In the brutal business world, the seemingly impossible sometimes happens: The small fish swallows the big one.

This reversal of fortune usually happens when a small company acquires some or all of the stock of a bigger, successful company. The objective here is to invest in the profitability of a company that can continue to run largely as it did prior to the acquisition.

It’s a far more unusual situation when a small company buys a big slice of a much bigger company, especially when that slice requires a lot of rehabilitation work. Yet that’s just what happened when Haggen, the operator of just 18 supermarkets in Washington state and Oregon, bought an astounding 146 supermarkets from the combined Safeway-Albertsons company.

Big Backstory

Here’s the backstory. Earlier this year, Albertsons bought the entirety of the Safeway company for $9.2 billion, forming a colossus of 2,230 supermarkets. Investment firm Cerberus Capital Management financed the deal. Cerberus has been in and out of various ownership permutations of Albertsons for years. The combined Albertsons-Safeway will be called Albertsons.

As might be expected, the Federal Trade Commission required a divestiture before allowing the merger to proceed; in this case the modest disposal of 168 overlapping stores. Of that number, 146 went to Haggen; the balance was parceled out to various other buyers.

Hagen said the availability of so many stores to buy at one time represented a unique opportunity that might never again present itself. Also unique was the purchase price of $300 million, or about $2 million per store. That’s quite a bargain.  Purchasing the stores afforded an opportunity to go overnight from being a small regional player to a significant market force across a wide area. Seeking mass was their objective.

From Little to Big

Haggen undertook quite a chore with this acquisition. Not only did it grow nearly 10 times larger in a single transaction, but its geographical footprint grew as well. The new fleet of stores is not only in Washington and Oregon, but also in Southern California, Arizona and Nevada. They are under multiple banners too: Albertsons, Safeway, Pavilions and Vons. Haggen also pumped up its employee roster. Prior to the transaction, Haggen had 2,000 employees, now it has 10,000., or at least it did at the onset of its adventure. All the new stores were buffed up and converted to the Haggen nameplate in short order.

And the elephant in the room issue arises: Does Haggen really have the managerial and financial capacity to pull off such a feat of magic? The auguries aren’t really on Haggen’s side.

Dual CEOs

First of all, presiding over this challenging task will be an office of dual CEOs. Overseeing the northern branch will be John Clougher who was CEO of all of Haggen prior to the buyout. In charge of the southern tier of stores will be new-hire Bill Shaner. Both of these executives have long and varied experience in the supermarket industry.

This bi-polar arrangement optimistically may pose the advantage of diffusing the work, producing better results. But that’s wildly optimistic and would make these two CEOs rare individuals. In reality, a co-executive-office arrangement is a slow-motion survival of the fittest contest intended to identify which CEO is the better manager and destined to become the sole head executive. Understandably, this has the potential to ignite an unnecessary distraction of internal competition.

As for Haggen’s financial capacity, it was acquired itself a few years back by investment firm Comvest Partners. Comvest pumped in greater strategic and managerial expertise, which, ironically, resulted in the closure of a few underperforming Haggen supermarkets.

Comvest will doubtless have to plough through some serious capital to support the costly store-conversion proposition. Haggen intends to spend about $1 million per store to make them look better.

But even at that spending rate, Haggen is undertaking little more than makeovers with cosmetic touches, the heavy lifting of major refixturing and product changes will roll out later. The bigger challenge will be triggered as the conversion process nears completion. Haggen will have to figure out how to market these new stores to attract customers in sufficient numbers.

Communications Nightmare

In its existing markets, Haggen has something of a reputation for high prices, but justifies them with the concept of local produce sourcing. In its new territory—the numerous stores across the Southwest—Haggen is a completely unknown entity. So introducing a new brand with a reputation for more expensive prices will be doubly tough.

Shaner, the CEO for the south, has said that the aim will be to go for the “white space” between full-service supermarkets such as Ralphs and Safeway and upmarket stores such as Whole Foods. It intends to do that by offering more fresh and locally sourced product, much as it does in the Northwest.  This is a good idea, and represents the direction consumers are moving; indeed it’s such a good idea that many operators such as Walmart, Target, Aldi, Amazon and Dollar stores are all seeking to capitalize on fresh to table. Nonetheless, Tesco was trying to accomplish this positioning with its unsuccessful Fresh & Easy stores in the Southwest. So it may not be easy.

