadian division, where it operates 176 stores and supplies about 65 Food Basics franchisees. Comparable-store sales in Canada were up 2% in fiscal 2003, following comp-store gains of 6.6% in 2002 and 7.8% in 2001.

Sales at A&P Canada totaled $3.25 billion in fiscal 2003, including $2.44 billion in the retail division and $814 million in the wholesale division. The total was a 24.4% increase over the preceding year's results and represented about 30% of A&P total sales for fiscal 2003.

Loblaw has always been the leader in the Canadian retail landscape, however, and continues to set the pace that others usually follow. Last year, the company began a new round of price cuts in anticipation of the arrival of Wal-Mart supercenters, an event that never materialized.

"I think Loblaw began its price-cutting initiatives because of concerns that Wal-Mart would eventually bring their supercenters to Canada," Caicco suggested. "And rather than wind up in the same situation as many grocers did in the U.S., where they had to play catch-up, Loblaw decided to get ahead of the game."

Although Wal-Mart has been in Canada for over 10 years since purchasing the former Woolco department store chain, the stores didn't include extensive food offerings. To make up the shortfall, Wal-Mart introduced 10,000-square-foot food sections called Grocery Shelf and began introducing Sam's Clubs last year. Caicco figures Wal-Mart can open between 70 and 80 Sam's Clubs in Canada.

"What Loblaw would like is for Wal-Mart to continue to be hesitant about introducing their Sam's Clubs to Canada," said Caicco. He said other chains, including the Canadian operations of A&P and Safeway, have been hurt by Loblaw's aggressive price cutting and are scrambling to catch up.

The primary battleground has been in Ontario and Quebec since Loblaw has already established aggressive pricing at its Real Canadian Superstore operations in Western Canada. The competitive pricing is pretty much restricted to branded grocery products, according to Caicco. As the prices of branded products drop, so do the prices of private-label products.

"A wrinkle in all of this is that Loblaw has negotiated a special union contract that allowed it to launch their Real Canadian Superstore in Ontario where it now has four outlets," said Caicco. "The branded groceries in these stores are much lower than a regular Loblaw store and I believe every new Loblaw store will be a Real Canadian Superstore."

The RCS outlets measure 125,000 to 140,000 square feet.

Loblaw has had an aggressive pricing policy for a number of years, beginning with its RCS, according to analyst Bill Chisholm of Dundee Securities, Toronto.

"Their business in Western Canada was built on the discount concept, which they then introduced to Atlantic Canada, followed by Quebec and Ontario. They knew Wal-Mart was going to be their main competitor and that future growth would largely be in the discount sector. As a result, Loblaw now has a different vehicle for every type of market."

After Loblaw acquired the Provigo chain in Quebec a few years ago, the analyst said Loblaw's growth in the province largely came by building Provigo's Maxi discount outlets, which now account for over half of Loblaw's Quebec business.

In response, the Metro and Sobeys-owned IGA chains were forced to drop prices, and Metro switched from weekly specials to everyday low prices at its Super C discount banners.

Loblaw's strategy in Ontario was to introduce RCS, where a food basket is about 10% cheaper than a regular Loblaw store and cost-competitive with Sam's Club and Costco, according to Chisholm.

In terms of product categories, Chisholm said pricing has been the most aggressive in produce -- due to the strengthening Canadian dollar against the U.S. dollar (up 22% since January 2002) -- and meat because of an oversupply brought on by the discovery of a case of mad cow disease in Canada last year, which saw the U.S. close its border to Canadian beef. The result was so devastating that Ottawa has earmarked $750 million ($1 billion Canadian) for a rescue package for Alberta cattlemen.

"The stronger Canadian dollar is good for the grocery industry because it brings the price down of produce from the U.S.," Chisholm said. "For example, the price of bananas in Ontario has dropped to 33 cents a pound vs. 50 cents a year ago."

Chisholm said the big difference between the U.S. and Canadian grocery sectors is that there is a well-developed discount segment in Canada, which accounts for about 25% of all grocery sales and growing.

"In the U.S., they don't have this well-entrenched two-tier system," he said. "Instead, it's mostly one vehicle across the country."

To keep margins up, Chisholm said Loblaw and Metro are growing their nonfood sectors, pointing out that the last quarter was the first time Metro had negative same-store sales in recent memory, an indication of a drop in prices and a loss of market share.

A&P Canada and Safeway Canada declined to be interviewed, but one Toronto food broker who asked not to be identified offered some insight.

"Loblaw is really reacting to Wal-Mart, and A&P and Safeway sort of get lost in it all," he said.

Most of the discounting at Loblaw is in consumer packaged goods and not in fresh or frozen foods, because Wal-Mart doesn't offer those products in Canada, he explained.

He said A&P has employed an effective strategy in discounting some pricing in meat or produce instead of making across-the-board cuts so as not disrupt their whole price structure, the broker pointed out.

"Besides, Loblaw is making good margins, which allows A&P and Safeway to make good margins," the broker added.

The aggressive pricing competition appears to be spread throughout the country because Loblaw doesn't want to give Wal-Mart any reason to open supercenters in Canada, according to the broker. But he doesn't expect to see a new outbreak of price wars that hammered the industry a few years ago.

"There's no need to play that game anymore," he said. "In Ontario alone, there are about 16 price zones, which allows grocers to fight battles where they need to fight battles and avoid an all-out price war across the province."

One industry observer from Alberta said Loblaw is positioned best to compete with Wal-Mart and Costco because it has diverse nonfood offerings for consumers such as clothing and electronics, while Safeway will rotate consumer goods in and out of its product mix.

"Loblaw also has the best understanding of its cost of operations and is willing to price accordingly," the broker said. "If a competitor prices something below cost, Loblaw will discontinue carrying that product.

"Some retailers in Western Canada are clearly not competing on price as they have gone through five margin increases the last few months. In fact, costs are significantly higher in Western Canada because most grocers operate on a high-low strategy."

The observer said Safeway doesn't compete on price because it believes it can price higher because of its locations and size.

"They believe they can service customers through convenience of location and product mix instead of offering lower prices as they consider themselves a traditional neighborhood grocery store."

Canadian Market Share by Region

Atlantic Canada

1. Loblaw: 37.0%

2. Sobeys: 32.0%

Ontario

1. Loblaw: 39.0%

2. A&P Canada: 18.8%

3. Sobeys: 5.5%

Quebec

1. Loblaw: 29.0%

2. Metro: 22.0%

3. Sobeys: 19.0%

Western Canada

1. Loblaw: 22.5%

2. Safeway: 21.5%

3. Overwaitea: 10.0%

Total Canada

1. Loblaw: 31.0%

2. Sobeys: 12.3%

3. A&P Canada: 7.3%

4. Safeway: 6.9%

5. Metro: 6.0%

Source: CIBC World Markets estimates for 2003