Kitchener Partners principal Tristan Kitchener’s presentation on the changing retail landscape attracted a high level of interest at the APAL Post Harvest Seminar. Here he shares his insights into how the major players may act to maintain growth in an increasingly competitive market and what that means for growers.
Why are the hard discounters (ALDI and Costco) set to change the retail landscape in Australia?
Attitudes to discount retailers have changed significantly since the global financial crisis (GFC). While prior to the GFC, shopping at ALDI might have been slightly frowned upon, shopping at ALDI can now mean you’re a frugal, savvy and switched on shopper.
The hard discounters – those retailers with a limited product range, low prices and a convenient shopping experience – are resonating with Australian consumers. Whilst ALDI is leading the charge of the hard discounters, Costco is also enjoying steady growth and Kaufland (another German retailer), will join the party in late 2019.
In the face of increasing food inflation and stretched household budgets, consumers are increasingly turning to ALDI and Costco, particularly low to middle-income shoppers. In addition to the drawcard of good value, consumers also appreciate the time-saving and ease of selection made possible by a limited selection of offerings. The predominantly private label ranges are good quality and competitively priced, and the everyday low price (EDLP) pricing strategy drives loyalty as consumers feel they get good value every shop.
Perhaps most worrying for Coles and Woolworths is that the hard discounter market share in Australia is well below the global average and is likely to double over the next five to seven years from 9 per cent currently to almost 20 per cent by 2024.
This is due in part to the gap in the market created by their own acquisition and closure in the 1990s of discounters such as Bi-Lo, Franklins and Food4Less – a gap into which ALDI stepped in 2001.
The fact that Australia was dominated by just two big retailers meant the profit-pool was large and ripe for the taking, and take is exactly what ALDI has done. Taking their own slice of this profit-pool is most likely the main motivator for Kaufland’s entry. In hindsight, Coles and Woolworths may have been better advised to maintain their duopoly, but with the clear high and low value formats adopted in the airline sector, where Qantas owns Jetstar, and Virgin owns Tiger.
What’s the likely future state for Coles and Woolworths?
Counter-intuitively, the rise of the hard discounters has also been fuelled by the marketing behaviours of the majors. Coles’ hugely successful value campaigns and relentless focus on price over the last nine years, starting with ‘Down-Down’ in mid-2010 and followed by ‘Deeper Down-Down’ in early 2014, de-stigmatised ‘low price’ in the eyes of consumers. Woolworths was forced to follow Coles’ lead in lowering prices, and ironically, this aided ALDI’s growth as ALDI is the retailer that really owns low price.
Coles’ strategy, based primarily on price, has exacerbated the already commoditised nature of grocery retailing in Australia – as evidenced by the low loyalty and high cross-shopping between retailers by consumers – and may eventually come back to haunt them.
Coles doesn’t have the scale advantage of Woolworths, with cost of doing business estimated to be 1-1.5 per cent higher, so it’s likely to be difficult for Coles to ultimately win the price war. Coles had over seven years of like-for-like sales growth higher than Woolworths until March 2017, with Woolworths then taking the lead. However, second quarter 2019 growth by Coles of 1.8 per cent and Woolworths of 2.7 per cent both lag behind the industry average (4.4 per cent), which suggests the fight is no longer just between themselves, and that both their turnarounds have run their course.
With the demerger of Coles from Wesfarmers in November 2018 and the arrival of a new MD, it’s likely that Coles will move away from
price discounting to protect profits. Coles will have to differentiate on non-price attributes, such as service, fresh offering, range, in-store theatre and shop-ability. The question will be whether after the years of investment in lower prices, they have the margin fire-power available – between 2009 and 2016 Coles lifted earnings before interest and tax (EBIT) by 125 per cent by investing in management, stores and private label, but EBIT has declined by 19 per cent since 2016 as competition has intensified and volume growth has slowed.
To achieve growth, or simply just to slow the decline, where will it come from? Certainly, Metcash is a target with small-format stores such as Coles Local and Woolworths Metro, otherwise it may be a case for a good old-fashioned price war – and ‘down-down’ for both of them!
