European grocery retailers are on a shopping spree. The results of a McKinsey analysis of the 400 largest acquisitions in the sector show that the volume of corporate takeovers more than quadrupled—rising from $2.9 billion to $12.4 billion—between 1994 and 1998 (Exhibit 1). Yet a comparison with North America’s retail grocery sector suggests that its European counterpart is only at the beginning of a period of consolidation. For, while the top five companies in the United States have a 35 percent share of the US market, the top five in Europe have only a 26 percent share of theirs.

Until recently, grocery retailers in Canada and the United States dominated a region or two at most. Today, the strongest have extended their hegemony to multiple markets, and these super-regional market leaders are earning higher returns than their smaller competitors. At the beginning of the 1990s, European grocery retailers grew mostly at the national level: from 1991 to 1994, the top ten realized almost 90 percent of their growth at home. In the next four years, the tables turned: almost half of the growth recorded then stemmed from European cross-border expansion, mostly by acquisition—a trend that is accelerating.

Consumer tastes are more homogeneous in the United States than they are in Europe, and this makes it harder for European grocery retailers to realize advantages of scale and scope by operating across different European markets. But there is a general trend toward converging tastes and lifestyles, particularly among younger consumers in Europe, and it will speed up with the introduction of the euro, since cross-border shopping will become more common and manufacturers will sell increasing numbers of identical products in many European markets. Despite the numerous obstacles, European retailers must therefore act now. Leadership positions in the European grocery retailing sector will be decided during the next couple of years—indeed, perhaps in only months.

We believe that the industry is likely to develop in one of two ways: either a European grocery "champions’ league" or strong regional fortresses. It is too early to say which outcome will prevail, but we can analyze the important drivers, such as capital markets and competitive pressures, as well as the economic rationale behind the present wave of consolidation.

Leaders under pressure

A look at the composition of the market value of grocery retailers such as METRO (Germany) and Casino (France) shows that current cash flows account for only one-third of their capitalization and investors’ growth expectations for the rest. Since such retailers are active mainly in saturated markets, growth could stem either from international expansion or from acquisitions. By contrast, British retailers such as Safeway and Sainsbury don’t carry a growth premium; their current performance almost completely explains their current market value. Because these companies seem to lack the credibility needed for future growth, they suffer from low market-to-book valuations, which put management under heavy pressure and make them potential targets for takeover.

The "Wal-Mart factor" increases such pressures. Since moving into Germany, with the acquisition of Wertkauf (1997) and Interspar (1998), and into the United Kingdom, with the acquisition of ASDA (1999), the US company has shown that it sees Europe as more than a test market. The French chains Carrefour and Promodès reacted quickly to Wal-Mart by announcing their merger, putting them one step ahead of competitors in Belgium, France, Portugal, South America, Spain, and elsewhere. Meanwhile, after years of making acquisitions solely outside Europe, Ahold (based in the Netherlands) acquired 50 percent of ICA, the leading Scandinavian grocery retailer. Such developments place the remaining competitors under even greater pressure to nail down their own shares of otherwise open markets.

International acquisitions are harder to swallow

The most successful takeovers have generally been made at home, where economies of scale are easiest to achieve. Carrefour’s acquisition of Comp-toirs Modernes in France (before the merger with Promodès) and METRO’s takeover of Allkauf and Kriegbaum in Germany have reduced purchasing costs at the acquired companies by one to two percentage points. Combining logistics networks and reducing the cost of information technology and central administration can also yield quick, meaningful savings of an additional 1 to 2 percent of sales.

Furthermore, value can be created at the national level through the transfer of know-how from the acquirer to the acquired. Applying a well-developed store format to newly acquired stores is one way to achieve this. The French hypermarket chain Auchan increased the short-term revenues of its Docks de France acquisition by as much as 20 percent after it applied its own proven formats to that company’s branding and assortment strategy. Similarly, in the early 1990s, METRO rolled out its "Real" hypermarket concept across its portfolio of acquired stores, including the German retailers HUMA, Meister, and SUMA, where sales per unit of space increased as a result. The transfer of know-how can of course work equally well in the opposite direction: the German retailer REWE, for example, is using the acquired Austrian supermarket chain Billa as a source of best practices in such areas as the management of private labels.

For these reasons, almost two-thirds of national grocery retail takeovers have won the approval of capital markets; by contrast, since economies of scale and the transfer of know-how are more difficult to achieve in international takeovers, only one-third of them have been so welcomed (Exhibit 2). Problems include the minimal overlap between grocery ranges from country to country and incompatible IT and logistics systems, which make it difficult to achieve cross-border savings comparable to those that can be realized at the national level. Finally, the simple fact that a number of local administrations and logistics networks are still needed when companies operate across national borders significantly reduces the potential savings.

Although some grocery retailers have been very successful in certain international markets—for example, Carrefour and Promodès in Argentina, Brazil, Spain, and Portugal—the problems of Promodès and Wal-Mart in Germany and of Tesco in France have shown how important it is to understand local market conditions, for consumer behavior, competitive environments, management styles, and legal regulations still vary across Europe. Wal-Mart, for instance, has had a hard time applying its management rules to employees belonging to German trade unions, which in some cases forbid them to wear name and greeting tags. Upon entering the French market, Tesco had trouble overcoming the poor image of British food.

Simply repeating a formula that works in one country in another isn’t enough. International success requires a more skillful approach to the extraction of savings from purchasing. When retailers expand abroad, they have greater need for so-called soft skills, such as disseminating best practices and managing talent.

International purchasing

International mergers have yet to realize the savings anticipated from the renegotiation of purchasing terms. After Intermarché acquired the German SPAR Group in 1997, the French retailer expected to improve terms to the tune of 3.5 percentage points by setting up a European joint purchasing entity called Agenor. Only about a single percentage point has been achieved so far. Global players have discovered that purchasing on the international level requires competencies in three main areas.

