Dire fate of the independents
On 31 May 2016, The Australian Financial Review wrote about Aldi’s rapid expansion in Australia. Aldi is now the most profitable supermarket retailer in Australia, with EBIT at 6% against 4.6% reported by Coles, and 5.4 reported by Woolworths.
But, on top of being more profitable, Aldi also retains prices at a level 20-30% below Coles and Woolworths. Consequently, the AFR article predicts that Aldi will grow its national grocery market share from 7% to 10% by 2020. I don’t entirely agree with this prediction – you can find my market share forecast later in this article. AFR’s projection has failed to factor in the fate of the Independent supermarkets.
Clearly Aldi is outperforming the incumbent supermarket operators. To understand how such a performance gap is possible between seemingly similar shop formats, we need to consider just one factor: the strategic time horizon.
As public companies subject to the Board and shareholders, Coles and Woolworths are perpetually preoccupied with the current financial year. On the other hand, as a private company, Aldi has the freedom to pursue a long-term strategy religiously and avoid reacting to short-term market sentiments. We must acknowledge Aldi’s management for their foresight and planning – not many organisations, private or public, are run so well.
Another influential factor in Aldi’s ascension started back in the 1990s when Coles and Woolworths began to squeeze their suppliers mercilessly and expand home brands, which reduced the choices available on their shelves. In short, they progressively achieved Aldi’s product cost levels, yet retained high prices to satisfy the share market. However, this extra gross margin seems to have been wasted on excessively expensive projects, which created ongoing interest and operating expenses.
So, it was Coles and Woolworths that inadvertently created the perfect environment for Aldi to thrive – they reduced their merchandise offer to more or less match Aldi’s, but concurrently failed to reduce their cost base, forcing them to retain high prices. The rest is history – Aldi can sell their goods for much less and still make more money than Coles and Woolworths.
Regarding Independent supermarket operators, they face additional problems. As a collection of separately owned businesses, they are forced to rely on a shared supply chain over which they have no control (Metcash). Such a business model leaves them with little chance of successfully competing against the corporate behemoths.
What does this mean for the supermarket segment over the next few years? The conclusions are obvious:
- The structural problems at Coles and Woolworths are unfixable. They cannot ‘unspend’ the money wasted buying excessively expensive computer systems or over-refurbishing stores.
- Aldi will continue to win business at the expense of Coles, and Woolworths, making them less profitable. The duopoly will not be able to shrink their fixed cost basis at the same rate as their receding market share.
- Coles and Woolworths will need to reduce their prices, although they will never be able to match Aldi’s price levels.
- The Aldi-Coles-Woolworths dynamic will, in turn, increase the pressure on independent supermarkets i.e. Metcash (see our earlier article http://retaildirections.com/blog/independent-supermarkets-face-extinction/ with predictions of what will happen in this space).
- In defending their gross margins, Coles and Woolworths will try to do more of the same: they will apply increasing pressure on suppliers forcing some of them out of business. There simply isn’t any blood left in the stones.
- Costco’s expansion will add to the pain.
As a consequence, I expect that by 2020 the mix in the Australian supermarkets segment will be as follows: Coles + Woolworths 60%, Aldi 14%, Costco 6%, Independents 4%, online and specialty supermarkets 16%. Note that I expect Aldi to take a larger market share than predicted by AFR.
It is a sorry tale for Coles and Woolworths, but a catastrophic prediction for the Independents. Unfortunately, the strong, structure-driven trends are unlikely to change. This is not a mere market fluctuation that could self-correct itself in time.