In addition, as ALDI extends in SA and WA and matures down the east coast capturing more of the highly profitable ‘main-shop’, ALDI will capture further economies of scale and this will place further pressure on Coles and Woolworths – and it’s important to remember that Australia is ALDI’s most profitable market globally and it could therefore invest more in lower prices!
Price war – rational or irrational?
Whilst the Coles turnaround has largely been a success since the Wesfarmers acquisition in 2007, the Coles demerger at possibly the top of the cycle suggests growth will become harder to achieve.
Coles’ commitment to a high dividend payout ratio and an around$1 billion supply chain investment may tempt Woolworths and ALDI to view a price war as a rational strategy on the basis Coles does not have deep enough pockets to compete.
A price war can be considered an ‘irrational’ strategy since it can lead to mutual destruction (retailers lose, suppliers lose, consumers win), but counter-intuitively it can become a ‘rational’ strategy if one party is perceived as not having deep enough pockets to match the price investment of their competitors, leading to a price differential whereby consumers switch to other retailers, with the market share of the indebted retailer transferring to the competitor retailers.
This is exactly what the hard discounters, ALDI and Lidl, did in the UK from 2011-14 to grow their market shares by around 20 per cent year-on-year due to Sainsbury’s and Tesco’s carrying too much debt. And for the record, ALDI and Lidl’s growth has been healthy ever since.
If a price war eventuates, Coles may be forced to cut their dividend commitment to fund a response and could find itself the next Metcash (IGA), a ‘me-too’ with an undifferentiated model, inferior scale and saddled with financial commitments, resulting in getting strategically ‘stuck in the middle’ between a lower cost Woolworths and a more efficient ALDI… the days of the complacent duopoly are well and truly over.
How do Coles and Woolworths compete with the hard discounters?
Coles and Woolworths have to compete on price, but do so rationally, and provide lower, stable pricing on the products that matter most to consumers. Based upon learning from overseas markets, this means ensuring Private Label ranges are within five per cent of ALDI’s prices on their 1,500 core lines. At the same time, they must provide wider ranges in areas where discounters cannot compete, particularly in fresh foods.
Coles and Woolworths have already taken action, although arguably could do more as the gap isn’t closing. This includes removing needless choice and providing a tailored range specific to the size and demographics of an individual store. Similarly, the majors must provide price certainty to customers by eliminating the promotional ‘high-low cycle’ and multi-buy discounts. Costco have been particularly successful in communicating everyday value to consumers on the premise of ‘bigger pack, better value’, and the majors have adjusted their offers accordingly.
However, perhaps the elephant in the room is Private Label. Even after 40 years of Private Label in Australia, Coles and Woolworths are still struggling to develop Private Label strategies that can actually compete with ALDI without cannibalising their branded profit-pool. Until this is solved it will be hard to slow ALDI’s growth.
How will the major retailers compete against Amazon?
Grocery is hugely attractive to Amazon, as not only is it the largest retail category, but it offers a good opportunity for using technology and smarts to reduce the consumer friction and pain-points.
Amazon is a retail juggernaut and it will leverage its scale, deep pockets, long-term appetite and ability to fund bold R&D to add competitive pressure to the grocery sector. The key enablers for successful entry and growth in grocery retail is money, time and data, all of which Amazon has in spades. Amazon is rolling out checkout-free contactless stores (Amazon Go) and is adept at using technology to improve the consumer experience.
Amazon’s non-food market share in Australia is forecast to be almost five per cent by 2026, and food share 1.1 per cent. Given the challenges around home delivery, sourcing and cool-chain maintenance with fresh foods, grocery food will be impacted first. However, perhaps the more relevant impact is the way that the imminent threat of Amazon is already changing the behaviours of the majors as they seek to become ‘Amazon ready’.