Consumer goods manufacturers want to retain substantial price differentials among countries

1. Getting better deals. The variety of European rebate systems alone makes the creation of a single database of comparable purchasing conditions an enormous challenge. Even when retailers work with comparable net-net price definitions (that is, after taking into account all rebates and benefits in kind), it remains hard to persuade large consumer goods manufacturers to give up the substantial sums of money they gain from historical price differentials among countries. To complicate matters, the authority of managers in the international and strategic-purchasing departments of many large companies is often limited by the managers of national units, who insist on having the final word on assortment strategy and the choice of suppliers.

2. Harmonizing assortments. Research carried out for a leading Southern European retailer, which had an international purchasing department in place for some years, indicated that the ranges in the French and Spanish markets overlapped by less than 20 percent. Even so, experience has shown that streamlining the supplier base and product variety can make companies more profitable, while recent work indicates that increasing the degree of assortment overlap in different markets can improve purchasing conditions by 3 to 4 percent.

Companies carrying a high percentage of private labels enjoy a strategic advantage here: because they often come from the same suppliers, they are identical wherever sold. In this case, the possibility of fully homogeneous assortments is limited only by different patterns of consumption in different countries. Thus ALDI, the German discount chain, says that 70 percent—and no more—of its largely private-label assortment is for sale in all of its stores across Europe.

3. Influencing suppliers. International cooperation with suppliers has so far yielded the fewest savings in purchasing. The most prominent examples of companies that have succeeded in this respect come from outside grocery retailing: Benetton, H&M Hennes & Mauritz, and Zara in clothing, and IKEA in furniture. As for grocery retailing, large food manufacturers still refuse to enter into preferred- or integrated-supplier relationships with global retailers because to do so would damage the manufacturers’ independence. The unusually high number of suppliers per retailer in the grocery business makes such relationships significantly harder to establish.

However, the balance of power is clearly shifting toward retailing. In 1997, the top ten grocery retailers accounted for 34 percent of total sales in Europe while the top ten consumer goods manufacturers accounted for only 14 percent of total sales. Continuing (and faster) consolidation in grocery retailing means that more and more manufacturers won’t be able to resist demands from retailers.

Managing knowledge

International companies can create value by spreading best practices across all of their operations; Wertkauf, for example, reportedly realized significant savings, at least in the short term, by implementing its parent Wal-Mart’s superior logistics system. Indeed, Wal-Mart relies on its strong systems capabilities—mainly in logistics, the management of sales data, and store operations—to generate value from most of its acquisitions.

Carrefour, by contrast, relies on "people initiatives" by sending employees around the globe to promote the adoption of best practices. Ahold takes a network approach to sharing them; it relies on expert databases, benchmarking initiatives, and project teams that bridge geographic divides. Whatever approach retailers take, those that build successful learning organizations will benefit from the scale and the scope of their international operations.

Managing talent

Many large European retailers give a shortage of talent as the main obstacle to growth, especially international growth. Managing talent includes finding, retaining, and continually developing managers who can transcend national and cultural barriers. In a recent survey, European business graduates were asked to rank European companies in order of their attractiveness as employers. The highest-ranking retailers were Marks & Spencer (which ranked 74th), Pinault-Printemps-Redoute (78th), and El Corte Inglés (125th). Consumer goods companies performed much better, with Procter & Gamble in 7th place, Unilever in 8th, and Nestlé in 14th.

This skepticism about retailers originates in their recruiting procedures. Retailers neither pursue candidates as avidly as consumer goods companies do nor offer candidates competitive pay. In addition, the survey found that the retail environment seems to lack what the best young managers are looking for: above all, international career opportunities, which at least for the time being are harder to come by in grocery retailing than in most other industries. Young managers—especially high performers—also want their employers to offer rapid advancement and financial recognition. Few grocery retailers promise either.

Consolidation will continue

Given these trends, as well as the expectations of capital markets, consolidation is sure to continue for some years. National companies in particular will come under increasing pressure to face up to European competition and to enter alliances—or simply to sell.

There are two consolidation scenarios (Exhibit 3). Under the first—the European champions’ league scenario—a handful of giant pan-European companies will emerge. So far, however, no such entities exist. Wal-Mart has spread no farther than Germany and the United Kingdom. The French are focusing on Southern Europe and the Benelux countries. German food discounters, though active across Europe, have made significant incursions only into Austria and the former Soviet bloc countries. And the British remain fixated on their domestic market. In short, it would take several huge deals to create a retail sector dominated by truly pan-European giants.

The second, a regional-stronghold scenario, presumes an acceleration of the trend to regional consolidation. The merger of Carrefour and Promodès was mainly intended to establish French and Southern European strongholds that would make it more difficult for competitors to enter those markets and to strengthen the merged entity’s position in Asia and South America. Similar strongholds may arise in Austria and Germany, in Scandinavia, and in Switzerland.

Carrefour, Promodès, and other large companies (such as METRO and Wal-Mart) are pursuing strategies suggesting that a pan-European champions’ league is the more likely direction for grocery retailing. Big acquisitions by Ahold, METRO, or Wal-Mart in France would force other companies to follow suit and to shift from a regional to a pan-European growth strategy. The top ten, as a result, could capture a combined market share of up to 60 percent by 2005, from today’s 38 percent.

In the meantime, the race remains wide open. Even the leading grocery retailers have yet to acquire the skills they need to exploit international synergies. When they do, the speed with which they develop and expand those synergies will be crucial in deciding who does and doesn’t make it into the European grocery champions’ league.