The Economy

Peter Crabb: The lesson of Albertsons is the organic growth is best

PETER R. CRABB, professor of finance and economics at Northwest Nazarene University in NampaNovember 19, 2013 

Peter R. Crabb

It wasn’t organic, so it wasn’t good for our health. In hindsight, Albertsons should have tried to grow by itself.

In 2006, Supervalu Inc., a private equity firm and CVS Corp. acquired Albertsons Inc. for more than $17 billion and divvied it up among themselves. Albertson’s management and board of directors at the time said the move was in the best interest of shareholders.

It didn’t necessarily turn out that way. For Supervalu, much of the investment has been lost because Supervalu still was unable to compete effectively against larger competitors or develop any niche markets.

The underlying strategy for Supervalu’s acquisition was sound: combine the operations of its Albertsons stores with Supervalu’s other retailers and achieve economies of scale. Firms that achieve economies of scale can better compete in their industry through lower costs and better pricing. Economies of scale occur when the average total cost for producing a product falls as the firm increases its production capability and quantity of output.

In general, companies achieve economies of scale by reinvesting profits into the business and expanding into new geographic markets. But many companies try to speed up this process by “buying market share” through acquisition.

Back in 2006, Supervalu management said the acquisition would help “realize a sizeable increase in [its] retail footprint and supply chain network, strengthening [its] ability to effectively compete in today’s challenging grocery industry.” The company expanded its retail footprint, but apparently that wasn’t the real “challenge” in the industry.

The recent rise and fall of Whole Foods Market suggests that competition in the grocery industry is closely tied to overall market conditions. As reported in The New York Times earlier this month, Whole Foods reinvented the supermarket by effectively selling high-priced, organic products.

Before the financial crisis and recession of 2008, the company was the leader in this market and experiencing strong growth. Then it acquired a competitor, Wild Oats. The acquisition saddled the company with debt and expenses just as the economy was turning down.

Whole Foods is back and doing well, having stuck to its niche and marketing well. But had the company not received new investor funds it would likely have closed as many stores as Supervalu over the last few years.

Two lessons, one narrow and one broad, emerge from this business and economic history.

The narrow lesson is that the grocery business remains a low-margin one in need of high volume to generate a reasonable return on capital.

The broader lesson is that growing a company through acquisition is just as hard as investing in the stock market. Timing is everything. Both Whole Foods and Supervalu bought at the wrong time.

The risk of overpaying at the wrong time suggests it is better to grow your firm from within. Just as Whole Foods sells organic products, “organic” growth is better for your business.

prcrabb@nnu.edu

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