The majors will need to integrate physical and online shopping. This will require leveraging their existing assets, including bricks and mortar stores, loyalty programs and customer data, and at the same time improving their offer in the areas that Amazon dominate, namely private label, click and collect models that are economically viable and the sweet spot of 1-hour delivery windows. Coles and Woolworths will increasingly need to understand their customers better to enable them to engage directly with shoppers and offer them unique services and experiences, and ultimately protect them from Amazon –Amazon is great at collecting all sorts of data and using it to offer things that people didn’t even think they needed.
This will all have to be done whilst increasing productivity to reinvest into lower retail prices. The end result will be further investment at a time when margins are already declining and ultimately ‘doing more for less’.
The difficulty for the incumbent bricks-and-mortar retailers is that the digital disrupters have a different set of financial incentives; Amazon doesn’t actually need to make a profit from its grocery business. The key growth metric for Amazon is to increase spend per person across Amazon’s vast suite of products and services – in other words getting consumers dependent upon the Amazon ecosystem, which in turn will make Amazon an even more attractive advertising platform for suppliers. It does suggest world domination with Amazon owning the customer as well as the suppliers, taking a slice of all revenue streams and doing so with no real desire for making a profit in the near-term. Scary.
What’s the opportunity for producers?
To avoid being caught in the intensifying retailer competition and inevitable focus on price, producers need to intimately understand their retail and end consumer, reduce costs through improving efficiencies, innovate and think differently.
For producers it’s important to do the basics well. There will be a greater need to ensure consistency in product quality, and this will be exacerbated by the increasing growth of the majors and need for greater volumes to meet demand. In addition, retailers’ growth will become increasingly dependent on the capabilities of their suppliers, with the more capable suppliers becoming increasingly more influential and gaining a louder voice.
In regard to technical expertise, specialist knowledge of fresh foods will become a core competency for success
(understanding seasonality, varieties, cool-chain management, ripening technology, handling and merchandising displays etc).
Retailers are increasingly directly employing sector specialists and industry experts to complement their internal buying teams and improve decision-making, including technologists, agronomists and supply chain experts, so it’s important for producers to be equally well resourced with technical skillsets or risk losing business.
There’s also an opportunity in Australia, compared to say Europe or the UK where the value of provenance is already well understood, for technical improvement around food safety and quality assurance, and engaging with retailers on a technical level to tackle some of the tougher challenges, such as environmental degradation through declining soil health, water usage, and on improving consistency in product quality. The challenges around farm labour and use of hire companies are also a critical part.
In order to achieve a differentiated customer offering, retailers will focus upon Intellectual Property and exclusivity. Suppliers that can secure IP and exclusive access to better tasting varieties, and access to varieties with, for example, high
‘functionality’, such as longer shelf-life and higher vitamin content will in turn secure their future. As has happened internationally, retailers will look to make customer-centric claims and communicate their unique initiatives around provenance, sustainability, business ethics, organic and non-GM.
Retailers are likely to embrace closed-system production that takes advantage of new technologies to ensure year-round security of supply quantity and quality, such as greenhouses using LED lighting and elevated carbon dioxide to increase yields to lower long-term production cost. Similarly, high density orchards that are designed for mechanical or robotic harvesting will improve product uniformity with more fruit falling within supermarket specifications and reduce the dependency on seasonal labour. These innovations are capital intensive with long pay-back periods and are likely to drive further industry consolidation and corporatisation of farming.
The retail market in Australia is undergoing more change that it has in the last 40 years, and as the retailers are raising the bar for their consumers, so must growers and suppliers. It is important to challenge existing business models, look
to innovate, and most importantly, ensure the right skillsets are in the business at the right time. Now is the time to take advantage of the changing retail landscape, as ultimately
‘change’ can also mean opportunity – and those that make the move first will be the ones to reap the benefits!
Sources: Morgan Stanley Research, UBS, Kantar, ABS, Roy Morgan, Euromonitor
Top banner: Billion Photos/Shutterstock.com
‘Price’ graphic: Modella/Shutterstock.com
About the author:
Tristan Kitchener is grocery retail sector specialist and principal of management consultancy Kitchener Partners. He can be reached at email@example.com, and you can see more at www.kitchenerpartners.com.au.