As Morrisons sets its sights on building a convenience store chain, is Costcutter, with its lack of supply chain, the best choice?

After The Grocer’s exclusive, last week, that Morrisons had been in exploratory talks with Costcutter since late last year, the trade has been trying to take in the ramifications of such a deal. How would it work? What would it mean? And will it happen? Here, we answer the key questions.

How would a deal work?

One option is for Morrisons to buy Costcutter’s 157 company-owned stores, and convert them to its highly acclaimed new M Local format. Independent franchisees could also sell up to Morrisons or take advantage of its buying power while retaining the Costcutter fascia. But the more radical solution is for Morrisons to buy Costcutter in its entirety, and operate as a symbol/wholesaler to independents.

What’s in it for Morrisons?

Morrisons is desperate to establish a significant presence in the fast-growing convenience sector. It currently has five M Local c-stores, and plans to open 20 by the end of this year and 70 by the beginning of 2014. But Tesco has 2,040 Tesco Express and One Stop stores and Sainsbury’s is due to open its 500th Sainsbury’s Local in the next few weeks.

Is Costcutter for sale?

A source close to Costcutter told The Grocer this week that it “is and has always been for sale. Even under its new owners”. Let’s put it this way. With two years left to run on its distribution agreement with Nisa, the clock is ticking for Costcutter’s parent company, Bibby Line, to find an alternative solution, and a sale would be a neat and potentially lucrative one, with an estimated sale value of £150m.

Costcutter MD Nick Ivel told The Grocer earlier this month that options under review included finding an alternative distribution partner (Palmer & Harvey is the most obvious choice), and “a bigger, better solution” in which Costcutter retailers receive “better promotions, prices and a different emphasis. Real ammunition to compete against the multiples.”

A decision would be made in the next eight weeks, Ivel said, adding that he hoped to have something to announce at the annual Costcutter conference in September.

Could Morrisons really become a wholesaler?

Why not? While there has been a clear divide between supermarkets and independent retailers in the UK grocery sector for many years, “a multiple entrant into the convenience sector via franchising is inevitable,” says one senior independent retail source.

Is there any precedent?

Not in the UK, but you don’t have to look too far afield to see examples of supermarkets working with indies, so it could happen, adds Shore Capital’s Dr Clive Black. Tesco supplies Star Bazaar in India and runs franchise stores in the Czech Republic and South Korea. And, significantly, Morrisons CEO Dalton Philips’ previous employer Loblaw works with independent retailers to operate its smaller format stores in Canada.

What do independent retailers make of the move?

Some staunch indies are sure to feel uncomfortable about getting into bed with a major supermarket, but it seems others are excited about the impact Morrisons’ buying power could have on their pricing.

“This marriage would be welcomed,” said one Costcutter retailer. “How many retailers already buy special offers from the multiples? We need better buying power than at present. This will enable us to compete with the likes of Tesco Express.”

Another independent retail chief said that indies would see Morrisons as a powerful brand under which to trade and that any deal could be a “watershed moment for the independent sector that will drive a lot more much-needed defensive consolidation and a requirement to improve standards and the consumer offer in the symbol groups sector to compete.”

Would there be any competition issues?

Deals in the grocery sector are heavily scrutinised these days, with concerns that the big four are cornering too great a share of the market. However, while deals between the big retailers themselves would raise serious competition issues, recent history shows deals within the convenience sector are not treated in the same way. Despite protests from independents, deals such as Tesco buying 77 Mills Group stores in 2010 often go through without much fuss.

So is Costcutter a good deal for Morrisons?

There is certainly lots of potential, but a deal would also require either Morrisons or Bibby to build a dedicated supply chain, as the current model of its small stores - which are supplied through a nearby Morrisons superstore - puts a limit on the locations in which it can open new stores.

As a logistics specialist, Bibby has a lot to gain from such an arrangement, but one wholesale chief said: “If Morrisons does its homework, Costcutter is not really what it is looking for. Colin Graves built up a really good business and sold it for a lot of money, but it doesn’t have its own stock, staff, stores or supply chain. Morrisons needs to cut Nisa in on a deal, because Nisa is its supply chain - and I can’t see that happening.”

So is Morrisons looking at any other options?

The Grocer understands Morrisons ran the slide rule over independent convenience and CTN chain Martin McColl, which has 1,263 stores, last autumn. Morrisons would have been interested in McColl’s 600 c-stores, and was initially talking to Costcutter about selling off its smaller stores.

However, as with Costcutter, Martin McColl does not have its own distribution - it is currently handled by Palmer & Harvey - and so Morrisons’ interest cooled. There are also rumours in the trade that it has considered a move for Spar, Budgens, or even the whole of Musgrave GB.

So what is the likely outcome?

Some believe talks with Costcutter have petered out; others expect a deal within weeks. But if it’s not Costcutter, it may be someone else - and more than likely soon.