8 June 2018
With the Corpse of Toys R Us Yet Warm, the Toy Sector Faces New Peril
Although the full ramifications of the collapse of the once-mighty Toys R Us remain unclear, the mooted merger of the Sainsbury's and Asda supermarket chains has seen the UK toy sector again reaching for its collective worry beads.
With the global retail market currently beset by turbulence and instability, the toy industry has proved just as vulnerable as any of the broader retail channels. While Toys R Us has dominated all toy-related headlines over the past six months, there are a number of other moves afoot that may prove equally transformative for many of the world's toy suppliers.
With many such developments likely to have a particular impact in individual countries, before rippling out globally, it has fallen to the UK – where many toy companies are still reeling from Toys R Us PTSD – to face yet another substantial market disruption. This follows the news that the country's second- and third-largest supermarket chains – Sainsbury's and Asda, respectively – are set to merge. Should the deal be approved – and there's always the possibility that the Competition and Markets Authority (CMA), the UK's anti-monopoly watchdog, may intervene – with combined revenues totalling more than £50 billion, the UK's biggest supermarket chain would be created overnight.
Bearing in mind that, back in 2016, Sainsbury's acquired Argos – the UK's largest toy retailer – this latest move would create an immensely powerful retail conglomerate, a development that would have implications far beyond the grocery channel. Overall, Argos is a leading UK digital retailer, selling more than 60,000 products through its website, mobile channels, 859-strong store network and via telephone purchasing. As well as being the UK's leading toy retailer, Argos is also the market leader in the country's homeware and electronics sectors.
Its online platform – Argos.co.uk – is the UK's third most visited website, with about a billion hits a year. In total, more than half of Argos' sales are online-derived, while about 120 million customer transactions take place within its store network every year. Clearly, then, extending Argos' presence in the conventional retail sphere (via Asda and Sainsbury's outlets, which are collectively visited on a weekly basis by millions of shoppers) offers huge growth possibilities.
Giving some insight into the rationale behind the merger, the joint statement issued as the news of the likely move began to filter out read: "The retail sector is going through significant and rapid change, as customer shopping habits continue to evolve. This has led to increased competition across the grocery, general merchandise and clothing sectors, as customers seek ever greater value, choice and convenience.
"Bringing Sainsbury's and Asda together will result in a more competitive and more resilient business, one that will be better able to invest in price, quality, range and the kind of technology required to create more flexible ways for customers to shop."
Although it has been billed as a merger, Sainsbury's is very much in the driving seat. The deal on the table values Asda at roughly £7.3 billion, with Walmart (Asda's current owner) set to end up owning 42% of the combined business, while also receiving £2.975 billion in cash.
Behind all the PR spin, which ticks all the expected boxes – better prices for consumers, employee security, no planned store closures, etc – how likely is the deal to go through and what aftershocks await the local and global toy industry?
Let's have quick gambol through the key issues as they stand, while laying bare many of the assumptions and dispensing with some of the bolder pre-merger gloss that is inevitably employed to duck the core concerns of the more-exposed parties involved.
Is the CMA likely to scupper the deal?
At present, the CMA is said to be 'looking into' the deal. As the Authority is broadly regarded as something of a 'chocolate fireguard' (i.e., not terribly effective), it will most likely wave the deal through, while hoping to quell any potential dissent with one or two cosmetic caveats.
How compatible are the cultures of the two retailers?
Possibly far more than you may think. Mike Coupe, the Chief Executive of Sainsbury's, is ex-Asda, while Roger Burnley, his Asda counterpart, is ex-Sainsbury's, a symmetry that will no doubt help when it comes to integrating the two businesses. It is also interesting that, historically, Sainsbury's has always maintained that it would be loath to take on the kind of exposure represented by the oversized store format favoured by Asda. A rethink on that particular issue is clearly on the cards for one or both parties.
Should the deal go through, will this see Sainsbury's expansion into the US market fast-tracked?
While that's possible, it's also somewhat unlikely. One of the key factors that brought Walmart to the negotiating table was its desire to withdraw from direct involvement in the European market, with Asda its last remaining stake in the territory. Indeed, the rumour mill has it that Walmart has been looking to unload Asda for the past two years at least. While Asda may seem a huge operation in the UK, there are actually more Walmart branches in Texas than there are Asda outlets across the whole of Britain.
Coming in at US$118 billion, Walmart's international business amounts to less than a quarter of its $500 billion turnover and, within that, it is the ever-expanding Chinese and Indian markets that it is looking to nurture, rather than the over-subscribed, underperforming European retail sector.
Significantly, Judith McKenna, Walmart's Chief Compliance Officer, only took over the reins of the company's international business unit in January this year. It would appear that it has taken her less than five months to decide that finding a partner and taking a minority shareholding, rather than continuing to go it alone, is the company's best European option.
Why, exactly, does Walmart want out now?
When Walmart acquired Asda in 1999, it was the UK's third-largest supermarket chain, generating annual sales in excess of £8 billion from 229 stores, while employing just over 78,000 staff. Fast forward 19 years, Asda now has annual sales a touch above £22 billion from 584 stores, while employing more than 146,000 staff.
While, on paper, it's a substantially bigger business, it remains the UK's third-largest supermarket chain, having failed to make any significant headway. As to its £7.3 billion valuation, that's a mere £584 million more than Walmart paid for it 19 years ago.
Similarly, Asda's operating profits were £436 million in 1999, while its inflation-unadjusted figure for 2017 was £720 million. Given that Asda's store estate and employee base has doubled in size over that time, that's hardly the result it might have hoped for. All in all, the disappointing conclusion has to be drawn that Walmart's stewardship of Asda has been far from successful.
Are store closures and job losses sure to ensue?
While the initial announcement stuck to the standard issue "no plans for any store closures" formula, it is entirely possible that the CMA may insist that a number of existing outlets are shuttered as a pre-condition of greenlighting the merger. Historically, the CMA has assessed the need for possible closures on the basis of how many outlets in any combined store network are within a 5-15-minute drive of one another. Of Asda's 630 stores, 526 are within five miles of a Sainsbury's outlet, while 76 stores are within the same postcode district.
Although it has been reported that Asda remains a primarily northern England retailer, while Sainsbury's has a corresponding focus on the south and southeast, there is actually a considerable overlap, one sizable enough to mandate a degree of judicial pruning.
As well as the loss of in-store jobs, will heads also roll among senior management?
Amid an ongoing flurry of management double-speak, liberally sprinkled with talk of 'rationalisation' and 'efficiency savings', the Argos / Sainsbury's integration process is far from being completed, although a number of executives have already been deemed surplus to requirements. Now, with yet another head office buying and admin team cast into the mix, the bloodletting is sure to resume with an added fervour.
For existing and would-be suppliers in the toy sector, what are the primary opportunities and challenges that lie ahead?
Almost without exception, suppliers firmly believe that the combined Argos / Sainsbury's toy offer is in a different league to that of Asda. The possible upshot of this is that its acquisition could see Asda emerge as a more potent force on the toy front. It is also likely that Argos collection points will be incorporated into Asda stores, inevitably boosting the turnover of Argos suppliers.
In terms of challenges, the inevitable demand for better terms and increased contributions for incremental business is something of a given. Additionally, should a toy company be in the fortunate position of trading across all three accounts, the individual terms that apply in each instance will soon be common knowledge among the surviving buyers at the combined business. Will they simply settle for the midway point of all three sets of the terms or will the most advantageous become the mandatory group norm? That's not exactly the most testing of questions upon which to conclude.
John Baulch is the Publisher of Toy World,
the UK's leading toys and games trade publication