Are Supermarket Economies of Scale Beginning to Fade?

Bigger is better, or so it seemed to the UK supermarkets over the last 20 years. Size seemed to offer all kinds of advantages (or ‘economies of scale’ in business terms). Many of those economies are still very present for the larger chains (especially with purchasing and technical benefits), but I’ve been reading that this mood is shifting. Since the early 90s, the UK's £160bn a year grocery business has understood that one of the key routes to success has been the ability to open more and bigger shops.Now it seems as though the major players have come round to thinking that size is not necessarily what matters, because shoppers are changing their habits fast. Has the “space race” run its course?

According to The Observer, supermarket customers are shopping in smaller outlets, more often, and moving online at a dramatic rate. They are also less loyal – food shoppers now use on average four different shops a month, and shoppers under 30 tend to use six.

Official data shows online retail sales reached more than £50bn last year, out of total UK retail sales of £350bn. That's already 14% of total spending. According to retail analysts more than 30% of retail sales will eventually be transacted online – and these purchases tend to be smaller and more regular.

You’ll already know that Morrisons has finally felt the need to shift online. More interesting was the Tesco announcement that it is buying Giraffe, an upmarket restaurant chain aimed at middle-class families. Tesco (who once seemed unstoppable, and have also stumbled in the US) is battling to prevent its market share being further eroded: last month, it slipped to 29.7% – its lowest level for seven years. Its CEO is fighting back with price promotions, which threatened a supermarket price war last year.

But shoppers are still defecting to upmarket Waitrose and hard discounters like Aldi and Lidl. These retailers have something in common - smaller stores, which require less time to do the weekly shop, and a clear price position.

Tesco is the biggest online grocer (and has recently opened a series of ‘dark stores’), but most analysts now think it has too many big stores. Their CEO has suggested that there are unlikely to be many more giant out-of-town superstores. But might the chain already have too much capacity?

Some people have suggested that the acquisition of Giraffe will help soak up some of that spare capacity, as might their new upmarket coffee chain Harris+Hoole and their artisan bakery business Euphorium.