As for that unfilled “white space” niche that Haggen is aiming for, it will be big news to incumbent supermarket operators if such a niche exists, let alone one that can be filled by a conventional supermarket. Haggen’s future will probably rest more than anything on whether it can successfully introduce its name to consumers and offer them an attractive price proposition when they try out the stores.

Reality Intrudes

So far, Haggen hasn’t been able to either properly introduce itself to consumers or find the right price point, let alone exploit the mystical “white space.” Those failures have sparked quite a train of events:

First, Haggen laid off or reduced the work hours of perhaps 2,000 or more of the store-level employees it inherited from Albertsons. Few shoppers equal fewer employees.  Haggen then closed 26 of the acquired stores and now acknowledges that more closures will follow.
Haggen was hit with a lawsuit from Albertsons that sought payment for more than $40 million in inventory that Haggen acquired with the stores, but it is now alleged that Haggen failed to pay for.

Then, Haggen sued Albertsons for $1 billion claiming that Albertsons sought to undermine Haggen’s success in several ways. It claimed that Albertsons allowed the stores to deteriorate prior to the time the deal closed; that Albertsons deliberately under stocked some stores; that Albertsons overstocked perishable product, resulting in costly spoilage; that Albertsons conveyed improper pricing information, causing Haggen to overprice product; that Albertsons used knowledge of Haggen’s store reopening schedules to mount aggressive competitive campaigns against the stores … and much more. Albertsons subsequently issued an unusually aggressive statement claiming that Haggen is using the suit only to deflect attention from the $40 million it owes, and that it has fulfilled all its obligations.

Finally, Haggen has also been sued by an in-store pricing specialist at one of the acquired stores. She claimed that she tried to warn Haggen that its shelf-price signs didn’t comport with scanned prices. After failing to get action from her supervisors, she emailed one of Haggen’s co-CEOs. She was then forced to retire in lieu of termination; an action that she alleges constitutes discrimination.

In short, it’s not going well for Haggen. To some extent Haggen’s lawsuit reveals naivety when it comes to claims about competition from Albertsons. Guess what? Albertsons is a competitor along with Ralphs and every other supermarket operator in the region. Fostering competition is why the FTC required divestiture of the stores in the first place.

Other Challenges

Assuming Haggen stays in the game, it will have another hurdle to clear. Suppose it ends up with more than 100 functioning supermarkets. That’s really too large a company to be supplied its conventional wholesalers, United Grocers and Supervalu. Conventional wholesalers are at their best when they supply smaller independent operators, preferably in rural areas where price competition isn’t too keen. After all, wholesalers are for-profit enterprises, applying a markup of roughly 8 percent above their own product-acquisition costs.

A company of 100 or more  supermarkets, with many in urbanized areas, should be supplied by its own distribution network so it can take advantage of better buying power and shed the wholesalers’ markup. Of course, it’s entirely possible that Haggen could shift to self-distribution, but the capital outlay to do so would be huge— much more than was required to acquire the additional supermarkets in the first place.

Lessons Learned

So goes Haggen’s Hobson’s choice. It must do what’s possible with what it has and hope for the best. Let’s hope that Haggen can overcome the odds and pull off its quest for mass. In the meantime, its situation offers a few lessons other companies might consider before such a move.

• First, it’s best to acquire a company that doesn’t require fixing up.
• Fixing up costs a lot. If your company doesn’t want to or can’t spend a lot, reconsider.
• Marketing efforts sufficient to establish a new name in the marketplace is also costly. If you can’t do that, reconsider.
• Infrastructure is complex. If you can’t undertake the backstage challenges of efficient product acquisition and distribution, reconsider.
  Competitors will be merciless. If you can’t face them head on, reconsider.

In the end, we Americans are known for our entrepreneurial spirit and tenacity. Haggen rolled the dice, so maybe that’s not all bad.